Greed is not good for US corporate titan
In 1987, Henry Kravis attracted the attention of the world with his audacious US$31.4 billion bid for RJR Nabisco, at that time the world's biggest buyout.
The deal came to epitomise 'the greed is good' culture that many associated with Wall Street in the 1980s and was immortalised first in a book, Barbarians at the Gate, and then a film. Kravis was a poster boy for the period. But the film's depiction of Kravis as an ice-cool greed-driven Gordon Gekko-type is far from the truth, although he is fabulously wealthy, measuring his wealth in the billions, with at least four luxury homes. Together with his wife, economist Marie-Josee Drouin, he's a prominent figure on New York's social scene. His wife is an influential figure in her own right, sitting on corporate boards and think tanks and the president of the Museum of Modern Art in New York. They are the ultimate power couple.
In Hong Kong recently to meet investors, Kravis comes across as genuinely charming. He is short but immaculate in a grey suit and looks fit for his 66 years. He has a southern edge to his speech as he talks about the origins of Kohlberg Kravis Roberts and how it grew into one of the leading private-equity companies.
When KKR opened for business in 1977 with Kravis, his cousin George Roberts and Jerome Kohlberg, it specialised in what was then referred to as bootstrap financing. It came to be called leveraged buyouts, before the current term private equity was adopted. The three partners had worked at Bear Stearns together and saw a business opportunity for this kind of financing, which was new at the time but has since grown into a multibillion-dollar industry and has been responsible for some of the world's biggest corporate takeovers.
However, Kravis seeks to put a little distance between his firm and Wall Street. 'We are not a finance firm per se - we pay fees to Wall Street firms.'
Buyout companies typically made their money by attracting funds from investors like insurance companies and pension funds that wanted to make higher returns than they could get from stocks or bonds.
They bought companies using some of the cash investors had given them, but largely by borrowing funds backed by the assets and revenue streams of the target company. As a result, the target became saddled with debt and the buyout company sought to maximise revenue from the company to pay off the debt, to pay its own management fees and to increase profitability. The idea was to sell it later or to list the company on an exchange, to produce profits for itself and its investors.
It's a process sometimes described as 'pump and dump': to achieve the necessary high returns, assets are sometimes sold off, and there are lay-offs and so on. Warren Buffett in particular has fulminated against this, saying that the increased debt load that accompanies leveraged buyouts puts some companies 'in mortal peril'. However, Kravis calls this approach financial engineering and says KKR buyouts differ significantly in that they operate from the perspective of an industrialist.
'An industrialist works his business. He's focused on how to improve it and grow it, and to develop new markets. He invests in research and development to come up with new products,' Kravis explains. 'This is what we do - it's a big focus.'
KKR seeks to increase the value of companies by improving them in profitability and revenue growth. It does this through a very detailed study of the company's metrics. 'You'd be surprised how few companies have good metrics, that measure every step of the manufacturing process, labour time, supply chain, productivity and so on.'
Kravis says that another way KKR differs from other investment firms is that it doesn't 'have an eat-what-you-kill culture', like - for example - Bear Stearns. 'At Bear Stearns, you'd lock your desk at night so that people wouldn't steal your ideas.
'Everyone is part of the team at KKR. Everyone from the tea lady to the managing partner has a stake in the firm. We operate as a partnership both with the companies we invest in and within KKR.'
Over the years, KKR has also changed and extended its operations. In addition to its private-equity business, it runs an oil-and-gas business and an infrastructure business. It has also become involved in asset management, primarily focused on non-investment-grade debt.
KKR has invested some US$400 billion in 175 transactions. For the past 34 years, it has achieved a compound return of a little over 26 per cent, with an average holding period of just over seven years. Some of the deals have been hugely profitable. Earlier this year, KKR paid US$330 million for shale gas producers East Resources in the Eastern United States and made US$1.5 billion in 14 months. In 1986, it bought the Safeway chain of supermarkets in the US at 50 US cents per share and eventually sold out some 14 years later at US$46 per share, making 50 to 60 times the original investment.
Ironically, the NJR Nabisco deal that brought the firm so much notoriety was 'not such a great deal for us'.
Five years ago, KKR turned its attention to Asia. In this short period in the region, it has built a diversified portfolio that includes dairy farming and consumer finance in China, beer in South Korea, a coffee chain, cement and mobile telecommunications towers in India, mining equipment and television in Australia and a human-resources firm in Japan. One of its investments in China, China Modern Dairy, had an IPO in Hong Kong late last month.
Earlier this year, KKR led a consortium which invested more than US$200 million for 20 per cent of Coffee Day Resorts, which owns Cafe Coffee Day - the Starbucks of India.
In its latest investment, KKR, along with Texas Pacific Group (TPG), is buying 10 per cent of China's leading investment bank, China International Capital Corp (CICC), from Morgan Stanley, which is selling its 34.3 per cent stake. In a deal said to be worth US$1 billion, KKR and TPG are buying slightly more than 10 per cent each, with Great Eastern, the insurer controlled by Oversea-Chinese Banking Corp, taking about five per cent and the remainder going to the Government of Singapore Investment Corp.
Kravis says KKR will partner with CICC and help them expand as a global investment bank.
'With the completion of this deal, we will have put a little over US$800 million to work in China,' Kravis says.
KKR has had to adjust its traditional model of buying companies outright, as in many Asian countries it is not possible to buy controlling stakes. The key theme in Asia, says Kravis, is growth. 'You don't buy companies in China, you provide equity capital to help them grow and become a partner with an entrepreneur or an SOE,' he says, adding that you have to be able to add something other than just money.
'Money is a commodity - everybody has got the capital - so it's much more about what we bring in addition to capital.' That extra something, he says, is KKR's knowledge of industry best practices, governance, and access to KKR's vast corporate network.
But he acknowledges investors have to be very careful with whom they deal. He recalls reading Tim Clissold's book Mr China on the plane to Asia when he was considering how to set up in the region. 'I almost told the pilot to turn round and go back,' he jokes. The book recounts the experience of a former investment banker who invested in various businesses in China, and the headaches experienced in managing them. But he says investing in China these days is similar to his experience when starting KKR in the US in the 1970s. 'Their information is sketchy, as it was in the US then.' But he says this is what creates the opportunities to improve companies.
Nevertheless, Kravis says it's important to know who you are dealing with. Investing is like marrying, he declares. 'You'd better get to know the girl. She looks pretty, seems to have all the right manners and appears to have the same interests as you. If you rush out and get married before you confirm all this - you're married.' Kravis says in investing it makes sense to take your time and get to know your partner. 'It's easy to get in - but hard to get out.'