Friday Letter The customer is always right

When Kohlberg Kravis Roberts blew the market away earlier this year with the first publicly quoted vehicle since the UK’s investment trusts of the 1980s and 1990s, many predicted a rash of similar offerings.  

That they did not materialise was partly a consequence of KKR’s success in tripling its original target for KKR Private Equity Investors overnight and soaking up ‘every last cent’ of investor appetite. The market was sated in one fell swoop.

But the industry was also a victim of Henry Kravis’s success partly because of the vehicle’s terms, which some investors reflected gave the KKR managers a little too much latitude to do whatever they liked.

As we observed in a previous newsletter the KKR PEI limited partnership can run for as long as it wants and it is “permitted to engage in any business activity that is approved by [its] managing general partner.”

Caveat emptor, we thought. It was not as if KKR had to march anyone to the cash machine under gun point.

The turn in market sentiment was confirmed just weeks later when Apollo Management launched its roadshow for a listing and its bankers ground out a result, just ahead of its target. It was a success but no home run.

The queue of managers, including Texas Pacific and Blackstone, mulling a trip to Amsterdam and a Euronext float, overnight become a huddle carefully watching to see who would make a break for the markets.

As one investment banker with an eye to the lucrative mandate of running the book for a buyout fund offering said, “They are all still there, looking to see if an offering will work for them. But none of them will admit it, so they can walk away pride intact.”

Doughty Hanson has risen above the crowd of ditherers to launch its bid for evergreen funding. But its terms are more sympathetic to investors, whom it has canvassed over the summer since it started working with Fred Watt, the ex-banker it has hired as chief financial officer for the quoted fund.

The buyout firm is stumping up the cash to pay for its own bankers. It is no free lunch for investors; Doughty Hanson is taking share options in return. But a source familiar with the firm’s plans notes that the options are only of value if Doughty Hanson’s investments perform well.

It has also addressed investors’ concerns on fees and carried interest, both of which only kick in once the fund’s net asset value begins to deliver. And it has taken steps to ensure an excess of cash does not drag on the fund’s returns by adopting a partially paid structure and only taking 60 percent up front.

It is reserving the right to leave cash with investors for up to 18 months, if that is more appropriate. The source said this would also reduce the pressure on the buyout firm to put the money to work too quickly in deals they would otherwise have passed on.

In its communication of its plans so far, Doughty Hanson has focused on the benefits for investors. It has certainly paid lip service to the salesman’s mantra: the customer is always right.

But the customer should also read the fine print and we look forward to receiving a copy of the listing prospectus for the detail.