FS- KKR Capital (FSK) is an unusual duck – an equal partnership between a privately-owned asset management firm with an incomparable ability to raise capital from investors (FS Investments) and the lesser known credit arm of a famous private equity group – now publicly traded – KKR & Co. However, before those partners joined together FS Investments had initially partnered up with another offshoot of a famous asset manager GSO/Blackstone, a subsidiary of Blackstone. ( In that case, GSO Blackstone was billed as sub-advisor, with FS Investments still in charge). With such a renowned family tree, you’d expect FSK’s performance since its establishment back in 2008 to be lustrous, but that’s not the case. Frankly, and we’ve been following the BDC since listing as a public entity in 2014, the results have been nothing less than poor. When GSO Blackstone was pushed or withdrew in 2017 and was replaced in December 2017 by KKR’s credit arm as external co-manager, we hoped for an improvement. Even as AUM has grown as FSK has gobbled up other non-traded BDCs managed by the two partners and by leveraging up in the wake of the relaxed leverage rules in March 2018, net book value and distributions per share have gone down and down. To the point that in 2020 FSK had to undertake a 4:1 reverse stock split to save the BDC from trading ignominiously under $5. Unfortunately all the financial engineering in the world – which includes a recently announced fund whose purpose is just to buy the BDC’s public stock – cannot readily cure FSK of its principal ailment: poor credit performance. Admittedly many of the troubled companies were booked in the Gso Blackstone days but that was years ago and still book value drops and the number of underperforming investments grows. The question has to be asked if KKR – responsible for all the investing – is capable of delivering in leveraged lending. Maybe the famous group has the wrong team or is attacking the wrong market -taking control debt positions in loans to very large borrowers or has just too much money where there are too few good quality deals. Thanks to FS Investments capital raising skills and KKR’s hallowed name amongst investors capital can always be raised. However, just because you can raise the capital should they ? In the years ahead FSK and its moneyed managers will have to prove they can stabilize credit performance and generate a steady and decent total return to shareholders. Unfortunately that critical test is occurring just as market conditions are at their worst since FS investments first brought the BDC to market.
FSK has reduced its dividend multiple times, most recently to $2.40 a year. Nonetheless, we expect that a combination of lower LIBOR; loss of income from credit losses and the need to shrink the portfolio to stay inside leverage guidelines will force FSK to cut its payout again: to $1.20. That’s a 50% drop which seems high but the BDC does have one of the highest percentages of underperforming loans out there.
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