Inside the Minds of Kravis, Roberts Private-Equity Icons
Opine on Their Craft; 'Any Fool Can Buy'
By HENNY SENDER
January 3, 2007; Page C1
New York
In the midtown Manhattan office of private-equity icon Henry Kravis, an eclectic collection of books competes for shelf space with Lucite "tombstone" trophies commemorating Kohlberg Kravis Roberts & Co. takeover deals. The tombstones seem to be winning.
KKR pioneered the buyout business in the late 1970s and did the first leveraged buyout of a publicly traded company when it bought Houdaille Industries in 1979 for $355 million. Even as the private-equity business has mushroomed in the past few years, KKR still owns bragging rights for the biggest deal ever: the $25 billion buyout of RJR Nabisco in 1988.
Since its opening, KKR has done 145 deals and now is among the small handful of so-called megafunds that have investment war chests of more than $100 billion and are rapidly snapping up companies around the world.
Last year, KKR invested $6.9 billion in 12 companies and participated in about $104 billion of deals. It is expanding outside the U.S. through a $4 billion fund it is raising in Asia as well as a €4.5 billion ($5.9 billion) fund for Europe. In total, KKR has $30 billion to invest.
Private-equity firms have become some of the biggest employers in the nation. Mr. Kravis and his cousin George Roberts, who are presiding over an expansion of the firm, head an investment company that has 35 portfolio companies with $95 billion in annual revenue and about 540,000 employees.
At a time when private-equity firms are the object of growing scrutiny, Messrs. Kravis and Roberts sat down to discuss how the world has changed -- and how it hasn't -- since the early days of KKR. Mr. Roberts, who is based in Menlo Park, Calif., was on speaker phone.
Perhaps the most surprising change? KKR is no longer the "barbarian at the gate," a term popularized when it became the title of a book that chronicled the RJR Nabisco takeover.
Like their counterparts at other top private-equity firms, Messrs. Kravis and Roberts believe that management disillusionment is helping to drive the vast expansion of private-equity investing.
"Managements want to take the long-term view, but they know they get clobbered in the short term," says Mr. Roberts. "A lot of companies want to start new projects but they can't because they are afraid of the hit to quarterly earnings, even though it may be right in three to five years. When we say our average hold [before selling the company or taking it public] is seven years, they sit up."
"There is a constant churn in the share ownership of public companies," adds Mr. Kravis. "Activist shareholders beat up the company because the stock isn't going up. Our size and indifference to quarterly results may make chief executive officers and boards take us more seriously."
Of course, private-equity investors like KKR want -- and expect -- good results from their portfolio companies. Their mission: to clean up and turn around the company, making it attractive to a buyer in the public or private market.
That can mean ruthless cost-cutting or movement of jobs to cheaper markets in Asia or elsewhere, moves that fuel criticism of the buyout firms. Private-equity advocates say the process makes firms leaner and more competitive.
KKR, like other big firms such as Texas Pacific Group, Carlyle Group and Blackstone Group, are swimming in cash, raising whopping multibillion-dollar funds with ease. "I have never seen a time like this when money is so available and so global," Mr. Kravis says.
The two cousins recall what it was like when they did the $355 million purchase of Houdaille 28 years ago.
"We had to figure out how much bank debt was out there. We enlisted five banks and none of them are around today," says Mr. Roberts. "Now fast-forward 27 years and finance is a commodity and the debt is sold to institutions all around the world. Today banks will [underwrite] $15 billion of senior debt."
Still, both men insist that the heart of their business is not financial engineering.
"We spend only about 5% of our time on that," says Mr. Kravis. "It's all about how to make better operating decisions [at our companies]. We have deeper teams. Our processes are better. We have formalized plans before we buy. We also make decisions more quickly on things like whether we have the right management structure."
"We hold managements to higher standards because we pay closer attention," adds Mr. Roberts. "In a public company ownership is so diverse."
Critics believe that the private-equity buying binge is loading too much debt on target companies. Messrs. Roberts and Kravis believe the debt issue is overblown.
"In 1987, the average deal was 93% debt and 7% equity," notes Mr. Roberts. "In 2006, the average deal had 33% equity and 67% debt. Given that the average company in the Standard & Poor's 500-stock index is now eight times the size of 20 years ago, that means 32 times the amount of equity of the old days to do a comparable deal. That is why we don't believe there is a bubble."
But they concede it is possible that some companies controlled by private-equity firms may get into trouble. Some may even end up in the hands of hedge funds that buy the debt of troubled firms in the hope that that debt eventually converts to equity in a bankruptcy restructuring.
"Private equity isn't riskless," says Mr. Kravis, speaking generally. "Some investments won't work out." RJR Nabisco, probably KKR's best-known deal, turned out to be a clunker. But, "even if a firm loses $1 billion on a particular deal, it's not good but it won't break the firm, given that even $1 billion is a small amount of the total size of the funds we manage."
Mr. Kravis also thinks the proliferation of deals hasn't reached a manic phase.
"It may seem like deal frenzy today," says Mr. Kravis. He says people don't decline to do deals because there are so many deals and so many players. Instead, they do deals if the deal makes sense. "The dollars are substantially bigger, but on a per-firm basis it isn't so different since we have grown our resources and human capital so much."
All this is a far cry from KKR's early days. "In 1981, we did eight deals, interest rates were 21% and the economy was not doing well," Mr. Roberts recalls. "As a firm we were a lot more stretched then. There were six of us in the firm."
The other big change in the industry is the global reach of the big U.S. private-equity firms. "Fifty percent of the money raised comes from outside the U.S. In the 1980s everything was domestic," says Mr. Kravis. "In 2006, eight of the 12 deals we did were foreign."
Next year, they see even more foreign spending sprees in more obscure places. In addition to its core hunting grounds at home, in Europe and in Asia, the firm may look more closely at Eastern Europe, Turkey and South Africa in the future, Mr. Kravis says.
What could bring the boom in private-equity activity to an end? The two said they haven't spent much time focusing on the issue, but they have two concerns. The first is financial protectionism.
"If there is more protectionism, if there were limitations on investment in the U.S. and capital flows were cut off, that could have an impact on liquidity," says Mr. Kravis.
He also worries about derivatives, which have become a major source of investment capital. "There are staggering amounts of derivatives," he says. "If there are difficulties and counterparties start to default, that could pose problems" for private equity and other parts of the market.
One thing that hasn't changed in the decades of private equity? "Any fool can buy a company," says Mr. Kravis. "You should be congratulated when you sell |
