KKR to compete with investment banks(3)

One of the biggest fee-payers on Wall Street, IPO-bound KKR plans to increase revenue by cutting out investment banks as syndication middlemen.

New York buyout giant Kohlberg Kravis Roberts plans to capture the millions in fees it pays investment banks each year by increasing its own capital markets activities around the world.

“We intend to use our capital markets business primarily to supplement our existing capital-raising capabilities and the underwriting and advisory services that our funds and portfolio companies currently receive from large investment banks,” KKR said in a regulatory filing related to its pending $1.25 billion initial public offering.

The firm is “currently building” its capital markets business.

Syndicating and underwriting portfolio companies’ securities will increase the amount of third-party capital KKR can commit to transactions, as well as help the firm avoid club deals, “thereby retaining more operation and economic control for ourselves”, the filing said.

Like many buyout firms, KKR has long charged fees to its portfolio companies in the form of transaction fees and monitoring fees, among other fees. KKR stands to profit handsomely with the launch of a capital markets division: In 2004, private equity firms coughed up $9 billion in M&A and capital markets fees – and KKR was the largest single contributor, paying more than $495 million, Dealogic found.

One industry insider estimated that a KKR deal of roughly $10 billion in size could generate a debt placement fee of $200 million. “So that makes a difference, particularly if the equity component on that deal was, say, $3 billion and they were only putting in $1 billion,” the source said. “They just got a 20 percent rate of return just on the fee associated with debt.”

“We expect to compete as a capital markets business primarily with investment banks and independent broker-dealers in the United States, Europe and Asia. . .” according to the IPO filing.

It also said that while it does not “in the near term” intend to make principle investments with the capital generated from syndicating deals, “we may consider using our capital markets business to buy and hold securities for investment purposes provided that we have sufficient regulatory capital to do so. In those circumstances, we would expect to act more as an investor than as a market-maker.”

KKR has had to file for a securities broker-dealer license in order to launch its capital markets business, which caused some speculation that it would start an M&A advisory arm similar to The Blackstone Group’s. In its filing, KKR said it has not registered as an investment advisor, but may do so in the future.