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KKR & Co. (NYSE:KKR)

Q2 2014 Earnings Conference Call

July 24, 2014 10:00 AM ET

Executives

Craig Larson – Head-Investor Relations

William J. Janetschek – Chief Financial Officer

Scott C. Nuttall – Head-Global Capital & Asset Management Group and Principal

Analysts

Michael S. Kim – Sandler O’Neill & Partners LP

Michael Carrier – Bank of America Merrill Lynch

William R. Katz – Citigroup Global Markets Inc.

Patrick Davitt – Autonomous Research US LP

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Brian Bedell – Deutsche Bank AG

Chris M. Kotowski – Oppenheimer & Co., Inc.

Marc Irizarry – Goldman Sachs & Co.

Devin Ryan – JMP Securities

Christopher Harris – Wells Fargo

M. Patrick Davitt – Autonomous Research LLP

Dina Shin – Credit Suisse Securities LLC

Chris M. Kotowski – Oppenheimer & Co., Inc.

Warren A. Gardiner – Evercore Partners

Operator

Ladies and gentlemen, thank you for standing by. Welcome to KKR’s Second Quarter 2014 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following management’s prepared remark the conference will be open for question. (Operator Instructions) As a reminder, this conference is being recorded.

I would now hand the call over to Craig Larson Head of Investor Relations for KKR. Craig, please go ahead.

Craig Larson

Thank you, Stephanie. Welcome to our second quarter 2014 earnings call. Thank you for joining us. As usual, I'm joined by Bill Janetschek, our CFO; and Scott Nuttall, Global Head of Capital and Asset Management. We would like to remind everyone that we will refer to non-GAAP measures on the call, which are reconciled to GAAP figures in our press release.

And this call will also contain forward-looking statements, which do not guarantee future events or performance. Please refer to our SEC filings for cautionary factors related to statements. This morning, we reported second quarter economic net income of $502 million or $0.57 of ENI per unit after taxes and equity based charges.

In the quarter, we were particularly active on the monetization front and are please to report record total distributable earning of $701 million, which is up 57% from last quarter and 74% from last year. On a per share basis this equates to distributable earnings net of taxes of $0.85 per unit for the quarter.

This increase was driven by $333 million of net realized cash carry also record figure and in certain we’ve announced a $0.67 distribution per unit for the quarter, which is up over 50% on a quarter-over-quarter and year-over-year basis. Before we move on, I would like to highlight the modified disclosure in our press release.

In this quarter, we changed our segment financial and Bill is going to cover how our new segment financials aligned with the metrics that we used to manage the firm. But at a high level, we’ve shifted the build to total segment revenues and total segment expenses to emphasize our three forms of revenue that’s fees, carry and balance sheet income and our two types of expenses compensation and other operating expenses.

There are four main changes, first, we made our total segment revenue and expense line items all inclusive this is true for page six which is the total segment summary as well as the individual segment P&L’s which follow on pages seven, eight, and nine. Total segment revenues now include fees, carry, and balance sheet income and total segment expenses now include the allocation of the carry pool.

Second investment income, so the income from the balance sheet is no longer attributable to only our third segment and instead we’ll spend each segment based on the source of the income generating.

Third and this is important we’ve added a new measure fee and yield earning on the front of the press release and with further detail on page 6. This item highlights the portion of our earnings that we think should be more recurring in nature including fee-related earning plus more recurring net interest and dividend income from the balance sheet.

And finally, after tax ENI per unit includes non-cash compensation charges at the total segment level.

And with that I’m now happy to turn over to Bill.

William J. Janetschek

Thanks, Craig. Before I review our results, I want to explain our thinking behind reporting changes that Craig just mentioned. Internally, we have focused on cash flow. We use total distributable earnings and distributions per unit to measure our performance as a firm. And the KFN transaction made us rethink the way we want to communicate our financial results.

In the KFN deal, we purposely gave up management fees in exchange for more permanent capital and more recurring balance sheet income. To exchange our reporting to better align our financials with the way we mange the firm.

In addition to total distributable earnings, we care about investment performance, which is important across of all of our businesses. And investment performance leads to ENI. We believe that today’s ENI is tomorrow’s distribution. And both of these metrics impact our profitability, which we measured through ROE and cash ROE. And when we evaluate our performance we consider both metrics.

So, with that, let’s turn to results. As of June 30th, our assets under management were $98 billion and fee paying assets under management were $80 billion. Both figures were down quarter-over-quarter, mostly from the KFN transaction as well as modernizations in our portfolio. However, those figures are up 17% year-over-year with that growth coming both from organic and inorganic activity through the capital we raised organically and inorganically through the Avoca acquisition.

Keep in mind; these figures do not reflect over $5 billion of committed capital that will be included in AUM once it is invested. This capital comes from a number of different accounts, including two new carry paying special mandates that closed in the quarter accounting for $1 billion of that $5 billion.

Turning to our segments, in private market, our private equity portfolio appreciated 5% in the second quarter, up slightly from the 4.5% appreciation we had in Q1. This caused an increase in accrued carry quarter-over-quarter, but was offset by lower investment income. In the second quarter, our private market balance sheet investments were up only 2%, compared to 5% last quarter. Together, this translated into $376 million of ENI.

Moving to public markets, ENI in this segment was $106 million, up 8% from last quarter. A few things contributed to the quarterly movement in ENI. As I mentioned, when KFN closed back in April, our fee paying AUM decreased more than $2 billion, which caused a decline in management fees and potential incentive fees.

However, these fees really just moved geographies in the second quarter and our now part of KFN’s investment income, which we are now reporting in our P&L since the transaction closed. As a result of the KFN transaction, our public markets investment income is up significantly in the second quarter and includes $34 million of net interest and dividend income. This is also our first full quarter with both are running through our financials and the bump in management fees in that business helped to partially offset the impact of the reduction in KFN’s management team.

To give you a sense of the impact that KFN had on our second quarter ENI, we generated total investment income across all our segments of $162 million, of which $56 million was generated by KFN for the two months that it contributed to our results. Touching on capital markets, we’ve reported second quarter ENI of $20 million, down from $47 million in the first quarter. This decrease was primarily driven by a lower capital market fees in the second quarter.

We have reported June 30 book value of $12.52 per unit, which is up 30% on a year-over-year basis and taken into account the impact of the KFN transaction and changing in the carried values of our balance sheet asset. Keep in mind, during the last year we also made distribution with our balance GP unitholders totaling $1.56.

In the second quarter, we also did a $500 million 30-year senior note offering that we priced last month with a coupon of $508 million. Our distribution in the second quarter will be $0.67 per unit, which includes 15 of fee and yield earnings, five of which came from KFN. Remember this $0.05 represents only two months of results since KFN closed on April 30. The other two pieces is $0.67 where $0.31 of realized carry and $0.11 of realized balance sheet gain.

Before I wrap up, I want to touch on one other point. We’ve made great progress over the last couple of quarters on a percentage of our assets in position to take cash carry. And as of today, all of our mature private equity funds are in position to take cash carry on a meaningful realization event.

And with that, I’ll pass it over to Scott.

Scott C. Nuttall

Thanks, Bill. I’m going to hit three topics today: realization, capital deployment and our business model. Let’s start with realization. We continue to monetize our private equity portfolio in the second quarter, returning our $4 billion of cash for fund investment for mixed strategic sales, secondary and dividend.

We exited Avincis and Oriental Brewery at 2x and 5x our cost respectively, and the secondary that HCA and NXP in the second quarter were down at 3.3x blended multiple of investment capital. We also completed dividend recap, the Capital Safety and Go Daddy.

Additionally, the pickup in strategic exit activity continues. Since the start of the second quarter, we agreed to sell two businesses as the strategic buyers, Biomet to Zimmer, and Wild Flavors to Archer Daniels Midland. We also agreed to sell stake in Visma, our software services business in Europe. These announcements combined with the pending sales of U.S. Foods, another strategic exit and Ipreo, which resigns Blackstone and Goldman Sachs, will provide a solid foundation for cash carry in the second half.

Now let me hit on capital deployment. We maintained our active investment pace in the second quarter in private market, putting $1.5 million of equity to work. This $1.5 billion includes our first investment in South America and Africa, and we believe we’ll find more investment opportunities on these two continents, as we continue to expand our global footprint.

We’ve also committed another $2.5 billion of equity to deals that have been announced, but not yet closed, of which approximately 60% will be put to work outside the U.S. We’ve also been busy in public markets. If you look at the gross assets invested across all of our accounts in investments, direct lending and special situations, we deployed $1.8 billion in the first half of the year.

These opportunities have been diversified by type and geography, and we’ve been particularly active in Europe where we continue to find some very interesting risk-reward opportunities. And more importantly, these strategies continue to perform. To give you a sense, our special situations, mezzanine and direct lending funds had gross returns of 41%, 24% and 15% over the last 12 months.

Overall we continue to find opportunities to both buy and sell across Asia, Europe and North America. And as of June 30, we’ve distributed over $6 billion of cash to our fund investors or 1.5 times the $4 billion that we’ve invested in private markets.

The last topic I want to spend time on is our business model. As we’ve explained before we believe our business model is unique. We are focused on marrying third-party capital with our balance sheet and capital markets capabilities to grow our cash flow per share.

We believe the combination of the three elements of our business model is quite powerful. Our goal is to double our cash flow by capturing maximum economics from the opportunities we see and the returns we generate. It is not that we don’t care about raising third party capital, we do. It is not that we don’t care about AUM or fee related earnings, we do. We just believe that those two metrics tell only part of our story. And, looking at them in isolation can be misleading.

Our model is quite different and that over 50% of our profits over the last 12 months have come from our balance sheet and our capital markets business. Neither of which contributes to AUM. We believe having our own capital invested in everything we do. And, marrying it with third-party AUM, plus capital markets, allowed us to increase alignment with our fund investors and drive a highly attractive ROE, and a larger quantum of total cash flow.

Ultimately, we believe that if we use all three aspects of our models to drive our cash flow per share higher and keep a high return on equity, all of us will benefit as shareholders as we will grow our distribution and our book value. We view the task as a simultaneous equation and are working to double our cash flow while keeping our ROE above 20% and limiting leverage and dilution. In effect our business model allows us to make more money from work we are already doing in the firm. We believe this approach has inherently less execution risk. As we are increasing our participation rate in the underlying value our teams are already creating.

So that’s how we think about our model at a high level, now let me drill down on some of the finer points. First, on the balance sheet our balance sheet generating significant cash flow approximately $800 million over the last 12 months. This cash flow is becoming increasing predictable. Despite building of our balance sheet investment generating a current return that we are including in our dividend.

As a result our overall cash flow is growing and has a more recurring base, but it’s not just about the balance sheet. We also have compelling growth opportunities, we have eight businesses moving from fund one to fund two. And this dynamics will allow us to see significantly greater profitability in the new businesses that we’ve created over the last three to five years. I said simply, the expenses are already here to the incremental revenues or high margin.

Finally, our cash carry is starting to increase rapidly, our year-to-date cash carry was more than double last years figure. I want to turn to how our business model actually works in practice and give you two recent examples. KFN and First Data, when we close the acquisition of KFN at the end of April we traded fee-paying AUM and fee related earnings for a bigger balance sheet and more recurring balance sheet income.

With more permanent capital inside the firm we are better aligned with our fund investors can accelerate our growth and generate more total distributable earnings and therefore, more distributions from everything that we do.

We also announced the large capital rates for First Data a few weeks down. We had a $3.5 billion private placement for the company. We invested $500 million from the 2006 fund, and $700 million from our balance sheet and our capital markets business was the store manager of the capital rates.

First day amendment and the capital markets team plays $1.8 billion of equity with new third-party investors, including mutual fund, hedge funds and sovereign wealth funds, the transaction closed earlier this month. First day is a good example of using our entire business model, third-party funds, our balance sheet and our capital markets business to generate more upside for a firm and our fund investors and more cash flow for all of us.

It is this combination of implementing our business model, gaining our newer businesses and monetizing cash carry. It’s driving our distribution of over 60% in the first half and while we have a return on equity of 29% and a cash return on equity of 22% for the last 12 months with no net leverage.

Stepping back, we have a strong pipeline of exit activity on the horizon. We had eight new businesses transitioning from Fund I to fund II, and the multiplied effect of our business model is starting to show up in our cash flow metrics. When we look at the first six months, our total distributable earnings are up 65% year-over-year. The more recurring part of our distribution is up over 50% year-over-year, and our year-to-date distribution of $1.10 is up 60%. In summary, we’re pleased with the first half results, but there’s a lot more to come in 2014.

Thanks for joining our call. Operator, please open the lines. And Stephanie, if you could, I’d like to ask everyone to please focus on only one question, so we can get through the queue, and then we answer the queue if you would like to follow up on any thing additional.

And with that Stephanie will take for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Michael Kim with Sandler O’Neill. Your line is open.

Michael S. Kim – Sandler O’Neill & Partners LP

Hey, guys. Good morning. So my question, as you continue to build up the franchise, can you talk about how you approach sort of the build versus buy decision, and then related to that, when might it make sense to acquire firms like Avoca, or Prisma versus may be forming partnerships with others like BlackGold and Riverstone?

Scott C. Nuttall

Great. hey, Michael, it’s Scott. Thanks for the question. I think that everything that we’re looking at, we do now analyze what makes persons to build it or buy it. As you know, historically, before a couple of years ago, we really did very much to the build, and really everything we have done before Prisma, we have decided to build organically. What we found though is that there are some parts of the world, frankly, where an acquisition may be a more viable way to go, to get us to scale faster. Some business is frankly where we’ll be able to add talent at more scale quickly through an acquisition approach.

So we really now would fair low-pass these efforts and analyze buying and building quite proactively, we create the corporate development group inside the firm, we did not have that a few years ago. So we have a dedicated team helping the business leaders to do this calculus. In terms of Avoca and Prisma versus BlackGold just to shed some light on that part of your question.

Really, the question is does it make sense for it to be strategically a 100% part of the firm. With Avoca and Prisma, we decided that it did make sense to bring them in strategically on a 100% basis versus BlackGold which is really a hedge funds stake, where we actually felt it made more sense that the owners of BlackGold to continue on the vast majority of that business. And really in that instance with Prisma in the first instance we felt that it was an important cornerstone to the hedge funds strategy that we wanted to build.

We felt that we could build up this dilutions part of their business, but leveraging the Prisma capabilities we felt that we could built a broader stakes and seeding business using our balance sheet capital because we like the cash-on-cash returns. And it made sense to have the Prisma team as part of KKR in total to be able to affect that overall strategy.

BlackGold is an example of one of those hedge funds stakes that we took as part of that strategy. Avoca similarly, we had been building out our credit business globally, as you know we had business in the U.S. at the time that had private and public credit working side by side. In Europe we only had private credit Avoca products to the public part and made sense to make a more holistically part of the firm. So that’s how we think about it and we will continue to access those path.

Michael S. Kim – Sandler O’Neill & Partners LP

Okay, thanks for taking…

Operator

Our next question comes from Michael Carrier with Bank of America. Your line is open.

Michael Carrier – Bank of America Merrill Lynch

Thanks guys. So maybe just on the modeling, when we think about the distribution, yes I think when you lose management fees and then goes to investment income. One of those things that sometimes you feel differently, but when you think of the mix now of your distributable earnings, is there a way to characterize like what portion of it you would say. I know you hit on it in terms of that’s more recurring, but is there a certain portion of the asset that have fairly consistent yields, just trying to get some understating on what can we start to think of is more kind of ongoing versus it’s going to ebb and flow with the market.

William J. Janetschek

Sure. I think Michael, we think about it. If you look at page six of the press release you see you now have this new metric fee and yield earnings. And really what was capturing there is the historical definition of fee related earnings I don’t think people had though of historically as more recurring in nature, but we are now starting to include this net interest and dividends component of the balance sheet. That’s the more recurring net interest and dividend that we get off our balance sheet. And about $5 billion of our balance sheet assets now are generating or we think it’s a more recurring dividend or yield and so that’s one metric that you can look to, they try to get a feel for that.

So you can see in the first six months and this is obviously without having KFN for the whole period only had it in for two months. You can see what that number look like that the $317 million that was show on page six. But the other page that I pointed to is page 15, which is the distribution calculation itself. And if you look at that page you can see the last box line, on that page we actually show fee and yield earnings per unit. And you can see that in the first six months was about $0.31. I’d expect that would continue to increase now that KFN is part of the fold completely and is that rolls in the numbers for the back half. You see that – I think that number will continue to grow on an apples-to-apples basis. But the other thing that pointing on that page is what KFN into our payout ratio.

So you can see last year Q2 is 76%, is now somewhere between 78% and 79% as we’ve changed our distribution policy to payout all of those earnings. So the point that we are trying to make though is while if you look at the numbers, its $0.31 in the first half out of a $10 of distribution. I think it would be the wrong thing, to do say that carry and balance sheet income otherwise are not recurring.

We’ve paid cash carry in each of the last 17 quarters and as you know we know the vast, vast majority virtually all of our private equity funds paying cash carry. So all though it’s harder to predict specifically quarter-to-quarter, it’s actually been quite recurring in nature and given that we’re – our own biggest investor, when we have cash carry events, it generates balance sheet realization events as well which also contributes through the dividend. So, I can’t view it as the spectrum and we have a lot of recurring income and we are excited it’s scaling so significantly as you know that dividend was up 60% in the first half.

Scott C. Nuttall

And Michael, just one follow-up when you thinking about the question at hand is the more recurring nature of that income. Keep in mind that KKR’s balance sheet traditionally was heavy into private equity. Now, private equity only makes up 40% of that balance sheet. As we diversify that you are going to see more recurring income come from the KKR part of the balance sheet those share repurchase page 15, and that $0.15 is really $0.09 of fee related earnings plus the nickel from cap end, but it’s only $0.01 from KKR.

But again as that portfolio continues to diversify, we will see more recurring interest and dividends come from that balance sheet and hopefully that number will go up.

Michael Carrier – Bank of America Merrill Lynch

Right, thanks guys.

Operator

Our next question comes from Will Katz with Citigroup. Your line is open.

William R. Katz – Citigroup Global Markets Inc.

Okay, thanks so much appreciate taking the questions. Scott you mentioned that you have eight different funds that could move from first to sort of second vintages, if you will. Can you walk through where you see the greatest opportunity will it be private markets, public markets, US, non-US, so give a sense of what investors are looking for right now?

Scott C. Nuttall

Absolutely, Bill. Thanks for the question, look I think before I answer, I would say the overall funding raising backdrop is quite positive. We’re seeing institutional investors get more cash back, frankly from their alternatives, portfolios and they we’re expecting for us and others. At the same time is over the last few years, they have actually increased their allocation to alternatives. So they are looking to put capital to work, so the fact that we are raising money probably second time funds is actually quite positive for us, we think we got the timing right. So, that’s good a backdrop and to answer your question. I think it’s pretty broad based.

In terms of the different strategies where we are active from a fund one to fund two, we are out with infrastructure two right now. Our infrastructure one fund has performed quite nicely, direct lending two is in the market. Frankly, we are virtually fully invested on our first special SITS fund. So we are going to be launching special SITS 2 as we mentioned in the remarks. Last 12 months returned in our special SITS strategy, we are over 40% gross.

So we are optimistic about that fund raise over time as well and there is a variety of other things on the private capital side, European direct lending. So, that a lot of what I mentioned that putting the more episodic both kind of real assets and originated credit buckets. So there is a significant amount of activity with a good back drop there. But also frankly we are seeing opportunities to scale in the hedge fund and credit side of the business is a more continuously raised vehicles as well Prisma, the two credit funds that we have is part of the credit business, the Stakes, Nephila, BlackGold et cetera.

And then in the credit side, we are raising CLOs, PCT continues to scale, so I would say there is a pretty broad based opportunity to continue to scale our capital, and I do remiss it’s not a fund to, but you have four strategies also in the market, it’s a bit early but so far so good.

William R. Katz – Citigroup Global Markets Inc.

Okay. Thanks.

Operator

Our next question comes from Patrick Davitt with Autonomous. Your line is open.

Patrick Davitt – Autonomous Research US LP

Good morning, guys. There was recent report on NPL sales in Europe up 6x year-over-year and since that you’re really starting to see banks kind of fixed about – curios, if you’re seeing the same thin and to what extent, you can still get good deals in that kind of environment with the amount of capital that has already been raised for this kind of stuff, both from you and your competitors?

Scott C. Nuttall

Good morning, Patrick. I think we are seeing more activity in terms of what banks are selling. Probably a year ago, there was a lot of noise, but the beta spread was frankly quite wide. And you’re right there has been more actual activity – why those portfolios are frankly reasonably well did. so while we have bought a few and those have touched, or performed quite well.

We’re not spending the bulk of our time there. We’re really finding more interesting opportunity and it’s particularly, the case across Europe and especially on the continent is the derivative fact, the fact that the banks are internally focused and/or not customer focused right now.

And so what we’re finding is that there’s a number of good companies that have capital structures that are maturing that need help. And so a lot of our activity is providing rescue capital for financing for those companies that’s really a consequence of the fact that the banks are going through, what they’re going through. So it’s created an opportunity for us, as a result of the regulatory environment and the fact those banks are quite levered. And so that’s the primary opportunity buying portfolios has been a secondary opportunity.

Having said that, we are in discussions with a number of banks about helping them, worked the way out of some existing assets in creating partnerships to do that, it’s hard to predict how that will play out. But the most activity today is actually, it is working directly with corporates.

Patrick Davitt – Autonomous Research US LP

Okay. thanks.

Operator

Our next question comes from Luke Montgomery with Sanford. Your line is open.

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Great. thanks, guys. I was hoping you might clarify your relationship with Capstone. I guess the key question here is whether or not, they might be deemed in affiliate, and it’s I guess unclear to me whether this hinges on the technical use in definition of that term in your fund documents, or whether it’s more about the economic relationship you had with them. so I was hoping maybe, you could touch on both of those aspects, and on the latter, clarify whether Capstone executives share any one of your revenue pools. And you think the fact that they’re captive and appeared to be at least partially controlled by a KKR has any bearing on whether they might be considered in affiliates somewhere down the road, is that term is generally or legally accepted to mean?

William J. Janetschek

Okay. this is Bill Janetschek. At its core, the Capstone is not an affiliate. Capstone is a consulting firm that provides services to KKR portfolio of companies. When you talk about economics, the fee income that they receive is as fair as they provide, or pay to all of the KKR executives and all of the Capstone…

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Capstone.

William J. Janetschek

All of those Capstone executives, sorry. In all of the supplement, the economics for those KKR – those Capstone executives, they’re not KKR. The carry pool that we have which is catered throughout KKR. A portion of that is actually allocated to Capstone executives that comes from KKR economics and not from our fund economics.

Scott C. Nuttall

And Luke, it’s Scott. I’d just add really simply, you are asking on legal analysis question, the punch line is KKR owns no equity in Capstone, legal analysis is not an affiliate. We’ve been open about that with our investors from the get go is actually in the limited partnership agreement as to how the relationship works. So we don’t think the people that we work for have any confusion on that topic.

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Okay, that makes sense to me, and it seems like you think the risk there is fairly low just a worst case scenario maybe you criticize the potential impact on unit holders and what are the fees that you are paying away to Capstone executives?

Scott C. Nuttall

I just did understand the construct today the portfolio companies pay Capstone directly. So the bottom line is do we not expect there to be any impact on KKR, it’s actually not in our financial segments.

William J. Janetschek

Right, to be clear none of this segment results that we provide have any Capstone economics running through it. Those fees have to be paid by the portfolio companies to Capstone and do not show up in our results.

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Right, somebody has to pay Capstone as is the GPs or the LPs, so I’m just wondering it’s determinant that the GPs are on the hook for then what is the potential size of that for some relevant period.

William J. Janetschek

The GPs and the LPs are not paying Capstone, the portfolio companies are paying Capstone.

Luke Montgomery – Sanford C. Bernstein & Co. LLC

Okay, I’ll follow-up with you guys. Thank you.

Operator

Our next question comes from Brian Bedell with Deutsche Bank. Your line is open.

Brian Bedell – Deutsche Bank AG

Great, good morning guys. You’ve talked a little bit about the growth in fee paying assets under management from here, maybe if you can just, when you think some of that $5 billion of committed capital can move into fee paying AUM and whether the new fund raises on Fund II whether you think that will be roughly inline with the – on Fund I. And just some color maybe start on, you talked about the U.S. versus non-U.S deployment, the non-U.S. deployment is increasing. If you can talk about maybe your footprint international in and over the long-term, opportunity is longer term being much more oriented outside the U.S.?

William J. Janetschek

Great. So I think in terms of handling those in turn. In practice, Fund I are – take longer to raise and historically they’ve been kind of a $1 billion, $1.5 billion or so in size. Because obviously the first time fund you kind of telling more stories and showing actual results and when you get the Fund II if you have investment performance that is actually an ability to scale the assets under management quite materially. So, I guess given that we’ve the investment performance; our general expectations will be that the Fund II for each of these strategies, those Fund II would be larger than Fund I. In some cases I would expect them to be a multiple of the size of Fund I. So that’s one of reasons for – about that opportunity.

But the other more important element as the economics and how that flows through our financial results. Because in Fund I it finished investing and Fund II turns on, we still collect a post investment period management fee on Fund I. So you’ve got the Fund II new management fees turn on, Fund I is still paying the trailer, usually had a reduced rate. And about this time Fund II turns on is about the time that Fund I carry starts to show up with the economic associated from this Fund I to Fund II move as we mentioned a quite significant given the expenses are already here.

In terms of the shadow question that’s really going to depend by strategy I think it’s a general matter we’d expect that to come into the actual fee thing of AUM over the next two to three years depending on the strategy. and in terms of our footprint, we now have 21 offices around the world, and a vast majority of those were outside United States. if you look at the deployment year-to-date about 60% plus of it has been outside the U.S. and we’ve been particularly active in Asia so far this year, where we’d count a lot of opportunity resulting from the dislocation. But frankly, we’re seeing opportunities in real estate, that’s a situation infrastructure across Asia and Europe.

So I’d say we’re well positioned, I mentioned Africa and South America, it really has become a very global opportunity stuff, and we think we’re quite well positioned to capture.

Brian Bedell – Deutsche Bank AG

And it sounds like based on the stuff – what you talked was direct lending in Europe, and your proportion of deployment with that 60% number could actually go up over the next couple of different valuations with U.S. Is that fair?

William J. Janetschek

It very well could and it’s impossible to predict, because it’s a lot of delay. But we still see some value in the U.S., but valuations are obviously. And so it’s getting harder to find value, we’ve had more success of late finding value in Asia and some of the other emerging markets.

Brian Bedell – Deutsche Bank AG

Great. thanks for taking my question.

William J. Janetschek

Thank you.

Operator

Our next question comes from Chris Kotowski with Oppenheimer. Your line is open.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Yes, good morning. I’m circling back between pages of 11 and 14 in the press release. And I wonder if you could flesh out a little bit what’s happening in the real assets business. You mentioned that you thought infrastructure was doing well, your infrastructure fund did real well, and that your raising fund too. But if you just look at where it’s market fair value, relative to costs, both real estate and infrastructure, it looks like they’re all marked reasonably closed to cars. So is that because it’s a yield vehicle, or because they were dividend recaps, or what…?

William J. Janetschek

Chris, if you’re looking on 2014, when you’re talking the infrastructure fund, you could see that you’ve got a cost of $780, and a value of $819. But in addition, it’s actually paid out $34 million in that yield component. So when you think about where that infrastructure fund is right now. And remember, it’s only been investing over the past couple of years. And so you will see an uplift hopefully prospectively, but again, infrastructure is more returning yield play as opposed to capital [application] (ph) play. And so you could see though, the total value on infrastructure is obviously well above costs.

When you’re talking about real estate, we’ve got a value right now of $400 million against a cost of $360 million, but we’ve already returned $129 million. So that real estate fund has a multiple of 1.5x, our money and keep in mind that that fund has only gone miles over the past year.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Great.

William J. Janetschek

An information on real estate, again, there is a yield component to real estate, but there is also a significant amount of appreciation in the real estate portfolio so far.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Right, okay. But actually, I was wondering about that, what it chose is the total invested is $360.8 million and the remaining cost $360.4 million, but $129 has been realized. So that, does that you’ve realized $129 million on $400,000 of cost basis? Can’t be, right?

William J. Janetschek

What happens is, for you to just get a little technical there is recycling provision in real estate. And so we have to return the cost and so that’s why that number maybe looks a little…

Scott C. Nuttall

When we have early exits, Chris, wherever they use the capital again.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Okay, great. And then what I’m looking at Page 11, I look at the real estate, it’s only marked up 5% above cost, it seems like that should theoretically be more?

William J. Janetschek

Well it is up, but remember this is only showing the costs and the fair value, it is not capturing any of the distributions, so my point back…

Chris M. Kotowski – Oppenheimer & Co., Inc.

Gotcha, okay.

William J. Janetschek

Page 14 is the 360 to 402 is up only a little, but not shown on the balance sheet again is all the distributions that have been made today.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Got it, great. Okay, thank you.

Scott C. Nuttall

Yes, I think look we had an early big win on Sunrise which we sold for over five times our cost, within 16 months. So what’s happening is that, capital is getting recycled the gain doesn’t show up, it’s already in the cash sitting on the balance sheet that’s maybe helps you.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Yes, and actually I meant to ask about the cash on the balance sheet, the way when we look at page I think it was 10 of the new balance sheet. The way to look at your net cash position now is the 3,375 minus the 1.05 billion of KKR debt obligations, right. So, in your view you have a 1.875 on the balance sheet in cash right?

William J. Janetschek

Correct. And then remember keep in mind Chris that, we’ve got that $3.4 billion in cash right now on a balance sheet we have mentioned that we are investing $700 million in First Data of our balance sheet and when you take into account, the $0.67 that we are going to be paying out in this quarterly distribution, that amounts due in access of $500 million, so cash is already find a home for $1.2 million of that $3.4 billion.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Okay.

Craig Larson

This is Craig. One other point to just highlight, and again we’re actually hesitating to give statistics like this just recognizing that on a Sun like real estate we think we are actually its an immature fund. And we remain in a pretty early stage in terms of the investment dynamics in that fund, but if you look at the IRR on real estate today, it’s a number that exceeds 60%. So again in terms of performance of the real estate fund, we’re actually very excited about the start that we have and again using Sunrise as an example of a modernization that we had very early in the life cycle of that the ability to recycle it. So that there from a performance stand point again it’s off to a great start.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Okay great. Thank you, that’s it from me.

William J. Janetschek

Thank you.

Operator

Our next question comes from Marc Irizarry with Goldman Sachs. Your line is open.

Marc Irizarry – Goldman Sachs & Co.

Oh, great, thanks. Scott can you talk about the percentage committed by the general party and I guess on page 14 you show your general partner co-invest by fund. I think you have a $1 billion in the release disclosed $976.9 million in the uncalled commitments. But on some of the newer funds the percentage that you’ll commit side by side to those newer funds are bigger and I guess as you get to later in the fund raising stages for the – for some of the newer funds. Can you give us a sense of just going forward, how should we think about the percentage that you commit side by side to particular funds versus using your own balance sheet capital to you know to opportunistically deploy side by side with investors?

Scott C. Nuttall

Thanks, Marc. What I think we are going continued to do both. The way we do really look at it is back to this ROE concept and total cash flow and what we were focused on doing is keeping the ROE at a very attractive level and keeping our cash flow per share high and growing it.

So what we’ll do is, we’ll actually look at the underlined investment opportunity and we’ll figure out how much capital we want to exposed to the strategy in the funds and a lot of instances frankly like we did with real estate, we find that if we’re speaking for more of our own dollars it makes the fund raising process faster and allows us to scale third party capital more quickly. And so we’ll go through that calculus, but really what we’ll do – if it’s a strategy where we think we can generate let’s say a 15% or 20% return. We review that is the first component to the return stream.

So actual dollars we have invested in that strategy that’s the first piece of it. Then we’ll look at it and say all right, we can get fees in carry back on top of that and this capital markets opportunities again on top of that. And so, really if you look at our business model, what we found is that, if we can generate 15% plus on the balance sheet investments themselves, and we get another 1500 basis points of ROE from fee and carry that’s how you get to the ROEs that we’ve generated with no net leverage.

So we are in the fund business, we’ll continue to have our percentage invested as GP. As you can see is kind of range between the very small percentages to much higher. But we also like that, keep some capital free for more opportunistic situations where there might be larger deals that we want to lean into. But what we do find is because the funds go first in the waterfall; we absolutely want to have our capital in those funds, so we participate as our own largest investor.

So I wouldn’t think about it as a percent, especially going from Fund I to Fund II, you can actually have a fund go from a $1 billion to $2 billion or $3 billion. So I think the percentage is not the right way to think about it. I would just think about it in terms of the aggregate dollars we want to expose to different asset classes.

And if you think about our balance sheet over time the reason we show this discloser is that’s how we look at it internally, is how much do we want in real assets versus private equity versus credit versus hedge funds. And so we’ll continue to report on that basis and then over time focus on making sure the ROE is 20% plus in each of those.

Marc Irizarry – Goldman Sachs & Co.

Great, thanks.

William J. Janetschek

Thank you.

Operator

Our next question comes from Devin Ryan with JMP Securities. Your line is open.

Devin Ryan – JMP Securities

Hey, good morning. Just a question on the current finance market, there is clearly been discussion in recent months just around the increasing regulatory scrutiny on banks that are providing financing on some of the more lever deals. And it doesn’t seem to be impacting the market of financing terms significantly at this point, but I guess it’s two part question. As the dialogue with banks changed it all in recent months related to this. And then secondly, are you seeing any maybe opportunities just to remediate the banks where you create funds that are maybe focused on the financing strategy here, just your thoughts there would be helpful.

Scott C. Nuttall

Happy to take that Devin, it’s Scott. I think couple of thoughts. When you write it hasn’t impacted our ability to get deals done to date. There is clearly more dialogue on the topic now then there would have been over the course of the last couple of quarters, so it’s clearly more top of minds for banks. What we found though is, we are testing a broader net in an environment like this. Our capital markets business is a huge advantage for us. Because there is opportunities for us given that we’ve direct relationships with the number of institutions around the world, some of which frankly are not subject to these potential limitation. So we’ve been able to get transactions done by discussing that broader net and using our capital markets team to do so.

But it also does create an opportunity for us and the private credit part of our business. I mentioned our direct lending business, that’s an example, our mezzanine business, the private credit markets will step in if there is a meaningful change in the behavior. So our perspective is we are well positioned through capital markets, so it still gets deals done in the private equity side. And our private credit business should benefit if these set guidelines getting here to, once the people figure out about all rules actually mean in practice.

Devin Ryan – JMP Securities

Got it. Helpful. Would your private credit business deals that you are doing as well as it or does that create a conflict of interest potentially?

Scott C. Nuttall

No, it does with the private credit business; we’re looking at KKR deals. There’s limitations as to the percentage of KKR deals that can be in individual vehicles. We obviously have evolved and compliance procedures in place. But there is an opportunity for those teams to look at those transactions if they like the risk reward. The vast bulk of our business is not financing KKR deals.

Devin Ryan – JMP Securities

Great thanks, helpful color.

William J. Janetschek

Thank you.

Operator

Our next question comes from Chris Harris of Wells Fargo. Your line is open.

Christopher Harris – Wells Fargo

Hey guys, just a real quick numbers question for you and I apologize if I missed it. But it sounds like the second half of the year shaping up pretty nicely from an exit perspective, sounds like you guys had a few things in a pipeline. Any guidance you guys you can give us around you know potential cash carry could be looking at it some of the things that are kind of in process.

William J. Janetschek

This is Bill. The only thing I could give you is a little color on third quarter and based upon the transactions we’ve announced and not yet closed. But we expect to close in the third quarter and that would be IPO and Prisma and we also actually had a secondary done it’s actually (indiscernible) and Jazz. Right now the cash carry number to the third quarter is $0.14 and a balance sheet number is $0.08, so that’s $0.22 so far where we are today, based upon expected closing and obviously that takes in, does not take into account any earnings from fee income or any earnings from KFN.

Scott C. Nuttall

Yes, I’d say just more broadly on the topic and – there is a lot of embedded value in the portfolios, as you think about our ability to generate cash carry going forward and as a reminder 12, 15 months ago we had about 35% of our private equity funds paying cash carry. Now its virtually 100% and so if you look at the make up of the unrealized value in that private equity portfolio that’s now paying cash carry, we have over $20 billion of its market one and a half times or greater and about 45% of it – of the unrealized value is from 2008 and prior vintages. And so obviously these companies are getting more mature, its part of the reason you’ve see our cash carry increase so significantly. But the good news is that there is plenty left to go.

Christopher Harris – Wells Fargo

Helpful. Thank you

William J. Janetschek

Thank you.

Operator

Our next question is a follow-up from Patrick Davitt with Autonomous. Your line is open.

M. Patrick Davitt – Autonomous Research LLP

Hey, guys, from the idea of around KFN rolling into higher yielding assets and strategies. Can you, maybe help us with the framework for thinking about the timeline for that happening as it is easier looking at the maturities of your CLOs and assuming those role into some of the more (indiscernible) remediation type stuff that you are doing or is that – is it just too hard to even try to think about that way.

Scott C. Nuttall

Patrick, it is Scott. I would – its hard to be precise, because it’s going to depend on a couple of things, one is how that portfolio rolls off to your point which is probably easier to model. If you also look the opportunity set in the market that we see where we can deploy more balance sheet capital against it. And some of that runs to Marc’s question about how much capital we have committed to our funds because we think about sizing our fund commitment to higher returning strategies, we’re thinking about how we use that KFN roll off to be able to do that.

But just a dimensional has it for you I mean there are extremes, we mentioned when we announced the KFN transaction at the return on capital there was a bit about 10% we are run rating there or frankly a little bit better that so far. So far so good, but as you heard just even our originated credit strategy is the returns to generating and those strategies are between 15% and 40%. And so it’s hard to get specific. But I’d say we are sitting here today not long after the KFN close still quite confident what we shared with you that we believe we can redeploy that capital as materially better returns and the 10% to 11%, it was generating before. And what we’re going to keep an eye on is making sure that we continue to generate an attractive yield of the balance sheet as we focus on that fee and yield EBITDA, and continue to drive up the much more predictable aspect of our dividends. So it’s going to be a combination of all of those factors that we’ll go into it, very difficult to give your modeling guidance however.

M. Patrick Davitt – Autonomous Research LLP

Okay. and just little quickly, it struck me that you said around the First Data transaction that you have indicated $1.8 billion, which is really a pretty big number relative to what you’ve been doing last six months. Does that portend a massive capital markets fee, or is that not the right way to think about?

William J. Janetschek

No, I think in terms of the First Data deals, just to break down the numbers. There I mentioned it was $3.5 billion capital raise. Recall that we, KKR spoke for $1.2 billion [Technical Difficulty]. so there was a total of $2.3 billion raised from third parties, $500 million of that $2.3 billion was raised from existing investments in first [Technical Difficulty] we’re not going to get a capital market beyond that. the $1.8 billion that will generate a capital markets fee in the third quarter. Actually First Data publically disclosed what that number would be; it’s a bit over $40 million from that transaction for our capital markets business in Q3.

M. Patrick Davitt – Autonomous Research LLP

Awesome, all right. Thank you so much.

William J. Janetschek

Thank you.

Operator

Our next question comes from Dina Shin with Credit Suisse. Your line is open.

Dina Shin – Credit Suisse Securities LLC

Hi, good morning. Thanks for taking my questions. We see most of them new funds and real assets in public markets are doing well. and so we are – just was wondering which funds are paying carry right now and which funds are closer to paying carry, just trying to understand paying carry ratio from the public market section. And also on the second point, the investment income seems like it was a lighter than we thought. So, what we’re – were there any sizable investments that had unrealized losses during the quarter? Thank you.

William J. Janetschek

This is Bill, if you refer to page 14, you can see that you are right, real assets right now, we’ve got committed capital of $7 billion plus in those strategies, as well as on the public market side approximately in other $7 billion. All of those are like private equity, like terms where we have the ability to receive carry. Each investment has been made over the past couple of years and the good news is in that most of the strategies, we are approving carry and running that through our P&Ls vis-à-vis ENI. but we haven’t had significant crystallizations in any of those mandates, and have been paid out much cash carry.

I do want to point out that in the first quarter of 2014, we did other realization event in one of the mandates that we have on the public markets side where we had gross carry of $25 million. And as you continue to see the performance developed in those strategies, we will continue to pay; we have the ability to pay cash carry. I also want to reference page 10 and you could see that right now on our balance sheet, in public markets alone, we have about $78 million of carry that has been approved in that portfolio of $7 billion that we’re managing and that’s ENI and that hasn’t turned into cash carry as again.

Scott C. Nuttall

I think with respect to the second part of the question, nothing that in particular that we’ve been pointed to that we’re not going to break down the individual’s main performance on the balance sheet. but I’d just point in the first half of balance sheet of 8% over the last 12 months of balance sheet was up about 22%, so it continues to perform quiet nicely.

Dina Shin – Credit Suisse Securities LLC

Thank you.

William J. Janetschek

Thank you.

Operator

Our next question comes from Chris Kotowski with Oppenheimer. Your line is open.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Yes, I guess just a follow-up on the opportunity in Europe. I mean I guess, I think it’s a funny situation right in that economic malaise there has been longer and harder than anybody would have thought a couple of years ago. And so that’s led your Europe II and Europe III returns to be fairly low, relative to your other fronts. but you can see the net IRRs are trending up now, and that’s nicely. but at the same time, Europe is kind of probably one of the world’s best investment opportunities or certainly one of the more distressed and dislocated ones.

And at the same time, kind of your views, most of the funds are uncalled commitments in front three. So I guess what is that – what is your strategy for raising a new fund in Europe before Europe II and III really fully have the kind of returns that you’d like to show to raise some new fund.

William J. Janetschek

That’s good Chris, I’d give – just give a couple of perspectives. You’re right. I mean Europe III is up 33% in the last 12 months. and frankly, the markets are strong, creating some attractive exits for us, strategic you’re buying. I mentioned the ADM purchase of our flavors business. So we’re returning a lot of cash royalties. and so liquidity is good.

And so really what happened is that as you point out, Europe III is now fully invested, or certainly passed its investment period. So the deals that we’ve been doing frankly, we’re now doing on the balance sheet pending a first close of Europe IV. We launched the fund rates for Europe IV in February, March, thereafter we had year-end numbers. And I say as a general matter, there’s quite a bit of optimism about the – an investment opportunity in Europe, whereas 12 months ago, kind of fear range, we’ve kind of just gone from fear degree, as it relates to the European investment opportunities. So the fundraising backdrop is much better than it’s been.

So what we’re doing is we’re continuing to be active. we’re actually adding talent in Europe. we opened a Madrid office earlier this year. And Europe is not a moderate. All right, so UK and Ireland are doing well. France, Netherlands, Italy are better good still, but weak. we are finding investment opportunities in private equity, although evaluations were watching very carefully, but we’re also finding opportunities in real estate and in special situations, which I mentioned previously.

So we do like the investment opportunity, the liquid markets have lowered back; the private and liquid markets are still yielding some very attractive opportunities for us. So the way we’re handling it from a capital standpoint is continuing to deploy, using our balance sheet in the intervening periods to fill the gap on private equity opportunities, and then we’ll drop some of those funded deals down into EIV when it has its first closing, which we expect will be sometime late this year, or early next year.

Chris M. Kotowski – Oppenheimer & Co., Inc.

Okay, very helpful. Thank you.

William J. Janetschek

Thank you.

Operator

Our next question comes from Warren Gardiner with Evercore. Your line is open.

Warren A. Gardiner – Evercore Partners

Yes. Thanks. Sorry if I missed this. So could you guys just give us a breakdown between private and public markets and private equity? I guess maybe the Biomet market; I just wanted to get a sense for kind of any EBITDA growth momentum there?

William J. Janetschek

Just to clarify the question. Did you want – Warren, did you want the mark, or how the underlying businesses are performing?

Warren A. Gardiner – Evercore Partners

Well, I guess both, I mean I was starting with the March, so I could get a sense, but I was assuming there maybe – it will be more EBITDA driven, maybe sort of color around those will be really helpful?

William J. Janetschek

Okay. Let me see if I can try to take a shot at it. So what we’ve seen with our private equity funds, about 24% over the course of last 12 months. And 5% or so in the quarter, if you look at what’s driving that, our private investments are actually up more than our public investments over the course of Q2. Year-to-date, privates were up a bit more than publics.

And if you look at what’s contributing to that, we still see some very attractive underlying growth; call it mid single-digit revenue growth, high single-digit EBITDA growth in those businesses. So I think if you look at the market broadly, you see that the performance of the U.S. stock market last year is 70% of it, was driven by multiple expansion, this year’s 70% of the market performance is driven by EPS growth.

And I’d say our underlying portfolio; we’re king of seeing its similar dynamics that there is more of an uplift that’s driven by earnings performance as opposed to multiples so far this year. In terms of the kind of public markets businesses, it’s a very different dynamic frankly.

Our mezzanine business is up a lot, because we’ve had some exits, we get warrants in some of those companies. So as multiples have expanded in some of those specific opportunities we benefitted from that, to special situations returns, which are quite highs, really driven by a lot of different things, but I’d say it’s a really combination of the recovery in the European markets, plus multiple expansion, plus some quick exits and some good investment decision. So it’s very hard to be two plus size on that. But overall, I’d say the overall tone feels like most of the returns are coming from operating performance as opposed to multiple expansion this year across everything we’re doing.

Warren A. Gardiner – Evercore Partners

Okay.

Scott C. Nuttall

And I would add, Warren is, we actually go through a pretty exhausted analysis at the end of every quarter. So we look by geography in terms of the privates how they’re performing. we look at that on a consistent company basis to try and think out noise, we look at that for the quarter, we look at that LTM and again, and when you boil down that kind of high single-digit EBITDA growth is a statistic test and pretty constant for us for the last several quarters. So that’s strength of something that we’ve seen pretty consistent.

Warren A. Gardiner – Evercore Partners

Okay. Very helpful, I got it. Thanks

William J. Janetschek

Thank you.

Operator

Thank you. that concludes the Q&A session. I will now turn the call back over to Craig Larson for closing remarks

Craig Larson

Thank you everybody for spending this with us. And if you have any follow-up questions, please feel free to follow up with us directly after the call.

Operator

Thank you. Ladies and gentlemen, that does conclude today’s conference. you may all disconnect. and everyone, have a great day.

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