KKR Private Equity Investors, the $5 billion publicly traded affiliate of New York-based Kohlberg Kravis Roberts, has written down the value of a number of its portfolio investments, according to an earnings report released today.
The valuation changes highlight an issue faced by general partners around the world: how to implement fair-value accounting standards in a turbulent market. Many market observers believe that private equity firms, especially large buyout firms, will have to dramatically write down the value of the investments done over the past two years, possibly changing the dynamics of the fundraising and secondary markets.
According to an earnings report issued today, KKR Private Equity Investors has written down the value of a number of its direct and co-investments, described in the report as “changes in the unrealised fair value of investments” from the third to the fourth quarter of 2007.
KKR Private Equity Investors, traded on the Euronext Amsterdam stock exchange, is a vehicle that commits capital to KKR private equity limited partnerships, co-invests in deals sponsored by those KKR funds as well as invests directly in its own deals.
The write-downs include a decrease in the value of an investment in NXP, a semiconductor company that was a division of Royal Philips Electronics and was in 2006 bought out by a consortium of firms including KKR, Bain Capital, Silver Lake Partners, AlpInvest and Apax for roughly €9 billion. KKR Private Equity Investors, an equity co-investor in the NXP deal, now values its position in NXP at 0.75 times cost. (On a dollar basis the value is marked at 0.86 times cost.)
It is unclear whether KKR’s primary limited partnership or any of the other private equity funds in the NXP deal will follow similar valuation policies with regard to NXP.
Other KKR Private Equity Investors write-downs include:
• German media company ProSiebenSat. 1 Media AG, decreased to 0.73 times cost from 1.0 times cost. The company was acquired last year for by KKR and Permira for €3.2 billion.
• German motorist retail chain ATU Auto Teile Unger, decreased to 0.17 times cost from 1.0 times cost
• US real estate finance company Capmark Financial Group, decreased to 1.28 times cost from a previously written-up 1.46 times cost. Capmark was acquired in 2006 for $16.8 billion in conjunction with Five Mile Capital Partners and Goldman Sachs Capital Partners.
KKR Private Equity Investors noted in its report that during 2007, the value of one of KKR’s largest deals, hospitals group HCA, had been written up to 1.2 times cost from 1.0 times cost. That deal, closed in 2006, involved $5 billion in equity from KKR, Bain Capital, Merrill Lynch and other investors. KKR Private Equity Investors did not write down the value of HCA during the fourth quarter of 2007.
Fair value accounting requires an investment manager to value a portfolio item using the price at which the asset would trade if sold today in an orderly process. Fair value is particularly difficult for private equity GPs because their firms usually own positions in private companies that are difficult to value absent an exit or financing event.
Many GPs have long been in the habit of holding investments at cost until a significant event, such as an IPO, give them the confidence to write up the value. But a new statement from the Financial Accounting Standards Board (FASB) called Statement 157 is placing pressure on private equity firms to abandon a tendency to keep interim valuations at cost and instead adopt a more dynamic valuation policy. This, coupled with declines in the stock market and a slowdown in the mergers and acquisitions market, may lead to dramatic valuation decreases for private equity investors over the next year or two.
Weakened private equity portfolio valuations may cause limited partners to slow the pace of new commitments in 2008 and 2009. It may also cause a wave of secondary activity as current limited partners seek to unload portions of their existing partnership portfolio ahead of further valuation decreases, some market observers have said.