KKR & Co. (KKR) Founder Kravis on Private Equity, the Economy, and Job Creation

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KKR & Co. (NYSE: KKR) co-founder Henry Kravis recently spoke on Bloomberg TV, offering thoughts on everything from the current state of the economy to diversification outside of private equity.

What's Kravis thoughts on 2011 for KKR?

He is surprised at the amount of investments done in 2011 so far -- about 10 major ones through September. Investments ranged from Del Monte (NYSE: DLM) to Pfizer (NYSE: PFE).
KKR has been active in China and Europe as well, and currently has a lot in the pipeline.
Shale gas investments worked out because they were early.

Kravis on the current state of the financing market.

Says KKR's overall all-in cost-to-capital was 5.5 percent in the Del Monte transaction, about the lowest its ever been for a covenant-light levered transaction. Kravis notes the deal was done in March.
In July, for its $2.5 billion Capsugel deal, the all-in cost moved to 6.88 percent. The Del Monte deal was about 27 percent equity, compared with 40 percent for Capsugel, making the Capsugel a less-leveraged deal. Kravis said crunching the same numbers today would have yielding a cost-to-capital of 9 percent.
Tightening debt markets will lead to an increased cost-to-capital, but Kravis said in the interview, "in a Del Monte case what would have happened is multiples would have come down, which is what's happened to the market in the last two, three months. They're as low as they've been in many, many years and so you have to look at the whole package."

Why couldn't KKR buy a company like McGraw-Hill (NYSE: MHP) today? What are the private equity markets currently like?

Kravis said KKR would still buy something like McGraw-Hill because financing is available for larger, more established firms. He admits it might cost more, but the financing is there.

Kravis says rates are still low, but relatively high to what they were.

What's the outlook for private equity exiting deals?

Kravis says any [idiot] can buy a company, its what you do with it once its acquired that matters.

KKR made some mistakes in the 90s assuming management would turn right when they'd turn left following the acquisition of a business.

The firm now starts with a 100-day plan, which aims to align the interests of the company and KKR. Management has to understand that private equity is there to work them, they are a partner.

Kravis said there will always be deals out there. "As long as you're cautious, and you've done your homework and you're thoughtful about macro, the macro environment, and you have your financings flexible - if you've got your financing that's so tight and any one thing goes wrong you're going to have problems."

On possible exits for HCA, Neilsen, and others:

Deals go in cycles, and KKR has been approached by a number of companies.

Corporations also have a record amount of cash on the balance sheets, and Kravis comments, "a lot of companies are now approaching the private equity world and saying you have such and such a company. We'd like to buy it."

What are investors' hold-backs about a publicly-traded PE firm?

Kravis says his firm, like Blackrock (NYSE: BLK) and Apollo (Nasdaq: AINV), become a proxy for the market. They've got PE deals, sure, but are also active in other things like long/short equities, mezzanine business, and more.

Investors speculate the speediness of when KKR, et al, will be able to exit investments. Kravis admits it isn't as quick as before, but the speed will come back. Once that happens, you'll see valuations begin to go up again.

Kraivs also is irked at analysts, saying they focus too much on the next quarter. With a public company, there is no time to reorganize, develop, and focus on growth. You can do that in the private world.

On diversification outside the PE world:

Kravis likes to focus more on what they know to tie everything together.

He said, "If we don't understand credit, then we've got a real problem at KKR. So this was a natural for us from that mezzanine finance, again, a natural extension for what we do in the private equity world...our capital markets business focus is primarily on our own portfolio, but does third party business as well where it's in an area of the smaller to mid-size companies that banks aren't paying attention to today. They can't afford to cover all of these smaller companies so these companies can't get financing. So that's a natural for us."

On PE return expectations for investors:

Investors want returns, and only require the return be more than what was initially invested.

Kravis said KKR has never promised a set return, but focused more on giving back 500 to 600 basis points above the S&P 500, Dow Jones, or whatever index, because everything's relative.

Kravis comments, "There are the outliers. There are firms that are going to have 20%, 15% net returns. And the difference between gross and net the gross is before the profit participation of typically 20% carried interest and the fees and so forth. So you look at a net number and that's what we always look at."

On whether PE firms are becoming systemically important enough that the government should be paying more attention.

Kravis says the government is paying attention to what PE is doing. With the entire industry valued at $2.5 trillion, and thousands of firms out there, it's hard not too.

But state pension funds might have 200 different partners they've given money to, Kravis said. "They finally have awakened and said this doesn't make any sense. We're offsetting each other. And by the way we've been telling them for a long time you don't even know the names of the people at those firms for the most part….and you certainly don't know anything about the portfolio. Yet you're giving them money," he concluded.

Pension funds are holding on to the assumption of 6, 7, 8 percent or more in returns just to pay beneficiaries. Those are the kinds of returns the bond market and stock markets can't deliver on a constant basis. Kravis says PE firms have been able to beat the 8 percent level by far in the past.

Another area where institutional investors are wanting to put money is natural resources, like oil and nat gas. Kravis comments, "Why? One, they get a good solid return and, two, it's a hedge against inflation. They're owning the asset and that over time that just the supply/demand equation for the demand for energy is going to go up large part because of emerging markets. So that's why they're putting a fair amount of emphasis today on that."

What should the U.S. do to get companies hiring again?

Kravis said one of the more important factors is getting certainty, which is currently missing in the markets and economies.

He doesn't get raising taxes in order to get folks hiring and spending more. Kravis quips, "Specifically related to private equity [President Obama] wants to tax carried interest as regular income." He says America has a spending problem, not a revenue problem.

Check out the full, 30-minute interview below:

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