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Posted by Keith Hahn, Jun 21, 2007, 2:05pm

Damn the torpedoes! Full speed ahead!

Kohlberg Kravis Roberts have hired Morgan Stanley and Citigroup as underwriters for the potential public offering, CNBC’s Charlie Gasparino reported today. While warning that the plans were still tentative, Gasparino said that KKR would pursue an IPO that would compete in size with Blackstone’s.

There has been rumor and speculation that KKR would follow its rival Blackstone into the public markets since news of Blackstone’s offering broke months ago. But the last time we checked in, people were saying KKR had rejected going forward with an IPO. What's more, some had wondered if tax legislation recently proposed in the US Senate would have a chilling effect on the urge to go public. The proposed bill would force private equity partnerships to pay taxes at the corporate rate if they go public, instead of treating profits as capital gains taxed when distributed to the partners under the current law.

But despite the potentially higher tax bills, Blackstone seems undeterred in their desire to sell shares. And investors are apparently undeterred in their desire to buy them. Talk that the higher tax bill could knock as much as 20% off the value of Blackstone has not been reflected in the appetite for the shares.

The success of Blackstone’s offering, which is expected to price tonight at the high end of its range and is reportedly oversubscribed by a factor of seven, has sparked talk of offerings coming from not only KKR, but Apollo, Carlyle and TPG. Gasparino says that Apollo is also leaning toward an IPO, something he has steadily maintained despite contrary reports in the New York Times.

There’s something of an irony in KKR following Blackstone in offering shares to the public. According to sources familiar with the genesis of the Blackstone IPO, the idea of going public was hatched after KKR succeeded in selling shares in one of its buyout funds to the public. At the time, Blackstone head Stephen Schwarzman publicly complained that the enormous offering had sucked the air out of the market for exchange traded private equity funds. Selling partnership shares of Blackstone was hatched as a new way of getting at the capital markets. So KKR may have inspired the very offering that they are now looking to imitate.

KKR May Launch IPO Later This Year: CNBC's Gasparino [CNBC.com]

Comments

Posted by , Jun 21, 2007 4:41PM

Can no one get this right?

Hahn said: "The proposed bill would force private equity partnerships to pay taxes at the corporate rate if they go public, instead of treating profits as capital gains under the current law." This is conflating two separate issues.

the cap gains issue and the corporate level tax issue are different. were Blackstone to be treated as a partnership, then the entity in which people own interests ("shares") would not pay any tax. the only tax would be paid by the "share"holders, presumably at 15% (depending on the income stream). under the current bill, blackstone itself will pay a corporate tax - 35% - and then shareholders will pay their 15% tax on what's left.

The WSJ was also wrong about the triple tax issue because they ignore the DRD.

Finally, the treatment of carry as ordinary income is a totally different issue, one which, I'm sure, will generate a bill in Congress sometime soon.

Posted by Sandy, Jun 21, 2007 6:23PM

A different view: The corporate level tax issue is a subset of the cap gains issue. They are related.

A brief explanation: If Blackstone's public entity is treated as a Master Limited Partnership (MLP) for tax purposes, Blackstone's investors, when paying their personal taxes, would carry-over the character of each line of income from the Blackstone public entity. Hence, if carried interests (the "20" of "2 & 20") are treated as capital gains (as they are presently), then the public unitholders would be taxed at 15% on such gains. [Note that the management fees (the "2" of "2 & 20") would likely be taxed at the unitholders marginal income tax rate, unless Blackstone is using a "blocker" strategy (usually done to avoid 40 Act registration), in which case Blackstone's already paying 35% on these gains.]

If the Blackstone public entity is subject to corporate level taxation, they're looking at paying 35% across-the-board on all profits of the public entity (i.e. no capital gains treatment for the public unitholders). For the public unitholders, this has exactly the same effect as eliminating the capital gains treatment for carried interests. But, and this is the key difference, for the insiders who retain non-public units in the Blackstone entities, they would continue to enjoy the capital gains treatment to the extent they retain such interests (provided they own units in the non-public subsidiaries and not at the public issuer-level). That is, *only* the public unitholders would have their carried interests taxed at 35%.

Of course, the "third way" of taxation (which I believe some senator or congressperson proposed today) is to tax carried interests as ordinary income across-the-board, irrespective of public/private distinctions. This would impact all private equity partnerships (and possibly other partnerships), whether public or private.

Bottom Line: The proposed legislation (i.e. treating publicly traded partnerships whose primary business is investment management as corporations for tax purposes) has the effect of changing the tax rate on carried interests from 15% to 35% *to the extent that* such carried interests inure to the benefit of public unitholders.

Keith, I for one take no issue with your above characterization. Conflate away.

Posted by , Jun 21, 2007 6:49PM

Sandy - an MLP is either a PTP taxed as a corporation or a normal partnership (ie, the entity pays no tax). whether it's a normal partnership or a PTP depends on the terms of the statute that the Blackstone bill aims to change. and there's a big difference between characterization of income streams and levels of tax.

Ex: If an MLP is a normal partnership, the MLP pays no tax, and the unit holders pay 15% (assuming income is all from cap gains). If MLP is classified as a PTP, then it pays the corp level tax (35% - no break on cap gains), and the unit holders pay 15% on what's left.

Your point about the corporate level tax being effectively the same as eliminating cap gains treatment misses the two-layers-of-tax point - your paragraph 3 should end with a sentence saying that after they got screwed with the 35% tax, unit holders would pay 15% on the remainder.

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