Billion dollar mezz bet

KKR’s newly raised $1bn mezzanine fund is an illustration of how popular this area has become with limited partners, who are increasingly attracted by its risk/reward profile

When Kohlberg Kravis Roberts recently closed a mezzanine fund with more than $1 billion of commitments, the firm highlighted the lack of financing available in the current private equity market; it clearly feels it can make money providing debt for these deals. And it’s not alone: the likes of The Carlyle Group and The Blackstone Group have run stand-alone mezzanine-related vehicles for several years now. KKR itself has been operating in mezzanine since 2005, but Mezzanine Partners I – which it decided to start raising in 2009 – is its first dedicated pool of capital for the strategy.

Mezzanine strategies have become popular among some private equity firms as a response to the lack of financing available for private equity deals. These firms believe opportunities are particularly rife in the smaller end of the market, since bigger firms tend to have less trouble securing financing for deals (partly because they have more options) – although in a general downturn, as we saw after the collapse of Lehman Brothers, financing tends to be scarce across the market.

The successful closing of KKR’s debut fund also highlights the strength of investor appetite for mezzanine. The firm was able to attract a geographically diverse group of institutions into the fund, including public pensions, endowments, insurance companies and high-net-worth individuals.

LPs like mezzanine for several reasons, according to Marc Ciancimino, a member of KKR’s mezzanine team. They like the return profile, which in a time of hampered credit markets can reach the high teens. And they like the risk profile, which is better than straight equity investments.

“Typically, you have 30 to 40 percent equity in front of you [in the capital structure], so the business would have to lose roughly a third of its value before our investment starts getting impaired,” Ciancimino says. “While equity valuations can move around a lot, especially levered equity, you have to have a big underperformance for mezzanine to move in the same way.”

LPs also like the current income aspect of mezzanine, in that they receive quarterly or semi-annual distributions on the interest, he says. This helps LPs reduce the “j-curve” effect of private equity on their portfolios, since they start seeing returns right away.

KKR has already participated in more than $1 billion of mezzanine financings since 2005, through vehicles managed by KKR Asset Management. The mezzanine team, which is led by Fred Goltz, and includes Ciancimino and Doug Tapley, along with Scott Cullerton, Lee Stern, Jason Ridloff and others, will continue to draw on the resources of the wider KAM team.

Generally, the firm partners with trusted private equity managers for deals. Earlier this year, KKR led a consortium that injected €105 million of mezzanine financing in Bain Capital’s acquisition of Netherlands-based IMCD, which distributes specialty chemicals. Given its extra firepower, there are likely to be plenty more where this came from.