KKR: Why Gabelli is Bullish

Updated with opening share price.

NEW YORK ( TheStreet) -- KKR & Co. ( KKR) started trading on the New York Stock Exchange Thursday, and among the shareholders is well-known investor Mario Gabelli.

Gabelli, Chairman, CEO and CIO of Gamco Investors ( GBL), says he has known KKR co-founder Henry Kravis since 1979, when both men were in their mid-thirties. An analyst at the time, Gabelli wrote a report on Houdaille Industries, a public company in which clients of his were invested.
Henry Kravis
Kravis on Gabelli: "Who the hell are you?"

Soon after he wrote the report came KKR's then-historic buyout of the Fortune 500 conglomerate, and Gabelli took out a ad in The Wall Street Journal.

"My ad was very tiny. It was like 140 bucks. I said 'Congratulations to my friends at Houdaille, and thanks to Henry Kravis, we made money.' He Kravis calls me up and says 'Who the hell are you?' I said 'Henry we went to Columbia business school two years apart. I'm older than you. Stop! And so we've done a lot of things together over the last 30 years."

Still, Gabelli did not buy shares of KKR & Co. Guernsey (KPEQF.PK), the offshore KKR vehicle that is being merged into the new U.S.-listed company, until they were near their historic lows in the $2-$3 range during the worst days of the 2008 crisis. Gabelli says he added to that allocation Tuesday morning, when the shares were above $10. According to Thomson Reuters data, Gabelli's Gamco Investors Inc. owns about $12 million worth of KKR & Co. Guernsey, making it the 10th largest shareholder. That stake amounts to just half a percent of the company.
Mario Gabelli
Gabelli on Kravis: "He's got an ego."

While part of the original rationale for the investment was that it was a cheap way to play Sun Microsystems, which was part of the KKR portfolio at the time, Gabelli is now betting on a private equity turnaround and the fact that Kravis is putting his reputation on the line.

"He's got an ego. It's not as visible as The Blackstone Group ( BX) Steve Schwarzman's, but he's got proven global skill-sets, and he's willing to go back and keep hammering away to do another KKR IV or VI or VIII--and Fund VIII will come at the right time. The way I look at it is like great wine vintages. Some years like 2000 are going to be fabulous and two years later the Bordeaux are not going to be as good," Gabelli says.

While Gabelli says he owns shares of Blackstone and Fortress Investment Group ( FIG), two other big publicly-listed buyout vehicles, he is not without his misgivings about private equity.

For example, he believes there are serious conflicts for big private equity firms that also run hedge funds, a group that includes Blackstone, Fortress and almost certainly KKR, though KKR never explicitly states in its S-1 registration statement that it runs a hedge fund.

"At some point in time that's an issue that's going to explode in their faces," Gabelli says. Calls to Kravis and KKR spokespeople were not returned.

Gabelli also notes the terms that investors in private equity funds agree to seem extraordinarily onerous compared to investing in, say Berkshire Hathaway ( BRK.B), in which Gabelli is also an investor.

"I can buy Berkshire Hathaway at a 20% discount from intrinsic value. I get in and out of the stock. Buffett works for $150,000 a year, takes no stock options and he's got a 23% compound annual growth rate, unleveraged, for 35 years. Now you're telling me, KKR, you want me to give you money; you're going to go do deals; I'm going to give you 20% of the profits; I'm going to get locked up for five years with a nine-year window?"

Gabelli also opposes the low tax rates paid by hedge fund and private equity managers. Much of their compensation, known in the industry as "carried interest," is taxed at the 15% (soon to be 20%) capital gains rate, rather than as at 35% as regular income.

"That should be reexamined and I'm all in favor of eliminating it. It's an egregious example of tax lawyers run amok," Gabelli says.

Still, Gabelli believes the private equity business is poised for a rebound. And clearly he has company. Shares of Blackstone and Fortress have been surging in recent days, though shares of both companies trade well below half of their debut IPO prices. KKR hit a high of $11.07 minutes after the open Thursday morning, but shares had fallen to $10.50 just over an hour into the trading day.

If markets rebound, it's hard to see how KKR won't benefit. But investors looking for transparency--in other words, to understand what exactly they're investing in--should look elsewhere.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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