Kkr Plays A Slower Game
Last October, Ronald E. Compton, the chairman of Aetna Life & Casualty Co., sat down for dinner at New York's Plaza Hotel with Henry Kravis and George R. Roberts, who run Kohlberg Kravis Roberts & Co. Compton wanted to sell the Hartford insurance giant's American Re-Insurance Co. to KKR, a deal the two companies' staff had been discussing for four months. During the dinner, both sides agreed to go forward. But it took eight months before the two sides announced the $1.2 billion deal this June.
For KKR, a year is an eternity. It took the firm just a few months to wrap up such 1980s megadeals as Duracell Inc. and RJR Nabisco Inc., the sort of consumer-products companies KKR specialized in acquiring. And in contrast to the busy pace of a decade ago, AmRe was KKR's first major buyout in two years. "We have to dig deeper to find the opportunities," says Kravis. "It's not as easy today as it was in the '80s. We have to be a little more creative."
So KKR is doing a lot more digging--and coming up with a lot less. With the days of easy credit and a plethora of woefully underleveraged targets long gone, KKR is changing its strategy. Although it hasn't abandoned leverage, it is using far less debt and focusing on out-of-favor industries such as financial services, publishing, cable television, radio, and resort properties. For many of its deals, KKR is using a technique it calls a "leveraged buildup." KKR has recruited an entrepreneurial manager for each of several industries. With KKR's financial backing, these managers seek to create a large company by acquiring a number of small ones. The industries KKR has selected tend to be fragmented, where there are many good properties not yet owned by giants. "The old LBO formula doesn't exist. So they had to do something very different," says William F. Reilly, the CEO of K-III Communications Corp., KKR's partner in the publishing industry. Joseph Rice, president of Clayton Dubilier & Rice, a New York buyout firm, puts it more directly: "They are trying to compensate for their inability to come up with critical mass in a single stroke."
`STILL IN BUSINESS.' While these strategies have strong merits, KKR may have to settle for being less visible, less profitable, and less popular with investors than it was in the 1980s. In contrast to LBOs, buildups may take years and may yield lower profits. Kravis and Roberts, though, believe buildups hold the same potential for controlling assets as LBOs. "We've got the experience, the capital, and the credentials. We've come through some pretty tough times and we'll compare our record to anybody's," saysRoberts.
It's hard to fault KKR's 1980s profit record. By its own reckoning, the annual compound rates of return to its investors after KKR's 4%-to-5% cut were 34.3% for the 1984 fund, 28.1% for the 1986 fund, and 24.1% for the 1987 fund, which were hurt by the bankruptcy of Seaman Furniture Co. and Walter Industries Inc.
KKR spent most of last year unwinding deals. It took six of its companies public, including RJR Nabisco and Duracell. Timing the equity market perfectly, KKR raised $6 billion in new equity last year, some 10% of 1991's equity offerings. The result is a portfolio of companies with far healthier balance sheets. The de-leveraging also reduced KKR's position in its companies. But the firm is still a large or controlling shareholder in some $45 billion worth of companies. It currently has some $2.8 billion to spend, including $1.8 billion it just raised for a new fund.
KKR admits, though, that it will not be able to match 1980s returns. So far, its new strategies have had mixed results.
Financial services have been the firm's most extensive foray, with a move into banking a big success. A year ago, before bank stocks had turned around, KKR teamed up with Fleet/Norstar Financial Group Inc. to buy the failed Bank of New England from the Federal Deposit Insurance Corp. Its paper profit after a year is about $255 million on a $283 million investment. Fleet CEO Terrence Murray says that Fleet may make a new ac-quisition by the thirdor fourth quarter. "There's no reason why we would not do another deal," with KKR, he says.
Insurance, while it may be more hazardous, appeals to KKR because it is so arcane, thanks to cryptic financial statements and layers of regulation. It is also at a cyclical low. Buying on the cheap now could mean big profits if premium income picks up. Leverage could magnify those returns.
The problem is that clients and regulators may be uneasy about KKR's use of leverage. AmRe is the largest LBO the industry has ever seen. It has an especially jittery client base--other insurance companies, who use reinsurers to lay off much of their risk. To insurers, creditworthiness is crucial. They need to believe AmRe will be around during the 30 years or so that reinsurance contracts encompass. "People are much more comfortable with insurance companies that don't have an LBO structure," says William Cavanagh, a Standard & Poor's Corp. analyst.
HOME RUN. KKR has structured the deal to assuage companies that deal with AmRe. The key element is Aetna's agreement to put up as much as $500 million to cover AmRe losses on coverage written before Jan. 1, 1992.
But that hasn't pacified ratings agencies. S&P has placed AmRe's AA+ rating on credit watch on the grounds that earnings that would have been retained to build up AmRe's capital structure will now be used to service debt. AmRe, which has had no debt, will now have a debt-to-equity ratio of 2.7 to 1. "That may be low for an LBO, but that's not low for an insurance company. And that's not low for an investment grade rating," says S&P's Cavanagh. KKR partner Saul Fox says that AmRe has already met with its major customers, and "after we explained it, they feltcomfortable."
With LBOs so few and far between, KKR is betting on its buildup strategy. So far, results have been unremarkable. The firm seems to have hit a home run in publishing. In just 30 months, K-III made 13 acquisitions, including eight consumer magazines--among them New York and Seventeen--from Rupert Murdoch for $650 million. Starting with a staff of three, it now employs 3,000 and has $800 million in sales with plans to grow to $2 billion. Largely through cost savings, CEO Reilly boosted earnings 7% in 1991, an unusually hard year in the magazine business. KKR owns 87% of the company's $500 million in equity, with some 164 managers owning the rest.
Yet the opportunities offered in publishing were unusual. In cable television, KKR chose Alan Gerry, chairman of Cablevision Industries Corp., a major cable operator, as its partner. But as soon as KKR announced its intention to buy $1 billion in cable properties in June, 1991, other big investors jumped in with the same idea. So far, KKR has announced just one $132 million purchase, which is still pending.
In radio, KKR formed Granum Communications Co. in 1991 with a radio veteran, Herbert McCord, and so far has bought just four radio stations. Since then, regulatory changes have made competition for radio stations fierce.
KKR is still pushing ahead with ventures in other areas. In March, 1992, it signed on two former Vail Associates Inc. executives to buy resort properties, such as skiing and golf, and possibly hotels. The firm is looking for a partner in the oil and gas industry.
HIGH FEES. While buildups, being less leveraged, have less financial risk, they are tougher to manage than LBOs, says K-III's Reilly. Finding good managers is tough. "We couldn't have built the company without Macmillan's farm team," says Reilly, who has hired 50 managers from Macmillan Publishing Co.
And raising money is getting harder. Some of KKR's longtime investors chose not to invest in its most recent fund. At issue is the firm's high fees. They believe KKR gets too big a slice of the profits. "Other LBO funds are negotiating and changing. They threw it on the table and said, that's it," says Robert Zobel, investment director of the State of Wisconsin Investment Board and a KKR investor who passed on KKR's latest fund.
But even Zobel admits it's a mistake to underestimate KKR: "I think they are a very powerful firm. Their power is in their creativity." Making big returns during the slow-growth 1990s won't be easy. But with its demonstrated record of breaking new ground in dealmaking, KKR just may find a way.
By Leah Nathans Spiro in New York, with Geoffrey Smith in Boston