Quantum Yields

It was difficult to not notice KKR’s 30% slide since peaking at $167/share on January 31^st . Part of this selloff, in my view, is driven by macro-economic uncertainty, partly by KKR’s high valuation, and lastly by KKRs recent announcement of share dilution via their capital raise. Let’s drill down into the latter. Essentially, they are raising up to $1.725B through selling preferred stock. This expected injection of capital is offset by increasing the total number of outstanding shares which dilute current shareholder equity. They state the specific purpose for this cash raise is for “acquisition of additional equity interests in core private equity companies in its Strategic Holdings segment and for other general corporate purposes”.  It’s important to recognize because this capital raise is indicative of one or more possibilities, including:

• Liquidity issues
• Solvency issues
• They see an attractive opportunity given their share price

Let’s quickly cover their liquidity and solvency issues using year-end 2024 financial statements. To check their liquidity and solvency status, we’ll assess several ratios to see if this is truly an issue. See the table below for metrics, what they measure, and what ranges indicate warnings.

Of all these metrics, the cash flow test poses a concern. KKRs’ operating cash flow ($6.6B) is much smaller than its current liabilities ($53B), which in this case is primarily interest payable. I mentioned in my prior blog how much debt KKR has taken on to fund growth. This could be a concern and here’s why. In addition to cash generated from operations, KKR holds $218B in current assets with $15B in cash and $97B in short term investments. The remainder is about $105B in receivables. Given this, there may be concern in these market conditions where everything is getting sold that the value of KKR’s current investments may also be declining in value, reducing their ability to cover interest, thereby reducing cash available for investment into growth opportunities and therefore compounding the pressure on its share price.

What reasons would a company choose to dilute shareholders for the sake of raising capital? KKR has sufficient cash on hand and could have used that cash to repurchase shares or to do exactly what they’ve proposed in this issuance. Given the froth in the market lately driven by optimism over AI, I believe KKR had been eyeing an opportunity to do this knowing their share price is probably overvalued compared to their peers, which I pointed out in my previous blog post, at 20.45% EV/AUM. If that was the case, then the capital raise makes sense but probably just very poorly timed given added pressure from macro factors.

Digging a little more into their capital raise, what companies make up their Strategic Holdings Segment? According to their 10K this segment consists of 18 companies they’ve acquired through their core private equity strategy. These are companies in which they’ve acquired and manage controlling interests in and plan to hold over a “longer period of time”. This strategy of buying more equity in such companies is very similar to the way Berkshire Hathaway operates and indicates management’s growing confidence in their core assets. It’s worth noting they did add that this funding will also be used for “general corporate purposes”, which does not strike a comforting tone to investors, but I’m hoping the primary use of these funds is to grow their equity in solid companies.

In conclusion, I see this as likely a smart move by the company which should generate incremental returns in the long run, but I’ll be watching what more the company says of this issuance in the near future.  If you believe market conditions will improve and that the U.S. consumer will ultimately prevail through what this administration is doing on the economic front, then KKR should continue to perform well going forward and this may be the time for those patient, disciplined investors to start buying.  

This brings me one of my favorite quotes from one of the greats: “Be fearful when others are greedy and greedy when others are fearful”. – W. Buffett