KKR & Co. Inc. (KKR) Earnings Call Transcript & Summary

Good morning, everyone. I'm Mike Cyprys, Morgan Stanley's brokers and asset managers analyst. Before we get started, I've been asked to direct your attention to important disclosures, the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions about that, please reach out to your Morgan Stanley sales representative. So with that out of the way, welcome to our fireside chat with KKR. And we're joined today by Joe Bae, who is co-President and co-Chief Operating Officer at KKR. As all of you know, KKR is an alternative asset manager with over $200 billion of client assets under management across Public Markets and Private Markets. The company also has a sizable Capital Markets business along with a $11.5 billion balance sheet for principal investing. Joe, thanks for joining us today.

Thanks, Mike. It's a real pleasure to be with you.

Great. So I'm going to kick off the discussion, Joe, with some questions, and then we'll leave time at the end to see if there's any questions on the web portal. So Joe, let's start with the current environment. And curious to hear your perspective on what you're seeing through the lens of your portfolio companies across the globe, how the global economy is reopening here. And what sort of lessons can we learn from Asia that's further ahead? And if you could also maybe touch upon what you're most excited about here and maybe what you're most worried about.

Sure. Thanks for that question. So Mike, as you know, we have a very global business today, both across our private investing platforms and credit platforms. To kind of dimensionalize that for you, we have around 180 portfolio companies around the world and 21 regional offices around the world. So we are getting a lot of different insights into different markets, different industries. And it's very hard to generalize across COVID in this environment because every country is at a slightly different stage. But what I would say is we're getting a lot of interesting data, in particular, as you mentioned, out of Asia, where the reopening in Asia is obviously, probably 1 to 2 months ahead of what we're seeing in Europe and in the United States. And there are clearly some green shoots in terms of how China is reopening and how other parts of Asia, like Korea, were really closed, where they have very, very strong testing infrastructure, contact tracing infrastructure. So what I'd say is when you look across our global portfolio, there are certain sectors and asset classes and industries that have been meaningfully less impacted by COVID. At certain instances actually, have seen their growth accelerated. So our global infrastructure book is doing really, really great. Our investments in data and digital services, enterprise software have held really, really well during this period of time. Our consumer staples, investments in food, et cetera, have done very, very well. And then there are a subset of industries and portfolio companies around the world where we're seeing reopening and signs of life and recovery that are very promising. Some of those businesses are nonelective health care companies like dental, veterinary, certainly, light manufacturing in China. We've seen the manufacturing capacity in our portfolio companies come back to somewhere between 70% to 90% in most instances. We're seeing the auto industry start to reopen, which is helpful, and health care services generally. I think the areas where we're seeing still delayed recovery are areas like travel, hospitality, restaurants. But fortunately, we have very, very limited exposure as a firm today. To your question as to what's exciting and what's worrying. I would say nobody has a crystal ball in this environment. Nobody really can predict the shape of the recovery, how long it's going to last. But this is going to be a gradual recovery. It's not going to be a V-shaped, snap back to the real economy. And I think that's really the opportunity and the risk. The opportunity, I think, is really around deployment is being very targeted, having themes and conviction and knowing what you're looking for in a period of meaningful dislocation and uncertainty, and being able to capitalize on those opportunities and buy assets at attractive prices before the markets rebound. But that's also the risk and things you worry about, if there's a second wave of COVID, particularly in the United States. Each country is going to have a different dynamic again, in terms of how they actually try to contain COVID and the testing, contact tracing. And those are unpredictable near-term dynamics. So we are very much focused in terms of the medium- to long-term dynamics. The industries, we think, are really compelling. The tailwinds in certain sectors that we think will survive not only COVID but potentially come out stronger post-COVID. And I think the one universal truth that we have learned through our 45 years of investing history is that it's in these periods of volatility and coming out of this volatility, that sometimes you find the best investment opportunities. And I think that was clearly true in the global financial crisis in 2009, 2010. Coming out of that crisis, we deployed nearly $4 billion in 17 investments. And those investments generated really outsized returns relative to the markets, in a close to 35% IRRs versus the CI world on a comparable basis that generated 11% return over that time frame. So we think being able to lean into the dislocation and the uncertainty in a very targeted thematic way, is really critical.

Great. And recently, it seems that not a day goes by without reading about a new KKR investment in the headlines. I guess just given the macro backdrop here, can you talk about some of the themes that you're investing into? And the deals that we have seen announced in recent weeks, to what extent has COVID impacted any of those deal terms? And how is the broader deployment pipeline looking here?

Sure. As I mentioned, I think the deployment opportunity is really one of the most exciting things we've seen as part of COVID. Our investment pace since COVID has really been quite intentional. We have a global platform with a lot of local origination capabilities, and we are capitalized upon the unprecedented level of volatility and dislocation in the markets to really buy high-quality businesses at attractive prices. Again, no one can predict the very near-term or the short term. But as long-term investors, we're focused on those industries and businesses with really strong fundamentals that can weather the storm of COVID. So let me give you maybe some examples of where we're trying to deploy and how we've deployed capital. So since February 21, which is one of the starting points we looked at, our firm has been reactive and again, very intentional on how to deploy and where to deploy. We have invested or committed approximately $18 billion of capital since February 21 as a firm. $7 billion of that is in our global credit books, including trade to credit and $11 billion is in equity investments. And again, the activity level and the pace of investments is really driven by a couple of mega themes, if you will, that we are excited about, and we've been tracking well before COVID struck. I think one of the most important trends that we're excited about and has really accelerated through COVID is the digital transformation and the usage and consumption of data, both by consumers and by businesses and governments around the world. Examples of those themes are our recent commitment to Jio in India; Masmovil, which is one of the leading mobile players in Spain; a large European data center platform that we announced, Global Technical Realty. And in our real estate businesses around the world, our continued investment around industrial and logistics platforms that are benefiting from the e-commerce trend. I think the second major theme that we're really looking to invest and have committed a lot of capital to is really around infrastructure, very stable, very cash generative, defensive, noncyclical businesses. So in this low-yield environment, I think many investors, including institutional investors, are looking at higher yields and higher cash returns, and infrastructure is a perfect asset class for that. So yesterday, we announced a further investment to our Telxius platform in Europe, which is a large towers business, and we're buying the German towers business out of Telefonica, Germany. Then in the waste management space, we announced in March an acquisition of Viridor, which is the second largest waste processing and recycling company in the U.K. In India, we've acquired renewable solar assets as well as transmission grids. These are all long term, highly contracted, highly stable and defensive assets. I think the third major bucket is really geographic. And for us, that is Asia, where I think we have a differentiated footprint in the region, 8 local offices, a lot of local origination. And again, Asia has been -- even in 2019 pre-COVID, Asia was our most active destination for capital at KKR. A lot of that had to do in 2019 with the global valuation environment. Asia was trading at a meaningful discount to the U.S. and Europe. And we pivoted capital, even starting at the beginning of 2019 into the Asia region. And with Asia opening up 2 to 3 months faster than the rest of the world, we're seeing the economic activity and the pipeline there also accelerating. I would say another thing that we've been investing behind is really the adoption of technology and this trend towards nesting. So examples of that would be our investment in OverDrive, which is one of the largest distributors of e-books as people are sitting at home. The add-on acquisition of Machine Zone through AppLovin, which is one of the leaders in mobile gaming; a technology platform and application, Slice, which basically empowers local pizzerias to enable online ordering and delivering; and o9 Solutions, which is a technology company, next-generation technology company really focused on supply chain for Fortune 1000 companies. So when you think about the complexity of global trade and sourcing, software solutions like this and technology solutions, we think, are going to become increasingly important. And I think there's the opportunistic bucket, right, that you would expect in COVID. Businesses and companies that have stretched balance sheets, maybe too much leverage or a need for liquidity, and you are able to provide a capital solution to these partners. So a good example of that would be our $500 million investment in U.S. Foods, a former portfolio company of ours, where we were able to provide and structure and convert to give them some liquidity extension. And most recently, the announced transaction in Wella and Coty to partner with them in terms of value creation, but also providing deleveraging and liquidity for that business.

Great. Well, thanks for all the color there. Maybe just on the China point, since that's been an area of focus for KKR for some time. Just curious in today's geopolitical climate, with some of the growing trade tensions, what's the -- how is the appetite for deploying capital in China evolving, particularly compared to the rest of Asia? And how are you managing around potential risk that these trade tensions could have some sort of impact on the ability to exit and monetize investments at some point?

Sure. I think that's a great question. Listen, at the highest level, I would say China is a very strategic destination for capital for KKR. We are committed to that market, and we are believers in the long-term growth of that economy and the potential of that marketplace. But with the escalation of trade tensions and geopolitical issues, it's clearly a more complicated area to invest in today than 5 years ago. And I would say our approach to China, where we've been very active, has really never been focused on full trade. And we're not looking to invest behind manufacturing companies in China that ship to the rest of the world or big industrial companies in China. The sweet spot for us over the last 14 years has really been partnering and targeting industries and companies that are focused on domestic consumption and services. So champions inside of China, homegrown champions in the areas of health care, education, consumer products, food safety, technology. And I think those industries are the ones that are going to see the best growth rates going forward as the standard of living continues to grow in China, and the middle class continues to expand in China, the trends around urbanization, the desire for better health care, better education, better food products. I think those are the key areas where we continue to see really interesting opportunities.

And shifting to the U.S., we've seen meaningful rebound in U.S. equity markets in recent weeks, and we're within a few percentage points now of all-time highs. So with the economic outlook uncertain here, it seems like equity markets are ignoring the sort of uncertainty here. So to add on top of that some of the civil unrest that we're seeing in parts of the U.S., is this sort of creating this pull -- and pull here for investing in the U.S., how do you think about that in terms of deploying private capital in the U.S. in this sort of a backdrop?

Yes. Listen, I think institutionally at KKR, we've been more cautious on U.S. deployment, as I mentioned previously even in 2019, well before COVID impacted the United States. And a big part of that, even in 2019, is where valuations were in the U.S. equity markets. And as you mentioned, despite COVID and the social unrest, we're basically back at those levels today, where the economic picture is much worse today clearly than it was in 2019. So I think you need to be extremely cautious. We're trying to be very cautious in the United States. And again, leaning to those themes where we have real conviction, and we think are kind of all-weather themes with a lot of long-term tailwinds back at weather of it. If you could find those opportunities, I think that's where you're going to see us deploy. And as I touched on earlier, we are seeing clearly better-adjusted returns in Asia than we are in the U.S. today. If you look at the public stock market since 2018, so briefly in the last 2.5 years, the S&P 500 is up 27%. And you compare that with the MSCI Asia Pacific Index, which is down 1%, and the MSCI Asia Pacific Index, ex-Japan, is down 3%. And that's something we were leaning to in 2009, certainly here in 2019 and certainly into 2020 in terms of relative value and opportunities to deploy capital.

Maybe shifting over to the fundraising side. You guys have an active fundraising pipeline, 3 flagship funds in addition to 20 other strategies that are set to launch over the next couple of years, which you've suggested should be able to grow management fees by 50%. But on your most recent conference call, you suggested it may take a couple of extra quarters now as a result of COVID. So can you talk about how the current market backdrop has created more demand or pull forward fundraising for any of these funds? And where you might see room for additional strategies to address some of the new emerging opportunities?

Sure. Absolutely. I think, overall, we remain pretty optimistic on the go-forward relative to fundraising. The destination that we articulated in the last earnings call remains the same, roughly 50% of the management fees over time as we get through this fundraising cycle. And with just the uncertainty in the market, it could take us a few extra quarters to get to that number, but we still think the destination is absolutely on target for us. We have our 3 large flagship fundraises penned in the marketplace in the short to medium term, which should meaningfully help us get to those types of growth rates. We're also seeing, obviously, the ability to raise and create capital even in the midst of COVID. I think my partner, Scott, mentioned on the first quarter earnings call that even during a market volatility in March and April, we were able to raise over $10 billion of new capital. 2 weeks ago, to your question about new strategies, we raised $4 billion related to our dislocation investment strategy through COVID. I think this is a really good example of a quick, efficient fundraise. We had over 20 new institutional investors participate in that and over 40 new investors to the KKR credit platform. So in a market like this, where there is uncertainty, I think you're going to see a continued flight to brand names, the flight to quality. And I think that should help the larger wealth managers in the space. And beyond just the dislocation strategy, I would say our real focus here is to look to scale our younger businesses. You had mentioned the 20 other strategies that we've been incubating at KKR over the last decade. I think that's really the opportunity to continue to raise Fund II, Fund III and Fund IV and get those newer businesses to meaningful scale. And the last thing on fundraising again is, I'll pivot back to Asia, where this is a really important time for our broader Asia franchise. We're not only raising money for our flagship Asia private equity business, but we also have important fundraises going on for non-PE strategies in Asia, including our first time Asia infrastructure and real estate strategies, as well as Private Credit, which is just down the corner.

Great. And there have been some headlines in the U.S. out of Department of Labor in the recent weeks with a letter clarifying how under existing rules, certain retirement plan sponsors and 401(k) plans can put money into private investments. So curious what you see here as the opportunity set and the time frame around that?

Listen, Mike, I think over the long term, this is going to be a huge positive for us and for the alternatives industry. The 401(k) complex has roughly $6 trillion of assets currently invested in these plans, which have historically not been able to access investments in private equity or in the alts. And we think this is a really exciting long-term opportunity for individual savers. And again, I think in this market, brand, length of track record, will all be key advantages over time to attracting capital. But I just want to be clear that we think this is a long-term opportunity. I think it's going to take time. And I think expectations need to be measured here in terms of how quickly this market opens up. A lot of the rules, the regulations and the requirements for this to happen are still being put in place by regulators and policymakers. So again, I think long term, really, really interesting, but I wouldn't get too excited in the very short-term of that capital flows.

Okay. And Joe, you mentioned the infrastructure fund. I was hoping you could dive in a little bit more there. This is the flagship KKR's fourth global infrastructure fund that you're going to be raising. Can you talk about how you see the opportunity set here for infrastructure evolving? You touched on it a little bit earlier. Maybe you could flesh it out a little bit more. And then also overlay your thinking around any sort of expectations around potential infrastructure spend in the U.S. and to what extent that can play in? Or to what extent is that a driver? Or is that even necessary?

Sure. I mean, infrastructure, I think, is one of the most attractive opportunities we see out there today. And it's really the confluence of, I think, 3 really big trends in the world. I think, first, we are in this unprecedented environment of 0 to negative interest rate pretty much around the world. And as investors, both individual and institutional investors look to yield, the fix of the markets are just not as attractive today with the current interest rate environment, what central banks are doing. So there's a real hunger both from investors, individual, institutional for better yielding, better returning but also very safe investments. And I think infrastructure really plays right up that power alley. I think the second mega trend that really plays into is the point I made earlier thematically around data consumption. So when you think about infrastructure investments in data and telecoms areas, the data centers, towers, undersea cable, fiber to the home, these are all areas that we've been leaning in quite aggressively in the last 5 years. So these are safe infrastructure assets that are already getting the benefit of this really large tailwind around data consumption and the explosion of the digital economy. And I think the third point really, is the one you've raised, really about government spending and some of the limitation, not just here in the U.S., but I think with governments around the world. There's massive fiscal spending to navigate the COVID crisis. Every local state and federal government here in the U.S. is strapped in terms of budget and capital. And I think that creates an opportunity for private providers of infrastructure capital to create public-private partnerships, whether that's in water, whether that's in utilities, renewables and energy, where private capital is going to play a very important part of filling that void.

Great. And it's been almost 2 years now since your conversion to a C-corporation. Can you talk about how the investor response has been relative to your expectations? And what would you say is the next milestone you'd like for KKR to achieve as a corporation?

Sure. Our conversion to a C-corp, obviously, is something we were very -- perfectly planning and executed. And I would say, across all major metrics, I think what's happened is it's exceeded our expectations in terms of results. I think one way to look at that is just in terms of price performance in our sector, but particularly in our name. While the Russell 2000 is off around 7% year-to-date and the S&P financials are down 13% year-to-date, our sector, KKR, Apollo, Blackstone, we're all trading higher today on a year-to-date basis, and KKR is up about 10% year-to-date. And I don't think you would have seen that type of performance had we stayed in our traditional PTP legal structure versus the C-corp structure. So at the highest level, as a PTP at the end of 2017, so 6 months ahead of our conversion, mutual funds and index funds were relatively small shareholders of KKR, roughly 150 million shares at that time we were in PTP format. As of 3/31 this year, that ownership from that group of mutual funds and index has doubled to 314 million shares. So it feels to us like the long-term orientation of our shareholder base has continued to evolve in a very positive way. And in terms of milestones, I would say, last Friday was an important one relative to the rough release on index inclusion. KKR, Carlyle and Apollo have been announced that they will be included in the Russell 1000 and 3000 indices. That rebalancing and reconstitution of the index actually won't happen until June 26. But we think that's a very logical and important step as we think about our shareholder base and attracting incremental long-term oriented shareholders.

Great. I'm just checking through the webcast here for some questions. We have some here on -- more on deployment, some here on realization. Maybe just on realizations, how does the sort of run-up in equity markets here impact your outlook for realization prospects off the balance sheet and also off from the funds?

Sure. Obviously, the rebound in equity markets, particularly here in the United States, is helpful in terms of the ability to access capital and pursue monetizations in our public positions, in particular. On our most recent earnings call, our CFO, Rob Lewin noted at the time, this was in early May, that we have pretty reasonable line of sight in terms of future carried interest and total realized investment income from transactions that have closed since the end of the first quarter and that have been signed and that are expected to close going forward. That number was in excess of $400 million in Q2 relative to $200 million, when you look back from our Q1 earlier this year. So again, with the S&P basically near an all-time high and where it was back in mid-December, we feel our path to liquidity, again, is going to be reasonably strong going forward. I think private sales may be a little more delayed versus public sales, but we feel good about the diversification of our portfolio, how global it is, and that's going to lead to opportunities to realize gains across a lot of different areas.

Okay. And then just looking at another question set coming in from the webcast here about the run-up in equity markets. How does that sort of impact or hurt the investment opportunity? Hearing how you're so bullish earlier in the conversation, particularly in Asia, it sounds like you're more pivoting, but maybe you could talk about if that's at all impacting that opportunity set. And also, if you could touch upon how your underwriting criteria has evolved as well. That was another deployment-related question here.

Yes. Listen, I would say while we have been active in deploying capital since late February when COVID really happened here in the States, I think we feel very, very fortunate that we were able to lean into that opportunity prior to this massive run-up in equity valuations today. And who knows where the equity markets will be 2 to 3 months from now. So that's hard to predict. But I think we're pleased with our activity level, our ability to lean in when the market was dislocated and valuations were meaningfully lower than where they are today. As I mentioned earlier in this conversation, I think we are more cautious, just given where the U.S. market has rebounded to and we're seeing better opportunities on a risk-adjusted and valuation basis, probably outside of the U.S. and today. The pipeline in Asia is very, very strong. The pipeline in Europe, we've got a couple of things that we think are pretty attractive in that pipeline as well. In the U.S., we're being quite disciplined, again, around the sectors where we think there are meaningful, long-term tailwinds and demand drivers, and where we, as private equity investors, can look beyond the near short-term impact of COVID to a more normalized economy, 2, 3, 4, 5 years down the road, and happy to buy those assets at the prices that we're paying today. In terms of returns, I would say there are a couple of things. Some deals we need to finance differently, that the leverage markets are not at the same levels as to where the equity markets have rebounded to. So from a risk standpoint, if you can't have as much access to debt capital, by definition, I think you are thinking about less leveraged capital structure and thinking about pricing deals differently. There will be normalization, obviously down the road of the debt markets as well, which will allow for dividend recaps and recapitalizing companies. But I would say deals today are probably getting structured in a more conservative way in terms of the balance sheet. There is obviously a tremendous focus on liquidity on any new deal, so making sure you have a resilient capital structure that could ride through a very extended recovery process in the economy. And the risk-adjusted returns, I would say, some of that you get through structure. So some of the convertible preferreds that we've invested in probably don't have as high an equity upside potential as straight buyout divesting, but they have meaningfully more downside protection in terms of their position in the capital structure as preferred the cash coupon you're getting. So it's a balance. But we think that the deals we've done and the capital we've deployed over the last 3 or 4 months have been put to work in a very prudent way.

Great. Well, this has been awesome. Thanks so much. I'm afraid we're going to have to leave it there. Joe, thank you very much for joining us today. And everyone, please join us for our next session starting shortly at 10:15 a.m.

Thanks, Mike.

Thanks Joe. Take care.