Kohlberg, Kravis & Roberts - Blue Chip Stock

The Dynamic Wealth Report
November 2, 2007

A Quick 13% In A Blue Chip Stock
by Brian T Mikes, Managing Editor

If you are a serious investor, you know that learning about the great
investors of our time is important, and you no doubt know who Henry
Kravis is.

Kravis is one of the founders of Kohlberg, Kravis & Roberts or KKR, one
of the leading players in the private equity space.  The firm was
started in 1976 with an initial deposit of $10,000, and since that time
they have completed more than 150 transactions with a total value in
excess of $318 billion.  Their returns have been nothing short of
phenomenal, locking up an annual IRR of 27%, handily trouncing the S&P 500 year in and year out.

Kravis’ investing formula is simple.  He uses the funds capital as an
equity investment and borrows money for the acquisition of businesses
with predictable cash flows and strong management.  He is able to
generate these amazing returns by separating himself from the short-term
perspective of the financial markets, and focuses on building businesses
over the long term.

Kravis has also mastered a key financial tool, leverage.  As an
example, he acquired Safeway, the grocery chain, in 1986 for $3.4 billion. He used leverage to his advantage putting up equity of $132 million, just
3.1% of the purchase price.  When all was said and done he recognized
more than $7.4 billion in profits.

You can’t invest alongside Kravis in many of his deals, but there is a
company that has just such an opportunity.  KKR Financial Holdings
(KFN) for all intents and purposes is the “bank” that helps KKR finance its
deals.  KFN’s core business is lending money to private equity shops
like KKR for their acquisitions.  Just like a bank, they use their
equity, and borrow money from outside sources which they turn around and loan out at much higher rates.

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Let's look at the chart on KFN...

The company was caught up in the mortgage market turmoil, and they
suffered dearly for it.  KFN has nearly a billion dollars in cash on hand
to finance their loans, and they have been able to mitigate a significant portion of their mortgage exposure.  Their short term mortgage exposure
in September was only $415 million of which only 17% was rated below investment grade.  In my opinion, the sell off was overdone.

One of the things that many people don’t realize is that the mortgage
market turmoil is actually going to be a good thing for the company.
The market turmoil has allowed KFN to raise the rates that they are
charging to lending long term money.  Higher rates mean better earnings.

Management has estimated that they will make more than $256 million in
net income over the next 12 months.  Keep in mind that the company has
a total market capitalization of $1.2 billion.  To top it off, KFN recently announced a $0.50 per share dividend for this quarter.  With the stock currently trading at $15, this represents a dividend yield of over
13%.

With one stock purchase you can capture a yield of at least 13% and
possibly much more.

•  Washington Post (WPO) one of the top holdings of Warren Buffett was upgraded today by Deutsche Securities from a Hold to a Buy. The analyst gave the company a $910 price target.

•  Schnitzer Steel (SCHN) one of the largest steel recycling companies in
the US received an upgrade from DA Davidson despite a recent drop in
earnings.

•  Trident Microsystems (TRID) was the recipient of 5 separate
downgrades this week after announcing that they would miss their revenue estimates. The firms downgrading TRID include: Deutsche Securities, Jefferies & Co, Longbow, Needham & Co, and Oppenheimer.

•  Bernstein rolled out coverage this week on the Healthcare and
Pharmaceutical space, announcing coverage on: AstraZeneca (AZN), Bristol-Myers (BMY), Eli Lilly (LLY), GlaxoSmithKline (GSK), Merck (MRK), Pfizer (PFE), Sanofi-Aventis (SYN), Schering-Plough (SGP), Wyeth (WYE).

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