KKR in 2003

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Authors: Ravi Madapati,
Faculty Member,
ICMR (IBS Center for Management Research).

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KKR at Crossroads

During their heydays, KKR's partners could choose the companies they wanted to buy, from the auction block or bid for them in a hostile manner. But deal flows started drying up in the late 1990s as the investors'interest shifted from old, maturing business to technology stocks. KKR found few opportunities coming its way. The company preferred businesses with predictable cash flows, strong brands and mature industries. It was not comfortable with the idea of investing in relatively new and unproven technology businesses.

KKR had traditionally invested in cash-rich firms that showed signs of "undermanagement." KKR played an active role in governance and remained an investor for five to seven years (while paying down debt), and then sold the shares for a capital gain. Often the company issued "Junk Bonds", which paid high-interest but were rated low by the rating agencies. Later on the financing technique led to many problems. For instance, after the collapse of Drexel Burnham and the junk bond market, KKR lost $ 1.7 bn for refinancing RJR Nabisco [RJR] bonds.

Before the much-publicized RJR buyout, KKR had made successful acquisitions including hotel chain Motel 6, broadcaster Storer Communications and food distributor Beatrice.

By the end of 2001, KKR had lost a combined $987 mn on movie chain Regal Cinemas, telephone service provider Birch Telecom, network equipment maker Zhone Technologies and Internet service provider, Ardent communications. Its own internal valuation reports showed that 32 out of 66 investments made since 1986 had lost money or were just breaking even through the end of 2002.

Competition had also intensified for KKR. During KKR's first decade of operations there had been only one other buyout firm, Forstmann Little & Co. By the turn of the century, KKR faced 850 competitors. One of KKR's bigger rivals, Thomas H Lee (manager of the second biggest LBO fund), Blackstone Group, (manager of the biggest LBO fund) had the best annualized returns in the LBO business at over 40%. With 20% returns, KKR was at the bottom of the top-tier funds. In 1995, KKR had been 10 times bigger than the rest of its competitors but by 2002 it no longer had a gigantic lead. In the summer of 2002, KKR lost out on the biggest buyout since its takeover of RJR, when Carlyle Group and Welsh, Carlson, Anderson & Stowe won the $ 7.1 bn Quest Communication's yellow pages business.

KKR decided to change tracks in the new competitive environment. Rather than squaring off against better-heeled rivals like the Blackstone Group, which raised a record $ 6.5 bn in 2002, KKR joined hands with them as buying partners. During the Qwest auction, it formed a bidding group with Thomas H Lee Partners and five other buyout firms. KKR had also discussed with the OIC and WSPF about selling a direct stake in KKR and a cut of its profits and fees.

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