Jul 09, 2018
Johannes Huth, Head of KKR EMEA, describes how KKR private equity has evolved from a U.S. focused start-up to a global franchise in the last 40+ years and why our distinctive strategy has been so important to that evolution.
Global Private Equity
Head of KKR EMEA
Good morning. Again, thank you everybody for being here. My name is Johannes Huth. I am responsible for our operations in Europe, Middle East and Africa. I joined KKR 20 years ago. I actually started my career in private equity in 1990 so almost 30 years in private equity and originally was a banker at Salomon Brothers.
KKR’s Global Platform and the Current Environment
What I focus on today is obviously looking after our private equity business, the investments we are doing. However, I spend a lot of time trying to connect our different businesses. That is really core. Henry mentioned it when he started that we are working as a team. That means I spend time talking to our colleagues in China if they are potentially looking to sell a business that we have in Europe to a Chinese acquirer. I am talking to our colleagues in the United States if one of our businesses in Europe would like to expand there.
We have businesses that may not fit private equity but that are very interesting investment opportunities and passing those businesses to maybe our special sits investment fund. It is important. We may see a hotel business that has a significant operational aspect. It does not fit our real estate business. I want to make sure that we are effectively using this opportunity in our private equity business. Staying connected geographically and across our businesses and making sure that happens is something I spend a lot of time on.
KKR Private Equity: From US-Focused Start-Up to Global Franchise in 40+ Years
With that, let me talk a little bit about what we are doing in our private equity business. I will give you a quick sketch of what we have today. We have been in this business for a long time: 42 years. I may look like I have been in it for 42 years, but it has only been 30. We have deployed a lot of capital over the history in this business.
What is important here is that we have a distinctive strategy. We are sourcing on a global basis. We are looking at thousands of opportunities globally every year. Out of those last year, we ended up doing 22 transactions. It is a huge funnel. Utilizing what we have across the globe in achieving that is very important.
I will talk a lot more about the second point, how do we really generate value? We generate value by working with the businesses that we own, by trying to improve the operations of the companies that we own. That is where we create value. That is how we generate alpha. That is why, I think, private equity is such an attractive business because this is something that is sustainable that cannot get arbitraged away.
Then as I started and I said where do I spend a lot of my time, we really try to work as one team globally, one private equity team. We talk on a weekly basis with everybody globally to understand what they are seeing in their businesses, what trends could we observe maybe in Asia, or in the US or in Europe that are applicable globally.
We are the biggest investor in our funds. $2.2 billion of the money that sits in the KKR funds come from its employees. We basically put our money where our mouth is. All of that has resulted in some very, very good returns: 26% gross IRR across our history in terms of what we have been doing.
With that, let me talk a little bit about what we are seeing in the market, how we are seeing the business today and then I will come back and talk a bit more in detail about how we are actually generating value in the companies that we own.
The Macroeconomic Outlook Is Strong Globally
Just very quickly, despite trade war, despite other wars, we see in each of the regions that we are active in: Asia, Europe and the Americas, the macro outlook still quite strong. The reason that I mention it, it sets what we are seeing reflected in our global portfolio.
KKR’s Industry Leading Global Private Equity Portfolio…
When you look at these slides − we have got a lot of logos on here − we are a market leader in our business and private equity in the US, in Europe and in Asia. None of our competitors is active in each three regions and is a leader in each three regions.
Our businesses, if you add them up, make over $170 billion of revenues. We have got almost 670,000 employees across the world spanning 19 industries and 20 countries. Every month, we look at that portfolio. We look at how that portfolio is doing. What we are seeing right now is what I said in the beginning, we are seeing a good macroeconomic environment reflected in the portfolio performance.
…Has Performed Very Strongly
Our portfolio has been doing well. We look at how it has been doing against budget. Almost 90% of our companies right now are making budget. We have a benign environment and that has resulted in some very, very good performance over the last few years.
The Current PE Environment
That is good but there is another side to that equation. Basically, high market prices and here, we really have two different stories from what we are seeing in Europe and the US and what we are seeing out in Asia and more in the emerging markets.
In Europe and the US, we have seen stock markets that have been running for a long time. We really think if anything, we are later in the cycle rather than early in the cycle. Acquisition multiples since 2007 have risen to really the highest that we have seen both in Europe and in the US. A little lower in the US than in Europe but about almost 11 times EV to EBITDA is what we are currently seeing in Europe.
Leverage multiples have gone up. There has been a lot of liquidity. That has been driving up some of these multiples. The environment is more challenging from what you need to do.
What have we been doing in response? We have really been trying to focus more on value transactions and complexity. Probably five years back, we would have looked more at growth businesses. We saw good opportunities there. But multiples today are so high that we have been trying to find value and we have been focusing on complexity in companies.
I will talk a little bit more about what we mean by complexity. It could be complexity in the acquisition process. A very difficult carve out where in the example of the margarine business we just bought from Unilever, we bought 60 different countries. We had to establish organizations in 60 different countries to buy that business. Or we may have complexity after we have purchased a business. Through that, we can find value and we can keep multiples at a reasonable level.
Still, when we look at acquisitions today in Europe and in the US and we look at the multiple that we are paying when we buy a company versus a multiple that we are projecting that we can get when we sell it, we are assuming either flat or decreasing multiples. That is just the environment that we are in today.
Now, that environment is a little different in Asia. In Asia, we have actually seen opportunities. Valuations have been more attractive. Just by the effect of market growth, there have been much more growth opportunities.
We actually last year had our most active year in the last 12 years in Asia. We put a lot of money to work, and that is really a reflection of the opportunities that we see there. Two different stories but in both of these markets, we are active and we are continuing to invest.
We Have Been Returning Capital While Unrealized Carry Has Increased
The other thing we have been doing is we have been trying to take advantage of what we have been seeing in the market. We have been trying to effectively use high multiples to sell, and to sell a lot more than we have been investing.
Here, as you can see, over the last three years, we have probably returned twice the amount of capital that we have put out. What is important though here and we have basically last year if you look at how much we have generated in terms of realized cash carry, $1.2 billion. It has been a very good market to realize capital.
What is more important though is that that has not meant that the carry that we have in the ground that effectively sits in the portfolio that has not yet been realized has decreased. That carry has also increased. We have continued to make good investments. The carry that is effectively available to be realized in the future has increased. We have returned more money, made good cash carry but also increased the amount of carry that is still available to be realized going forward.
Strong Global Historical Private Equity Performance…
You have seen different versions of this slide before, but I am just going to quickly again go through it. Performance has been very good. That is really the key of this slide. We have returned a lot of capital. We have invested a lot of capital.
…As well as Regionally in North America, Europe and Asia
It has not only been on a global basis. Here, I am trying to split it out and I like this slide a lot because it shows that in Europe, we made four times the MSCI. We have basically returned multiples of what you have been able to realize in the public markets across each one of our markets. That is why we have been able to grow our AUM because we have been continuing to deliver very, very good results across every region that we have been active in.
Performance of Flagship Funds Has Helped Drive Scaling
We have talked about scaling. The numbers in the top corner there are the gross and net returns that the fund has returned. In the North Americas XI fund for example, we have had a 26% gross and 21% net return. That performance has allowed us to significantly increase the amount of capital that we have been able to raise.
You can see there in Europe IV, we are saying we have a successor fund. We are currently 77% invested in our fourth European fund. Hopefully, we will see at least a similar gross there going forward. Good performance basically allows us to continue to what is already a scale business to grow that business.
As we said, we have got $70 billion in the ground in private equity, but we are continuing to be able to scale it by driving the scaling of our existing funds.
Growing Private Markets AUM
This shows the AUM over the period. The real point here for me is that the other private equity point is something that I am going to come back to just in a second. We have been able to add new businesses. We have been able to effectively expand what we are doing in private equity by adding further things. Let me go into detail on that.
We Are Well Positioned For Continued Growth
This is how we are growing the private equity business. I talked about one which is delivering good performance and because you have delivered good performance, you can raise bigger funds. We have done it North America. We have done it in Asia. We are going to do it in Europe.
Secondly, we are adding other businesses. Some of these are important. Our TMT growth business, we today have a fund that is $750 million in TMT growth. You may say that really does not move the needle very much. It is a relatively small fund. But first of all, it is the first time we have raised that fund. Secondly, there is a strategic idea behind this. We want to invest in growth to basically have a window of what is happening in the disruptive space and utilize that information to be better informed in our core business to see are there potential trends coming down the pipe that could adversely affect the business that we have invested in in our core business. Therefore, we should sell it sooner. Or are there opportunities that we may be able to leverage? Again, we are trying to leverage what we have across the firm to create better returns for everybody.
Healthcare growth is another good example. We have a very good franchise in private equity and healthcare in the United States. We are really the leader in that business. What we said is, there are other sectors in healthcare which are probably a little bit smaller and more growth driven but we have all the contacts that we have to pass on.
We created a separate fund for that, raised significant capital. We think we can basically repeat that model in other areas of the firm where either we have a leading franchise in a particular area where we can go into more of a growth aspect where we can find other opportunities to grow that business.
Something that we touched on only shortly is ESG. That has been something that has been very important in our investing. When we look at investing in companies, in our due diligence, we look at environmental, social and governance matter of every business that we buy. Once we own the business, we have a lot of standards that we implement. We try to make sure these businesses source responsibly. We try to make sure that these businesses from a green perspective are responsibly run. This is something that we have been doing for a long time in all of our companies.
We have had then some of our investors come to us who have seen this and said, ‘Look, could you create a fund that just invests in those assets for us?’ We have done that for a number of our investors.
We have taken that idea a step further and we have said, ‘Let us raise a separate fund.’ That is we call our impact fund for that and we are going to try to raise that fund in the next year or so. We have an idea here that we have used. It was attractive to some of our investors. Now, we are effectively creating AUM and fees for the firm out of that.
Lastly, in three, there are some additional opportunities − permanent capital vehicles. What is an important one is that last point. We have a lot of our investors who want to give us long-term capital. A key part of those arrangements is to have private equity part of it. We are able to raise money for the private equity business which is not reflected in one of our core funds but comes from outside of those core funds and pays us very good fees. It is AUM that does not come through one of our traditional funds but effectively expands again the amount of money that we can deploy.
Before I go into the sort of more how do we generate value section, I think to remember is our private equity business is a scale business. It is highly profitable. It generates a lot of cash. It has got significant growth left.
Decades of Experience and Decades Investing Together
I just thought we would spend some time on this because very often, what we hear is well, all you guys are doing is basically putting some leverage on. If I put some leverage onto the public market interest, I will make the same returns that you make in private equity. I think nothing could be further from the truth. We are doing something very different. It all starts with our team.
We have a great team across the world, over 200 people that are very active in private equity. Now, almost 60; it says 55 on there. We have hired some more people since of people that are operational executives. These are people that have been at a consultant firm or have been a CEO of the company that help us going into the businesses we own and helped us restructure those businesses.
In addition to these 215, we have our capital market team which work with us on the fundraise and the raising of debt and equity for each of the businesses we own. We have a group of 40 senior advisors around the world that have significant industry experience and expertise that advise us with that and we work with our public affairs team. We effectively scale other parts of KKR within what we are doing in our private equity area.
Unique Opportunities across Sectors and Sizes
What this allows us is to source opportunities. I talked about 22 deals in 2017 and probably over 4,000 opportunities that we looked at globally so a big funnel. A couple of points to make on here.
The average, over 55% of the transactions that we have done have been less than $1 billion. When you ask people what does KKR do, everybody will say, ‘Well, you are doing the big $10 billion deals.’ Actually, more than half of what we have been doing hasn’t been there. We like that sector. It is very often less transparent than what you have in a very large company. They are mainly family businesses where we partner and work with family businesses. We are really focusing significantly on that.
Yes, there are some very big deals that we have done. However, the majority of what we have done have been deals that have been less than $1 billion.
We are sector agnostic. We have done deals in many different sectors. We have expertise in many different sectors through our teams. Most importantly, by having a global sourcing team that has been working together for a long time, over 40% of the deals that we have done have been proprietary. That means there has not been an auction. There has not been another competitor. We have been in a one-on-one dialogue with the family or the seller of that business. That is part of the reason that we have been realizing very good returns. We have avoided the competition.
Private Equity Model Evolution: 40+ Years of Experience
Just maybe to sort of take a step back and say how has our industry evolved. Probably when we started, well, when Henry and George started in 1976, you were able to buy assets at some attractive prices. There was not much competition. There was an arbitrage game there.
Then in the 1980s and 1990s, we were able to generate value by leveraging businesses significantly. Financial engineering effectively was a differentiator. That again got arbitraged away.
Probably in the 1990s, we started to become more active but really through active board membership. Again, that’s something that the competition became harder. What we realized is that for us to create permanent value, to create alpha, we have to improve the businesses that we own.
To do that, we created that toolset that you see there on the right with all of the different teams that we have in our various businesses. KKR Capstone, I will come and talk more about in some detail and the various different aspects of our firm that help us to really improve companies fundamentally. I am going to go through a few examples to explain what does that actually mean. What do we mean by creating value and how do we do it?
KKR Capstone—Value Creation through Operational Improvements
KKR Capstone is 60 people, as I said, with significant operational background working together with the PE team. We have a couple of portfolio examples here as to what they have been doing.
Latitude was probably one of the largest deals that was done in Australia. It was a consumer finance business that we bought from GE Capital. When we came in there, we realized management was not that great. We changed the CEO, the CFO, the CIO, the head of HR, so a significant involvement in recruiting a new team.
Then we spent a lot of time looking at improving their product platforms. Through improving the product platforms in New Zealand and in Australia with Capstone, we were able to improve productivity of this business in terms of how they sold their credit products, their credit cards, their credit insurance businesses to the consumer by almost 30%. We achieved some significant overhead savings. The business has performed very well. A large number of KKR executives in the company involved in the outset helping recruit management and then involved in actually improving the business itself.
Hensoldt is another example. This is the electronic defense business that we bought from Airbus. It was a highly complex acquisition. We needed approval from the German government. It took us over a year to get all of the approvals to actually be able to buy the business. Again, it was a carve up. It was not even a business before. It was just some divisions.
By putting this together, getting it more focused, getting the Capstone team inside, we were able to identify €105 million of cost savings that we could realize in this business. That is over 20% of the company’s cost base. We have already realized 50 of these cost savings and effectively created a lot of value by doing this.
The last example is Epicor, the transaction that we did here in the states. The reason that I picked it is that it was a company that we bought from another private equity firm, in this case, Apax. You may say, ‘Well, if somebody else owned it, there is probably not much left to do.’ That is really not very often the case. Very often, we find other people that we compete with do not have the same focus on operational value improvement.
We were able to go in there and in this case, again, we have hired a new C-suite here. But what we had identified was really not necessarily a cost-cutting approach. This was focusing on how can we drive the top line. We had a Capstone team in there focusing on CRM, focusing on pricing, effectively better running the funnel and trying to improve sales growth in this business. A team that was working very actively with the management of Epicor to try to aggressively drive growth in that business.
Three separate examples of focusing on cost, of focusing on growth where we are actively working with the companies to improve their operations and in that way generate alpha and generate return for our investors.
The reason that we are spending time on it is to really explain it is not all about picking stocks. It is really about working with the companies and improving their operations. It is through that that we generate value for our investors.
KKR’s Value Creation Approach: Panasonic Healthcare
I have got one more example that I wanted to spend a bit of time on because this is an area where we see so much value. It sort of highlights a number of things that we do well.
In the late 1990s, early 2000s in Europe, what we saw is we saw an opportunity where there were some very large existing conglomerates like Siemens or Daimler in Germany, like Schneider in France. Where we could go to those conglomerates and say, ‘Part of what you need to do is focus and sell us one of your businesses.’ Then those businesses, we were able to improve significantly.
We have taken this playbook to Japan where you have significant conglomerates. Those conglomerates are under exactly the same pressures. They need to focus. We have been able to basically convince them to work with us to improve their portfolios. We have done that with Panasonic. I will spend a minute on that in a second but also we have done it also with Pioneer, we have done it with Nissan and we have done it with Hitachi. We think there will be significantly more opportunities. These are all scale opportunities where we can create significant value.
Firstly, when we bought this business, it was a complex carve out. Again, it was not that simple to buy this out of Panasonic in 2014. We then worked with our colleagues from KKR Capstone to improve the operations in this business. Focus on procurement, effectively focus where before that was all done at headquarters across all of Panasonic, they now could do this themselves. It turned out that they could do it a lot more efficiently than they had done it before.
About a year and a half into this acquisition, we identified an opportunity in Europe that Bayer AG, the large chemical company was selling. They were selling a diabetes care business which was going to fit extremely well with Panasonic Healthcare. The European team worked together with our Japanese team in trying to convince Bayer to sell this to us.
We were able to get the Japanese bank to finance that business with 100% debt in that acquisition. There was not a lot of competition here. It added significant value to Panasonic Healthcare through synergies.
In the beginning of 2017, we were able to sell a 22% stake to Mitsui. We returned 1.7 times our cost in cash and the business is currently marked at 4.3 times cost. It is an example of how we can create value across different geographies by using our active value creation approach.
KKR Well Positioned To Continue To Deliver Results in Private Equity
With that, I am going to finish up by just going through the key themes. We currently see the macro being pretty strong. We see that reflected in our portfolio on a global basis. Our portfolio is performing very, very well. That has resulted in some very good returns in our private equity business.
We have a strong global team that works on an integrated basis with significant experience. We have got $34 billion of dry powder in our private equity business so a lot of money that we can deploy. As I said before, we have got a business that is very profitable that is generating good cash and that has significant growth opportunities going forward. With that, I am going to hand back to Craig. Thank you very much.
Craig Larson: Thanks, Johannes. Just first from a schedule standpoint so everybody knows, Pete Stavros is going to be up on stage here in a minute. We then have Ralph Rosenberg who is going to run through our real estate business. After that, we will take a 10- or 15-minute break.
Ahead of Pete’s presentation, I wanted to provide a minute or two of context. It actually builds on one of the things that Johannes said a few minutes ago. I do think when many people think about private equity and really the industry as a whole, they can think that we buy companies, we put a lot of leverage on these businesses and we hope multiples go up.
Now, of course, that really would not be much of a business model. That brings us to Pete’s presentation. Pete is the head of the industrials vertical within our US private equity business. He is also a member of the investment committee for our US private equity business. We really asked Pete to touch on three things. First, at a very granular level, how we look to affect operational change within the portfolio of companies that we invest in as a control investor.
The second thing is Pete has a couple of interesting examples in here how we can be the second or third sponsor, and again, recognizing the focus we have on operational improvement, how we are still able to see operational change in the framework of those companies.
Then thirdly, again, it is a very interesting piece as part of this, but how as part of all of this we actually can do some pretty neat things for the employees of those companies in which we invest. With that, I am pleased to turn things over to Pete.
DisclaimerInvestor Day podcasts and corresponding transcripts have been prepared for KKR & Co. Inc. (NYSE:KKR) for the benefit of its public stockholders and is not intended to be a solicitation or sale of any of the securities, funds or services that they may discuss. Please find a copy of the presentation here.