Quick viewing(Text Mode)

On the Upswing

On the Upswing

page 24 private international equity international july/august 2011

privately speaKing On the upswing One year on from fl oating its management company and 35 years after its founding, continues to aggressively expand and refi ne its franchise. In a rare in-depth interview, co-founder George Roberts discusses both the fi rm’s and private equity’s ongoing evolution as they past crisis ‘hiccups’ and closer to maturity. ‘Investors are starting to realise this is the best performing asset class they have,’ he tells Amanda Janis

photography by marK byron july/august 2011 private equity international page 25

aiting for a meeting at Kohlberg Kravis Roberts’ NewYork headquarters, you’re unlikely to get bored. Perched high above West 57th Street with dramatic floor-to-ceiling win- Wdows, the office has breathtaking views of Central Park and Manhattan. The interior is equally grand – traditional dark wood accents are offset by an eclectic modern art collection. Massive paintings of knees, clowns and clocks (by Francis Alys, Cindy Sherman an Edward Ruscha, respec- tively) were just a few of the items encountered while waiting for one of the private equity industry’s most renowned and influential people: George Roberts. KKR’s 67-year-old co-founder, co-chairman and co-CEO has long called California home and is based in the firm’s Menlo Park office. On this occasion he had flown to NewYork for PEI’s and the UN PRI’s Responsible Investment Forum. Scheduled to give the opening keynote address at the forum on the following morning, Roberts begins our meeting by asking for input on what the audience might want him to discuss. “I hope it’s what I’ve already prepared,” he quips. “But just in case.” It would not be the only time during the conversation that others’ opinions would be sought by the direct but soft-spoken Roberts, whose slight drawl, utterance of the occasional “ain’t” and use of folksy phrases call to mind his Texas roots. Despite leading one of the world’s most storied and powerful private equity franchises alongside his cousin, , Roberts doesn’t come across as a leader wishing to pontificate. When talking politics, for example, he is careful to follow up strong statements by noting they are “just one man’s opinion”. Encountering a friendly, straight-talking Roberts wasn’t exactly a surprise. “He’s very candid and a very nice guy,” one large investor in KKR’s private equity funds previously told PEI. It’s an example Roberts wants the firm’s nearly 700 employees to follow: according to a source inside KKR, one of the catchphrases Roberts uses most with colleagues is, “People do business with people they like and trust.”

ahead of the puck

Another catchphrase Roberts is fond of using is this: “We want to go where the puck is going, not where it’s been.” It’s a concept he associates with why hockey great Wayne Gretzky was able to achieve such heights, and he refers to it often to illustrate the importance of anticipating change. Sure enough, it’s the Gretzky analogy Robert uses when asked why KKR suddenly seemed to have become swept up over the past year or so with the growing trend among fund managers to develop responsible investment programmes pursuant to environmental, social and governance (ESG) issues at portfolio companies. “We started doing a lot of this over five, six years ago,” Roberts says, adding that he personally has been involved in such initiatives for more than 20 years. In addition to The Roberts Enterprise Development Fund, a San Francisco-based venture philanthropy organisation he founded, he and his late wife Leanne Bovet (he was remarried last year to partner Linnea Conrad) helped establish the Roberts Environmental Center at Roberts’ alma mater, Claremont McKenna College in Claremont, California. One of its initiatives is publishing sustainability scores on companies’ self-reported ESG efforts. page 26 private equity international july/august 2011

Today, six full-time employees at KKR track and integrate ESG been pickets outside,” he says, noting however that times have changed. At management into KKR’s private equity investment process. Their efforts the firm’s investor day earlier this year, for example, KKR invited Andy are complemented by KKR Capstone, a 60-strong affiliate that focuses on Stern, former head of the Service Employees International Union, to operations and management at portfolio companies. The firm is a signatory join a discussion panel. Years prior, Stern would have been more likely to the UN Principles for Responsible Investment and a member of CSR to picket the event than be a part of it. Earlier this year, Stern told US , a European business network focused on corporate responsibility. It newspaper Politico that KKR “has been a leader in trying to promote a has also started publishing information on its efforts and results in an annual more partnership, shared-value type of business model”. ESG report and a dedicated website, http://green.kkr.com. Active stakeholder engagement, responsible sourcing and encouraging more environmentally conscious portfolio companies are the key areas KKR has been focused on, the latter in partnership with Washington DC-based non-profit group the Environmental Defense Fund (EDF). Their relationship was established in 2007, when EDF and a number of other environmental groups including “The idea that Henry The Natural Resources Defense Council collaborated with KKR, TPG and Goldman and I are sitting Sachs prior to their $45 billion of Texas utility. around making all the The environmental groups – which had decisions – that passed previously criticised TXU’s environmental policies – endorsed the deal after the private a long time ago” equity sponsors killed plans for eight of 11 new coal-fired power plants that were in TXU’s pipeline, agreed to reduce the company’s carbon emissions to 1990 levels by 2020 and endorse a federal carbon cap. Private equity’s size and scope – Roberts estimates that if roughly The sponsors also pledged to double the company’s purchase of $900 billion in private equity capital has been raised globally, it equates wind power and efficiency expenditures, explore new coal generating to about $3 trillion of purchasing power with – requires that technologies, devote $400 million to demand-side management it pay attention to ESG issues, he says. initiatives, tie executive compensation to climate protection goals and “If you just look at KKR alone, we have more than 60 private equity create a advisory board. investments, and these companies have over $200 billion of revenue. “These things are genuine and substantial changes, and we wouldn’t There’s 900,000 people employed in nine different countries. And have been interested in supporting the buyout if it were just a PR stunt,” we’re indirectly responsible, at the last count I made, just in the US Dave Hawkins, director of the Natural Resource Defense Council’s alone, for the retirement benefits of nine million people. You can’t be Climate Center, said at the time in response to critics’ claims the of that size and substance and not pay attention to what the world’s sponsors were simply ‘greenwashing’ the deal. His organisation had been telling you, what’s really important and what are the right things to do.” negotiating with the potential buyers for weeks, he said, and wouldn’t The “right thing to do” is a phrase Roberts returns to repeatedly have bothered doing so if the private equity firms weren’t serious about when discussing the firm’s ESG initiatives. “What does it mean to us? improving TXU’s policies. It means doing the right things by the environment, to the extent you Irrespective of the financial difficulties the TXU deal has since suffered can do that without putting yourself out of business. It means making (see p. 29), it was in many ways the catalyst for KKR’s “Green Portfolio” sure – now that we’re a global world and you can make investments programme launched in partnership with EDF in 2008. Meant to help in all parts of the world and you can buy products and services from reduce and waste, and save money in the everybody in the world – that the people you deal with [have] the right process, the programme initially started with three portfolio companies kind of human principles. It also means trying to engage in a constructive and quickly expanded to include 16. In two years, EDF and KKR say dialogue with labour.” it has resulted in a savings of $160 million in operating costs and the elimination of 345,000 metric tons of CO2 emissions, 8,500 tons of not just pr stunts paper, and 1.2 million tons of waste. “It’s the equivalent of taking 20,000 cars off the road, it’s the Roberts acknowledges that the firm has had issues with labour unions in equivalent of taking 37,000 houses off the grid,” says Roberts. “And the past. “I can’t tell you how many meetings I’ve gone to where there’ve that’s with only 25 percent of our companies in the portfolio.” While july/august 2011 private equity international page 27

he says those results may be “peanuts” compared to what’s needed idea that Henry and I are sitting around making all the decisions on a national and global scale, individual companies taking action – that passed a long time ago.” is how Roberts believes real change will be effected. “I think that KKR today has a management committee of 11 people in addition to private equity has a real chance to be a leader here.” investment committees for all of its asset classes and funds. Both Kravis KKR plans to roll out its “Green Portfolio” programme more and Roberts sit on the management committee as well as the private widely, but wanted to first make sure what it was doing was making equity investment committee and have the overarching responsibilities a measurable impact and being embraced fully throughout the firm that correspond to their roles as co-chairmen and CEOs. So in some and at the portfolio companies, Roberts says. respect the duo retain veto power, but Roberts indicates that he and Kravis no longer make all the decisions at the firm like they might have necessary evolution 20 or 30 years ago. The best-run businesses are those that attract, retain and empower In July 2010 KKR listed its management company on the New York employees to further grow the business, he says, noting that often some Stock Exchange and the firm has been pleased with its performance. of the best ideas are generated from younger staff. “Traditionally around At press time, its units were trading at around $15.86 each, up here, when we have an investment idea, we ask the younger people what more than 50 percent from its $10.50 listing price and represent- they think first. You know, we were both in that position at one point ing a $3.4 billion market capitalisation. (KKR rival The Blackstone in time, and we didn’t have any Solomon up here telling us what to do, Group, by comparison, had a market cap at press time of just over or sprinkling holy water. We basically just went out and did it. And I $20 billion based on a $16.26 share price, down nearly 50 percent would hope that we will always be able to keep that culture around from the $31 per share price of its 2007 IPO. Other large private here – that we’re not risk-averse, and that [the next generation will] equity firms to have listed their management companies include speak up and be able to take the firm even further than we’ve gone.” Fortress Investment Group and . At press time, Oaktree Capital Management had just registered its on fame and friendship intent to list on the NYSE, while was widely expected to do the same in the near future.) The public listing, which Roberts and Kravis did not use to “cash out” their stakes in the business, gave KKR a multi-billion dollar balance “The last time we sheet to invest directly in its portfolio companies, making KKR its own largest investor. It also created another mechanism to pay and reward fought was when employees. we were about eight Roberts shies away from saying the way forward for all private equity firms is to become a large diversified asset manager with a publicly listed years old – and that management company. Some private equity firms may wish to “stay a was over a bicycle” smaller, regionalised, specialised investment firm and you know, crank away, raise money, invest it and do what you’re going to do”. KKR’s take-private of RJR in 1988 was memorialised in There’s nothing wrong with that model, he says. “But there’s some the best-selling business book (and later fi lm), Barbarians at the disadvantages to it. One, you don’t have permanent capital and secondly, Gate. The title of the book is perhaps something KKR’s founders would have changed if they could, for it implies that the fi rm you don’t have a third way of paying your people. So for us, and for and the industry approach deals in a way that is at odds with its Henry and me, in terms of what we want to do and perpetuating our core values emphasising partnership. firm way past us, you know, I think it was essential that we do this.” But title aside, the book and fi lm catapulted George Roberts Every single KKR employee is a unitholder in the company, a fact and Henry Kravis onto Main Street, making them household KKR professionals often cite when discussing how the firm’s various names. Ask Roberts what it’s been like to be one-half of the most famous duo in private equity history, and to have built up divisions work together. KKR and KKR Capstone employees own 70 an extraordinary franchise over the years, and the fi rst thing he percent of the firm, with the balance owned by public unitholders. Kravis emphasises is they were originally a trio, giving credit to fellow and Roberts, each of whom owns a 13 percent stake, note in the firm’s co-founder Jerome Kohlberg who retired from KKR in 1987. annual report that KKR has held back more than 30 million units “to Having gained such fame and notoriety must have compensate rising stars as they grow at the firm”. Equity ownership, impacted their day-to-day lives and relationships, it’s suggested. But Roberts quickly refutes the implication. “It has had no impact the pair note, is “the ultimate aligner of interests”. on anything, including on my relationship with Henry,” Roberts says. “I get up and go to work every day and do the best I can daily thoughts about succession do. I’ve never looked at it any other way.” Henry, Roberts says of his cousin, is the hardest-working person he knows. “We have total trust. We look out for one Roberts says KKR rejects the notion that the best private equity another. We don’t let anything get in the way of that. The last houses are driven by a small group of founders. “We’ve got a pretty time we fought was when we were about eight years old – and broad bench of pretty capable people around here,” he says. “The that was over a bicycle.” page 28 private equity international july/august 2011

Roberts says he and Kravis are still what you have to do on every investment is enjoying what they do, but admits he you have to create value that wasn’t there thinks about succession “every day”. before, right? So the way to go about it has “That’s part of being a CEO and doing changed over the last 35 years that we’ve the right things: you’ve got to think about been in business, and it’ll change again. It’s who’s going to replace you and how it’s not going to be a static kind of thing. And going to be. And we need to put people the firms that stay ahead of it and anticipate in positions, which we have, where they’re the changes you have to make, and how you actually running businesses in KKR. We have to go about doing it, are the ones that all have pretty thorough evaluations every will continue.” year, in terms of what our strengths and Roberts and Kravis open KKR’s 2010 weaknesses are, and I know you’ll be annual report by noting that “two years ago, shocked to realise that we all have some just about every measure of value and health weaknesses around here and areas to in global markets was in freefall”. work on. We try to address those, and The uncertainty and dislocation resulting everybody tries to get better. So I think from the credit collapse and global financial when the right time comes, if we’ve done crisis in 2008 was followed in 2009 by our job right, we’ve groomed the next market unpredictability and upheaval. A succession, next group of leaders.” dearth of leverage brought buyout markets He refuses to be drawn on potential to a standstill; too many of GPs’ portfolio contenders to run the firm. “We really “I can’t tell you how companies were showing severe signs of don’t have a list … and there distress; fund valuations were written down could even be somebody within the firm many meetings I’ve gone dramatically; limited partners kept tighter nobody’s even thinking about today. So to where there’ve been grips on their purse strings; and critics once like I said, we’ve given people a lot of again were taking aim at an industry whose rope to go do things – we’ll see how it pickets outside” core tenets were being called into question. all takes place.” The situation prompted a number of industry insiders and observers to question whether the private equity portfolio, portfolio model still worked. But Roberts says those discussions weren’t really taking place internally at KKR – they had their heads down working on Part of the reason why succession is such an interesting topic for the the portfolio. “Look, when you’re up to your ass in alligators, you don’t 35-year-old firm is that KKR is no longer just about . Since 2004 think about draining the swamps,” he laughs. “We had plenty enough to it has been expanding its franchise to include platforms for infrastructure, do, with managing what we have.” natural resources, special situations, China growth equity and high yield Roberts hopes critics and investors alike will indeed judge the and mezzanine investments. It has also started putting teams in place to firm by how its handles itself – its performance, portfolio work and focus on real estate and long/short equity opportunities. communications with investors – “when things are really, really bleak”. In Its , between 2004 and the end of March the past three years or so, KKR grew its “client and partner group”, or the 2011, grew by more than 300 percent to $61 billion. Asked if private investor relations unit charged with LP communications and fundraising, equity would continue to be the firm’s core focus, Roberts responds from five to nearly 40 people. It also instituted more regular “market affirmatively, saying “that’s really the girl that brought us to the party”. update” calls, on top of regular quarterly reporting, to discuss broad He continues: “If you just look at where our assets are, we’ve got $46 macro topics together with limited partners. billion today invested in private equity, and $15 billion, plus or minus, in credit and other things – so that’s always going to be the engine that the game’s not over drives the other things we’re doing. We’re basically going to stay within our core competencies and where we think we have got competitive Pundits were too quick to trumpet the shortcomings of the private advantages; we’re not going to go out and do things that don’t really equity industry during the credit crisis, Roberts says. “It’s easy to write relate to what our strengths are.” something [critical] when you’re in the first or second inning and the One of the firm’s core strengths is adding operational value to home team’s getting killed,” Roberts says, likening a market cycle to a portfolio companies, Roberts says, noting that was particularly crucial baseball game. “But it’s nine innings; it’s not one or two. And so write during and post-financial crisis. “We’ve sort of had a mantra here for the the articles in ‘14, ‘15, when the cycle has completed itself. And you’re last four years: ‘portfolio, portfolio, portfolio.’” going to know how a particular investment fared.” But he fails to see that as any different from how the firm previously Figures so far are largely positive, according to KKR’s first quarter operated (KKR Capstone was founded in 2000, for example). “I mean, earnings report. In the past two years, KKR’s private equity funds rose 90 july/august 2011 private equity international page 29

A steep decline in natural gas prices has severely impacted performance rising what remains the largest-ever LBO on record, agreed by KKR, KKR’s private equity funds have rebounded significantly post-credit crisis. TPG and Goldman Sachs for $45 billion in 2007. It’s currently Return figures are as of 31 December 2010 Fund Vintage Size Gross return Value increase marked at 0.2x cost. The radical change in Texas’ power prices year multiple over prior year – at one point dipping to $3 per MMBtu from the roughly $11 Millennium Fund 2002 $6bn 2x 27% per MMBtu when TXU was purchased – has put the utility KKR 2006 Fund 2006 $17.6bn 1.2x 29% company’s under intense pressure. The 2007 European Fund I 1999 $3.1bn 2.8x 48% was agreed with a $40 billion debt package, $28.7 European Fund II 2005 €4.5bn 0.9x 39% billion of which was due to mature before 2016. European Fund III 2008 €4.7bn 1x 2% The sponsors have worked hard to amend and extend that Asian Fund I 2007 $4bn 1.4x 51% debt, pushing out approximately $20 billion-worth so that Source: KKR Annual Review 2010, Private Equity Connect only $8.4 billion remains due prior to 2016. They’ve also increased the company’s power generation with two low-cost percent in value, equivalent to an $18 billion gain. Revenue at portfolio coal fired power plants going online in the past year and implemented companies rose 8 percent while EBIDTA grew 12 percent over the KKR Capstone programmes in plant operations and mining to help 12 months ended in March. Since the beginning of the year, KKR has optimise operations. Another crucial initiative helping TXU to survive is returned $3.5 billion in capital to investors, compared to $4 billion for a hedging programme employed to offset natural gas prices. Ultimately, all of 2010 and less than $1 billion in 2009. the investment will depend on what happens when the hedges roll off The firm’s capital markets team has also worked hard on debt and where natural gas prices are in four to six years’ time. refinancing and maturity schedules. In 2009 and 2010, roughly $46 billion of debt was refinanced. At the end of 2010, according to remarks made investors’ best-performing asset class during the firm’s first quarter earnings call by Scott Nuttall, head of KKR’s Global Capital and Group. Some $56 billion Roberts believes generally that the private equity industry will of portfolio company debt was due to mature in 2014. “Over the course “really surprise people on the upside”. Already, KKR funds have of the last four months alone, we’ve been able to reduce that number by shown they outperform public markets: since 1976, its funds have 40 percent to $33 billion,” Nuttall said. booked 26 percent gross and 19 percent net IRRs and outperformed The firm has also had eight companies go public in the past two the S&P 500 index by about 8 percent on a net basis, according to years. “Our IPOs are performing well with average price to current documents from its investor day in March 2011. of 49 percent,” Nuttall said during the call in May. “Nielsen, HCA, and “Investors are starting to realise, you know, despite all the hiccups, Far East Horizon completed so far this year (and they are up 26 percent this is the best performing asset [class] they have,” says Roberts. on average).” The private equity industry didn’t create the financial crisis, he It has also had some blockbuster exits stemming from its investments continues, noting most firms have done well managing their debt in the US shale gas sector. In June 2010, it scored a 4.5x return on maturities and have largely shown the benefits of being control investors its investment in East Resources when Royal Dutch Shell bought the even with leveraged capital structures. “All the institutions who were company for $4.7 billion. It recently repeated that success this June over-allocated and angry and frustrated all through the tough times … with a 2.7x return on its investment in Hilcorp, sold to Marathon Oil between now and ’14, there’s [going to be] a wall of money coming for $3.5 billion. back to them.” troubled txu It’s just too soon to judge many of these deals, or indeed the industry itself in the wake of the financial crisis, Roberts says. “I think we’re in the fourth or fifth inning…we’ve got to wait ‘til the game’s over before It’s the firm’s deals done pre-credit crisis, however, which remain we can decide who wins, what the final score was.” n under a microscope given the investment climate at the time allowed for very large deals to be agreed at high valuations and with large leverage components. But a lot of critics that predicted the failure Visit PrivateEquityInternational.com of deals done at the height of the lending boom between 2005 for more content stemming from and 2007 may be proven otherwise. Hospital operator HCA, for example, the subject of a $32.7 billion buyout by KKR and Bain our interview with George Roberts, Capital, is estimated to have earned sponsors nearly four times their money so far. Semiconductor company Avago Technologies, taken including his views on emerging private by KKR and Silver Lake Partners in 2005, is estimated to markets, the industry’s image have returned 5x. , a discount retailer KKR took private in 2007 for $7.3 billion, is thought to have returned 4x. problem and why Safeway remains That’s not to say all of the deals done in that era will be winners. his favourite deal of all time “The biggest issue is no big secret – it’s TXU,” acknowledges Roberts.

Top View