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

All right. Good morning, everyone. Welcome to day 2 of our 24th Global Financials Conference. I'm Ben Budish, I cover the U.S. brokers, asset managers and exchanges. And with us from KKR, we have Chris Sheldon, who's Co-Head of Credit and Capital Markets. Chris, thanks so much for being here.

Yes. No, thanks for having me.

I think you have some slides to run.

Yes. What I thought I would do, just to sort of set the stage a little bit, give a brief overview of just our credit markets business. Maybe talk a little bit about what we're seeing and some of the reflections over the last 12 months on some of the themes we're seeing across the business. Then they'll pivot a little bit into the markets in terms of tailwinds for credit and why we think those are going to persist even in some of the volatility and then a little bit on how we're tackling it, and then we can go and you can pepper newly some questions, and we can move from there. I did hear last year, there was a fire alarm during this session. So it was our competitor. So hopefully, it doesn't -- that competitor doesn't get back at us. But -- if I just do a quick snapshot of us today, we're $300 billion across our credit business, 250 professionals, global. You can see 12 cities, 10 countries. We think about the business in sort of 3 areas. One, our leverage credit business, which is everything liquid traded both corporate and ABS. We run a number of different strategies there. That's about $143 billion the private credit, which is the center, similar sized. But think bias 2 different businesses. Our corporate private credit business. So I think direct lending junior debt and then our asset-based finance business, which may be surprising to some of you, our asset-based finance business, which in the press doesn't get as much as the direct lending business is actually larger at $91 billion versus the close to $50 billion in our corporate private credit business. And then we have $11 billion in our strategic investment group, which is really structured equity, hybrid capital solutions, something that will go in a little bit more detail, but is really, I think, will end up becoming a more permanent asset allocation is developing as an asset class. About 10-plus years ago, we combined our credit principal business with our capital markets business, primarily to be solutions providers for our borrowers and our clients, and it's really playing dividends, particularly around origination and supplying our clients with a lot of diversified cost. The last thing on the bottom is, as many of you know, we own an insurance company, Global Atlantic, an annuity business. We closed that transaction in early '21. and fully integrated within the credit business. So those team that investment office rolls into our credit markets platform. If you look at our capital, it's scaled meaningfully over since that period of acquiring the insurance business is up 50% since '21 and with management fees up 32%. And then even year-to-date, we're up double digit. So if I think about reflections on the last 12 months on our business, one, credit allocations are continuing to flow despite some of the noise in some of the press, we rather we read or hear about regarding private credit. We're still seeing that asset class see inflows. I think a lot of it, which I'll go into some of the tailwinds in terms of the attractiveness of risk reward and relative value. As a result, we're seeing our management fees continuing to grow, and we expect them to continue to grow. The other big thing, which I don't think a lot of people talk about is we're seeing a much more trend to diversified income and narrowing their LP or their GP exposures to one. You're still seeing some allocators allocate per asset class, but we're actually now much more seeing multi-asset class partnerships across public, private, corporate ABF senior subordinated. I think they're relying on us to do the relative value. I think they're going to people that have scale, breadth and actually can assess risk-adjusted return, particularly given the volatility and how quickly that reval can change across the credit spectrum. And then if you actually rewind 5 years ago, you actually couldn't -- it was very difficult for an allocated to get diversified income, right? I mean if you just pick the asset-based finance sector alone. That's not a new asset class, but really in a multi-asset type way. It is essentially newer to allocators because you need big teams, you need a resi team, a consumer team, a commercial team, a transportation team, a renewables team and to be able to do that [indiscernible] across the board if you wanted to give that exposure to hire multiple different managers to do that. We're also seeing, as I mentioned, this capital solutions growth and really be at the spoke capital solutions, both in the below investment grade and then last ball, in private IG. You're seeing much more bespoke financing to help companies grow. Some of that is off balance sheet. like in the private IG world where people are financing and using the technology, no different than real estate sale leaseback to more capital solutions, hybrid structured equity -- and a lot of times, they're looking for incremental help in the boardroom. And so a lot of that sourcing for us is coming from our PE channel. Credit has had a good run in terms of allocations and flow over the last handful of years. We think that the tailwinds are going to continue. And a big part of it is, one, rates are higher for longer. We're seeing it today just given where the tenure is. This is our forecast versus consensus. Maybe that consensus is creeping up over the last few days. However, if you think about in the low interest rate environment, private equity returns are here, treasuries are down here in a higher interest rate environment, those are compressed. As a result, credit is just naturally going to look much more attractive from a risk-adjusted basis. So we think that's going to continue to compound. And then there's also a ton of demand just for credit. And then we use the AI here on the top right. Just if you look at the CapEx from the hyperscalers over the next 5 years, it's $7.6 trillion forecasted. get financed through public markets, equity markets, but they're going to rely a big part on private IG as a result. There's still a lot of dry powder in private equity. And the last time I checked, they're not going to return that capital. So that will start turning on. We're starting to see that turn on. And then also credit allocations are evolving and becoming more permanent, as I sort of mentioned before, this multi-asset partnerships in multi-asset Capital is a big trend we're seeing and will continue. And so here is just sort of an example of a balanced portfolio across that. The other big driver is -- and our Head of macro and CIO as a balance, she talks about this a lot and there's been a big trend from capital-intensive businesses to capital light. And the capital-intensive businesses are trying to become more capital light because if you've been a public company, you've been capital light, you've been rewarded as you can see in the blue line. You've been capital intensive, you haven't been rewarded in the stock price in the purple line. And so you're seeing a big trend to accelerate growth and how do you accelerate growth is raise capital However, if you can do that off balance sheet, it's super attractive and it's been accretive. So if you think about what we're doing across our asset-based finance, we've done financing facilities for PayPal, Lenovo, Volvo Harley-Davidson and when -- immediately after doing those transactions, the stock price is up 5% to 10%. And so you're going to see this technology get rolled out. And it's still not sort of known by all. I mean there's still a lot of CFOs or CEOs that are looking at what their competitors are doing and say, "I want some of that. And so we're starting to see that origination really start playing through. and fueling the ABF business, our private IG business and our Capital Solutions businesses. which is illustrated what we've done in just private IG year-to-date, which is over $80 billion of transactions either originated or placed, which is up 104% versus all of last year, so for 6 months. And as you can see, it's not just data center from the lows it's not just data center. broad-based across all sectors. It's energy, health care, tech, consumer and really that technology of sort of the off balance sheet, giving equity treatment for these companies, not burdening their ratings is something that is sort of flowing through sort of the corporate world. where there's multiple conversations every day, new conversations every day happening and saying, wait, how does this work? How can I get access to this capital, which is exciting. So finally, and then before we go to sort of questions, how are we navigating the market. I think the key takeaways are, if you look at the supply and demand imbalance in sort of the traditional less in market. There's more capital than there is deal flow right now. Spreads are tight. We hear it a lot when we talk to investors, how are we navigating that. One, just keep that high quality and diversified. If you are running diversified portfolios at high single-digit income, which is what the yields are, it's hard not to make money. I think it's where you have bad portfolio construction or concentrated bets whether by issuers or sectors is where that sort of tails off, been focused on the contrary, that's where the supply and demand imbalances in your favor. And so those would be areas like this Capital Solutions, where there's just not enough capital for the needs in the financing. And then regions like Asia, where 80% of the financing is done by banks and they have a box and they're less flexible to be able to go after it. Origination is key. You got to make your own luck. And so we're big internally focused on how do we tweak origination, how we improve origination, are we covering responses the right way or covering corporates the right way or we're partnering with banks the right way. and constantly looking at that model because that's going to be the key, particularly in a market like this where M&A has been depressed. We're also trying to take advantage of this multi-asset class partnerships so that the teams to write down, break down barriers, have a collaborative approach across the firm, not just within credit markets. And I think that's where KKR in terms of one P&L is actually pretty and it is able to go mobilize pretty quickly. So that's sort of setting the stage of what we're seeing and what we're doing, and maybe I'll pass it on and you started off with some questions. you can.

Well, thanks for all that, Chris. So most of this is going to be served in the credit space. for KKR, I think your credit AUM is up about 35% since your '24 Investor Day. I think you said in the last quarter, you expect a record third-party credit fundraising year. So what makes you so confident in that growth. Talk about the main drivers, the LP types? Where you're seeing the most appetite? How do you think that evolves over the next few years?

Yes. I mean, some of it is the trend that I sort of mentioned where you're -- from a risk-reward standpoint, it's attractive given where yields are. I think the private credit has now become a permanent asset allocation in people's allocation. And I think as a result, it's worked. And I think what people don't talk enough about is in this environment, assuming you don't raise any new capital, the big shift that we've seen, particularly in -- as asset classes mature in credit, particularly within this private credit, is they no longer desire or take the income. They're allowing us to reinvest the income. And so if you just think about that, if you're earning high single digits or double-digit 10% type cash on cash and you're reinvesting that, you're just compounding and doubling every toner. And I don't think enough people are talking about that shift in the market. The vintage 1.0 of these direct lending funds were LPGP structures where you take Apple in, you invest it, you distribute out the income. Now there are evergreen structures where you're just compounding that out. So that's even before some of the market tailwinds that we're seeing. In addition, you're starting to, I think, private IG is in its infancy. Really, it's being fueled by insurance capital. I think pension capital will follow. There's no reason why the pension capital can't take 5% of their core fixed income strategies and put it into the liquid. It's the same essential risk just giving up the liquidity and you're getting paid 150 to 200 basis points incremental yield. So there's a ton of different trends, whether it be Asia, whether it be the [indiscernible], whether it be the compounding that we feel pretty confident that this growth continue.

Okay. You mentioned private IG. I guess 2 questions. How do you think about the size of that opportunity? You mentioned insurance is a big buyer, pensions or maybe starting to become a big buyer. And then the other question, maybe talk a bit about KKR's origination capabilities, something that you guys talked to a little bit, not as much as some of your competitors, but your platforms where you source assets and the like.

Yes. I mean it's a huge opportunity. If you think about the direct lending at $1.9 trillion and then we just put up the CapEx over the next 5 years, need is $7.6 trillion gives you a sense that's just one sector. Now some of that will get financed to the public markets. But even if you look at the investment-grade index and you say all those hyperscalers max out the max have the highest percentage that we think is prudent around 3% issuer in the index, you still have a gap of $6 trillion. So obviously, digital infrastructure is going to drive a lot of that. But you're also seeing this capital-light capital heavy, which is just much larger in terms of all the other sectors that are going to drive that growth there. So there's a huge opportunity there. I think it's how do you take advantage of it, how do you raise the capital associated with, as you sort of alluded that I mentioned, is that starting with insurance, but I think pension is going to follow quickly.

And on the origination side.

Yes, yes, on the origination side. Look, how we're tackling it is we -- or as I sort of imagine, we're tweaking on in terms of constant tweaking in terms of how we're making sure we're covering corporates, covering sponsors covering banks the right way. But we have a massive infrastructure franchise. We have a massive private equity franchise. It's teaching those investment professionals to understand what we're doing in insurance, what we're doing in private IG to be able to source transactions. Every time we have a -- we do a transaction, there's a sort of an education process that goes out to all the teams globally of sort of saying, okay, where is this repeatable in some of your contacts that you may have across your different industries. And so that's the one difference that I think we do have a little bit of different competitive advantages is that one P&L where people don't just wear a jersey on their back that says their asset class or their investment team. Really people at KKR think about I work for KKR first, then I'm within my group, whether it be credit markets and then with my group, whether it be assets.

Got it. We've talked about the hyperscaler opportunity a couple of times. So maybe just talk about AI a little bit. It's becoming a really kind of defining allocation theme, I think, across the sector. and KKR, I think you participated in a number of ways in for equity, Helix, now the credit franchise we're talking about. So maybe two questions there. First, I guess, how does KKR actually participate? Like what types of investments are you making equity debt? And how would you sort of say the platform is positioned for success? And then second, just given the demand, particularly for financing data centers, chips and AI-related initiatives, how do you think about the opportunity set and at the same time, the risks?

Yes. I mean, we touched a little bit on the opportunity set. It's there, and it's massive. And I think the key to all of this is having the right origination and having the right underwriting and under understanding the risk you're taking. And it's very easy to underwrite the offtake, the credit, whether it be one of the hyperscalers, it's private IG, it's an investment-grade offtake, you can do that credit underwriting. It's much harder to actually understand the asset, the location, the power associated, where is that coming and then structure around all those. And that's where I think you really need to bring all the expertise to the table. So you mentioned our infrastructure team, which knows the sector, know the assets, what's the repurpose of assets, if the lease isn't there. We bring our real estate team that understands on what is normal, what is market with regards to project finance and structuring these things and then you bring the credit professionals that are able to structure around this and the documents and understand the credit risk. And I think that's where you're starting to see some slippage in some of the risk to touch on the risks, where you essentially have some tourists in the market where they don't have all that skill set. They may not truly understand the structure of how a lease can be broken or they may not truly understand if the lease is broken, what's the value of that asset and where it sits or how the energy gets to that asset. And I think that's where bringing our infrastructure team in the Helix capital to be able to truly understand all of those dynamics are going to be super important. The other risk I just wanted to highlight is the capacity, the financing capacity risk. And I think we're spending a lot of time thinking about, okay, at $7.6 trillion like how is that going to work, right? I mean Yes, you can tap some of the public markets, but a lot of them are already taphole markets. They can tap the equity markets and you're starting to see hyperscaler trend widen. And so where is that capital coming from? And from a credit investor landscape, portfolio construction is just as important as credit picking. And so as a result, you're not going to all of a sudden get 40% exposure to the data center in your private portfolio. So that needs to be -- something needs to give in that realm where either new capital really needs to get formed to go after this. That CapEx, $7.6 trillion may be -- may come down a little bit or these companies need to grow into and produce free cash flow to offset some of that.

Interesting. Okay. Maybe another question on asset-backed finance more broadly. I guess, where would you say we are today in terms of institutional adoption? And how much of that addressable opportunity do you think is accessible for alternative asset managers?

Yes. It's still early innings. I mean, if you think about it reminds me of the direct lending market 5, 7 years ago. And there's still a lot of organizations that are still starting building out their private credit allocation. And it's worked, right? I mean I think despite some of the noise in Q1 around direct lending and the retail redemptions -- the actually performance, what we're seeing when we talk to clients is very strong, and it's actually working. You've had high income low volatility and relatively modest defaults throughout that cycle. So I think people are sort of sitting here and saying, okay, now building out my direct lending, what comes next is asset-based finance. And there's a lot of benefits to it, which is inflation protected, less correlation. And as you get this trend toward multi-asset and building more broad, diversified income, asset-based finance is still in the early early innings. And if you think about that just on the institutional side, if you think about on the wealth side, we really haven't seen real or any growth in terms of individual investors really participating in these structures. So that's -- that will naturally come, which I think is important. And I think the main difference, I think, in asset-based finance is barriers to entry are much higher. You need scale to be able to afford all these different asset types and these teams to be able to underwrite that risk. And so if it took 10 years to figure out who the large-scale providers are in corporate private credit or direct lending. I think it's already been decided who the scale players are in asset-based finance.

Got it. maybe spring Global antigen. How do they fit into the equation? I presume there are buyers of some of these assets that KKR originates. But maybe talk about how that all works internally. A big part of the thesis I remember some years ago when you guys were talking about this transaction was that tighter integration that facilitating the ability to kind of scale up your private IG business, so some color on that?

Yes. I mean it's fully integrated into KKR, into our credit and capital markets business. And I think about global Lennox, our annuity business is a true multiplier to what we're doing across the business. It provides alignment in terms of when we're -- alignment and scale when we're coming to certain transactions, particularly of some of these large transactions across private IG and asset-based finance. It's really enabling our capital markets business as some of these large transactions are. And I think that you'll see really huge, huge opportunity to take advantage of that aspect of our business is underwriting and distributing some of these transactions. So it's fully integrated now. We made that shift of about 1.5 years ago when we bought the remaining 37% of global in really for the purpose to turbo that integration and that alignment to be able to maximize that multiplier effect.

Maybe moving a little bit of a different direction. You also oversee capital markets at KKR. How would you describe the current capital markets backdrop? It does seem like KKR has been able to get a lot done lately, but can you talk specifically about the sponsor side of the business, which seems to be particularly challenging over the last few years.

Yes. I mean I'm glad you mentioned our private equity folks. They've done a phenomenal job. And I think they've -- they -- in terms of deployment and actually monetization in this environment, which is -- it is a challenging M&A environment, which is not surprising, right? I think it's -- you have a lot of uncertainty out there, a lot of geopolitical noise, inflation, still some tariff noise, in addition, we've been in this rolling recession where there's been in certain sectors that have been in recession and some that are getting out and some of that are going it back in. So it's been a challenging environment. if you're either an investor or a CEO in the C-suite of a company on to you make an acquisition and what are the different dynamics in play to get you confidence around that multiple. If you guys have learned to lesson in the GFC, where linear deployment, diversification, geographic exposures. I think that has enabled them to actually get a lot done because they're seeing monetizations of returning capital and then their operational improvement. Not everyone has all that playbook are learning some of those lessons that we learned in the GFC, where concentrated deployment in 2020 and 2021. And so they're sort of sitting here being like frozen a little bit. We're starting to see that unleash a little bit. and we're starting to see activity pick up. I think a little bit has helped to some of the rebound in certain sectors, whether it be software, where you've seen those multiples where we're actually seeing a potential new LBO of a software company, which is -- we'll see. But I think that is helpful. I think the nice thing about KKR is we're so diversified across our capital markets business. Even in this environment, we're still putting up relatively strong numbers year-over-year as a result that shows sort of the diversification of the platform. And then when it does open up, they'll relieve some -- hopefully some of the supply and demand in to.