NEW YORK (TheStreet) -- KKR (KKR - Get Report) continues to grow the amount of distributions it pays to investors, as the private equity firm exits some longstanding investments and bolsters its balance sheet with acquisitions.
The firm generated economic net income of $501.6 million in the second quarter and 67 cents in distributions per share, a sharp rise from this time a year ago. KKR's quarterly distribution per share beat analyst estimates at Oppenheimer & Co. and Sterne, Agee & Leach, and were buoyed by cash generated from realized asset sales and the impact of the firm's acquisition of asset manager KKR Financial, a deal that closed in the second quarter.
KKR's distribution consisted of 9 cents in fee-related earnings and 41 cents in realized cash carry plus distributed net realized investment income of 12 cents from KKR and 5 cents from KKR Financial.
Although distributions and earnings rose at KKR, overall firmwide assets under management and fee-related earnings fell as a result of investment realizations and the accounting nuances of its KKR Financial acquisition. KKR also re-classified a few of its reporting segments to reflect the firm's reliance on its balance sheet for growth, possibly creating some confusion for investors.
KKR shares were falling nearly 3% in early Thursday trading at $24.63. Analysts generally believe KKR has conservatively marked its private equity portfolio, giving the firm the ability to generate continued earnings from asset realizations.
Second-quarter earnings results, while impressive relative to year-ago comparables, may contain some idiosyncrasies that mask positive trends running through KKR's businesses.
The bankruptcy of Energy Future Holdings in the second quarter and a heavy quarter of asset realizations meant that KKR's private equity assets under management fell in the second quarter. The closing of the KKR Financial meant that $4.5 billion in assets went from being managed to KKR's balance sheet, causing AUM to drop.
However, KKR believes its balance sheet will be a key source of growth in coming years, potentially driving a significant portion of the firm's recurring earnings. Investment income from KKR's balance sheet, combined with its growing capital markets business is now forecast by management to create half of the firm's overall profits.
"Overall, we see the quarter as a good demonstration of KKR's balance sheet contribution to cash earnings, a significant positive, though most other metrics were mixed or in-line vs. our forecasts," Deutsche Bank analysts said of KKR's second quarter results.
Second First Data Investment, New KKR
On a conference call with analysts, KKR highlighted a recent $3.5 billion private placement in First Data as indicative of how the company's balance sheet will be used in the future. In that deal, KKR invested $700 million directly from its balance sheet. Meanwhile, its capital markets business underwrote the transaction. While neither impacts assets under management or fee-earnings assets -- two traditional measures of private equity earnings -- KKR expects the deal to drive some future profits.
KKR is also realizing investments from its 2006 buyout fund, one of the largest in the industry's history, and analysts generally believe that the portfolio could generate significant earnings.
"We believe that KKR has a very reasonable potential of generating around $1.82 per share distribution in 2014. At nearly half of KKR's invested private equity capital, the 2006 Fund will be the main driver of the next wave of distributable earnings now that it has crossed into cash carry mode," Oppenheimer wrote in a note prior to earnings.
For instance, European pharmacy chain Alliance Boots remains KKR's largest aggregate portfolio company investment, representing about 9% of the firm's overall private equity investments. As Walgreens (WAG) works to close a second leg of its takeover of Alliance Boots, KKR may stand to benefit from a rising cash and stock value to the two-stage transaction. Like the Walgreens and Alliance Boots deal, KKR also took stock in its announced sale of U.S. Foods to Sysco (SYY).
As KKR farms out legacy investments, Oppenheimer also likes how the firm is positioning to grow. The acquisition of KKR Financial, which added over $2 billion in net assets to KKR, could be a key driver in coming quarters and years.
"[W]e like KKR's substantial balance sheet because it funds both organic growth initiatives as well as provides income to shareholders, especially with the 2Q14 closing of the KFN acquisition. We also think the growth story in KKR's Public Market's ventures is under-appreciated," Oppenheimer notes. The firm rates KKR a buy with a $28 price target.
The firm said on a conference call it expects to target 60% of the firm's private equity investments outside of the United States. KKR also said the firm has been finding better value in Asia, other emerging markets and Europe. "It is getting hard to find value," KKR said of its investments in the United States.
"Our realization activity in the second quarter drove the highest cash carry and total distributable earnings we've reported since going public, contributing to a quarterly distribution of $0.67," Henry R. Kravis and George R. Roberts, Co-Chairmen and co-CEO's of KKR said in a statement.
-- Written by Antoine Gara in New York