I'm back to blogging--I think.
Anyway, I was reading this Bloomberg interview with private equity pioneer, Henry Kravis, and found it interesting. I don't follow private equity and don't really have much in common but it's remarkable how their thoughts and approaches apply to small investors as well (obviously everything doesn't apply so one can't apply everything). It's a pretty good interview so do check it out if you have some time to kill. (As long-time readers may be familiar, anything in square brackets is by me and bolds are typically mine.)
JK [Jason Kelly, Bloomberg journalist]: What’s changed in those 40 years [since KKR was founded]?On top of huge money printing by central banks--maybe I'll get to this in a future post--a big difference nowadays is that practically everyone is investing money in stocks. This is one reason I suspect we will enter a big bear market (when everyone is overloaded in one direction, it will swing the other way eventually).
HK [Henry Kravis]: There’s money everywhere today. There’s almost no institution in the world—whether it’s a sovereign fund, a foundation, an insurance company, banks, pensions funds—that doesn’t do something in the private equity sector. Information today is better than ever before. Markets are pretty darn good. There’s so much more transparency. Which also means our business has much more competition. I sort of liked it when it was just us.
JK: Buy-slash-and-sell is the typical perception of the private equity industry. How do you think of yourselves at KKR?I consider 10+ years to be long-term and wouldn't really consider 7 years to be a very long-term. However, given how short-term-oriented the market is right now, KKR holdings do look more long-term than the rest. According to this Jason Zweig article in The Wall Street Journal, NYSE average holding period in 2015 was only 19 months (63% turnover!!) and mutual fund turnover in 2015, according to Morningstar, was very similar at 66%! From a long-term historical perspective, these figures are extremely low and "off the charts". Brokers, HFT funds and others charging commissions are probably making a killing right now.
HK: We like to think of ourselves as industrialists. I’m using industrialists in a broad sense. We buy a company and look at what we can do to make it better. How can we improve operations? Maybe it’s fixing the pricing or the supply chain, or putting the proper metrics in place so we can better measure what the company is doing. Maybe we have to change some of the company’s management. And understand that we are long-term investors for the most part. Our average holding is seven years. To me, there’s so much more to investing than buying low and selling high.
JK: What’s the most surprising thing you’re doing as an investor?Funny how Warren Buffett always ends up in stories, most unexpectedly. Anyway, it is interesting to hear how private equity is picking up lending/loaning/credit where banks have withdrawn. Stricter regulation has forced some banks away from credit and this may be bad for bankers and their shareholders but it is good for society. It would be much better if banks went bank to traditional businesses and avoided certain types of risk. Kravis does suggest that banks have withdrawn from small and medium businesses and that sounds bad but if those not profitable given their risk profile, that's fine IMO.
HK: We did only private equity until 2004. We’d go see a company and by about the third sentence somebody on our team would ask, “Is your company for sale?” And the CEO would say, “We have no interest in selling.” And our team wouldn’t have much more to say after that.
Today KKR is in three broad buckets: private markets, public markets, and capital markets. Private equity is probably 40 percent of what we do, and the rest is these newer businesses, which are all growing very well.
We didn’t start off thinking we would be in the credit business, or real estate, or hedge funds. This is an evolution. We didn’t do any of this overnight. It took a long time. In the process we became much more of a solutions-provider that can invest up and down the capital structure as opposed to a pure private equity investor. So we never have a conversation that begins and ends with, “The company’s not for sale.” Now we start off with, “What do you need today that you’re not getting?”
JK: Did you miss deals because of that?
HK: In 2002, I remember going to see an energy company called Williams, in Oklahoma. I’d grown up with the Williams family in Tulsa, and they were having some financial difficulty and needed to restructure their balance sheet. We said, “Why don’t we buy the company, take it private, and as part of that we’ll restructure the balance sheet?” They thought about it and decided they didn’t want to go private. So we said, “All right, let us provide you with a structure that can fix your balance sheet.” They thought about what we gave them and said, “That’s a great structure, but we have no money for this.” They ended up taking the exact structure we gave them and calling Warren Buffett. After about five minutes, Buffett said, “This is a no-brainer,” and he did the deal. We decided right then that KKR needed to get into the credit business.
JK:When you think about how deals are done today compared with back in the day, how are things different?Interesting to hear how it was easy to leverage up 20x to 30x the equity in the 1980's when interest rates were really high whereas now they can only borrow 1x to 2x. I didn't know these funds were able to borrow so much back in the 80's. No wonder the successful ones made so much money so quickly. I wonder if the massive bull market in bonds facilitated this (recall how, at that time, long duration bonds were making as much money as stocks (due to capital gains arising from falling interest rates)).
HK Well, we used to be able to put up a dollar of equity and borrow $20 or $30 to buy a company. When we bought Safeway in 1986, it was about $5.3 billion, and we put up about $123 million of equity. When we bought RJR Nabisco, originally we put up $1.3 billion of equity against $30 billion of total purchase price. But today, that’s all changed. You put up a dollar of equity and borrow a dollar of debt, maybe two, depending on your total earnings. So the capital structures have changed entirely.
JK: How does that change you as an investor?Same thing that Benjamin Graham and Warren Buffett and Charlie Munger and Howard Marks and Martin Whitman and numerous others keep saying. Unfortunately, I, and many others, have a habit of ignoring this and getting in trouble. I need to keep reminding myself to always consider the downside.
HK: When you buy a company, obviously you’ve got to look at the price you’re paying. One thing that’s different from the 1970s and the 1980s is that the valuation of companies has changed significantly. So we look at where the industry is going, and we look at the downside.
JK: Where did you learn that?
HK: When I was in my early 30s at Bear Stearns, I’d have drinks after work with a friend of my father’s who was an entrepreneur and owned a bunch of companies. “Never worry about what you might earn on the upside,” he’d say. “Always worry about what you might lose on the downside.” And it was a great lesson for me, because I was young. All I worried about was trying to get a deal done, for my investors and hopefully for myself. But you know, when you’re young, oftentimes you don’t worry about something going wrong. I guess as you get older you worry about that, because you’ve had a lot of things go wrong.
HK: Also, if I can take one thing other than integrity and instill that in people, I’d want it to be curiosity. Because to me, people who are curious are going to be better investors and better stewards of others’ money. If there’s no curiosity, you’re basically doing something that’s already been done by someone else.
Tags: insightful, private equity