Investment Thesis
KKR & Co (NYSE: KKR) gained popularity with the buyout of the tobacco company RJR Nabisco in 1988. The deal also helped them earn the nickname of Barbarians. The Barbarians are back once again but this time they are causing a watershed moment in the credit space of corporate America. The $34 trillion private credit space has made headlines quite a lot and KKRs proactive steps to maximize the firms hold in the private credit space have been well rewarded by the market. When writing this article, KKRs stock has outperformed S&P500 by 50% this year. However, even then, the stock is far from its true intrinsic value and presents investors with an upside of 149%
McKinsey &Co
Business Model
Kohlberg Kravis Roberts (NYSE:KKR) & Co. is one of the largest asset managers in the world, with over $600 billion in AUM. KKR bundles all its investment strategies broadly into five asset classes: Private Equity, Real Assets, Credit and Liquid Strategies, Capital Markets, and Principal Activities. The following chart shows the split among the asset classes and strategies as of September 30, 2024.
KKR & Co
Private Credit
Private credit is a sub-category of Credit and Liquid Strategies. The Liquid and Credit strategies as of September 30, 2024, have $ 271.4 billion AUM and the private credit strategy currently manages $105.8 billion in assets. Additionally, KKR manages $140.4 billion of credit portfolio for Global Atlantic, an insurance company that KKR bought in January this year. Like a typical private credit asset manager, KKRs private credit strategies incorporate direct lending, mostly the senior part of the companys capital structure, junior mezzanine debt and asset-backed debt finance. As mentioned in KKRs 10Q filing for Q3 2024, the asset manager invests in the senior debt of middle-market companies for their direct lending strategy. For their mezzanine strategy, KKR primarily seeks to generate high yield and marginal equity exposure, and this is achieved by investing in subordinated debt of companies. And finally, the asset-backed finance strategy invests in loans backed by hard assets.
Recent Fund Raising
KKR brings the private credit strategy and strategic investment group (SIG) under the umbrella of Alternative Credit. SIG primarily provides capital solutions to companies in various event-driven circumstances. This ranges from helping a company meet its covenant mandate to exit financing. The chart below from KKRs 10Q for Q3 2024 illustrates the recent funds it raised for the Alternate Credit strategy to deploy in private credit.
KKR SEC filings
KKR has deployed a sizeable portion of dry powder in private credit strategies in the last four years, with the most notable one being the Asset-Based Finance Partners II. KKR committed $2.833 billion to the Asset-Based Finance Partners II just a few months after the acquisition of Global Atlantic. Coupled with the Asset-Based Finance Partners, KKR raised almost $4.8 billion in the last four years, the highest of all its private credit niches. This helps us gauge KKRs vision and strategy in the coming years amid the changing dynamics of the private credit landscape.
Fund Performances of Private Credit Strategies
KKR SEC Filings
KKR saw some formidable performances among its direct lending and asset-backed finance funds, with Lending Partners IV hitting the 19% Net IRR mark. However, some of the private strategies such as mezzanine posted underwhelming results. For starters, Mezzanine reported a frugal Net IRR of just 3.6% over the five years. This would entice KKR to allocate additional capital in asset-based finance and direct lending space in the coming years.
Investment Upsides
Surge in deal activity.
PitchBook in its 2025 US Private Credit Outlook comprehensively explained how The Fed rate cuts in 2024 have enabled debt issuers to raise debt at lower costs. And the revival of cheap capital is likely to spur deal activity and propel M&A deals in 2025. Furthermore, the market has a strong conviction that the incoming US administration would relax regulations and antitrust surveillance. And this presents a huge revenue opportunity for KKR. The direct lending fund, Lending Partners IV, can expect to finance these deals and expect a modest yield income for their portfolio. Furthermore, private credit has snatched a significant number of issuers from broadly syndicated loans (BSLs) over the past few years. However, this trend might take a hit with the tightening of the spreads. But with nearer-term maturity, KKR can still expect bankroll in the M&A deals, that would inevitably surge next year.
Growth in Asset-Backed Finance
BlackRock (NYSE:BLK)
As we saw above, KKR raised a total of $4.8 billion for their asset-based finance strategy, the highest in across all the strategies under the private credit in the last four years, the chart above, complied by BlackRock, helps us understand the reason behind it. Only 5% of $5.5 trillion of assets backed by finance in the US is held by private lenders, as per Oliver Wyman. The consulting firm also expects an acceleration in the rate private lenders take on more share of the asset-based finance space in 2025 and surely KKRs $2.8 billion Asset-Based Finance Partners II would be one of the front runners spearheading the paradigm shift.
Insurance Money
The high yield the Insurers can get by having private credit strategies in their portfolio is tempting. Furthermore, private credit offers insurers better illiquidity premiums and lower drawdowns over public debt. This is also echoed by Neuberger Berman in their white paper The Case for Private Credit in Insurance Portfolios. This led to an explosion of private equity firms either buying or partnering up with insurers. This provides private equity firms with a gateway to easily accessible dry powder and delivers stellar IRR for their shareholders. The buyout of Global Atlantic gives KKR access to almost $140 billion to deploy in private credit strategies.
Valuations
WACC
KKR SEC Filings
Unlevered Free Cash Flow
KKR SEC Filings
Morgan Stanley (NYSE:MS) expects the private credit industry to grow at a CAGR of 23% to $2.8 trillion by 2028. The research firm Research and Markets expects the Asset-Based Lending market, the market KKR is prioritizing for the next few years, at a CAGR of 16.4% through 2030. Hence an average of 18% growth in KKRs revenue over the next ten years is reasonable to project.
DCF
KKR SEC Filings
The target share price of KKR is $365.88, offering investors an upside of 149.0%. The buyout of Global Atlantic was an excellent strategic move. The net investment income from the insurance segment is already up by 20% in the first nine months of this year from the last year. And the net premiums give KKR a cushion in case of unprecedented market turmoil.
Investment Risk
With the S&P500 and NASDAQ hitting all-time high points, the market and the US economy at large have shown strong and resilient growth. However, the probable protectionist measures of the Trump administration are likely to drive up the input prices of raw materials imported from China and Mexico, putting upward pressure on inflation. Regardless, a further rate cut of 25-50 bps is expected by the economists at BofA, Goldman and JP Morgan (NYSE:JPM). Hence this would tighten the spreads even more, curtailing the yield income of KKR on their private credit strategies. However, the drop in yield income would be compensated for KKR by the surge in M&A volume next year. Furthermore, Blackstone (NYSE:BX) Credit and Insurance has $432 billion AUM as of Septembe30, 202424 enough to dwarf KKRs entire $271 billion credit portfolio. And Apollo Global Management oversees $598 billion AUM as of September 30, 2024 thanks to its $11 billion merger with Athene Holdings in 2021. Hence, it is not a free lunch for KKR, the New York-based asset manager has hunted for deals, especially in the asset-backed finance space, which represents a humongous opportunity for KKR.
Portfolio Management
The target share price for KKR & Co. is $ 365.88. This offers investors a potential upside of 149.0%. KKR along with a handful of others is spearheading the paradigm shift in corporate America. The hard asset-based lending market presents a trillion-dollar opportunity for asset managers as depicted by BlackRock in their 2025 Private Markets Outlook. KKR seems to be leading the pack to grab the maximum share as they seem proactive with their multi-billion fund launches targeted for the Asset-Based Lending space. However, the growth in valuation multiples in the next few years might distract KKR. Any form of material distraction could significantly hurt the stock as firms like Blackstone and Apollo also have huge piles of dry powder in their armoury to be deployed in the private credit space. KKRs stock, nevertheless, has outperformed Blackstone and matched Apollos returns this year, forging an indication of the markets faith in KKR in the long run.
This content was originally published on Gurufocus.com
