Jul 09, 2018
Scott Nuttall and Joe Bae, Co-Presidents and Co-COOs, share their personal backgrounds and the four main takeaways for Investor Day.
Positioned for Continued Growth
Joseph Bae: Good morning everybody. My name is Joe Bae and I am here with Scott Nuttall, my Co-President of the firm. Thank you again for coming today for the 2018 Investor’s Day. Before we get started on the presentations, we thought it might make sense just to give everyone in the room a couple of minutes on our own personal backgrounds.
So as Henry mentioned, Scott and I joined KKR back in 1996. We were the two analysts that year that KKR was hiring in our New York office. We were both 24 at that point in time. So we have spent the last 22 years working together here at KKR. For me, I started with my first ten years at the firm in our traditional US private equity business. So that was really ‘96 to 2005. And in ‘05, I was asked by Henry and George to move to Asia to start building out our business in that region really from the ground up and for the next decade that is really where I spent most of my time and attention, building out our Asia Business. Today, we have eight offices in Asia, around 150 executives and close to $18 billion of assets that we manage in the region. In 2015, I moved back to the US and was asked to take on the additional role of oversight for our global infrastructure business and our global energy businesses until the recent change Henry mentioned in July of last year where we were asked to be Co-Presidents of the firm.
Scott Nuttall: So as Joe said, we had the same start. We were the two analysts hired in New York in 1996 and we had our offices next to each other. So we actually grew up working on private equity deals together. I was a private equity investment executive for a number of years. Then about the same time Joe moved to Asia, I started to shift my attention to, really, three different areas. The first was building non-private equity investing businesses for the firm. The first and largest of which was in credit. The second major area of focus for me turned to distribution and how do we get more people to invest with us and alongside us and also how do we monetize our ideas to a greater extent. Working with a big team, we now have our client and partner group and our capital markets business as a result of those efforts. Then the third area of my focus was really permanent capital. How do we create more permanency to our capital base, extended duration of our capital base and ideally have capital for the firm to invest off its own balance sheet? So I have spent the last 10 to 15 years really focused on business building, distribution business building and strategy.
As Joe mentioned, we joined together at age 24, we have been close friends from the beginning, which I think is a really important element of this. It is a lot of fun to do this job with a great friend and Henry and George have been friends, mentors, partners for over 20 years. We are having great time working together and we have an extraordinary group of colleagues around the world, some of whom you are going to hear from today.
So, we are really excited to take you through our story. We have a lot of exciting aspects of what we are up to that we want to share with you. With that, let us kick it off.
Joseph Bae: Thanks, Scott. We have a lot of content to share with you over the next four hours. You will be hearing from all of the senior leaders of our firm and very exciting growth opportunities ahead of us but what we thought we would start with is really what we hoped you would take away today summarized in a couple of bullet points.
Positioned for Continued Growth
So, the four key takeaways. First is the alternative asset management industry itself is a very large and growing industry. Growing at double digit rates over the last ten years and projected to double in size by 2025. Within that very attractive industry dynamic, we are absolutely taking share, as Henry mentioned, both in terms of diversification of our product and geographic diversification. While the industry has many participants today, when you hear the story, I think hopefully you will walk away understanding we have a differentiated model that is different from our major peers in the public markets, our comps, as well as the private competitors in this space. We marry large scale third party capital with our own permanent capital on the balance sheet and what sits in between that is a large and effective capital markets business, which ultimately allows us to maximize the economic participation in all the activity we do at the firm and allows us to compound value and shareholder value sustainably.
Third, while we are a 42-year-old firm today, it is really our US private equity business that is 42 years old. We are the youngest 42-year-old firm you are ever going to meet. Most of our businesses have actually been launched in the last ten years. We will spend some time talking about that. Many of these businesses are at an inflection point where they are just starting to kick in significant contribution to earnings and carry. The opportunities are both global and scalable. Perhaps most importantly, our alignment of interest is absolute with all of you in this room. KKR and its executives own 40% of our public shares. We wake up every day thinking about shareholder value creation. We believe this recent change to C-Corp is an important milestone in unlocking that value for all of us in this room. As Henry mentioned, none of this would be possible, obviously, without investment performance and we are extremely proud of our 42-year track record in this regard.
The Alternative Asset Management Industry is Growing
So let me start a little bit with the industry. Again, our industry is a very attractive growth segment today. It has compounded at over 11% and again expected to grow to $21 trillion in AUM by 2025. What is driving this growth is a handful of strong tailwinds, secular growth trends. Our limited partners, which are typically large institutional investors and pension funds, are in search of yield and return today. If you talk to any CIO of a major pension plan in the US, they will tell you the alternative space, private equity in particular, has been their best performing asset class for probably the past five to ten years. So there is more allocation going to alternatives. We are seeing the emergence of new classes of investors around the world. In Asia, the Middle East in particular, the emergence of large sovereign wealth funds who have not been allocating to private equity and alternatives for the past 35 years, like many US pension funds have, but who are just starting to enter the market in the last five years. You are starting to see insurance companies and high net worth investors also start allocating meaningfully to private equity and alternatives.
Beyond the investor side and the capital side, you are also seeing an increased importance in terms of the role that we play in the markets. We have seen a retrenchment of banks, a pullback of risk taking, a shrinking of balance sheets across Wall Street. Governments around the world are stretched in terms of budgets. They do not have the capital or the money to invest in infrastructure and other asset classes that they desperately need. Finally, shareholder activism. We are seeing this as a unique opportunity where a firm like KKR can really lean into the complexity, work with activists and companies to provide solutions to the problems that they have.
This is what we are hearing consistently from our investors around the world. This is the most recent Preqin study of large pension funds and institutional investors, and there is absolutely an intent and a desire to increase allocations to the alternative space on a go-forward basis. Particularly in the areas that we are focused on today. Private equity, private credit, real estate and infrastructure. While this industry has very strong growth dynamics, I think what we are particularly proud of is that within this context we are taking share. Our AUM growth has been north of 20% over this time frame and we expect in the next five to ten years, as we continue to scale some of the new products and strategies globally, we will continue to grow faster than the overall industry.
Driven By Innovation and Diversification
As Henry mentioned back in 2007, so this is ten years ago, we were predominately a private equity firm. We had global reach in the US, Europe and Asia but that was really the extent of our PE franchise. We did not have any presence in real assets. So in real estate, energy and infrastructure, we had 0 AUM under management. In the public markets, we were effectively in the liquid credit space. Bank loans and high yield bonds. Capital markets was a nascent business, helping us to finance our own buy-out transactions but very limited in the scope of what they do. If you roll the clock forward to where we are today, a little over ten years later, you can see the dramatic diversification of our business. In private equity, we have not only continued to scale our traditional flagship products, but we have growth equity investing, we have core equity investing. In real assets, we are building large scale platforms now in infrastructure, in energy. In the public markets, again, we have expanded from two liquid credit strategies to a broad range of specialized credit strategies and today operate as one of the largest private credit providers in the US. Finally, capital markets, which Scott will spend a lot more time talking about, we have gone from financing our own portfolio companies to being a meaningful player of third party financing to the street, to mid-cap sponsors, also getting in the equity underwriting business in terms of IPOs and creating specialty finance platforms, like our platform in India.
Our goal is to be a top three player in every one of the strategies that we decide to enter. We are not going to be all things to everybody and we are not going to be great at everything, so our job is to really focus on those strategies, those product lines, those geographies where we can have a sustainable competitive advantage and get to a top three position.
Our Business Has Been Scaling
We have been scaling. So in our largest business, private equity, in 2010 when we went public we had $45 billion of AUM. Today that business is $81 billion, around 1.8x. In energy and infrastructure, again, we started from a very low base of $1 billion at the time we went public. Today, that is $15 billion of AUM. In real estate, we had 0 back in 2010. You are going to be hearing from my partner Ralph Rosenberg about the progress we have made in real estate and today we manage $6 billion. A similar trend in the public markets. In hedge funds, we had zero presence in 2010. Today we manage around $29 billion of AUM. Leveraged credit has nearly doubled from $13 billion to $25 billion and again, in private credit and alternative credit, we have made a dramatic jump in our market share, in our industry positioning from $2 billion to $34 billion in size.
KKR AUM Growth
Scott Nuttall: So, if you add up all this work on the diversification and the scaling front, this is what the AUM trajectory looks like. So, since we have been a public company, we have gone from about $60 billion to about $190 billion. If you look at the make-up, the majority of our capital that we are managing today is actually not in private equity. Our pure private equity is about 37% of our AUM and non-PE is now 63%. If you look at management fees, you will see a similar trajectory, a significant amount of growth over the course of the last several years and if you look at the split, it is about even now between private equity and non-private equity.
KKR Management Fee Growth
If you look at performance income, and this is really our carry plus our incentive fees, the definition we are using here, a couple of things on this topic. One, we do not think this is that well understood. The first obvious takeaway from the chart is that it is up and to the right. The second thing is what we are going to take you through in more detail later, is it is much more consistent than what the market thinks. The third thing that is really not that well understood, and we are going to spend some more time on with you today, is the right-hand side of this chart. If you look at our realized performance income, over 90% of it has been coming from private equity. Remember I just said that only 37% of our AUM is pure private equity. So we are under earning our carry potential as a firm meaningfully. The reason for that is a number of the businesses we have created are relatively young. So, there is dollars invested in the ground with a carry right and they are just starting to mature. So we expect that non-private equity component of performance income to scale considerably from here. We will take you through what we think that will look like over time. We also believe the private equity carry will grow at the same time. So a lot of upside further up and to the right on this chart.
KKR Book Value Per Share Growth
Book value is another metric we look at. I am going to break it into two periods of time. The first is 2010 through 2015. That is the period of time where we were paying out about 70% of our cash flow in our dividend. Over that period of time, you can see that we paid over $7 per share. We changed our distribution policy in the fourth quarter of 2015 to go to more of a fixed distribution so that we would compound our balance sheet. You can see the book value per share is just starting to compound in a very meaningful way and we think there is a lot of upside from here. So total distributions, as Henry said, nearly $9 per unit since our listing, broken into those two periods. We think this compounding of book value is a big opportunity for value creation on a go-forward basis.
Building Blocks for Future Growth
So, when we step back, we see an extraordinary amount of opportunity for growth. As Joe said, we are a 42-year-old firm, we are the youngest one you will ever meet because so much of what we have been doing has been created in the last two to ten years. We are in an industry that takes about ten years to start to achieve scale. So massive amount of opportunities.
There are really five building blocks for this growth opportunity. The first is continued performance of our flagship strategies, which have been performing great. We see continued opportunity for those to perform and grow. The second is growth and scaling of our newer strategies, both in terms of AUM and fee opportunity but also, as I said, as this latent carry opportunity already invested in the ground. The third is we are still building things. Many of our businesses have been started in the US and Europe and we are just now starting to think about bringing them to Asia. High priority for us, Asia real estate, Asia credit. There is a lot of businesses that we still see opportunities to create on a go-forward basis. Next is this concept of compounding, which is consistent throughout everything we are doing. It is both balance sheet and AUM. Finally, our model of AUM plus balance sheet plus capital markets allows us to capture more of everything that we are doing, and it is meaningfully more economics from every activity that we have. If you put all those together, there is a significant multiplier effect on all of our metrics.
In Order to Double Earnings and Book Value by Year 5
So we asked ourselves the question, we obviously doubled our AUM, our revenues, our profit, our book value now multiple times over and we thought we would spend a little bit of time on just a question, what do you need to believe to double our earnings and our book value per share again over the next five years?
So by way of background first, what did we do over the last ten years? Fee paying AUM grew from $40 billion to $133 billion. So, a 13% annual growth rate. Last ten years, if you look at management fees plus capital markets fees, they grew from less than $300 million to over $1.3 billion. So over $1 billion increase, a 16% annual growth rate. So that is just context as we sought to answer this question as to what do you need to believe to double again in five years.
The first answer to the question is if you believe just 8% fee paying AUM growth from here, you more than double. We think that is an incredibly conservative assumption, given what we have done historically and the fact that we have a number of young businesses that are now reaching real inflection points. It is also incredibly conservative by virtue of the fact that we already have $25 billion committed to us in AUM that is not yet in fee paying AUM. It will actually turn on the fees when it is invested but it is already contractually committed and there is an even more conservative capital markets growth consumption behind this. To be clear, we expect to do a lot better than this, but this is all you would have to believe.
From a return assumption standpoint, same thing, here is all you would have to believe, 17.5% gross returns before fees and carry for private equity and growth equity. 5% leveraged credit and 13-15% for a number of our other carry bearing strategies. Again, much less than we have been achieving historically.
So our goal is to exceed this level of performance, to be clear. We would be very disappointed if this is all we achieved. But if this is all we achieved, here is what the numbers look like.
KKR Looking Forward
So last 12 months, we have made $1.4 billion of distributable earnings. That is basically our pre-tax cash flow. If you use the numbers I just walked through in terms of the assumptions, in year five that becomes $3.2 billion, so more than a double. Part of the reason you got more than a double is carry kicking in from the dollars we have already invested across all these newer strategies. If you run that out to year 10, you get to five billion dollars. Book value per share, same assumptions running through, $14.56 as of Q1. In year five, it is $32. Back to this power of compounding. In year 10, it is $63. Again, our goal is to exceed this level of performance.
So Joe and I wanted to start with you with the high level and the punchline, which is what we just walked through. But now what we want to do is turn our attention to how we got here. So there is two more things we want to talk to you about in terms of main topics. The first is the foundation building we have been doing in the last ten years to get to this point and then the second is looking forward: what are we focused on in terms of how we build from here and achieve our potential?
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.