Please ensure Javascript is enabled for purposes of website accessibility

Tax Reform Prompts KKR to Consider Incorporating

By Dan Caplinger - Updated Feb 8, 2018 at 10:44AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Could lower corporate tax rates entice the partnership to make a fundamental move?

For years, private equity companies have structured themselves as partnerships in order to obtain valuable tax benefits and avoid the high rates that corporations pay. Yet now that tax reform is a reality, and corporate tax rates have come down enough to offset some of the negatives of corporate status, KKR (KKR 0.95%) believes that it might be time to incorporate.

Coming into Thursday's fourth-quarter financial report, KKR investors expected to see substantial gains in key fundamentals. KKR's results were solid, and the company says that it's embracing diversification to take advantage of the hunger for smart investments among its clients.

Curved wall with stock quotes, up in blue, down in red.

Image source: Getty Images.

How KKR fared

KKR's fourth-quarter results were once again mixed in many shareholders' eyes. Total reportable segment revenue soared 52% to $1.01 billion, which was a much faster growth rate than most investors had expected. The company's favored after-tax economic net income measure was higher by 22% to $414.9 million, and that translated to $0.48 per adjusted unit, up 20% from year-earlier figures.

KKR's fundamental business finished the year strong. Assets under management soared 30% to $168 billion, rising by $15 billion in just the past three months. Book value hit $11.7 billion, which worked out to $14.20 per unit, up $0.40 since September and $2.05 over the past year. Fee-paying assets under management were up roughly 16%, and uncalled capital commitments soared by roughly half from year-ago levels.

The strategies that KKR has followed have worked well. In its goal to produce strong investment performance, KKR's flagship fund strategies were generally up 9% to 34% during 2017. Capital raising has been successful, and KKR put $18 billion to work globally in pursuing attractive investment opportunities. Returns on equity were favorable, and solid distributable earnings to unitholders helped validate the model that KKR has followed.

Yet not everything went right for KKR. Total investment income was down 19%, as higher dividend income in the portfolio failed to offset reduced gains. Expenses were also higher, by more than 40%, mostly because of higher compensation related to solid investment performance for fund personnel.

What's next for KKR?

KKR is happy with the way things are going. "Through our integrated model -- the combination of our investment funds, balance sheet, and capital markets capabilities," said co-CEOs Henry Kravis and George Roberts, "we were able to create more investment opportunities for our fund investors and generate record results in our capital markets business." The co-CEOs also mentioned the rise in book value and assets under management as noteworthy.

Yet one of the most interesting things in KKR's report was a simple sentence: "KKR's Senior Management and Board of Directors are evaluating whether to convert from a partnership to a corporation." The move stems from the changes that tax reform measures have brought about, especially the reduction in the corporate tax rate from 35% to 21%. The penalty for having carried interest taxed at the entity level was larger under previous law than it would be after reform, since carried interest qualified for capital gains treatment when passed through the partnership structure. It'll take time for the private equity company to evaluate fully the pros and cons of making a switch, but for investors who don't like dealing with the additional paperwork that comes with investing in a partnership, a change to corporate status could make KKR look more attractive.

KKR shareholders didn't seem particularly excited about the news, and prices of KKR units were down just a fraction of a percent in early-morning trading following the announcement. The bigger question for the company is whether it can successfully navigate the new turbulence in the market. If it can profit from it, then investors might well appreciate the new environment, regardless of whether KKR remains a partnership or chooses to incorporate.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

KKR & Co. Stock Quote
KKR & Co.
KKR
$46.73 (0.95%) $0.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.