KKR & Co. Inc. (KKR) Q4 2011 Earnings Report, Transcript and Summary

Good day, and welcome to the KKR & Co. L.P. Fourth Quarter Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Craig Larson. Please go ahead, sir.

Thank you, Rachelle. Welcome, everyone, to our fourth quarter 2011 earnings call. Thank you for joining us. As usual, I'm joined by our CFO, Bill Janetschek; and by Scott Nuttall, Global Head of Capital and Asset Management. We'd like to remind everyone that this call will contain forward-looking statements, which do not guarantee future events or performance. Please refer to our SEC filings for cautionary factors related to these statements, and we will also refer to non-GAAP measures on this call, which are reconciled to GAAP figures in our press release. This morning, as you may have seen, we reported our fourth quarter and full year 2011 earnings. A few highlights. Our fee-related earnings were $117 million in the fourth quarter, up 23% versus 2010, and for the full year, fee-related earnings increased 31% to $417 million. Our fourth quarter distribution is $0.32 per unit. This includes $0.09 of realized cash carry and our fourth quarter tax distribution. Beyond delivering strong operating results, we also had a very busy quarter on the new investment front across all of our segments. This ranged from the $7 billion acquisition of Samson Resources, which ranked as the largest private equity-backed transaction in 2011, to our infrastructure, China Growth and Mezzanine funds and to our special situations business, which continues to be busy, particularly in Europe. In total, we completed over $27 billion worth of transactions in 2011. We thought, though, we would begin with a topic where we know there is a lot of interests, fundraising. We're happy to announce that we've continued to raise capital since year end, principally from 2 areas. The first of these is the initial close of our 11th North American private equity fund, referred to internally as NAXI. We are now at the $6 billion mark, having closed on over $5.5 billion of commitments at this point and with expectations of at least another $500 million in the near term, subject to documentation. This is only the initial phase, and while we are limited by private placement rules in elaborating further, we think $6 billion is a great start. It adds to our $40 billion of existing private equity AUM and brings dry powder to over $13 billion after only the first close on this fund. Second is the strategic partnership with the Teacher Retirement System at Texas, which, we're pleased to say has now been finalized. We were selected to manage $3 billion of TRS capital across a variety of asset classes within our Private Markets segment and our alternative credit strategies within our Public Markets segment. In a few minutes, Bill will walk through how NAXI and the TRS strategic partnership impact our financial statements, and Scott is also going to spend some more time on our fundraising initiatives, including the launches of 3 new funds across our Public and Private Markets segments. Before we move on, I also want to bring your attention to an upcoming event. On March 12, we'll be hosting an investor presentation focused on KKR Capstone, our team of operational experts and how Capstone differentiates our Private Markets investing platform. We'll put out a press release beforehand with information on the live webcast. We hope you'll be able to join us. And one additional note about the distribution. The record date is supposed to be February 21 and not the 20. We'll be confirming this publicly later today. And with that, I'll turn it over to Bill.

Thanks, Craig. Good morning, everyone. Our continued progress in raising capital and building out new businesses drove a 31% increase in fee-related earnings in 2011 to $417 million. We've now organically grown our fee-related earnings by nearly 70% since 2009. We also reported gross distributable earnings of $196 million, our highest quarterly number as a public company. Our fourth quarter fee-related earnings of $117 million was our second best as a public company. Remember, this doesn't include fees on the new capital we've raised since the end of the year. Our PE funds, which are the biggest drivers of ENI today, since they make up most of the carry-generating balance sheet assets, were up 2% in the fourth quarter and 4% for the year. This compares to 2010 appreciation of 11% for the fourth quarter and 33% for the full year. Because valuations appreciated less in 2011 than in 2010, you saw a decline in our ENI both for the quarter and the year. If our public companies alone had been valued on December 31 at the stock prices they closed at yesterday, our ENI for the quarter would've been an additional $300 million or approximately double what we've reported. But remember, this is just a point-in-time estimate. Relative to the market though, our 4% growth for 2011 compared to a 5% decline in the MSCI World Index, so our full year performance reflects 900 basis points of outperformance. And if you look back over the last 2 years, our portfolio was up 36% versus an increase of just 7% for the MSCI World. So in short, the outstanding performance on fee-related earnings, much of which came through IPOs and continued transaction activity, was somewhat masked by a less significant mark-to-market appreciation, meaning less mark-to-market carry and less balance sheet investment income. On a cash basis, strong fee-related earnings and a strong quarter of modernizations drove gross distributable earnings up 24% year-over-year. This led to our largest quarterly distribution as a public company, $0.32. And it's important to remember that this is before some of our big funds are paying cash carry and in a realization environment that still hasn't fully normalized since the financial crisis. As a reminder, our distribution policy is to retain gains on our balance sheet assets so we can reinvest in our business. But since those gains may generate flow-through taxable income to our unitholders, we do make a year-end distribution to cover the estimated tax liability associated with this flow-through income. This portion of the distribution amounted to $0.13. Our AUM at the end of the year was $59 billion, and fee-paying AUM was $46 billion, both up slightly from the end of last quarter. At year end, our book value stood at $8.29 per unit, including net cash of approximately $500 million. Touching on our segments. In Private Markets, we put more than $3.5 billion of capital to work this quarter, about 50% of which was through our funds. This drove a substantial uptick in transaction fees, leading to an increase in fee-related earnings of 39%, relative to the fourth quarter of last year. As we discussed, ENI was lower, given the more limited increase in valuations this quarter relative to the same time last year. The full year showed essentially the same trends for both fee-related earnings and ENI. Capital deployment and monitoring fee termination payments contributed to a 24% spike in fee-related earnings, even after taking into account the additional costs incurred in building out our business operations, fundraising and real estate teams. Moving on to Public Markets. This quarter, fee-related earnings and ENI were more modest than in the same quarter last year for 2 reasons: first, we've continued to invest in the build-out of our newest strategies. The KKR equity strategy team joined us from Goldman Sachs, at the start of 2011, and we've also been expanding our special situations platform. Second, we earned a smaller incentive fee at KFN. However, management fees were up 27%. This was driven by the significant new capital raise in the business over the last year at attractive fee rates and with potential to generate future carry. Looking at the full year, we grew total fees in the segment by about 22%, with the roll on of management fees from these new strategies, but this was largely offset by expenses associated with building out those strategies, many of which are just beginning to raise capital and generate fees. In Capital Markets and Principal Activities, KKR Capital Markets or KCM, had a record-breaking quarter and year, generating its best quarterly fee-related earnings and 66% growth for all of 2011. The team's equity syndications effort did more than just drive fees, they also facilitated our ability to add attractive new investments to our portfolios. On the Principal Activities side, we saw an increase in the value of our balance sheet investments but to a lesser degree than last year. As a result, other investment income declined for both the quarter and the year. I thought it would help to discuss the impact recent fundraising will have on our financials. Remember, the fee-related earnings growth I've gone over is all before you factor in the inflows we've recently announced. For NAXI, we expect that in the fourth quarter, we'll begin accruing an investment period management fee. All third-party capital in the new fund will be added to fee-paying AUM at that time. At that point, the management fees on the 2006 fund will step down to 75 basis points on remaining costs. Regarding Texas Teachers. As we've mentioned, the partnership is focused mostly on our Private Markets segment, with some allocation to our alternative credit strategies. Some of those dollars have already been committed. $1 billion of the $3 billion is already accounted for in our AUM and fee-paying AUM. The simplest way to think about the economic impact of this partnership is that over time, additional AUM and fee-paying AUM will show up in our figures as the partnership makes commitments to new funds we raise. And given the recycling provisions in this relationship, we would expect the total $3 billion in -- to grow as we perform. I'll now pass it over to Scott.

Thanks, Bill. Hi, everybody. Thanks for being on the call with us today. Now that Bill has taken you through the financial results, I thought I'd take some time to talk about the progress we're making in realizing our vision for the firm. Our view is that the financial and capital markets are changing. Many traditional providers of capital are impaired, but the needs for capital are greater than ever before. This dislocation creates an exciting opportunity for us. So in addition to optimizing the value in and growing our private equity business, we're working hard to invest into the dislocation and scale our newer businesses. Our goal is to be able to invest behind our ideas and partner well with our clients to help them take advantage of the opportunities in the market. To accomplish this, we're working to achieve several objectives. If we do these things well, we'll continue to make progress as a firm, and the financial results will follow. Let me spend a few minutes talking through each. The first goal is creating value for our clients. We feel very good about the progress we've made on this front. Our private equity funds are up 36% in the last 2 years, meaningfully outpacing the Public Markets, which were up 7%. Our funds are currently marked at 1.5x cost, and the realized and partially realized investments in these funds have returned more than 2.8x costs. And our private equity portfolio continues to perform operationally. The EBITDA of our companies grew over 7% over the last 12 months. In addition to private equity, our energy and infrastructure platform continues to perform well, generating mid-teens returns, and our Public Markets businesses remain top quartile performers. The second goal is monetizing investments when it's sensible to do so. Here, even with the volatile market conditions we all experienced in 2011, we had a great year. We had over $5 billion of realizations in our private equity portfolio in 2011 at an average of 2.4x our invested capital, and more than $9 billion of realizations over the last 2 years at an average of 3.4x invested capital. Approximately 30% of our portfolio or $9 billion is now in public stocks, which allows us to exit more readily. We're also seeing strategic exits start to pick up, with 5 sales to strategics last year. In Public Markets, we've been taking gains when it's sensible to do so and locking in attractive returns for our partners. So overall, cash back is a good story for us. The third goal is to source attractive new investments. Here, we had an extraordinary year. We see this as a good environment in which to be investing capital, and we've been investing aggressively. We closed on $26 billion of new private markets investments during the year. Total equity in these transactions was $13 billion, of which over $4 billion came from our funds and the rest was syndicated to various partners. In private equity, we announced or closed on 16 new investments in 2011, including 6 growth equity investments, 7 LBOs, 2 joint ventures and a corporate carve-out. We also began investing out of our Infrastructure Fund, where we've now competed 4 investments. In Public Markets, we also had a busy year, investing more than $1.1 billion through our Mezzanine and special situation strategies, and the level of activity continues to increase as we take advantage of the pullback of traditional lenders. Our fourth goal is to monetize more of the content we generate. An important part of our vision for the firm is to be able to invest behind our ideas in scale and when we source a transaction, be able to retain as much of the economics on that transaction as we can. Building adjacent investment capabilities allows us to do that. 3 years ago, if we sourced an infrastructure investment, we had nowhere to make the investment. Now we have over $2 billion in dedicated funds through which we've been able to act on our ideas. This is now the case in energy and infra, liquid credit, alternative credit, real estate and public equities. So we're acting on far more of our ideas than ever before. Our Capital Markets business also allows us to monetize our content. It gives us an ability to syndicate excess equity and debt in our own transactions and in many cases, retain economics on what we syndicate. In 2011, our Capital Markets revenues were up 62%, and our fee-related earnings were up 66%, so we feel like we're seeing real traction here. Samson is a great example of how our Capital Markets business is allowing us to punch above our weight. The equity requirement in the Samson transaction was over $4 billion. While we spoke for $1 billion, we decided that to execute our strategy with the company, we needed to control it. So instead of being a 25% holder alongside several other sponsors, we decided to bring the excess $3 billion of equity to others, so we ended up being able to speak for the entire $4 billion, control the company and make more money in the process. This business has grown from $34 million in revenues in 2009 to $170 million in 2011. The fifth goal is earning the trust of our investors. Without this trust, we cannot build our firm. We're making great progress on this front as well. We've grown from about 275 investors 2 years ago to approximately 400 today or an increase of about 40%. Including where we are on NAXI, we've raised over $10 billion of capital since the start of 2011, almost double the $5.4 billion raised in 2010, and that $10 billion figure includes only a portion of the capital from TRS. In addition to NAXI, we were able to close our Mezzanine Fund, add to our energy and infra funds, scale capital on our liquid credit businesses and launch our first equity hedge fund, all last year. We remain very busy on the capital raising front and recently launched fundraising for a new direct lending strategy, Asian private equity and special situations. We have made and continue to make a meaningful investment in distribution around the world. Here again, the expenses show up before the revenues, but with the goal of significant investor growth. We believe it is an important investment to make with a high return over time. The sixth goal we've got is to create more scale in the newer businesses we've launched. If you step back and think about it, we really have one scale business at KKR, which is private equity. It's a wonderful business, where we have about a 4% market share in what is about a $1 trillion global market. Our other investing businesses: energy and infrastructure, real estate, high yield, leverage loans, mezzanine, distressed, hedge funds are all at relatively early stages in their evolution. Two exciting things about this from our standpoint. First, the end markets in these businesses are materially larger in aggregate than private equity, roughly $6 trillion, so we have a lot of room to run. Also, the expense for these businesses is already burdening our P&L. So as we raise new capital, the flow-through from revenue to profits should be quite high. So how are we doing overall? Well, we now have $12 billion in leverage loans and high-yield, $4 billion in energy and infrastructure and $3 billion in mezzanine and distressed. We're an aggregate of $19 billion in non-private equity assets, all built organically. Most of this was achieved in the last few years, and the momentum's growing. Our committed energy and infra capital grew over 100% last year, and our mezz and distressed capital grew 37%. We continue to use our balance sheet to further accelerate our momentum in these businesses. Since our last call, we've committed $300 million to seed 2 new energy strategies and $100 million to launch our direct lending strategy. As we scale capital in these areas, we expect our AUM, fee-related earnings and our carry opportunity will benefit. But we can't do any of these things without retaining our culture and attracting and retaining great people because we're passionate about getting this right. Our greatest accomplishment is that we've been able to grow our firm globally and into multiple asset classes, while keeping our one-firm culture intact. While we have a lot to do, we feel great about our progress in 2011, especially considering the very large investments we're making in new people, new businesses and distribution. Our fee-related earnings were up 31% in the year and about 70% since 2009. Our PE portfolio beat the global market by 900 basis points last year and was up 36% over the last 2 years. Our investment performance in energy and infra and public markets remains very strong, and our distributable earnings were up 23% last year, and our distribution is up materially. We think it's a great time for us. We're sourcing attractive new investments on a global basis and generating strong returns for our clients, which is allowing us to scale our businesses and grow our firm with a consistent culture. We remain resolutely focused on execution, and we're excited about the future. Thanks for joining the call. We're happy to take your questions.

[Operator Instructions] And our first question, we'll hear from Bill Katz with Citi.

Scott, I just wanted to -- maybe one of the themes you had highlighted, you've sort of laid out a few, but in terms of the number of LPs that have participated in the, I guess, the North American #11 fund, the NAXI fund I guess you're calling it, how many are sort of new, if you will, versus maybe your existing LPs? And how much maybe outside of the United States versus inside of the United States?

Bill, just give you some color. About 50%, roughly half, are from the U.S. and about half is from non-U.S., which is about what we would expect, with really broad-based support. And remember, this is just a first close so we've got another year of fundraising ahead of us. But to just give you some color, it was pension plans, sovereign wealth, insurance companies, some financial institutions and high net worth as well. We would expect in a first close a very high percentage to be re-ups from prior funds, and that's what we found here, that the majority and the vast majority kind of think about it is 3/4-plus of the first closers are existing relationships with us, and then we've got a very long list of prospects for the second and subsequent closes.

Yes, that's helpful. And second question is just in terms of the Texas account, it seems like there's a lot of that going on. I think a couple of your peers have had similar type of dynamics. So 2 questions. One is to help frame maybe the economics of the business. I guess, there's been some discussion of fee give-up but longer-lived capital. And the second part of the question is are there others behind this from a pipeline perspective that you can see?

Sure. I think the way to think about it is this is highly accretive type of relationship for us. I think what we're finding is a number of institutions, and we've talked about this on prior calls, are looking to consolidate the number of relationships they have and really go from kind of a siloed one-product relationship to a multiproduct relationship. So if Texas is going to give $3 billion to 10 groups, maybe we get our $300 million of that. But in this instance, they decided to give us $3 billion outright on a long-term basis with a recycling provision. So as we perform, the $3 billion of AUM will increase over time. The fee give-up is not a meaningful figure, frankly. This is a -- the way I would think about it, it's highly attractive and highly accretive for us. And over time, we think this is going to be a big win for us and for them. So think of it as multiproduct, long term, large scale and broad based across most of what we do as a firm without a meaningful give-up on the economics, some give-up but not meaningful. In terms of others, we'll see. I mean, this is hard to -- they're hard to get done. It took us a couple of years to get this strategic partnership with Texas completed. There are other dialogues going on out there, but it's hard to predict how many will actually get over the finish line.

Okay. One last one. I think if I got the numbers right in the capital [indiscernible] and private equity, it sounds like about 50% equity contribution, just sort of given the improvement in the markets and so forth and a little bit of an opening in the funding markets in the United States, in particular, has there been any kind of relaxation of that trend? Or is it -- maybe just a big picture of how you sort of see the allocation going forward to the equity and debt in incremental private equity deals.

Yes, sure. I'd say that the market right now in the U.S. is a little bit different from Europe, Bill. So I'd say the U.S. is probably 30% to 40% equity in transactions. Europe's probably going to be 40-plus percent at this point. So I think last year, you had some numbers that maybe -- some deals that maybe skewed the number a little bit, including a deal like Samson which was a big transaction that had more than half equity in it. But I'd say, the overall markets are 30% to 40% equity contribution today.

And next, we'll move to Michael Carrier with Deutsche Bank.

Maybe first question, maybe just when we think about the mark-to-market and the returns just in the quarter, the color on the public portfolio as of today, it's helpful. If I think about the private side though, when I think about this quarter, when you look at what drives those valuations in terms of the assumptions, the discounted cash flows, as we continue to get some incremental better data out of the U.S. on the economic or the macro front, like, how should we expect that to change? Or were there many changes made in those assumptions this quarter but the likelihood that those could get incrementally more positive if this data continues? I'm just trying to figure out the value on the private side versus the public.

Sure, Michael. Scott, I'll take that one. The first thing I'd say, and I'll come around to trying to address your questions, I would not get too focused on the quarter. So keep in mind -- you got to remember in Q3, our portfolio was down 8.5%, but the market was down 14%. And for the year, we outperformed by 900 basis points, and for the last 2 years, we outperformed by 29 percentage points, so 2,900 basis points. So we're not as focused on the quarter-to-quarter, and we're really happy that we're outperforming the market so -- by such a large margin over the last couple of years and in 2011. Specific to Q4, what we found is that the publics did perform well. Our publics went up but a bit less than the market, just happened to be mix. And the privates, some of our private portfolio companies adjusted their longer-term projections down a little bit, which impacted their DCF valuation somewhat in the quarter. But keep in mind, that was done in a bit of a different environment in the fall, the world feels a little bit better today. So the way we look at it is, it is a moment in time, I think you've got the right interpretation. As management teams get more optimistic about the economic environment and the prospects, in the longer term, you would expect those DCF valuations to move up but there was not a material change in approach in the quarter. And I think what Bill said on the prepared remarks is really important. It is a moment-in-time calculation. Our publics are up 11% in the last 5 or so weeks, so that impacts our income statement meaningfully and would've basically doubled our ENI for the fourth quarter on that basis alone, created the better part of $300 million of incremental earnings just by that move, all else held equal.

Right. But again, it's just a moment in time, and so we control when we exit investments. And so even though the S&P was up, say, 12% in the fourth quarter and our publics were up 7%, 6 weeks later, our public portfolio is up 7.5% and the S&P is only up 7.5%. So it's really hard to just fixate on a particular mark at a particular quarter end.

Yes, it's helpful, all the color. And then maybe on the exit side. You guys have probably been a bit more active than maybe the overall industry. But when you look at especially on the public side in terms of going through the market, is that environment getting better, just given the increase in the overall market levels, conversations out there? It seems like it's been more subdued, and there's been more strategic sales than outright, like IPOs. But just any color on that?

Yes, I'd break it into a few buckets. I think first is where we're seeing a lot of our realizations is around companies that we have that are already public. So I mentioned that, we've got about 30% of our portfolio is already in public stocks, so companies like HCA, like Dollar General, like Avago that have already gone public, and what we're doing is secondary offerings to sell down our position. And what we're finding is as our companies continue to perform, those stock prices are performing quite well. I mean, HCA is up 30% since the beginning of the year. We've got other companies like Rockwood up 40-plus percent since the beginning of the year.

And XP is up 40%.

So we're seeing good performance, and as the companies perform, there's an opportunity to monetize in the secondary market. And that's actually where you've seen a lot of our realizations happen. The second dynamic is strategic sales, and that has been relatively quiet the last few years. We are seeing that start to pick up. I mentioned 5 strategic sales last year, which was a big increase over the prior. We've been particularly active in our energy businesses in the strategic sale area. And I think that will continue to pick up as corporates are sitting on a lot of cash. And I think that one of the big beneficiaries of increasing confidence at the CEO level will be increased M&A activity. And so I think that will aid our strategic sales. In the IPO market, frankly, it's very company-dependent and it's kind of almost week-to-week. But since we've got so many companies that have already jumped through the IPO window, that's probably the least important consideration as we sit here today.

Okay. And then just you mentioned on some of the new funds, I think there was a lending one, the Asia private equity and the special sits. Just any color or update on progress on some of those new products.

All 3 of those relatively early, so it'd probably be better to give you an update in next quarter and subsequent quarters.

And we'll next move to Roger Freeman with Barclays Capital.

I guess first just on the Texas Teachers, is there a rough timeline that you anticipate the rest of that capital flowing in, like over a 1- to 2-year period?

Roger, it's Scott. I would expect the capital will start to flow -- will flow in over the next, call it, 2 to 3 years.

Okay. And then how does the recycling work? Is that over a specific period of time like if you have realizations early on then you can reinvest those?

Think of it as -- basically, the way it works is that we can recycle all of the capital, so the entire $3 billion, and then a portion of the profits that we generate on that capital. So we'll get to use the $3 billion over and over, and as we generate profits, we get to take a portion of those profits and recycle them back in. So the $3 billion of AUM, that will start to show up over the next few years, should grow over the subsequent several years.

But I forgot to say, does that have a lifespan to it? Or is this just perpetual?

It is very long term. The lifespan has not been disclosed by them or us, but think of it as much longer than your normal fund relationship.

Think of it as long-term capital.

Okay, great. And then I think you touched on this a bit, but you've seen a nice increase in number of clients, the 250 to 400. Maybe of this 400 now, how many of those are invested in 2 strategies? Or maybe how many are in 3 or more? I'm just trying to get a sense. You're both growing the client base as well as cross-selling. And I'm curious how you view that opportunity.

Yes, we think that's a big opportunity, Roger. So on average, I think the number is about 1.6 products per client, and as we've added meaningfully to the number of products we have, we are just starting to make a real dent in that figure. And so I think the opportunity for us is exciting on both fronts, and we've talked a lot about adding to the number of clients but I think you're right, the cross-sell opportunity is pretty exciting as well, and we're really just starting to get traction on that in the last year or so.

The only thing I'd add on that, Roger, is if you think of the capital that we added in 2010 in particular, a lot of that was in first-time funds, it was energy, it was mezzanine, it was infrastructure and the like. So as we are now marketing some of the more traditional strategies like the North American private equity fund and second Asia fund, et cetera, that's certainly something that we're very focused on.

Okay. Can you remind us how...

Keep in mind, we're in the early innings here because we just started launching these new strategies over the last 2 or 3 years. And so that's why it's so important that we've got the client and partner group to actually get out there and introduce these new products to a whole host of current and new investors.

Yes, and that was actually my other question. How big is the sales team today versus when you had the 250 clients? And how much do you expect that to still grow?

Yes, roughly just -- rough just as we had, at the end of '08. You see, that is our starting point. We had about 4 people marketing product for KKR globally. We now have over 40 people in that group, probably 20 to 25 of those client-facing and the rest, more in the service and support side. So we've made a meaningful investment in that area, and we'd expect those numbers to continue to grow this year.

Great, all right. Just lastly, what are your updated thoughts on opportunities for the firm in the new regulatory environment, when you think about factoring in Basel, Dodd-Frank with respect to the dealers, particularly I'm just thinking something like Volcker, which from -- given a market-making standpoint, you have a capital markets business on the balance sheet, like there to be some opportunities to buy liquidity on a short-term basis, rehabilitating some of the credit markets if they become uneconomical.

I'd say that the opportunities are pretty exciting for us coming out of all the regulatory change. As we'd discussed in the past, a lot of the traditional sources of capital to the markets are seriously impaired for all of the reasons you've talked through and all your reports and what we're seeing on the regulatory fronts impacting that as well. We think with Basel and Volcker, that's only going to increase. And so if you think about what that means for us, I'd say there's really 2 primary benefits. One is just investment opportunities. So you've seen us really try to scale our special situations business. That business is spending a lot of time today lending to providing capital to companies that don't have alternative sources. It's also spending a lot of time with banks, and today, particularly in Europe, that need to sell assets. And so the opportunity for that business is very exciting. We're also seeing that in our alternative credit strategies. So a lot of companies, especially middle market companies, are finding that their banks are not providing them with capital anymore. So what we're doing is we're stepping into the fray. Our Mezzanine business is doing that, we've launched this direct lending strategy we mentioned. That business is providing senior loans to companies that need capital. And so we're seeing opportunities in those parts of our business, and so we've really been scaling quite a bit. And part of the reason that opportunity is there, Roger, is that the traditional providers are either out of those markets permanently or temporarily, and so we're stepping into the void. The other thing that is providing the second opportunity for us is really talent. What we've found is that under Volcker and as these banks have been trying to figure out how to operate in this new regulatory regime, they've been letting people go, they've been getting out of businesses. The prime example of that for us is the Goldman Sachs Principal Strategies team that we brought over and started that hedge fund that Bill mentioned last year. So that team came over en masse and joined us. It's not clear to me if it hadn't been for the Volcker Rule that, that would've happened. So I'd say the opportunities for us are really one, investments; and two, people.

And next, we'll move to Michael Kim with Sandler O'Neill Investment.

First, I know you've got the European funds, the Asia fund, sounds like another one's on the way and kind of the China Growth Fund. But is the plan to continue to come to market with more specialized funds, either from a geographic standpoint or in terms of different strategies to kind of continue to broaden out the franchise and maybe improve the consistency of fundraising going forward?

Michael, it's Scott. Yes, I think that's right. I mean, we've got -- the way I would think about it is we have our traditional larger-scale funds. So in private equity, we've got North American fund, European fund and our Asian fund. And so obviously, we've talked a lot about NAXI, that's a continuation of -- more one of our more traditional funds. The Asian private equity vehicle that I mentioned is really our second vehicle for Asia, more in the traditional fund category. But then, we are going to launch adjacent strategies like China Growth, which raised $1 billion in a very short period of time that we've talked about. So I think you're thinking about it right. We'll have a group of traditional funds that we'll continue to scale, and then we'll build adjacent strategies alongside in Private Markets. But that's just kind of in the private equity space. If you think about what else we've been doing, we've been launching vehicles in energy and infra. We've been launching vehicles in alternative credit. At some point, we'll figure out what we're going to do in terms of launching a real estate vehicle. So I think you're right, we're going to have just a constant stream of ongoing traditional funds. We're going to have a kind of the newer funds that we'll be launching and raising that will, then, have their successors. And then we have a group of businesses where the fundraising is continuous, think high-yield, loans, our hedge fund business. So it's really going to be the case that I think we're going to have several products in the market at any given time.

Okay, that's helpful. And then maybe just a follow on realizations. Any color in terms of how we should be thinking about maybe the trajectory of realized cash carry this year and into '13, just given some of your comments around your public company holdings, as well as the pickup in strategic sales?

Well, let me take that one. If you look at our portfolio today, as Scott mentioned, about 30% of our assets are in public securities, and we've done a primary and we've done secondaries. And to the extent that there's an opportunity to exit those positions, we will react accordingly. Just to give you some color, in 2010, we actually distributed about $4 billion to our LPs. That number was up in 2011 to over $6 billion. So we actually have the assets that are quite liquid. As it relates to what the impact is on carry and more importantly to your point, cash carry, all of our funds but Europe II accrue carry. And of the 7 funds that we have, 4 of them are in cash carry mode. So if we sold an investment in the European, Millennium, Asia or China Growth Fund, to the extent that there would be a realization, it would be cash carry to pay. '06, as we mentioned on several calls, is well above cost. But right now, there are a couple of investments in that portfolio that are below cost, so that even if we sold an investment, we actually wouldn't receive cash carry. But again, if you took the portfolio as a whole right now and sold it in its entirety, you would receive cash carry. E3 right now is more or less breakeven. It's, as of December 31, just a little bit above cost. And then, as I mentioned, D2 is the only fund below cost. So that'll give you some color that, as we exit investments, where you'll see the opportunities to see cash carry.

I think the way to think about it, Michael, as you can see in the back of the press release, we've seen a meaningful increase in realized cash carry year-over-year, Q4-over-Q4, and so as we continue to make progress in creating value in the funds and see future realizations, that should translate into incremental cash carry over time. It's very hard to predict exactly when and how that's going to show up, however. So a lot of that is going to be dependent on the markets, and then whether we have any of these larger strategic sales happen, then you could have some nice surprises. But it's very hard to predict quarter-to-quarter.

And just to drive on the point again on cash carry, from 2010 to 2011, cash carry distributed in 2010 was 19, and in 2011, it was 26. So that's up over 30%.

Okay, that's helpful. And then just finally just to come back to the real estate business. I know it's still early days but maybe if you could talk about some of the opportunities that you might be in a position to capitalize on today and then how you see that franchise developing over time.

Sure. Look, I think what we're trying to do, Michael, is broaden our dialogue, back to your first question. We're now talking to CIOs and just institutional investors and high net worth investors about a variety of different ways that they can deploy capital and a lot of different ways we can help. And really, what we've been trying to do is target our efforts in areas where we see the most severe dislocations and the most severe imbalance from a supply-demand standpoint. And one of the reasons that we've started our real estate business is it looks like there's a significant supply-demand imbalance from a capital standpoint in the real estate markets that's going to persist for a long time. And a lot of the clients that we're trying to help are figuring out how to participate in that dislocation and benefit from moving their capital to it. So what we've done is we've brought on a team, which has been with us better part of the year now and have been looking at a variety of different transactions. The statistic that I think is interesting is there's about $1 trillion of CMBS coming due between now and the end of 2014. We think probably half of that does not have a home. And so what that means is there's a variety of different very interesting opportunities, U.S., Europe and Asia. And what we're finding is that there are still lenders to the very senior part of capital structures for real estate. The life insurance companies in particular are prepared to lend to the senior 50% of a capital structure. But there are very few providers of capital to the bottom 50%. And so the securitization markets have not recovered, and so what that means is that there's a significant capital need at that bottom half of the capital stack. And so where we're spending our time is both equity, so think about it as opportunistic equity. And we're also spending time in kind of more the mezzanine part of the capital stack, think of the 30% to 50% tranche where we're finding very attractive returns. And what the team's finding is the opportunities are very broad-based. We've never had a team come into the firm and get as busy as quickly as this team has. And there's just a variety of opportunities on a global basis, commercial, multifamily, U.S., Europe, Asia. There's a variety of opportunities around the world. So the way we're attacking it is a couple-fold. One, we've got the real estate team integrated with and working with other investment teams in the firm, so a lot of the work is going to kind of meld between real estate and distressed. And so our special situations team and our real estate team are working together on some projects and trying to get those done. And we've also dedicated $300 million of capital off our own balance sheet. And the team is working with that $300 million of capital and is working on a variety of different transactions. And we will use our Capital Markets business to syndicate any excess that we want to keep. And so the idea is build our track record, do some deals with the firm's capital and through the syndication mechanism and then, over time, we'll launch a fund. But what we don't want to do is miss any of the current opportunities, which, we think, are pretty exciting.

And we'll move on to Guy Moszkowski with Bank of America Merrill Lynch.

It's actually Patrick. I had to run because the mortgage settlement came out. So on the realized cash carry in the fourth quarter, we had tried to account for some of the shale sales that you had, still came in a lot better than we expected. Could you kind of run through all of the components of that realized cash number that was distributed?

Patrick, this is Bill. Sure. We had already given you information last quarter, that approximately $0.06 was going to come through in the fourth quarter from the 2 shale plays. But during the quarter, we also had a secondary sale of Legrand, and we also had a secondary of Dollar General, and that accounted for the additional $0.03 of cash carry during the quarter.

I thought Dollar General was in the 2006 fund. Is it not?

It is, and it's a small amount. And thanks for pointing that out. When we did Dollar General, not only did we make the investment through the fund but we also had co-invest vehicles, which we were fortunate enough to have the opportunity to receive some carry on. And so when that transaction closed in the '06 Fund, our LPs received all of the capital, and that went towards filling the netting hole in '06. But with co-invest vehicles, we actually are entitled to receive cash carry. That amount -- not to get too excited, the amount, $0.01 a share.

Okay. I thought that you would recycle co-invest back into co-invest? Or is that not the same as the principal portfolio when you say co-invest?

No. Think of that as -- syndicated co-invest, that's a third-party.

Okay, all right. Okay, cool. So the new Capital and Private markets, I assume that roughly $1 billion of that was Texas Teachers because there was $1.4 billion for the quarter, I think. Am I looking at the year?

No, you're looking at the quarter. What ended up happening in that $1.4 billion is roughly about $700 million was from infrastructure and energy-related SMAs. And the other amount was from co-investments that we made where we were entitled to receive some carry.

So to answer your question directly, there was not $1 billion from TRS in the quarter. It was other capital raising.

Right, yes. As a matter of fact, there was no Texas.

Yes, there was no Texas in Q4. There was some Texas in prior quarters, but nothing in Q4.

Right, the prior quarter number, just for clarity, was $1 billion.

But as the new money comes in from TRS, it will show up in that line item?

Correct.

As they commit new strategy and we close that particular fund, it'll show up in AUM and the fee-paying AUM, yes.

Okay, all right. Finally, it looks like Capmark Financial disappeared from your principal activities kind of run down. Could you explain that?

Sure. We've been carrying that at 0 for the better part of a couple of years. We carried it on our balance sheet only for the fact that we still own the asset. Capmark emerged from bankruptcy and the equity that we held got canceled and so we took it off our balance sheet. No impact to the earnings.

And Matt Kelley with Morgan Stanley will have our next question.

Hoping to drill down a little bit more on your LP base. If you talk about pension, sovereign wealth and high net worth, among others, what are those -- what strategies are those investors by type looking for the most? I appreciate your color on real estate, so wondering where you're getting the most traction there, where in Europe, et cetera.

Sure. Matt, it's Scott. I think frankly it's fairly broad-based. What we're doing is we're talking to investors about what they're trying to achieve. And everybody we're talking to is just trying to figure out how to get return overall as the first priority. They've been looking at their historical results and long on the equities and high-grade fixed income for the last decade, and they've generated low-single digits at best. And so that theme is very consistent. Another theme we're hearing is that they are prepared to take some illiquidity in order to increase their returns. I think we're kind of out of the bunker fully now, and people understand that you're not to going to be able to get 10-plus percent returns without giving up some liquidity. And so that's been a great help as we've been launching new strategies and engaging in this dialogue. Pension funds, in particular, I'd say, are looking for a number of things. They want to figure out how to beat their 8% growth in their liabilities, and so they're rotating into a variety of longer-term alternatives, private equity amongst them, but there's also an interest on the part of pension funds increasingly in yielding strategies, the thought being if they can actually generate a yield of 8-plus percent, then they've got their growth in their liabilities covered. And they knew anything above that is kind of upside from there, so we're definitely hearing that theme from pension funds. We're also hearing that theme from high net worth, that there's absolutely an interest in that. So as you think about what we've been launching as a firm, all of our products, except for private equity and our hedge fund, have some kind of yield associated with it. And so we're finding that those products are playing particularly well with those audiences. It's absolutely the case. Insurance companies, I would say it's a bit of a different flavor. Insurance companies, because they are more focused on GAAP bottom line or probably even more focused, as a priority matter, on yield, and so we're finding a lot of interest there more in the high yield area, mezzanine, distressed, anything that's going to have a current yield is attractive. But the interest is broad-based, and it's on a global basis. As we look at where the capital has been coming from recently, it's where you're seeing capital formation happen, a lot of interest out of Asia, a lot of interest out of the Middle East. We're increasingly noticing more activity in the U.S. and in Europe. So I'd say it's global and the themes are: they like return, they like yield, they like energy, they like Asia. And if -- we've got a lot of products that kind of fit within what they're trying to achieve.

Okay, that's really helpful. So as we're talking about returns and some of your investors more willing to tie up money for longer periods of time, what -- have return bogeys come down for them? Are their expectations reset lower?

I think most of our investors, Matt, look at it, our returns, relative to public indices. So I think what has happened is that their expectations for returns out of the public markets have come down, and they're looking for a certain number of basis points that have outperformance relative to those public markets. And so that's why we tend to talk about it on that basis. I think they're looking at it on that basis. So part of it is based on the individual investor you're talking to and what they think they can get out of the public markets. And the way they look at it is: How much excess return do I need to basically forgo the liquidity and give capital to you, KKR? And so that tends to be the basis on which the conversations happen and how they measure our performance. And I think as a general matter, expectations in terms of the overall markets have come down a bit. But having said that, everybody would still, especially in PE, like to get a 15%, 20-plus percent return. So it kind of depends on who you're speaking with, but the way most of them are compensated and we're benchmarked is relative to the public markets.

Okay, very helpful. Just one follow-up from me. Any interest from your side on launching or getting into actively managed ETFs to distribute more to high net worth?

Not on the near-term game plan.

And next, we'll move to Robert Lee with KBW Securities.

Actually, Bill, just can we go way back to your comments about when the NAXI fund starts coming into the financials? I'm not sure I understood it correctly. Is that Q4 '12 that you'll expect that to start rolling in, and that's when 6, I guess, flips to its -- flips over?

Correct. We expect that to occur in the fourth quarter of 2012, and the subtlety here is remember, in the '06 Fund, we still have $1.8 billion. The capital that we're investing for those investors, our assumption is that those funds will be invested in the first half of the year. And the reason why I was specific about the fourth quarter is that just we have a contractual arrangement with our '06 investors that we won't actually start charging a fee on the NAXI fund but for the one-year anniversary of the last fee charged for the '06 Fund. And so the '06 Fund runs from September '11 through September '12, and that would be its last investment period. And so then even if we started to deploy capital in the third quarter of 2012 for NAXI, the fee actually wouldn't turn on until the fourth quarter of 2012. At which point, the '06 Fund, as I mentioned, would start paying its post-investment period fee of 75 basis points.

Right. And on the '06 Fund, when that fund flips, do you kind of hold back some capital that stops earning fees? Or is it kind of all in?

Well, right now, we do have a reserve set up for that '06 Fund, and if by chance and it would have to be based upon a fact pattern, if we ended up reserving a certain amount of capital and then started investing in NAXI, and then we use those funds for a particular investment in the '06 Fund. Once it got invested, we'd start receiving a post-investment period fee on that capital.

Right. But until that point, you wouldn't earn the fee on that reserve?

That is correct.

Right, okay. And...

And Rob the only thing I -- 2 points to add on that is that there's no obligation to invest the reserve and thinking about that it's not allocated to -- it's a pool of money, so it's not as though there is something that those dollars are pre-allocated towards.

Okay, great. And then trying to think about what it would take to move, say, '06 and maybe some of the other funds to a cash carry position. I mean, understanding if you liquidated the whole thing, you'd generate cash carry. But is there any way to that of quantify that? And I know it's maybe somewhat of a moving target, but you need, I don't know, $400 million of cash realizations in order to get Fund '06 to a cash carry position. I mean, how should we kind of think what it would take to kind of get that to cash carry?

So you are right, it is a moving target. Obviously, each quarter, we value our portfolio companies and on some of these private portfolios, if the investment is marked below cost, we don't have the ability to pay out cash carry. And we have to look at this quarter-to-quarter because if we are carrying an investment below cost, and then if the company starts to perform, if we write down investment up in a successive quarter, that netting hole actually shrinks. So it's really hard to give you any sort of guidance as when to expect cash carry other than I will tell you that as we get close, we'll make sure that everyone knows that we are getting close.

And we'll move on to Marc Irizarry with Goldman Sachs.

Marc Irizarry, Goldman. Scott, just on TRS again. Can you walk through how willing you are to allocate -- like how big TRS could potentially be as a component of new strategies that you're seeding? And how you're sort of going through -- where you're going to allocate their $3 billion?

Sure. Mark, I think generally speaking, the way to think about it is in 3 buckets: there's going to be a private equity component; there's going to be an energy, infra, real assets component; and then there's going to be an alternative credit strategies and just opportunistic component. And roughly, we'll see, over time, how that develops in conversations between us, but if you want to think about that as approximately 1/3 each, that you'd be about right in terms of the thinking today. So we would expect that, that will change over time. I think one of the things that we and they saw as part of this is an ability to work together to launch newer businesses for the firm. And so I expect it could be a source of capital for some of the new things that we do together. It's clearly not going to be a majority of the capital, but it will be an attractive source of capital, and that'll be something that we develop in conversation with them. Just parenthetically, our oil and gas business, our KKR Natural Resources business was a business that we started with Texas Teachers. So it actually initially came out of a meeting where we were talking about a theme in the energy space, and we and they decided to start that business together. And so they're actually a meaningful source of capital for that business, and we've talked together about real estate as an example and other areas that could follow on for that. But one of the other things that we saw, the benefit here, both they and us, is an ability to move quickly into market dislocations. And so there is a portion of the capital that's not even allocated to specific strategies. It's just when we together see interesting market opportunities, we can rotate the capital there quickly because the traditional diligence effort of months and months of back-and-forth, sometimes the opportunity can go away. So we have an ability together to move very quickly to fill voids and take advantage of market opportunities with the capital as well.

Okay. And then just a quick follow-on on that. Do you think as you bring on more of these deals or more of these LP relationships, does this at all alter the general partner co-invest when you're thinking about new strategies?

No, I wouldn't think of it as changing that dynamic.

Okay, great. And then just one more time on the '06 Fund. I mean, I don't know, Bill, if you can give us any color on -- are their individual investments that are above costs today that you could monetize, that would put you in cash carry mode in '06?

Yes. Okay, again, I mentioned earlier that if you took the entire '06 Fund and sold it at today's cost, we would receive cash carry. So we have several positions in the '06 Fund that are well above costs, take for example, ATA or Dollar General. And so if there was a significant monetization in either one of those, that would certainly go well to filling the hole and getting us a lot closer to paying out cash carry.

And Chris Kotowski with Oppenheimer will have our next question.

Most of my questions have been asked. Then you may not be able to answer with this one but is there a way to think about, historically, in the funds that you've raised, is there a typical spread between the first close and the final close?

Chris, it's Scott. There's not a typical spread. It's really been all over the map. And frankly, given that this is really the first traditional fund we've raised since the credit crisis, I'd be loathe to give you any prediction or anything that you could work from. So no data to help on that front, unfortunately.

And we've certainly thought about it.

And our final question will come from Roger Freeman with Barclays Capital.

Just had 2 follow-ups. One, just on the earlier discussion around LPs. I'm just wondering, in your discussions with pension funds, you'd sense that there's a lot of -- they're getting a lot of pressure on there end to lower their return assumptions. And is there a -- are we at a catalyst point here? Is that part of why the discussion is picking up or are you going to have to bite that bullet or show near-terms that are better return profiles?

I think that could be driving part of it, Roger. But I think it's just a bigger practical issue. The practical issue is they've had 1% or 2% returns over the last decade and their liabilities are growing 8%. They're underfunded now. And if they project that out using 1% or 2% or 5% or 6%, they're going to be even more underfunded. And so I think part of it is what's the right return assumption for the long term, but I think there's just a bigger practical issue of where are they going to go to find return and the subpoint, kind of where do they get return that's not completely correlated with everything else they have. And so I think it's part of it, but the bigger driving consideration, frankly, is they know that if 90% of their portfolio is generating low-single digits, it's very hard to get anything into the 8-plus on the overall portfolio unless you change allocations and you're more aggressive in terms of what you do with your capital.

Yes. Change your allocations pretty aggressively too.

Right.

Okay. And then other thing and I may have missed this. Have you said on the equity launch strategy -- I know you just launched it, but where does that stand right now in terms of the AUM and how much of that is your capital? And I think you have said you've started raising third-party money back in the fall.

Yes, we've started -- we're managing about $400 million or so today.

Okay. Is most of that still is yours?

No. Most of that is third-party at this point.

Oh, it is. Okay.

Yes, we just -- we've been out raising capital and picking up speed on that front.

And that will conclude today's question-and-answer session. I will now turn the call back over to the speakers for any additional.

Everybody, we really appreciate your time this afternoon. We look forward to talking with you next quarter.

And that will conclude today's call. We thank you for your participation.