Photographer: Spencer Platt/Getty Images

KKR Finds an Activist at Its Gate as ValueAct Reveals Stake

  • ValueAct owns almost 5 percent of KKR via derivatives: Morfit
  • KKR reported first-quarter profit, topping estimates Thursday

KKR & Co., the original Barbarian at the Gate, now has an activist knocking on its own front door.

ValueAct Capital Management has amassed a stake in the buyout giant in an investment that puts KKR co-founders Henry Kravis and George Roberts in an unfamiliar position: Under an investor’s spotlight rather than holding the torch themselves.

But while KKR built its name on a series of not-always-friendly deals in the 1980s, the relationship with Jeffrey Ubben’s hedge fund seems amicable.

ValueAct has held friendly talks with the investing firm, including discussing the possibility of converting KKR from a partnership to a corporation, according to a person familiar with the discussions. The switch may be beneficial under potential changes to the U.S. tax code proposed by President Donald Trump, said the person, who asked not to be identified because the talks were private.

KKR welcomes ValueAct’s investment, Scott Nuttall, KKR’s head of global capital and asset management, said Thursday on the firm’s first-quarter earnings call.

“We have had interactions with them and they’ve been great,” Nuttall said. “We like having smart, long-term investors as shareholders.”

Gadfly: Here’s hoping ValueAct has some more ideas for KKR

$750 Million Stake

Ubben’s firm owns almost 5 percent of KKR through derivatives -- a stake valued at about $750 million -- the fund’s President Mason Morfit said on stage at 13D Monitor’s Active-Passive Investor Summit in New York Thursday. That would make it the second-largest outside shareholder, according to data compiled by Bloomberg.

It’s also the first time in the U.S. that an activist has invested in a publicly traded private equity firm, the data show.

Speaking minutes before KKR began its first-quarter earnings call, Morfit drew parallels between ValueAct and its new investment target.

“If there’s any business that we ought to know something about, it’s the asset management business, given that we’re in it,” Morfit said.

KKR’s values “are exactly the type” that Ubben imbued in ValueAct when it was founded, Morfit said, citing as examples a team-first approach, long-serving employees and sharing profits across the firm.

Bright Future

KKR could be worth as much as $37 a share once investors fairly assess its assets raised, as well as its recurring management fees and “tremendous operating leverage,” Morfit said. That would surpass KKR’s all-time high share price of about $26, reached in January 2014, and value the company at almost $30 billion.

“I think the future is quite bright” for KKR and some of its big investing peers, he said.

KKR earlier reported first-quarter profit that topped all analyst estimates as payment processor First Data Corp. and other holdings drove gains. Economic net income, which reflects both unrealized and realized moves in investments, was $549.9 million, or 65 cents a share, compared with a loss of $553 million a year earlier, the New York-based firm said in a statement.

Shares rose as much as 7.4 percent Thursday to $18.82, the most in 14 months, valuing KKR at about $15.1 billion.

LBO Playbook

KKR, founded in 1976 by Bear Stearns & Co. alumni Jerome Kohlberg, Kravis and Roberts, was formed on the basis of taking controlling equity stakes in companies and driving change. The firm helped establish the leveraged buyout playbook: Borrowing money to buy underperforming companies then selling for a profit after several years of cost cutting and operational improvements.

Their most famous corporate buyout -- the contentious 1988 battle for RJR Nabisco Inc. for about $31 billion -- was chronicled by Bryan Burrough and John Helyar in “Barbarians at the Gate.”

While several hedge funds own passive stakes in private equity funds, an activist buying up a large public stake is unique. As publicly traded partnerships, firms like KKR, Blackstone Group LP and Apollo Global Management LLC offer public unitholders limited voting rights. In the case of KKR, public stockholders cannot elect or remove board members and Kravis and Roberts, who control the majority of the firm, also control the majority of votes on all business matters. 

That means ValueAct is buying into a business it has little room to influence -- except through collaborative talks.

“If our common unitholders are dissatisfied with the performance of our managing partner, they have no ability to remove our managing partner, with or without cause,” KKR wrote in its 2016 annual report.

‘Human Capital’

Morfit likened ValueAct’s investment in KKR to others it has made in professional services companies, including Morgan Stanley, Willis Towers Watson Plc, and CBRE Group Inc. He described them as “ideal human capital businesses.”

ValueAct disclosed in August a stake in U.S. investment bank Morgan Stanley, attracted by its shift to asset-light, fee-based businesses such as wealth and investment management and advisory services. It sold part of that stake during the fourth quarter as bank stocks rallied after Trump’s election victory.

KKR differs from many other publicly traded partnerships such as Blackstone given the size of its balance sheet and how it’s utilized. The firm uses the $14.3 billion stash to reinvest earnings in and alongside its funds, seed new strategies, and fund strategic deals. It has also switched to a fixed dividend policy, now paying out 17 cents a share each quarter and holding onto the rest of its earnings.

San Francisco-based ValueAct, which manages more than $16 billion, has ongoing activist investments that include Microsoft Corp., Twenty-First Century Fox Inc., CBRE and Rolls-Royce Holdings Plc. 

The firm, which typically works behind the scenes, favoring good companies with recurring revenues, has influenced the direction of public companies including Gardner Denver Holdings Inc., Reuters Group Plc, Adobe Systems Inc. and Sara Lee Corp.

Tax Proposal

Even without becoming a corporation, KKR could still stand to benefit from the Trump administration’s tax proposals.

Under preliminary plans announced Wednesday, the top corporate tax rate would drop to 15 percent from 35 percent. In an unanticipated twist, that rate would include limited partnerships and other so-called pass-through businesses, which don’t pay tax at the corporate level but whose owners are taxed on their share of income. Many private equity firms, including KKR, have pass-through structures.

Despite that, the Trump plan doesn’t specify whether the 15 percent rate would apply to all income earned by investment partnerships and their partners, Gary Friedman, a tax lawyer at Debevoise & Plimpton LLP, said in a phone interview Wednesday. The White House may seek to reclassify investment-firm partners’ business income so they’d pay a higher rate, Friedman said.

Aside from potential tax benefits, converting from a partnership to a corporation is viewed by many as a way to boost share prices, because it makes bigger stocks eligible to become members of indexes. That allows institutional investors to add them to passive portfolio allocations that use indexes. It also simplifies public investors’ lives by letting them calculate taxes on dividends using normal 1099s rather than a special tax statement called a K-1.

Some of the income of KKR Management Holdings, a entity that houses KKR’s fund management and capital markets subsidiaries, is already taxed at the corporate rate, according to company filings.

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