AVCJ Awards 2017: Firm of the Year & Fundraising of the Year - Large Cap: KKR

“We have records of how many times Henry Kravis flew to Japan to meet the chairmen and CEOs of different conglomerates, as well as other senior partners from around the world, not just those based in Asia,” says Ming Lu, head of Asia private equity at KKR. “They do this when there isn’t an initial, specific target. It is about sharing our experience and showing companies how we can be operationally helpful.”

KKR’s pursuit of a meaningful piece of corporate Japan has been protracted. By the end of 2012, seven years after establishing a presence in Asia, the firm had deployed $5 billion in the region, but Japan only accounted for 6%. Since then, KKR has completed four corporate carve-outs in the country, with a fifth pending. Aggregate equity committed to Japan deals to date now stands at about $2 billion, excluding co-investment.

It has become the firm’s most active market in Asia, with two of those transactions closing within the last 12 months. They include the JPY498.3 billion ($4.5 billion) acquisition of automotive components manufacturer Calsonic Kansei Corporation, a process that started with an agreement to buy Nissan’s 41% holding in the company and ended with the completion of a tender offer for the entire business. It is the largest-ever private equity-sponsored transaction in Japan.

KKR announced 12 new investments between October 2016 and September 2017 – the qualification period for the AVCJ Awards – across China, Korea, India, Australia, and Vietnam, as well as Japan. There were also distributions from seven investments, including five full exits. Meanwhile, beyond the private equity world, the firm scaled its business across credit, real estate, infrastructure, and capital markets.

Yet the focal point for the period was KKR Asian Fund III, which closed in May at $9.3 billion, breaking the firm’s own record for the largest pool of capital ever raised for deployment across the region. KKR spent about six months in the market and ended up raising substantially more than its $7 billion target due to strong demand from LPs, many of whom had their allocations cut back.

Big in Japan

This interest is based on track record and deal pipeline, and Japan is a prominent factor in both. There is a sense that the large-cap investment opportunity across the region is growing due to a combination of economic growth and structural change. Lu notes that when he started in private equity, buyouts were limited to Australia, Singapore, Hong Kong and to some extent Korea, but now emerging markets such as China and India can deliver sizeable deals.

But Japan looms large in almost every pan-regional investor’s consciousness. Whether the shift is driven by governance reforms that prioritize return on equity (ROE) over scale, a recognition that being globally competitive means concentrating on core competencies, or an appreciation that private equity can be a good partner, conglomerates are more willing to sell to financial sponsors. While the gate hasn’t fallen from its hinges, it is gradually opening, ending years of frustration.

“One part is that corporations are very reluctant to carve out subsidiaries in Japan,” says Sakae Suzuki, a managing director with KKR’s Capstone operations team in Tokyo. “It’s an emotional and cultural barrier – they might say they know it’s the right thing to do but it feels like selling your children. With the success of Panasonic Healthcare, I think they have seen that it can be beneficial.”

Panasonic Healthcare, KKR’s second carve-out in Japan, has become its calling card. In 2013, the GP firm acquired Panasonic Healthcare for JPY165 billion, telling Panasonic – which retained a 20% stake – that it could drive expansion domestically and overseas. Since then the business has doubled in size, in part due to the purchase of Bayer’s diabetes care business. Last year, Mitsui & Co. invested at a valuation of JPY245.9 billion, enabling KKR to make a partial exit.

“We have exceeded many expectations with the company, and it is a reference point in every other meeting on the topic of carve-outs and our cross-border capabilities,” says Lu. “Japanese companies know we worked with all the stakeholders at Panasonic Healthcare to grow this business, and those stakeholders have now seen the value-add beyond capital that we bring and are advocates of our partnership model.”

PE firms have agreed five carve-outs from Japanese conglomerates in the past 12 months. Each was a competitive process and KKR prevailed in three. The acquisitions of Calsonic Kansei and power tools player Hitachi Koki have closed, while a deal has been struck with Hitachi over Hitachi Kokusai Electric but the tender offer to shareholders in the listed company has yet to be completed.

Even though these were auctions, KKR had reached out to the sellers long before any transactions became imminent. Suzuki recalls visiting Nissan with the deal team for preliminary discussions on potential carve-outs and then being drafted in once the due diligence began on Calsonic Kansei and the firm needed to draw up proposals for what it planned to do with the business. Given the company has 78 factories around the world, KKR emphasized its global network and sector expertise.

“They are keen to understand what kind of value-add we want to achieve and to see our track record. They may fear – at least this is my observation – that a PE firm will come in and dismantle the subsidiary, causing tremendous hardship for employees,” he says. “But we have shown that we really support the growth of businesses. We hope they see when KKR invests in a company, it tries to increase the value through growth rather than by cutting back on people and cost.”

While those concerns might be shared by all vendors, the methods of engagement vary. For example, when working on the Panasonic Healthcare deal, Capstone had extensive discussions with the subsidiary’s management as well as with Panasonic executives. During the Calsonic Kansei process, though, Suzuki didn’t speak to management until after the deal was signed. Then it was a case of sitting down with as many people as possible.

Capstone distills its value-add strategies into a 100-day plan and a fast-start playbook. The latter lists immediate post-acquisition priorities, covering areas such as cost savings, revenue generation, research and development, and innovation cycles. Those initial meetings with management help the team develop ideas for what should go into these plans.

“The content of the fast-start playbook and the 100-day plan has a lot in common with deals in other countries,” Suzuki adds. “But then there are also mannerisms and considerations that are unique to Japanese management teams, so we have to customize our approach. We adjust and evolve our approach each time based on the situation.”

Replicating the model

KKR is now in the process of taking its proven Japan template and applying it to Korea, where global private equity firms have long pursued carve-outs from the chaebols but to relatively little avail. An initial breakthrough came at the end of June with an agreement to invest in two divisions of LS Group subsidiary LS Mtron at a combined valuation of KRW1.1 trillion ($940 million).

The GP will acquire 100% of LS Mtron’s copper foil and laminate business and enter joint ownership – albeit with a 47% interest – of LS Automotive division. Automotive components sector research carried out for the Calsonic Kansei deal proved helpful in assessing LS Automotive. A full takeover of the latter division is an eventual possibility, but preserving the LS Group relationship is paramount.

KKR is one of the few Asian buyout firms that can claim to have a true pan-regional presence. Fund III is being deployed by more than 60 investment professionals – supported by Capstone and KKR Capital Markets – based in offices in Beijing, Hong Kong, Mumbai, Seoul, Shanghai, Singapore, Sydney, and Tokyo. However, making each local team among the leading players in its market is not easy.

“Running a true pan-regional fund has its challenges – it is challenging building a strong team in all markets and understanding the dynamics of those markets in real depth,” says Lu. “There are some pan-Asian platforms that are particularly active in one or two markets, which is an easier approach to establishing a team and a track record.”

A pan-regional strategy also requires a degree of flexibility. In late October, KKR paid around $74 million for a 12.6% stake in Nippon Indosari Corpindo, a listed Indonesian bakery business. Regardless of the appeal of a proxy to rising consumer demand or the chance this might represent the first part of a multi-stage investment, mid-cap PIPE deals seem off-strategy for a $9.3 billion fund. In fact, the transaction is an example of KKR thinking strategically about an emerging market.

Indonesia, like most Southeast Asian nations bar Singapore, cannot be relied upon to deliver a string of large buyouts, but pan-regional players hoping to develop the market still need to be there. Furthermore, Nippon Indosari Corpindo is backed by local conglomerate Salim Group, owner of a string of consumer businesses. It is the kind of partner with which PE firms want to become aligned.

“We have to be very flexible in each market. If we approach a market thinking we only want to do $500 million deals, then we wouldn’t end up doing anything in some places,” Lu explains. “But that doesn’t mean five years from now it won’t be different. And if I’m not there today building my track record, franchise and relationships, then I won’t be there five years from now. You have to think about it strategically.”

Preexisting relationships in Southeast Asia’s business community have already paid off once this year in the form of Vietnam-based Masan Nutri-Science. KKR invested $359 million in another Masan Group subsidiary, Masan Consumer Corp, between 2011 and 2013, exiting its position last year. This shared history helped the firm win a competitive process to invest $150 million in Masan Nutri-Science, an animal feed supplier that is expanding into mid-stream agriculture. KKR also bought $100 million worth of shares in Masan Group because it thought they were undervalued.

Pricing pressure

Whatever the strategy for deploying a $9.3 billion fund, the lingering question – which was also asked of the firm’s $6 billion second Asian vehicle – is: How much is too much? With large amounts of capital entering the asset class globally, most of KKR’s large-cap regional peers have raised or are raising substantially more capital than in the prior vintage.

A pan-Asian fund managed by a brand-name GP is the logical option for an institutional investor that must write large checks and wants reasonably broad exposure. It remains to be seen whether the small subset of firms that operate at the top end of the market are raising so much money that they will be unable to efficiently address the investment opportunity as it stands. The KKR view is that opportunity set – in Japan and elsewhere – is growing fast enough to justify its fund size.

There are concerns about rising valuations, particularly in competitive processes and Lu shares them, noting that he sees plenty of deals in which the multiples are purely liquidity-driven rather than supported by the fundamentals. An investor will enter at a 20x price-to-earnings multiple in the expectation that they can enter at the same valuation in five years’ time.

“A generation of investment professionals has grown up and never seen a high-interest rate environment, and that troubles me,” Lu adds. “There is no 20x P/E in my vocabulary. We underwrite based on long historical averages of P/E through cycles. If we can’t justify a deal on that basis, we walk away. But even in the most expensive markets, you will find sectors that are good value.” 

Pictured: The KKR team, led by Asia PE head Ming Lu (third left), receive the Firm of the Year award from Stephanie Keen of Hogan Lovells (second left)

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• Topics
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