Commentary: KKR: Barbarians At Your Gate

The private equity giant opens itself up to the public. Why that may be a red flag

Investors looking to buy into private equity giant Kohlberg Kravis Roberts & Co. used to have to flash $25 million at the door. Now it costs about $25. On May 3, the storied buyout shop listed KKR Private Equity Investors LP, a $5 billion fund, on the Euronext exchange in Amsterdam. It wasn't private equity's first foray into a public exchange. Last March, New York-based Ripplewood listed its holding company RHJ International, in Brussels. And KKR itself offered KKR Financial (KFN ), a real estate investment trust, last year, to name a few. But never before has a firm of KKR's stature opened itself to small investors betting directly on its legendary buyout prowess.

Just don't place grandma's buy order yet. Whether this initial public offering will deliver private equity riches to the little folks remains to be seen. What's certain is that it's one sweet deal for KKR.

Private equity firms buy struggling companies, fix them up, and sell them off, generating huge returns for their stakeholders. They do it away from public scrutiny. As private entities, they needn't bother with irksome tasks such as complying with Sarbanes-Oxley or kowtowing to analysts. But just as a shark never stops swimming, buyout firms never tire of raising money to finance more deals. The boom in private equity funding in recent years has raised the stakes for everyone. Institutions and wealthy individual investors dumped a record $134 billion into private equity coffers last year -- more than twice 2004's take.

Demand for shares of the KKR fund is sure to be high given the firm's history of success. Its $6 billion Millennium Fund, for example, has returned an astounding 55% a year, compounded and net of fees, since its 2000 launch.

And by listing in Amsterdam, KKR stays insulated from SarbOx and other U.S. rules. In this novel deal, it'll use what one observer calls "dumber money" -- from public investors -- to finance deals from which private partners could reap windfalls, without divulging too many things they want kept private. "Tapping the public markets gets you the money up front," says Joel L. Rubinstein, an attorney with Manhattan-based McDermott Will & Emery who focuses on public-private equity convergence.

The windfall makes KKR less reliant on other partners to take down big kill -- such as when it linked with six other shops in the $11.3 billion buyout of SunGard Data Systems Inc. last year. KKR has a history of big deals: Its 1989 LBO of RJR Nabisco for $31 billion, documented in the book Barbarians at the Gate, stands as the largest ever.

Now the barbarians are strolling down Main Street. Says a private equity manager: "They're thinking, 'There's so much demand for what we do that we should get the money at the most advantageous terms."' But what about those who invest in the KKR fund? The source says it's a one-sided deal and investors shouldn't expect to get the golden treatment KKR lavishes on its traditional investors. The biggest difference: The fund won't track the larger firm completely. At least 75% of the proceeds will be earmarked to private equity investments, the prospectus says.

But the firm is devoting the remaining 25% or so to "opportunistic" investments, such as public debt and equity. Investors, in other words, won't be getting $1 of private equity buying power for every $1 invested. If the shares perform well, that won't matter. But the firm concedes in its prospectus that it doesn't expect its torrid performance of recent years to continue. A KKR spokesman declined to comment.

Fees, which KKR has never been shy about levying, are a whole other matter. Retail investors in the new fund will likely pay more than big institutions working directly with KKR, says the private equity manager. It hasn't disclosed its full fee schedule, another advantage of listing in Amsterdam.

The track record of other public-private "business development companies" is not inspiring. RHJ International has gained only 2% since its debut; KKR Financial has lost 8% since its IPO. Already, investors haven't fared well in KKR Private Equity Investors, which shed about 2% on its first day of trading -- not that that prevented KKR from collecting $5 billion. With traditional funding sources getting tapped out, more firms will be looking to the public markets for money. It's a familiar story: When individual investors get in on a trend, its days are numbered. Don't blame KKR, though. It gets paid to be opportunistic.

By Roben Farzad

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