Steve Schwarzman still has a step on Henry Kravis

March 7, 2011

By Lauren Silva Laughlin
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

NEW YORK — Steve Schwarzman still has a step on Henry Kravis. Efforts by the private equity firm Kravis co-founded, Kohlberg Kravis Roberts, to diversify are off to a good start. And its chunky investment in its own buyout funds could help shareholders in the near term. But KKR has much to prove while rival Blackstone Group, run by Schwarzman, has found its stride as a public company.

The leveraged buyout recovery looks on track as valuations improve and public equity investors buy up shares of portfolio companies being sold. That bodes well for Blackstone but even better for KKR near term. The financial gymnastics it performed to list on the New York Stock Exchange stuffed $6 billion of fund investments on its balance sheet. That will deliver shareholders an extra bonus if large deals become very profitable.

KKR also is making efforts to branch out. Blackstone has been advising other companies on merger transactions since its inception 25 years ago, but KKR’s capital markets group more than doubled fees in the fourth quarter from a year earlier. What’s more, KKR’s fee-paying assets under management in its hedge fund group grew by 16 percent, a bigger gain than Blackstone managed. Kravis’s firm is also expanding in other ways, for example by raising $5 billion to invest in China, energy and elsewhere.

That gives KKR the aura of growth while Blackstone’s steady progress makes it seem more like a value stock. But that’s not the case with valuation. As far as multiples of estimated 2011 earnings go, equity investors peg KKR at a 40 percent discount to Blackstone, according to Keefe, Bruyette & Woods.

That’s because KKR still relies very heavily on buyouts — 70 percent of the firm’s revenue in 2010. And that business is shrinking for everyone. For its sixth fund, Blackstone raised about $15 billion, two-thirds the size of its fifth one. KKR may only raise half as much as it did last time around. Meanwhile, competition for new energy sector assets is fierce. And KKR’s hedge fund assets remain less than 15 percent of what Blackstone runs. KKR’s high exposure to fluctuations in the market value of its portfolio investments is a risk for its shareholders.

Until Kravis can accelerate growth and show that KKR is more than just a buyout shop, his shares will struggle to escape the shadow of Schwarzman’s valuation.

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