It seemed a little strange when KKR recently purchased a controlling stake in FGS Global, a strategic and financial communications firm.

FGS, a mashup of three long-standing communications consultancies (Sard Verbinnen, the Glover Park Group and Finsbury) previously owned by the holding company WPP, is large and profitable.  It is one of the leaders in its space and counts among its executives some of the most respected and trailblazing professionals in communications and lobbying.  It would certainly be a gem in any portfolio.

But what was KKR’s plan for the business?  How would it achieve a big multiple, having paid a significant price to WPP?

It would seem unlikely that another holding company would see value at the price a private equity firm would expect.  By my math, KKR paid roughly 7.5x FGS’s earnings, assuming that reporting from PR Week is accurate (on $455M profit in 2023 I assume a 50% profit margin, resulting in ~$225M in profits, and KKR reportedly valued the business at $1.7B).  In a few years, assuming conservative growth to $350M in free cash flow, is somebody going to pay 10x or more, some $3.5 or $4 billion plus?

Perhaps one of the Big Four or other leading consulting firms would see adjacencies in the CEO and Board advisory nature of FGS’ business, but those firms tend to seek bolt-ons that they can scale, not more mature businesses like FGS.  While there are a few publicly traded professional services firms (like WPP itself), an IPO of FGS seems unlikely (unless SPACs come back!).

But thanks to Fortune’s illuminating profile of KKR’s co-CEOs, the strategy is clearer.  KKR is embarking on a bold (indeed, as Fortune says, a “revolutionary”) change in strategy, away from the typical PE model of buying businesses to spin them out a few years later to a new owner or the public markets, and towards a longer-hold model, inspired by the great Warren Buffet’s Bershire Hathaway strategy. In its new strategy, KKR might hold portfolio companies for decades, as opposed to the traditional 3-7 year hold period in PE.

KKR’s approach is based on its own Buffet-like move into insurance, through the acquisition of Global Atlantic, mirroring what other PE shops have done (most notably Apollo with its insurance subsidiary, Athene).  Insurance generates cash from the premiums it receives from policyholders, creating a new pool of capital that can be invested to generate returns greater than the liabilities that will be owed on the underlying policies.  Simple!  Genius!

(NOTE: For those that don’t subscribe to Fortune, you can see a bit on the strategy in their CEO Daily newsletter and you can also reference KKR’s April investor day discussion of its Strategic Holdings  business.)

A few questions come up:

Will it work? 

Fundamentally, a buy-to-sell model is completely different from a buy-to-hold mindset.  Are the executives that are drawn to private equity, who as the Fortune article suggests are drawn to the thrill of the deal and it’s attendant reputational and financial payoffs, likely to be enthused by the low and slow cook of a cash-flow generating investment?  Certainly, wealth and fortune like Buffet’s is a motivator, but will that hold their attention over time?  Indeed, KKR made its name in the swashbuckling 1980s on the back of its RJR Nabisco buyout, where the firm and its brethren were the “barbarians” at the corporate gate.  The new KKR strategy is led by co-CEOs Scott Nuttall and Joe Bae, who took over from Henry Kravis and George Roberts, two legends of the industry.  Bae and Nuttall are putting their mark on KKR like few other new leaders of private equity have, giving them a unique opportunity to not only continue the success that a firm’s founders created, but to eclipse it.

Will this be a model for other PE shops?

Like many industries, private equity tends to move as a herd.  In a short span, virtually all of the big players in the space went public.  They’ve also radically shifted their branding, communications and engagement, away from the old “We keep the private in private equity” mindset to appealing to a wider, more public set of audiences.  (A fun experiment is to show the front-page graphics of KKR’s website, without the logo, to somebody and ask them what kind of business it is.  It looks more like a consumer products company than a global investment behemoth.  Nobody in the 90s or early 2000s would have expected Blackstone to put out a self-mocking, comedic holiday video, which is now an annual tradition.)   Will more private equity firms adopt a longer-hold model in the wake of KKR’s big shift?

What are the hidden risks? 

Buffet has famously and repeatedly said that Berkshire keeps billions of dollars on hand in cash to ensure that it can cover its insurance liabilities.  If private equity firms take insurance profits and plow them into long-hold businesses, in essence investing cash into cash-flow, does that make them vulnerable to liability mismatches in the future, if economic downturn, climate change, or other events cause insurance claims to spike?  Are there other unseen risks that even the smartest guys and gals in the room cannot see?  History is littered with economic surprises that spring up to bite industries that make what seem like well-founded assumptions, most notably the 2008 financial crisis that proved there could, in fact, be a nationwide downturn in home values.

Whatever comes, KKR’s strategy is indeed a massive departure from the rest of the PE crowd.  It may prove wildly successful, minting a new generation of billionaires, and it may signal a broader shift in strategy among the big private equity firms (who generally now call themselves “investment firms” to reflect their more diversified positions).  Even if there are initial profits, it will be important to look for the possibility of lurking downsides.