Our 2007 Business Highlights

2007 was a year of transition for the private equity industry, with the healthy economic environment for buyouts in the first half of the year deteriorating in the second.  Concerns about the sub-prime mortgage sector, a supply-and-demand imbalance for LBO debt and other factors led to a sudden re-pricing of risk in the summer.  The severe challenges in the leveraged loan and high-yield markets sharply curtailed deal activity in the second half of the year.  As we enter 2008, uncertainty about the economy, particularly in the United States, but also in Europe, poses challenges for many industries and businesses, including those financed by private equity.

Despite this difficult environment, 2007 was a very good year for our firm and our limited partners and we see many more reasons for optimism than pessimism in the years ahead. In 2007 we invested $15.2 billion of equity in 14 companies that have an aggregate enterprise value of $144.5 billion. In total, our funds distributed $4.3 billion in 2007 and more than $23.6 billion in the past five years.  Our fundraising initiatives included closing the $17.6 billion KKR 2006 Fund and the $4.0 billion KKR Asian Fund.

We took advantage of the abundant liquidity in the leveraged loan and high-yield markets in early 2007 to acquire several large national and global brands, including First Data Corporation, Energy Future Holdings (formerly TXU Corp.), Alliance Boots, Dollar General, Biomet and U.S. Foodservice. We were able to lock in flexible, low-cost, long-term financing terms that are unlikely to be replicated in the near future. Such financing will enable these companies to pay down debt while investing in future growth and competitiveness. We believe that when we have executed our value-creation strategies in the coming years, the companies we acquired in 2007 will produce overall returns that are significantly above those of public markets and compare favorably with private equity industry benchmarks.

As with all our investments, our acquisitions in 2007 were made with an eye toward the inevitable turn in the business cycle.  Our general approach to private equity has several characteristics that are designed to ameliorate the impact of an economic slowdown.  Our focus on the large end of the buyout market is driven, in part, by the relative lack of volatility in global franchises.  These companies tend to attract the best senior managers, whose experience generally includes successfully managing through downturns. Although the macroeconomic environment and markets impact all forms of investing, our portfolio comprises discrete investments in diverse industries and geographies.  Our control positions allow us to exert more influence on the performance of our businesses than other asset classes.  We decide not only what companies to buy, but also how to improve them and when to exit them.

Our careful approach to capitalizing portfolio companies was documented in a January 2008 Moody’s research report, which singled us out as more conservative in acquisition financing than other large private equity firms.  The report noted that only one of our portfolio companies had a debt-rating downgrade between 2002 and 2007 and that “KKR was the only firm to have more upgrades than downgrades.”  FridsonVision, a publisher of independent research on credit topics, built on the Moody’s study, quantifying the incidence of distressed debt in buyouts and concluding that our firm “can make a fairly strong claim to superior performance.”

Over the past two years, our industry teams have sought out companies that not only are great franchises, but also would likely perform well in a more challenging economic environment.  Examples of such investments include First Data Corporation, a global provider of electronic commerce and payment solutions for merchants, financial institutions and card issuers.  The continuing shift from cash and checks to electronic payment transactions is a secular change in commerce unlikely to be reversed.  We expect that Biomet, a leading international manufacturer of orthopedic devices, will benefit from both an aging U.S. population and improvements in implant devices that can benefit younger patients.  Alliance Boots has the largest portfolio of pharmacies in the United Kingdom, where sales of prescription medicines and over-the-counter pharmaceuticals have been very stable and largely immune to the economic cycle.

Economic headwinds will adversely impact some portfolio companies more than others.  We have no more important priority, particularly in a tough economy, than monitoring closely our portfolio companies and taking action to address major challenges.  Our portfolio management committee, which includes investment professionals and senior advisors with extensive operating experience, instills discipline into the process of reviewing the financial and operating performance of our portfolio companies.  This committee ensures that value-creation strategies are executed and it focuses particular attention on investments that are underperforming.  The professional capabilities we make available to our portfolio companies include the industry expertise of our investment professionals, the operational skills of KKR Capstone executives, the experience of our senior advisors and other specialized resources.

Our business has never been risk free.  Yet we believe that our portfolio of private equity investments will continue to perform well relative to other asset classes.  Over the past 32 years, we have invested successfully in high- and low-interest rate environments, liquid and illiquid credit markets and periods of economic expansion and recession.  Such consistent performance is not an accident.  It is a consequence of experience and a disciplined approach to long-term value creation.  We buy great franchises for reasonable prices, we partner with quality management teams, we develop appropriate capital structures for our portfolio companies, we create value largely through improvements in business operations and EBITDA growth and we determine the optimum timing and method for exiting an investment.

It is our belief that difficult markets play to our fundamental strength – the ability to finance, acquire and improve portfolio companies.  The U.N Ro-Ro and Northgate Information Solutions acquisitions, which closed in December 2007 and March 2008, respectively, demonstrate our ability to execute transactions in tough markets.  Our investment in Legg Mason, which closed in January 2008, shows how proactive deal sourcing and industry expertise lead to proprietary opportunities.  With a portfolio of companies that are diverse in geography and industry sectors and with KKR Capstone’s ability to drive operational improvement initiatives, we believe that our portfolio companies are well positioned to weather difficult economic times.

Over the years, our firm has grown from a handful of members, associates and support staff to more than 400 employees worldwide.  We have also adapted our business to changes in the private equity market. In 1998, for example, we recognized that a global footprint was a requirement for continued industry leadership.  Since then, we have opened offices in London, Paris, Hong Kong and Tokyo.  In early 2008, we established new offices in Sydney and Beijing.

What has not changed at our firm are our values and culture, which we believe have been central to our long-term success.  The fundamental value, upon which all others rest, is integrity.  In practice, this means honesty with our investors, portfolio companies, financial and other service providers and all internal and external constituencies with whom we interact.  We invest in companies and work with people with whom we are proud to associate ourselves.  We strive to be the best at what we do and we are not afraid to assume prudent risks to achieve an appropriate return.  We hire and promote high-intensity self-starters who are analytical, disciplined and results-oriented team players.
We are pleased to report that in 2007 Ken Freeman, Craig Farr and David Sorkin were appointed Members of our firm.  Ken, the former chairman and chief executive officer of Quest Diagnostics Incorporated, joined us as a managing director in 2005 and has taken an active role in managing our investments in Masonite and Accellent.  Craig, a former managing director at Citigroup Global Markets and co-head of North American Equity Capital Markets, joined us in 2006 and is co-head of our Capital Raising team.  David, a former partner at Simpson Thacher & Bartlett LLP and a longtime advisor to us, joined our firm in late 2007 as general counsel.

Heinz-Joachim Neubürger, the former chief financial officer of Siemens AG, joined our London office in 2007 as a managing director.  Shusaku Minoda, the former managing executive officer of the Global Investment Banking Group of Mizuho Corporate Bank, was appointed a managing director in Tokyo and the chief executive officer of KKR Japan.

To support our ongoing global growth, we made three other senior executive appointments in late 2007 and early 2008: Bob Gottlieb, who spent nearly 20 years at Goldman Sachs in senior human resource management and administrative functions, was named chief human resources officer; Peter Fasolo, former vice president of Global Talent Management at Johnson & Johnson, joined KKR as chief talent officer, North America, to help assess, recruit, train and coach management teams at our North American portfolio companies; and Ed Brandman, a highly experienced technology executive, joined us as chief information officer, responsible for global technology and information strategy.

We also strengthened our team of senior advisors, all of whom have held leading positions either in major corporations or in public agencies in the United States, Europe, or Asia.  Senior advisors contribute to our success by serving on the boards of portfolio companies, helping us evaluate individual investment opportunities and assisting our companies with operational matters.  Senior advisor appointments in 2007 include: Sanjiv Ahuja, former chief executive officer of Orange SA; Thierry Breton, former French Minister of Economy, Finance and Industry; Richard L. Clemmer, former chief executive officer of Agere Systems; and David M. Cote, chairman and chief executive officer of Honeywell.  In early 2008, we made the following appointments to our team of senior advisors: John F. Bookout III, former director of McKinsey & Company; Lee R. Raymond, former chairman and chief executive officer of ExxonMobil; and Wolfgang Reitzle, president and chief executive officer of the Executive Board of The Linde Group.

As 2008 progresses, we believe that we will continue to see good investment opportunities and that financing will be available for transactions by leading private equity firms.  Some of the best investments in our firm’s history were made in periods of economic uncertainty.  Valuations for potential portfolio companies are becoming increasingly attractive and interest rates remain low when compared to historical standards.  We believe that in a less robust environment for mergers and acquisitions, our strength in deal sourcing, our industry expertise and operational skill set and our outstanding reputation with market participants will provide opportunities for us to distinguish ourselves from competitors.