KKR-Backed Credit Fund Faces Troubles, Highlighting Strains in Private Markets

A credit fund managed by KKR & Co. Inc. Experienced a significant downturn on Thursday, revealing mounting challenges within the private credit sector. FS KKR Capital Corporation (FSK) saw its stock price fall 15% after announcing dividend cuts and asset valuation markdowns, signaling broader concerns about potential defaults and investor withdrawals in private equity portfolios.

Mounting Concerns in Private Credit

The difficulties faced by FSK are part of a larger trend impacting the private capital industry. Shares of companies like Blue Owl, Blackstone, KKR, and Ares Management have collectively declined roughly 25% over the past year, reflecting increased investor anxiety Financial Times.

FSK’s Portfolio Adjustments

FSK, which manages a $13 billion portfolio primarily consisting of loans to mid-sized, private equity-backed companies, has been affected by the shift in interest rates following a period of historically low rates in 2021, and 2022. The fund’s fourth-quarter performance was impacted by markdowns on debt extended to software companies, janitorial services groups, dental clinics, veterinary groups, and defense contractors.

Troubled Assets and Valuation Adjustments

Several companies within FSK’s portfolio are experiencing financial distress. These include:

• Cubic Corporation: A payments software system used by the New York City subway, acquired in 2021.
• AmeriVet: A network of over 100 veterinary hospitals acquired in 2022.
• Dental Care Alliance: A roll-up of hundreds of dental offices.
• Medallia: A customer service software company acquired in 2022, which has seen significant valuation cuts by multiple business development companies (BDCs).

Impact of Software Takeovers

The downturn is particularly noticeable in software companies acquired during the surge in takeovers in 2021 and 2022. For example, Blackstone appraised its enterprise value of Medallia lower by 70%, valuing its loans at a 78% discount. Thoma Bravo, which acquired Medallia for $6.4 billion in 2022, made a substantial $5 billion equity investment in the deal.

FSK’s Overall Performance

Despite the recent challenges, FSK has maintained a 9.1% net internal rate of return since its inception. The company attributes part of its weaker fourth-quarter performance to strategic asset sales aimed at recalibrating its portfolio.

Broader Market Context

Consultancy Bain & Co. Estimates that private equity firms are currently holding approximately $4 trillion in unsold deals, many of which are burdened with high debt levels and face uncertain exit strategies.