Distressed Eurozone Asset Sales Should Benefit Buyers KKR Financial, Macquarie Group

Includes: KKR, MQBKY
by: George Fisher

European banks are selling assets to raise cash, partially to meet higher capital requirements of the Basil agreements and partially to support their loan stress in the sovereign debt sector. The buyers of these assets could be getting a great deal due to the distressed nature of the sellers. The New York Times ran an article titled "US Firms See Europe Woes as Opportunities," which probably was not widely read, as it was published on Christmas Day, but the thesis is interesting.

The banks are not keen on selling their assets into what could be construed as a buyer’s market where money is cheap, but risk is out of favor. The more assets European banks collectively offer, the cheaper the eventual selling prices. Two firms might be considered as potential buyers of European bank assets at distressed levels are KKR Financial Holdings LLC (KFN) and Macquarie Group (OTCPK:MQBKY).

KKR Financial is a financing arm of KKR Kohlberg Kravis Roberts & Co (NYSE:KKR), the private equity and venture capital firm. Structured as a flow-through Limited Partnership with tax-advantaged distributions, KFN invests as a specialty financier in mezzanine loans and high yield bonds of deals mainly indentified by KKR. KKR is the managing partner of the LLC and earns an annual fee for such. A list of KKR Financial top 50 holdings by issuer at estimated fair value can be found on page 19 of the latest investor presentation (pdf).

KFN should earn between $1.65 to $1.75 a share this year and next. Distributions are set at $0.67 for 2011 and estimated at $0.72 for 2012. Assets as of 9/30 were $8.4 billion with offsetting liabilities of $6.6 billion, for a book value of $9.14 a share based on 178 million shares outstanding. Most of assets have been pledged as collateral for CLOs, or collateral loan obligations, of which $3.6 bil comes due between 2016 and 2020. Share prices have been strong recently and trade at $8.80, for an 8.4% yield and a 4% discount to book value.

Using its strong cash flow, KFN has been buying back its convertible notes, reducing future share dilution. KFN has adequate liquidity to expand its asset base by upwards of an additional $400 million to $900 million, based on facilities currently in place.

Macquarie Group is an Australian–based international bank with a growing portfolio of fee-based assets and a strong cushion of capital. Macquarie’s strength is providing value-added management expertise to investment funds of mainly capital assets. During the financial crisis of 08 and 09, Macquarie was buying money managers and investment banking offices to expand its presence in the investment-banking field. However, the market has been slow to recover, especially in Asia, and revenues per acquired employee have not been as strong as projected. In addition to a declining market, its market share has been slipping.

MQBKY trades at $24, giving the company a market capitalization of $8.4 billion, and it pays a semi-annual dividend based on earnings. FY May 2012 dividend yield should be about 6.5%. An advantage of owning Australian banks is their historically high dividend payout ratio, with MQBKY set to earn around $2.50 in FY 2012 and to payout about $1.60 in dividends. With a potential turn in profitability of financial markets in late 2012 and into 2013, FY 2013 estimates are for a rebound to $3.30 in earnings and $2.02 in dividends.

One interesting development to follow is the possible imposition of Basel III rules on US banks by the Federal Reserve. After strong lobbying efforts by US banks, they had hoped for a pass on these more stringent rules. The Wall Street Journal reported on Dec 19 the Fed was about to announce its decision in favor of Basel III. If the Fed moves in this direction, it could be a relative positive to Macquarie, who is already one of the banks to be governed by Basel III regulations. It is estimated that compliance of Basel III will reduce Macquarie’s ROE several percentage points from the low teens to the high single digits.

Macquarie has sufficient liquidity to finance upwards of $2 billion in asset expansion. For example, Macquarie is one of a group of companies bidding for a multi-billion aircraft lease portfolio being offered by RBS. If successful, this will add to their already substantial aircraft and auto finance business.

Both KKR Financial and Macquarie Group have access to capital and the business models to profit from the needs of European banks to turn assets into cash, preferably US dollars. Investors seeking exposure to this looming trend should research these firms. KKR offers a reasonable tax-advantaged distribution yield for a publicly traded LLC, with the potential for upwards of 20% increase in share price. MQBKY offers a higher capital gains potential through growth in its fee-based assets under management, especially at fire-sale prices.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: I am long MQBKY.PK, and have been a shareholder since 2008.