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Kohlberg Kravis Roberts: Is this petty cash or high interest?

By William D Alessandro on August 28, 2013 at 4:38pm.
Content:

This is KKR’s third annual report on environmental, social, and governance affairs. KKR formalised ESG due diligence efforts in 2011. The attempt to monitor pre-investment deals against triple-bottom line factors started in 2012. So it is fair to say ESG screening is just getting off the ground for the 37-year-old global investment firm.

The activist consulting group Environmental Defence Fund (EDF) gets the credit for convincing the leveraged buyout artist that careful management of ESG factors will unlock hidden value. KKR’s continuing close relationship with EDF arose during the acquisition of the electric utility TXU in 2008.

By the time KKR arrived on the scene, EDF had already mobilized public opposition against plans by the Texas-based power generator to build 11 coal-fired plants. Litigation was underway against several. EDF had no shortage of ideas how TXU could avoid building them. Given the costs of construction, KKR was keen to listen — and did. The affair between EDF and KKR is examined in a case study taught to business students in the Yale School of Management.

After the TXU takeover — the largest of its kind — KKR hired Elizabeth Seeger from EDF to oversee sustainability reporting and manage what has become KKR’s approach to ESG for their private equity portfolio companies. Seeger was an intern and project manager in the corporate partnerships program at the advocacy group.

The latest sustainability report is 55 pages and contains three main sections. One explains how KKR handles ESG issues before and after acquisitions. The presentation contains broad descriptions of the due diligence process and outlines other procedures used to identify risks and opportunities, measure them, and apply the findings to improve the performance of companies KKR owns.

A second chapter deals with KKR’s internal ESG practices and community good-will programs.

Lastly, key performance indicators are listed in a table. In four columns KKR summarise their commitments, tell what has been accomplished for each objective since 2010, and state the aims for 2013.

KKR had 82 companies in their private equity portfolio in North America, Europe, and Asia at the end of 2012. Just 24 of KKR’s portfolio companies are publicly enrolled in the ESG program so far. They are named in the report. ESG data are submitted by only 16 of them. Their accomplishments for the period 2008 through 2011 are shown as cumulative results. KKR expects seven more companies to report in 2013.

More than 60 percent of KKR’s assets under management are in the private equity funds. But KKR is expanding their business into energy and infrastructure companies, real estate, and debt and public equity investments. The ventures in these new areas are not dealt with at any length in the ESG report. KKR explains why:

“Many of these additional business models do not lend themselves to the same ESG-management approach that we apply in our private equity portfolio. This is primarily because of varying investment theses and levels of influence. However, we still believe that responsible investment can play an important role in many of these businesses.”

KKR says they are prioritising efforts to integrate ESG considerations in the private equity investment process and are also exploring ways to do the same for the other asset classes.

At the conclusion of the 2013 sustainability report, KKR publishes a short but not-to-be-ignored list of online resources. The hot-linked web sites flesh out aspects of KKR’s ESG program.

Communication:

KKR’s report is one of those rare corporate sustainability reports that warrant cover-to-cover, word-for-word reading. This is high praise for sure. (But see the next section of this review.)

The material in the report flows logically. The discussions are intelligent, illuminating, and not self-serving (most of the time). The text is easy to read. The graphics are not spectacular or numerous, but they are instructive. The photos just separate sections. They don’t gobble up space wantonly. KKR’s report appears overall to be a sincere attempt to disclose ESG practices rather than be a superficial, promotional endeavour.

The report makes no attempt to comply with the framework from the Global Reporting Initiative (GRI) or any comparable norm. KKR does claim to be “guided” by GRI’s technical protocol [see https://www.globalreporting.org/resourcelibrary/GRI-Technical-Protocol.pdf]. That sometimes overlooked document from GRI helps reporters define the appropriate scope for their disclosures, select a range of topics to cover, and prioritise the subjects they choose to discuss.

Credibility:

KKR’s buyout of RJR Nabisco in 1988 was chronicled in a best-selling book and a film called “Barbarians at the Gate”. KKR stood in the vanguard during that frenzied era of macho speculation.

How much time must pass before socially responsible investors accept fallen idols back into their good graces? Sustainability rating agencies and environmental activists differ on the subject. By now KKR is probably free of the cancerous greed that spurred the false opulence of the 1980s. Or, maybe not. In any case, the KKR of today is a signatory of the UN Principles for Responsible Investment.

The fingerprints of lawyers are evident in the report, as in this statement about the green management program: “Impacts of such initiatives are estimates that have not been verified by a third party and are not necessarily reported according to established voluntary standards or protocols. KKR does not guarantee the accuracy, adequacy or completeness of such information. They may also reflect the influence of external factors, such as macroeconomic or industry trends.”

KKR is frank about the competitive landscape they till: “.. a decision to invest or not is rarely due exclusively to ESG issues because these concerns can be intertwined with other business issues that might make the business more or less attractive for investment.”

If some fidelity is lacking, it is because KKR uses a broad brush to portray their ESG activities. What does the ESG management process actually ask the portfolio companies to do? Readers won’t learn in the report that the typical initiatives are of the low-cost or no-cost, quick payback variety. For example, they are not told that US Foods simply reduced idling time of delivery trucks and installed fluorescent lighting with motion sensors at its facilities.

The key performance indicators are not finely drawn either. The targets for 2013 are described in ways such as these: “continue to enhance”, “continue awareness-building”, “maintain the capabilities”, “continue to look for opportunities”, and “encourage additional”. As for the commitment to expand the team of dedicated ESG professionals, “No additional goals at this time” are set beyond the hiring back in 2011 of a director of public affairs in Asia and an ESG and stakeholder engagement manager.

High-level assessments of sustainability do not factor in KKR’s scheme, at least not yet. Investing in fracking for natural gas is not ruled out of bounds. And, for example, Dollar General is touted in the report for reducing cardboard waste from stores and distribution centres. Stewardship concerns about deep-discounters selling cheap, short-lived, and, sometimes, hazardous items from China and knockoffs of brand-name consumer products are nowhere to be found. Nor does KKR deal with the spate of allegations levelled by critics about unfair practices the private equity industry is said to engage in.

Recommendations:

1. Be more specific.

2. What ESG issues are most threatening to your investment strategies? How do you intend to manage them?

3. Next time, reveal more about the role ESG matters have played in your investment decisions.

William D’Alessandro is president of Victor House News Co., an independent agency reporting on law and the environment for trade publications and executive newsletters. He also edits Crosslands Bulletin http://www.crosslandsbulletin.com covering strategic corporate environmental management and sustainability issues.