(Adds background on ValueAct, private equity shares)
By Koh Gui Qing and Michael Flaherty
NEW YORK, April 27 (Reuters) - ValueAct Capital on Thursday said it was investing in private equity firm KKR & Co LP , unveiling its latest position as the activist fund dives deeper into the financial sector.
The move was disclosed just as KKR posted stronger-than-expected earnings, and underscores how activist hedge funds are increasingly crossing into the turf of private equity firms.
With an economic exposure of just under 5 percent, the investment brings together a respected activist shareholder and a legendary Wall Street firm, whose co-founders - cousins Henry Kravis and George Roberts - pioneered the leveraged buyout (LBO) industry starting in the 1970s and continue to run the company.
ValueAct President Mason Morfit disclosed the interest at a conference in New York, saying KKR had done an excellent job investing in new products and businesses.
KKR said separately that it welcomed ValueAct's investment and that the hedge fund shared its vision for its business.
The stock rose 4.1 percent to $18.50 on Thursday. A presentation from Morfit showed ValueAct has a target price of $37 for KKR shares.
Activist hedge funds have tended to steer clear of financial companies because of the difficulty in agitating for change at banks, which are tightly regulated, or private equity firms, which are often tightly controlled by their founders.
ValueAct has, however, shown a willingness to buy into some of the big names on Wall Street when it perceives they are undervalued, scooping up $1.1 billion worth of Morgan Stanley stock last year, ahead of a post-election rally in bank stocks. It is not pushing for any changes in Morgan Stanley’s strategy or seeking representation on its board.
"One of the oldest and most storied LBO firms that has operated through market cycles has built up a tremendous brand," ValueAct President Mason Morfit said of KKR at a summit in New York.
Shares of private equity firms have consistently lagged those of their peers such as mutual fund managers, as investors discounted the stocks to account for the volatile nature of their earnings.
KKR, for instance, trades at around 8.5 times its projected 2017 earnings, while BlackRock Inc and T.Rowe Price Group trade at 17 times and 13.5 times respectively, Thomson Reuters data showed.
Spotting bargains, some hedge funds too have started buying private equity stocks. Tiger Global Management LLC, a hedge fund, said earlier this month it had bought more than a tenth of the shares of KKR's peer Apollo Global Management LLC.
Like other buyout shops, KKR is structured as a partnership, not a corporation, allowing it to be controlled by Kravis and Roberts.
As such, investors buy KKR shares with the understanding that no shareholder meetings will be held and there is no room to force changes to the firm's leadership.
A buoyant U.S. stock market, which hit a record high last quarter, has helped bolster the performance of buyout firms that rely on strong returns to generate fees. Earlier this month, Blackstone reported earnings that more than doubled.
New York-based KKR said it had earned economic net income of $549.9 million after taxes in the first quarter, compared with a year-earlier loss of $553 million.
On a per-share basis, that came to 65 cents, while analysts on average were expecting 50 cents, according to Thomson Reuters I/B/E/S.
Economic net income, a key metric for U.S. private equity firms, accounts for unrealized gains or losses in investments.
KKR said its investment income, comprising net realized and unrealized investment gains, stood at $298.7 million in the quarter, reversing a loss of $529.6 million a year earlier, when sliding oil prices dragged on returns.
As a result, the company reported $348.5 million in performance income, made up of realized and unrealized gains in fees tied to investment returns, compared with a year-earlier loss of $124.9 million.
KKR said its transaction fees more than doubled to $243 million from $96.1 million.
An improved performance led to higher employee payouts. KKR said total compensation and benefits jumped more than five times to $284.7 million.
In line with KKR's promise this year to increase its quarterly dividend to shareholders by 1 cent, the company said it was distributing 17 cents per share.
Although buyout firms pride themselves on generating market-defying returns, the broader market is still a significant influence on their performance.
For instance, sources told Reuters earlier this year that KKR was preparing an initial public offering of Gardner Denver Inc.
The IPO could value Gardner at between $6 billion and $7 billion, well above the $3.9 billion that KKR paid to take it private in 2013, as higher energy prices have increased the U.S. industrial machinery maker's value. (Additional reporting by Svea Herbst-Bayliss in New York; Editing by Lisa Von Ahn and Andrew Hay)