KKR sharpens capital markets ambition
The alternative asset manager has seized an opportunity to climb the European leveraged finance rankings by underwriting more deals for its rivals. Investment banks should take note
Market dislocation often throws up anomalies, but the emergence of KKR Capital Markets (KCM) as a top 10 arranger of European leveraged loans during the first half of 2022 should not be dismissed as a blip.
KCM was ranked eighth by revenues for leveraged finance deals originated in Europe in the first six months of the year, up from 30th a year ago, according to Dealogic. This is the first time a non-bank financial company has broken into the European top 10 in leveraged finance — and it is ranked above both Barclays and Deutsche Bank.
Admittedly, its rise comes as overall revenues slumped by 65% — and some banks are sitting on the sidelines amid widespread market dislocation — but its progress in debt underwriting is no accident.
“The current market environment has likely contributed to our position in this league table and shows our aspiration of where we want to be,” says Mark Danzey, partner and head of KCM for Europe. “The clear progression of our business in the league tables is very deliberate and reflective of the growth in our business with other financial sponsors.”
KCM was established in 2008 and Danzey joined from JP Morgan a year later with the aim of providing best-in-class access to the capital markets for businesses that KKR owned or was looking to acquire.
“From the outset, we capitalised the business with a balance sheet and sufficient resources to position it to become a fee-generating business,” Danzey says. “Over the last 14 years, KKR’s business has transformed, and our strategy and platform have developed in parallel. We concluded that once we were doing capital markets work for arguably one of the most sophisticated sponsors, it was entirely logical to take those capital markets capabilities to other financial sponsors.”
KKR has transformed itself from being a monoline private equity firm to an alternative asset behemoth with funds spanning credit, real estate and infrastructure, as well as funds that invest in specific sectors such as technology and healthcare — and over a longer time period than the five year cycle traditional private equity is used to. It has made KKR one of the biggest and most important clients for investment banks globally, when it comes to handing out advisory and financing mandates.
In 2021 KKR paid $1.2bn in corporate finance fees to banks — second only to Blackstone, which paid $1.4bn, according to Dealogic. That doesn’t include any ancillary fees associated with hedging or trading.
KCM has broadened its expertise in line with KKR’s diversification and its revenues are growing fast. According to an investor day presentation last year, KCM has generated average revenues of $490m from 166 transactions per year between 2017 and 2021, compared with an average of $172m revenues from 88 deals between 2012 and 2016.
Goldman Sachs and JP Morgan, which have the biggest financial sponsor teams, earned more than $3bn each last year from private equity firms in corporate finance fees alone, so KCM has a way to go before it poses a serious threat to their top line. Even so, it is still eating the lunch of banks that regard it as one of their most important clients.
Danzey is keen to foster a collaborative rather than combative approach with the Street. “There is room for all of us to co-exist and we have good working relationships with lending banks,” he says.
“On most of our deals we partner with banks and on our own transactions, more often than not, we are working with banks. At some point in time, we have partnered with most of the large banks. We can also help them solve problems around capital structure given that we’ve got the credit pools of capital as well.”
Besides, as a captive capital markets arm to one of the world’s pre-eminent private equity funds, KCM offers something different. Danzey says: “The nature of the dialogue we have with the investor base is somewhat differentiated by virtue of the fact that we are issuers of a lot of KKR product into the market. That makes the conversation we have with the end investor slightly different from the one a bank could be having as a true intermediary. We have long-term skin in the game.”
In Europe, KCM has a team of about 15 professionals led by Danzey, which he thinks is the right number to achieve his aim. KCM also has an equity capital markets business in New York but in Europe the focus is on debt underwriting. It works on a broad array of transactions from traditional underwriting to bespoke deals, both for its parent and for other private equity firms.
This month it was an underwriter on a debt package for Groupe Brussels Lambert on its $1.7bn acquisition of diagnostics company Affidea from B-Flexion, in what Danzey describes as a straight underwriting role alongside banks.
But it can also combine with KKR to deliver a broader credit offering. “What differentiates us from some of our competitors in banks is that we often pair our capital markets capabilities with our credit capabilities,” Danzey says. “So, there are situations where we, as KCM, are underwriting and our credit business is holding alongside KCM. Really, it’s a very solutions-oriented approach vis-à-vis the client. We know what sophisticated clients want and that provides us with a slightly different lens to the business than traditional banks offer.”
For example, last year KCM worked on two deals for Goldman Sachs — Advania and LRQA — which involved a direct lending solution. On those deals, KCM underwrote and distributed while the KKR credit business took a long-term hold in those deals alongside KCM.
This gives KCM an edge on deals where banks often fear to tread. Danzey adds: “Banks are good holders of revolving credit facilities but they are less likely to hold term loan ‘B’ and/or unitranche notes. Very few — if any — are holders of second lien paper or junior debt. Within our credit business we can be holders of any one of those product sets.”
In a pioneering move for Europe’s leveraged finance market, KKR, Goldman Sachs and Jefferies underwrote the buyout of Norgine in June with debt that they sold directly to private credit funds, in a move that avoided the need to route the transaction through traditional syndicated markets. This is thought to be the first deal of its kind in Europe — although Danzey doesn’t believe it will signal a meaningful shift for similar deal structures, as the market still requires development from a syndication standpoint.
Bringing more to the (third) party
KCM’s firepower is far smaller than the likes of JP Morgan, Credit Suisse or Bank of America. Its typical underwriting size is $500m-$1bn and some transactions are as small as $75m-$100m. But it has also proved it can go toe to toe with Europe’s biggest leveraged finance houses. For example, its biggest single commitment in Europe came in 2018 when it provided $2bn of debt underwriting to support its parent’s €6.8bn acquisition of Unilever’s spreads business.
Around a fifth of the bank’s capital markets business comes from third parties — companies that are not associated with KKR. KCM would like to grow that to 40%.
Persuading private equity firms to invite their rivals into transactions may sound far-fetched but it is becoming more common, especially when it comes to direct lending and the more esoteric deal structures. For example, Apollo, one of KKR’s big rivals, has provided fund finance to a credit vehicle for another rival, Blackstone, which in turn is one of the largest direct lenders to Apollo’s private equity companies.
Danzey believes that a quality first approach sways the sceptics who grow to appreciate the value of doing business with them. “Our approach to third party business is about building trusted relationships and being appointed to lead a transaction,” he says. “Once people have worked with us, typically they like what they see and come back for more. I believe we have a compelling proposition and there is a lot of white space for us to grow into.”
At 14 years old, KCM cannot be viewed as a new kid on the block, but Danzey believes the business is approaching an exciting new phase, given the market dislocation. “We have come out of an environment where capital has been completely commoditised," he adds, "and for us it has been harder to grow our presence in a market where there is an excess of capital. Now we are in a market where accessing capital for new deals is relatively challenging. So, to some extent, it does feel like it’s our time.”
Europe’s leveraged finance market is effectively closed to new business and a number of incumbent players have been hobbled as they try to sell down legacy positions. “This market environment is a real positive for us in terms of developing our third party franchise,” Danzey says.
“We are being helped by the fact we have to access capital for our own businesses, so we know where to find capital when people think the markets are closed. Another tailwind is that in periods of volatility a lot of banks take themselves out of the market or retrench to their core geographies. We are fortunate in that we are relatively small and a relative newcomer and therefore able to move quickly.
“If you are smart, that represents an opportunity to lean in. There are clearly fewer players extending capital in the market today than there were even a month ago. It’s a challenging market for sure.”
More pain ahead
Danzey sees this retrenchment as an opportunity but also thinks that banks need to take some pain on their existing positions in order to get the LBO market moving again.
A group of banks led by Goldman Sachs placed a bond backing the buyout of UK supermarket Wm Morrison’s at a steep discount in May. It was a similar story this month when JP Morgan and Morgan Stanley made steep losses on a £1bn bond and loan deal backing online gambling company 888’s takeover of William Hill.
“Looking ahead, I expect underwriters will use the next six weeks to clear some capacity but I don’t think you will suddenly see a market that has healed,” Danzey says. “If banks start to take some pain around the existing inventory, you might see the market slowly grind its way back into life from September. Until that happens, it’s going to be difficult to contemplate taking on new risk, regardless of how well priced that new risk is for the current market.”
As Europe’s leveraged finance market starts to heal, banks will re-emerge — but KCM is challenging the established order. Banks are going to have to get used to seeing one of their best clients in the same league tables, not just at pitch meetings.