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KKR Sees Solid Future Despite Sinking Profits

The world of private equity isn't something that most rank-and-file investors know much about, but success in making long-term investments in businesses that are privately held is what has made KKR (NYSE: KKR) a big name in the private equity world. As a pioneer in the industry, KKR has been gathering assets from sophisticated investors for more than 40 years. Yet recently, concerns about the staying power of the private equity industry have led shares of companies like KKR to fall to attractive-looking valuations.

Coming into Thursday's third-quarter financial report, KKR investors were comfortable with the idea that the private equity specialist wouldn't make as much money as it had the previous year, but they still wanted to see signs of long-term growth potential. KKR's results weren't entirely satisfying, but the company's management remains optimistic that it's on the right strategic path toward reaching its goals over the long run. Let's take a closer look at how KKR did and whether private equity is ready to bounce back.

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KKR sees mixed results

KKR's third-quarter results showed some of the challenges that the private equity business has dealt with lately. Total reportable segment revenue was down by a quarter to $769.7 million. That sent after-tax economic net income down by roughly half to $308.4 million, working out to $0.36 per adjusted unit. GAAP net income saw similar performance, falling to $153.6 million from more than $352 million in the year-ago quarter, or $0.30 per unit.

As dire as those numbers sound, KKR's key metrics actually showed plenty of promise. Book value per unit came in at $13.80, which is up almost 14% from what the figure was at the beginning of 2017. Assets under management were up by 17% to $153 billion, and fee-paying assets made up a larger proportion of that total number, climbing by more than a fifth to $114 billion. KKR has raised more than $37 billion in fee-paying capital over the past 12 months on an organic basis, reflecting the popularity of its funds amid solid performance.

KKR's fundamental business performance during the quarter was somewhat at odds with the more volatile aspects of its revenue stream. On one hand, KKR was able to implement increases in transaction fees for its capital markets and private markets segments, as well as higher management fees for its private market clients. Yet lower net investment income weighed on KKR's near-term performance, and the private equity company also got less money from the carried interest gains related to the investments that its private equity funds make. Those downward factors can oscillate dramatically based on market performance, but long-term investors should be more interested in the fact that KKR has the pricing power to keep its client base even during brief periods of challenging performance.

Can KKR keep ahead of the pack?

KKR was generally pleased with how things are going. "Continued strong operating fundamentals across the firm were evidenced by double-digit growth year-to-date," said co-CEOs Henry Kravis and George Roberts, "across our management fees, fee related earnings, economic net income, and book value." The executives also pointed to the completed formation of two new strategic investment partnerships during the quarter, and positive momentum in being able to raise funds has KKR excited about future opportunities.

KKR was able to sustain its regular quarterly distribution, rewarding income investors. It will distribute $0.17 per unit this quarter to its investors, and that gives the company a distribution yield of more than 3%. That's not as high as some of its competitors in the space, but it's still worthy of notice.

Despite the upbeat prognosis for its future, KKR unit prices fell 1% in Thursday's trading session following its morning announcement. Those who aren't worried about short-term fluctuations in the price of KKR's equity units should feel comfortable about the way that the private equity company keeps attracting assets from investors hungry for strong returns.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends KKR. The Motley Fool has a disclosure policy.