KKR & Co. Inc. (NYSE:KKR) Q2 2023 Earnings Call Transcript

KKR & Co. Inc. (NYSE:KKR) Q2 2023 Earnings Call Transcript August 7, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to KKR’s Second Quarter 2023 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following management’s prepared remarks, the conference will be opened for questions. [Operator Instructions] I’ll now hand the call over to Craig Larson, Head of Investor Relations for KKR. Craig, please go ahead.

Craig Larson: Good afternoon, everyone. Welcome to our second quarter 2023 earnings call. As usual, I’m joined by Rob Lewin, our Chief Financial Officer; and Scott Nuttall, our co-Chief Executive Officer. We’d like to remind everyone that we’ll refer to non-GAAP measures on the call, which are reconciled to GAAP figures in our press release, which is available on the Investor Center section at kkr.com. And as a reminder, we report our segment numbers on an adjusted share basis. This call will contain forward-looking statements, which do not guarantee future events or performance. Please refer to our earnings release and our SEC filings for cautionary factors about these statements. Turning now to the quarter. We’re pleased to be reporting fee-related earnings per share of $0.67 and after tax distributable earnings of $0.73 per share.

I’m going to begin by walking through the financials. Management fees in the quarter came in at $749 million; net transaction and monitoring fees were $190 million in Q2, with capital markets generating $150 million of revenues. Capital markets activity was most pronounced in our infrastructure business, which contributed approximately 45% of revenues in the quarter. And along with core private equity, these two strategies generated over 60% of capital markets transaction fees in the quarter, reflecting the continued diversification of the business. So, in total, fee-related revenues were $967 million. This was up 7% from last quarter, and it’s up 25% year-over-year. Fee-related compensation was right at the midpoint of our guided range at 22.5% of fee-related revenues and other operating expenses were $147 million.

Putting this together, fee-related earnings came in at $602 million or $0.67 per share with an FRE margin of 62%, which continues to be best-in-class looking across our industry. And for the quarter, FRE improved 10% from last quarter and on a year-over-year basis, so this is compared to the second quarter of 2022, FRE is up 31%. Moving to realized performance income. Realization activity, as we discussed last quarter, was more muted against the slower transaction environment. So, for the quarter, we generated $149 million of realized performance income, while realized investment income came in at $115 million. In total, our asset management operating earnings were $752 million. Our Insurance segment generated $170 million of pretax earnings in the quarter as Global Atlantic continues to operate at a high level.

As a reminder, we expect pretax ROE to be in that 14% to 15% range, so performance this quarter was just above the top end of that range. In aggregate, this resulted in after-tax distributable earnings of $653 million or the $0.73 per share figure that I mentioned a minute ago. Next, moving to investment performance. The traditional private equity portfolio was up 5% in the quarter and over the last 12 months appreciated 2%. Importantly here, inception to date, IRRs for our blended flagship funds, so that’s Americas XII, Europe V and Asia IV remains strong at 22%, which is meaningfully ahead of the corresponding 9% figure for the MSCI world. In real assets, the real estate portfolio was flat for the quarter and down 11% over the last 12 months.

Our portfolio continues to be heavily weighted towards those assets and themes where you’re seeing strong fundamentals and cash flow growth. So, think industrial assets, data centers, rental housing, student housing, and self-storage. However, as cap rates have increased over the last 12 months, that more than offset the underlying NOI growth and that’s what’s leading to the decline you’ve seen over the LTM period. Infrastructure was up 2% in the quarter and up 10% over the last 12 months, reflecting the strength of the portfolio really on a global basis. And with higher interest rates, we’ve strategically leaned into more inflation protected assets. And in credit, the leveraged in alternative composites were up 3% and 2%, respectively for the quarter and 12% and 5%, respectively over the last 12 months.

Moving next to capital metrics. We raised $13 billion in the quarter. Fundraising activity was actually quite diverse, driven by our middle market private equity strategy. Our case series suite of products focused on private wealth, which Rob is going to touch further on in a moment. Our core infrastructure strategy and real estate across all geographies, and this is in addition to inflows from Global Atlantic as well as capital raised for our Ivy reinsurance sidecar fund, which held its final close in the quarter. With that, our assets under management increased to $519 billion and fee paying AUM to $420 billion. And finally, we’ve continued to deploy capital. In the quarter, we invested approximately $10 billion, pretty evenly spread across private equity, real assets and credit.

Deployment within private equity was largely driven by core PE, while real estate deployment was most focused on credit in the U.S. as well as equity investments in Asia. And in our credit business, deployment was relatively diversified across asset-based finance and direct lending. Now, before turning it over to Rob, we want to spend a minute or two on our work to create and protect value through sustainability, which we detailed in our 12th annual sustainability report that we published in June and is also available on our website. Now, one of the areas where we’ve shown real leadership is our work around broad-based employee ownership in our portfolio companies and billing off of the CHI overhead doors and Minnesota rubber and plastics examples discussed previously, we’ve another case study in RBmedia.

RBmedia is one of the largest audiobook publishers in the world, and in connection with our investment, we introduced a broad equity ownership program across the company. And by partnering with the workforce and through all of their great work, wonderful things have happened, including a 22% CAGR in its core publishing business EBITDA over the life of our investment. So, we announced the sale of RBmedia in late July, and this will be a very successful outcome for its employees. All RBmedia colleagues will earn significant cash payouts with non-management employees receiving a 100% of annual income on average, and the most tenured employees receiving two years of their annual income. This outcome can be a financial game changer for people, and it’s driving real value.

Over these three recent exits, we’ve averaged approximately a 6x multiple of costs on behalf of our clients. So, at this point we’ve introduced broad-based employee ownership programs at over 35 companies and we’ve touched over 60,000 employees. And we expect these numbers to continue to grow from here and hope and expect we’ll have more stories like RBmedia to share with you in the quarters and years ahead. And with that, I’ll turn it over to Rob.

Robert Lewin: Great. Thanks a lot, Craig. The operating backdrop has begun to improve and as Craig just ran through, our model continues to deliver consistent results. With that, let’s shift the focus of the conversation to the future. Our model, growth trajectory, and culture are differentiated within our industry. I thought it would be beneficial to go through three of the foundational building blocks that have driven much of our differentiation and will importantly be a key driver of KKR’s future earnings quality and growth. We have taken very deliberate steps to build a business that benefits from several different growth engines, providing both greater earnings stability and significant long-term earnings power. Number one, we’ve built a business that has meaningfully increased the durability and recurring nature of our revenues, and we expect that trend to continue.

Page four of the earnings release highlights this point very well. On the left hand side of the page, you see that over just the past two and a half years, we have doubled our management fees, our most recurrent revenue stream from $1.4 billion in 2020 to $2.9 billion over the last 12 months, and fee-related earnings in turn have also increased meaningfully from $1.3 billion in 2020 to approximately $2.3 billion over the prior 12 months. Alongside this growth, the quality of these earnings has significantly improved as we’ve become much more diversified by strategy and by geography. In addition, the form of our capital base has also evolved, with our perpetual capital increasing from $22 billion at the end of 2020 to $200 billion today. Our perpetual capital now accounts for roughly 50% of our fee paying AUM relative to approximately 10% at the end of 2020.

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We will continue this focus of increasing both our recurring revenue and profitability, as well as diversifying the form of our fundraising and capital base. The second building block are the multiple identifiable growth avenues at across our business. We have discussed a number of these drivers over the last couple of earnings calls, but today I’m going to focus on just two areas that have been more notable in the quarter. Insurance and private wealth. Global Atlantic has continued to be a fantastic acquisition for us. Looking at the past few months, we’ve highlight two very important initiatives. In May GA announced a reinsurance agreement with MetLife funded by GA’s balance sheet, our Ivy platform and co-investors. With this transaction, AUM will increase by $13 billion upon closing, and the transaction will be beneficial, both management fees as well as insurance operating earnings.

And in June, KKR and GA together formed a strategic partnership with Japan Post Insurance. This partnership allows us to pursue additional growth opportunities through our collaboration with a key player in the Japanese insurance market. And as part of this, Japan Post committed meaningfully to Ivy II, which as Craig mentioned, held its final close in the quarter. Overall, GA is continue to demonstrate significant momentum with $144 billion of AUM as of Q2. This has doubled since we announced the acquisition in 2020, a further proof point of our acquisition and a demonstration of how the alignment we’ve created can drive real success. A specific area where GA has really helped accelerate the growth of one of our businesses is private credit.

Today, we manage $78 billion in private credit with $45 billion of that in asset-based finance. We are a leader in the ABF space, encompassing both our high grade and higher yielding strategies. And with recent regional bank retrenchment, the already five plus trillion ABF addressable market has even more structural tailwinds for us, as those seeking capital look to KKR as a real solutions provider with scale. The multi-year relationship announced in the quarter with PayPal is just one recent example. And now turning to private wealth. We’ve touched on this topic a number of times given the market opportunity alongside the significant investments we have made in order to launch and distribute a number of new products. In Q2, we started fundraising for two new private wealth strategies focused on private equity and infrastructure.

The launch of these products was a critical step in addressing the massive private wealth end market and introducing on a global scale products that traditionally have not been accessible to non-institutional clients. We’re off to a really good start here. In total, including capital that has raised in Q2 and so far in Q3, we’ve raised $1.9 billion across these two strategies. While we are still in the very early days, these initial results are ahead of our expectations. We have also launched in just a handful of platforms so far, and we would expect that to increase over the coming quarters. In our credit business, we look forward to the launch of a new private BBC later this year. In addition to direct lending, the strategy incorporates a specific allocation to asset-based finance, which we think will be viewed as a real differentiator.

So, at this point, we have a full suite of private wealth solutions strategically aligned with our four key investment verticals across the firm. Our focus here remains very much long-term oriented, ensuring that we are a real winner in the space over the next five to 10-plus years. Our conviction around success is high and is driven by a number of factors, including our brand, investment track record, our significantly expanded distribution and marketing teams, and our scale to be able to invest into the opportunity set. And importantly, each one of our core products across PE, infra, real estate and credit have aspects that are unique and a real testament to the innovation capabilities of our team. Now turning to building block number three.

We continue to achieve substantial growth in our earnings power because of both an increase in our fee paying AUM and capital deployment. We currently have $10 billion of embedded gains that sit on our balance sheet. That’s the fair value of our carry and investment portfolio relative to the underlying cost, that’s up from $3.7 billion just a few years ago. This provides a real lens into our ability to create meaningful revenue outcomes in the future. And over the next few years, with continued investment performance and further capital deployment, that number is biased to increase, even as we expect to monetize more as the environment hopefully becomes more constructive. A reminder for how we think about earnings power. Distributable earnings is largely a cash metric.

So, in times like these, when we sell less through the monetization environment, we are underearning that intrinsic earnings power and embedded gains are only one piece of that equation. Our expectation here is for continued scaling of our more recurring revenue businesses as well. Just looking at management fees alone, without raising another dollar, we currently have $38 billion of AUM with a weighted average management fee rate of almost a 100 basis points, that is not yet turned on. This capital once activated, would directly flow into management fees and be additive to earnings, but is not reflected today in our FRE or after tax DE. We also have $100 billion of dry powder, 96% of which is carry eligible. When we invest that capital, it creates the potential for more embedded gains and therefore revenue over time.

These are the main reasons why we are so constructive around the potential for further significant and sustainable growth in our earnings per share over time. We have never been more confident around our model and our prospects, which is one of the reasons that you saw us buyback some stock in the quarter. Since the end of Q1, we have brought back or canceled approximately 6 million shares at an average price per share of less than $50 share. Repurchases have historically been and will continue to be an important driver of value creation for our shareholders. As a reminder, since we initiated our buyback program in 2015, we have bought back or canceled approximately 92 million shares at an average price per share of just over $27. This represents more than 10% of KKR shares outstanding today and almost 15% of our free float.

And with our recent acquisition such as KJRM, our Japanese REIT Manager and Global Atlantic, we have completed almost $5 billion of purchase price M&A with limited share issuance. We remain as a management team, the largest owners of stock, and are highly aligned with shareholders in our focus on equity value creation. So, to summarize, our earnings growth will continue to be supported by more stable forms of income, including our diversified high-quality and growing management fee business underpinned by our $200 billion of perpetual capital. Number two, we have several differentiated growth avenues, including insurance and private wealth amongst many others. And finally, our embedded gains and more broadly our earnings power is expected to continue to increase.

These compounding pieces are why we continue to feel more confident than ever in our 2026 targets of $4-plus of FRE and $7-plus of after tax De per share. With that, Scott, Craig and I are happy to take your questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Craig Siegenthaler with Bank of America. Please proceed with your question.

Craig Siegenthaler: Good morning, everyone. Hope you’re all doing well. My focus is on the next fundraising cycle. When do you expect to have the first close for global infrastructure investors V? And do you believe this will be your first of the flagship fundraise?

Craig Larson: Hey, Craig. It’s Craig. Why don’t I start? Thanks for the question. I think as we look forward, we continue to see a really active amount of funds and strategies that we expect to be in the market with. We talked historically about having 30-plus strategies in the market over the coming 12 to 18 months. I think if anything, that number probably would’ve increased relative to what we would’ve talked about six or 12 — three or six months ago. So, I think the level of activity and the number of strategies remains at a high level. We don’t have any guidance or specificity as it relates specifically to our infrastructure strategy. But I think when you look at the back of the tables and you look at invested and committed capital relative to the size of the fund, I think fair to assume that that’s something that is becoming a front of mind topic for us, but nothing to announce specifically as it relates to individual timings, let alone closings at this point.

Craig Siegenthaler: Thank you, Craig.

Operator: Our next question is from the line of Alex Blostein with Goldman Sachs. Please proceed with your question.

Alexander Blostein: Hi. Good morning, everybody. Rob, I wanted to go back to some of the points you made at the end of your prepared remarks around the buyback and just capital management. Definitely nice to see a little bit of a pickup and repurchases here. Just curious that whether we are at a point now where you feel like the balance sheet has enough sort of scale to recycle capital for what you guys need. And the buybacks could become a bigger part of the story going forward where M&A aside, we could actually expect the total share count to start to decline in absolute terms. Thanks.

Robert Lewin: Yeah. Great. Good morning Alex, and thanks a lot for the question. So, taking a step back just more broadly as it relates to capital allocation, the most important thing for us, and you’ve heard me say this and us as a management team say this before, most important thing is to have a consistent approach. And ours is one that I think is really maniacally focused on driving ROE and the highest per share earnings that we can with the lowest per unit of risk. And we talked about four strategic areas of deployment that we think can accomplish that. And so that’s core private equity investing, continuing to invest across the insurance space. You mentioned strategic M&A. And the fourth one is share buybacks. And we think a real core competency of our management team is being able to move that marginal dollar of liquidity around to the highest return opportunity.

And the thing that’s going to drive the most earnings per share over time. And maybe the final point here is we’re highly aligned in that decision-making process. As you know, KKR management owns close to 30% of KKR stock. And so, back to your specific question on share buybacks, as you mentioned, I noted on the prepared remarks, we’ve bought back over 90 million shares that represent almost 15% of our free float since we initiated our buyback program seven, eight years ago and just over $27 per share. So, we really like the body of work that’s been accomplished over a long period of time. And so, all to say share buybacks going to continue to be a very important part of our go-forward capital framework and capital allocation policy. But we’re going to continue to look at other ways of driving growth in earnings per share over time as well, including in areas like core private equity insurance and M&A.