‘We knew it was difficult’

For Kohlberg Kravis Roberts & Company (KKR), 2010 marked the two-year anniversary of its infrastructure fund. The publicly traded US company rolled out its maiden infrastructure offering, named KKR Global Infrastructure Investors (KKR Global), in May 2008, touting the vehicle to Wall Street as part of a more comprehensive bid to broaden its asset management business. 

“The new initiative is a logical extension…building on the significant expertise we have established,” said a KKR press statement announcing the fund launch.

But the opening of KKR Global suffered from unfortunate timing. Between 2007 and 2008, the global financial crisis had routed Wall Street and rattled investor confidence.

Meanwhile, infrastructure investing was getting a bum rap. Public backlash against privatising US infrastructure was mounting. In addition, the asset class was not performing well. Now well into 2010, the fund had not announced a single investment.

To Marc Lipschultz, global head of energy and infrastructure for KKR, the underwhelming debut of KKR Global was academic.

“In all candour – and fairness – we started into the market when we knew it was difficult,” Lipschultz recalls.

Lipschultz, who joined KKR in 1995 having previously been with Goldman Sachs, continues: “We were in a market, in 2009, that has essentially been seared into our collective mind. That was not exactly a moment when people were looking to secure capital for the long term.”

Moreover, Lipschultz is quick to argue that, with KKR Global “we got in at exactly the right time, by my definition”. His argument is valid: KKR Global closed in June this year with more than $1 billion. Company-wide, KKR now has $4 billion committed to energy and infrastructure.

And Lipschultz stresses that 36-year-old KKR is continuing to position itself as a long-term infrastructure fund manager.

“This is just the beginning,” he says. “We’re not going anywhere.”

‘IT TOOK TIME’ 

Headquartered in New York, KKR is a private equity firm co-headed by Henry Kravis and George Roberts who, while working for Bear Stearns (with retired KKR partner Jerome Kohlberg), teamed to pioneer a type of transaction that would become widely regarded as a private equity staple – the leveraged buyout (LBO).

In an LBO, a private equity firm can borrow capital to finance the purchase of a company using the equity and debt of the target company itself as collateral, arguably foregoing risk. By 1988, Kravis and Roberts had plied their signature transaction – and put an exclamation point on the corporate takeover boom that helped define the decade – when KKR paid $31 billion for conglomerate RJR Nabisco. Along the way, the LBO model perfected at KKR went on to be duplicated by The Blackstone Group, run by investment banker Stephen Schwarzman, and the Carlyle Group in Washington, D.C.

The likes of KKR, Blackstone and Carlyle would go on to establish private equity as a global asset class throughout the 1990s and into the millennium, and by 2005 KKR found itself at the forefront of another LBO boom, joining Bain & Company and Merrill Lynch & Company to acquire HCA for $33 billion.

But with the global financial crisis and the credit market freeze in full swing in 2008, KKR sought to branch out from its buyout business through mezzanine financing, real estate and infrastructure.     

Infrastructure seemed like an ideal progression for KKR, given its penchant for investing in complex, regulated businesses. Plus, KKR had energy sector pedigree (energy infrastructure is a core KKR Global Infrastructure Investors holding): not least, both Kravis and Roberts hail from wildcatting hotbed Oklahoma.

Apart from energy, the fund aspired to a “core infrastructure” portfolio, including social infrastructure, transportation, and water and wastewater management. To help steer KKR Global, the firm brought aboard noted investment banker George Bilicic. Bilicic, while with Lazard, had guided KKR in its high-profile deal for TXU Corporation.

But by the end of 2008, Bilicic had left. Meanwhile, KKR, as well as Blackstone and Carlyle, lost market share to the likes of Industry Funds Management (IFM) and Global Infrastructure Partners (GIP) and other independently run managers.

“There’s a subset of investors who are going to favour stand-alone funds,” Lipschultz acknowledges. “The thinking is, ‘I want people whose fundamental business is running an infrastructure fund’.”

In the meantime, infrastructure investing was proving to be a hard sell in the US. A 2005 toll road concession of the Chicago Skyway had led to a surge of fundraising followed by highly publicised failure, including the would-be Citigroup deal for Chicago Midway International Airport that fell through for lack of financing.

Though both the industry and would-be investors had been left shaken, Lipschultz cited the perceived impracticality of the US infrastructure market as a selling point for KKR Global.

“People fundraising in 2005 or 2006 raised a lot of capital and by and large have had a tough time investing it,” Lipschultz charges. “That era, the easiest time to raise capital, was a very challenging time to put that capital to work successfully.”

In addition, overpricing was rife, according to Lipschultz.

“Look at the price of a toll road then, compared to now,” he says. “Look at the strategy drift for a fund amid the ever-expanding notion of ‘infrastructure’. It was an easy time to get capital and a lousy time to invest it.”  

Likewise “it was a perfectly reasonable time to begin a process of education,” Lipschultz explains. “We were willing to go through backbreaking labor to fund raise, and feel that we are putting that capital to work at a time when there are many attractive opportunities.”

“It took time,” he adds. 

‘A HUGE ADVANTAGE’

Today, with the close of KKR Global, Lipschultz is hopeful that the asset class is moving on from its rocky Stateside honeymoon into what he calls “Infrastructure v2.0”.

“The market went through a painful exercise, but it really was an education,” he notes. “We spend a lot of time explaining to people that the failure was not due to infrastructure as an asset class but rather poor investment decision-making”.

Meanwhile, KKR, a $60 billion investment company, has emerged post-crisis with what Lipschultz has determined to be a competitive advantage as an infrastructure fund manager.

“Having an infrastructure fund that is a part of KKR is now a huge advantage,” he insists. “Committing capital to an infrastructure fund is a long-term investment. You want a company that is going to be there long-term like KKR.”

“We are in the investment business,” Lipschultz continues. “There is a contrary risk to have a fund on a banking platform. Will a bank still want to or be able to have a fund with regulatory changes?”

Though he could not go into detail, KKR, Lipschultz stresses, is planning to follow-up Global Infrastructure Investors.

“We would not have started fund I without a strategic vision to get to fund IV,” he says. 

INFRASTRUCTURE 'DEFINED'

Though Marc Lipschultz and KKR Global Infrastructure Investors receive plenty of recognition for championing shale and renewable energy, the fund has a sector-agnostic portfolio. “We invest in infrastructure, but we define infrastructure by risk profile,” Lipschultz says. “We do not focus on what business the asset is in, but the risk of owning that asset.”

In defining infrastructure based on risk, KKR, Lipschultz says, has developed a list of criteria:

1. The asset is a ‘physical asset’
2. It is specialised in a core function
3. It has a high barrier to entry
4. It has long-term visibility of cash flow
5. It is Inflation protected
6. It has limited market correlation

“For example, a port is a typical infrastructure asset that we would be sceptical of,” he says. “A port is a deeply cyclical business. A US port importing from China is a sensitive business.”