John Rogers (Trades, Portfolio) of Ariel Investments made KKR & Co. (KKR, Financial) his No. 1 pick. KKR converted from a publicly traded partnership into a corporation. KKR is undervalued and the value may become unlocked due to the conversion.
Ariel's top pick
KKR is an investment I’ve highlighted previously right here on GuruFocus. Rogers told Forbes about the KKR investment:
"Here at the firm, we were pleasantly surprised by the decision and the courage to do it. We think that it's a good decision and we're very supportive of it," he said. "They had the feeling that if the market does not continue to value them appropriately, this would help to get them get a appropriate valuation."
Ariel is a solid shop and over 30 years, according to GuruFocus data, it outperformed the S&P 500 by 0.9% per year or 565% cumulatively. I'm not the first to look at performance data, but 30 years starts to look like a good bit of data. You could argue his real alpha is probably a little bit higher given we are just coming off a long stretch where Ariel's style -- value investing -- isn't doing well.
Conversion
The reason all private equity shops are considering converting into a regular corporation is because partnerships are getting the short end of the stick in terms of market value.
Although the partnerships can make for more tax efficient vehicles under the right circumstances, they can impede publicly traded companies. There are many tax complications that go along with an investment into a partnership, and there are many institutional, professional and individual investors who don’t want the hassle. This in turn cuts back on the constituent of buyers and depresses volume. Insiders tend to own a high percent of the shares in these companies, limiting their float.
For the above reasons, the major PE firms are virtually not represented in the exchange traded fund universe. That’s been quite the drawback over the years as capital has been flowing in that direction.
Blackstone (BX, Financial), the largest of the PE shops, is over $40 billion in market cap and bigger than Twitter (TWTR, Financial). Yet Twitter is represented in countless ETFs even among the top 10 largest positions. Blackstone is represented in only four ETFs and among the top 10 positions in only two.
Undervalued
The entire asset management game is somewhat out of favor due to the pressure on fees imposed by the emergence of ETF investing and indexing. However, private equity has been able to defend its fee structure reasonably well. In addition, private equity due to recent strong risk-adjusted performance has been able to grow assets.
KKR is somewhat of an outlier among the big PE shops -- Blackstone, Carlyle, Oaktree and Apollo -- because it retains much more capital on its balance sheet, which it reinvests alongside clients in its funds.
If you consider its cash and investments per share, resulting in a book value per share of around $14 and the earnings power of its total assets under management of $150 billion, partly subject to 2-and-20-type fees, its share price of $28 starts to look very attractive. The $150 billion in assets under management could indicate normalized earnings power between $2 and $6 because that's without considering the returns from the company assets that get invested, that indicates it trades between 2.2x and 5x earnings.
Disclosure: Author is long KKR and BX.
