We are maintaining our BUY rating on KKR & Co. Inc. (NYSE: KKR) following 3Q earnings, which benefited from growth in management and transaction fees and realized investment income.
In July 2020, KKR announced plans to acquire Global Atlantic Financial Group Ltd., a retirement and life insurance company. The acquisition is expected to close in early 2021. The acquisition price will be 1.0-times Global Atlantic’s book value as of the closing ($4.4 billion as of March 31). The operations will be a significant addition to KKR’s business, as they will increase total AUM by 33% and fee-paying AUM by 45%. They will also boost perpetual capital to $91 billion from $19 billion. The acquisition is expected to add scale to KKR’s real estate credit and principal finance operations, and expand its distribution capabilities.
Management has noted a meaningful change in the company’s shareholder base, with increased mutual fund ownership, index fund sponsorship, and a decline in ownership by hedge funds and broker/dealers. KKR was a trendsetter in the conversion to corporate from partnership status, with Blackstone and Apollo Global following suit in 2019.
The company expects to drive operating results by: (1) generating strong investment performance, (2) raising capital, (3) capitalizing on new investment opportunities, (4) monetizing existing investments, and (5) expanding its business model. Management is also focusing on expansion in Asia and on developing its real estate segment.
The stock’s yield is about 1.6%.
Over the past year, KKR shares are up 18%, compared to a 13% advance for the broad market.
On October 30, KKR reported 3Q20 distributable earnings of $0.48 per share, up from $0.46 a year earlier and $0.08 above consensus. Revenues rose 11% to $1.07 billion, as growth in management and transaction fees and realized investment income more than offset lower realized performance income. Distributable earnings were $410 million, up from $389 million a year earlier.
Assets under management were $233.8 billion at September 30, 2020, up 12% from the prior year, aided by the appreciation of private and public market portfolios and new capital raised, mainly in the company’s Asia private equity, real estate, and private credit strategies.
In July 2020, the company agreed to acquire Global Atlantic, a leading retirement and life insurance company with $70 billion in assets, for 1.0-times book value, or $4.4 billion as of March 31.
EARNINGS & GROWTH ANALYSIS
The company historically reported results for four operating segments: Private Markets, Public Markets, Capital Markets and Principal Activities. However, quarterly earnings now focus on total firm performance, while segment P&Ls are reported only in quarterly and annual SEC filings. The change in reporting was prompted in part by the growth of the company’s balance sheet since its public offering. The new Principal Activities segment shows stand-alone balance sheet performance, as well as the allocation of operating expenses across segments. It also shows the impact of capital commitments previously excluded from AUM, and the pro rata portion of strategic partnerships.
Long-term financial objectives for the company include:growing profits and book value to create an additional $20 billion of market capitalization, controlling headcount and limiting complexity, controlling the share count and limiting shareholder dilution, keeping ROE attractive, and limiting leverage.
Recent AUM growth has benefited from capital raising, particularly in infrastructure, real estate and leveraged credit strategies, as well as from improvement in the value of private equity holdings. Nearly $9 billion was raised in 3Q, and $32 billion over the first three quarters of the year. The company’s top five holdings as of September 30 were Fiserv, USI Inc., BridgeBio Pharma, PetVet Care Centers and Heartland Dental, with a total carrying value of $3.8 billion. Other investments of $10.2 billion brought total investments to $14.0 billion. We note that the Fiserv holding came about after Fiserv acquired First Data, in which the company had a significant stake.
Importantly, fee-paying assets have been growing nicely, up 16% in 3Q, while management fees jumped 14%. Management intends to grow management fees by at least 50% over the next three years.
Reflecting the better-than-expected results in 3Q and the continued rebound in asset values, we are raising our 2020 distributable earnings estimate to $1.70 from $1.56 and our 2021 forecast to $2.08 from $2.04.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on KKR is Medium, the midpoint on our five-point scale. The company ended 3Q20 with a book value of $20.26 per share, up 5% from the end of 2019, aided by asset appreciation in the investment portfolio. Liabilities are about $6.9 billion.
Between December 31, 2019 and October 23, 2020, KKR spent $324 million to buy back 10.2 million common shares and to retire equity awards representing 2.8 million shares. In May 2020, the company increased its existing authorization to $500 million.
Prior to 4Q15, the company made quarterly cash distributions of substantially all cash earnings from its investment management business. It made distributions of $1.58 per unit in 2015. In 1Q16, it began paying a fixed distribution (initially $0.16 per quarter) tied to its fee-generating business, and in 1Q17, it raised this amount to $0.17 per quarter, which continued through 2Q18. However, along with the change in status from a partnership to a corporation, the company began paying an annualized dividend of $0.50 in 3Q18. It increased the annualized payout to $0.54 per share beginning in 2Q20. Our dividend estimates are $0.54 for both 2020 and 2021.
Alternative asset managers are an admittedly difficult group to value. Realized gains and carried interest are difficult to predict. However, the company’s recent change to corporate status has simplified its reporting structure.
The stock trades at 22-times our depressed 2020 distributable earnings estimate, below the DE multiples of larger rivals Blackstone Group and Apollo Global. Blackstone and Apollo both converted to corporate status in 2019 and saw a significant jump in their shares. KKR shares trade at a more reasonable 18-times our estimate for 2021, when we expect a more than 20% earnings recovery. Our revised target price is $45, raised from $43 to reflect the improving environment for asset values and realizations.