KKR cuts a slick IPO deal

(breakingviews.com) -- Kohlberg Kravis Roberts' deal to sell shares in its initial public offerings through Fidelity appears smart -- at least for KKR. The private equity firm will give the U.S. fund and brokerage giant's retail clients first dibs on shares in its portfolio companies. It will also offer them to Fidelity's institutional clients.

Adding these investors to its existing contacts should help the buyout shop build its equity syndication business. But it's risky for Fidelity. Its reputation could be hurt if KKR's deals turn out to be duds.

KKR has been trying to diversify its business beyond straight private equity for quite a while. And this deal gives Fidelity the ability to give its clients access to coveted IPO shares, which are usually hard for retail investors to obtain.

But Fidelity might need to plaster stern warning labels on some of the shares. Private equity shops leveraged their portfolio companies to the hilt during the boom. Though KKR owns some strong, countercyclical outfits, like Dollar General, it also has some struggling LBOs, such as First Data.

It is unlikely KKR will try to float hard-hit portfolio companies anytime soon. But even apparently well-performing ones could turn out to be risky. Public offerings of buyouts from the last debt boom are untested.

Yes, retail investors can hope for a big opening-day price pop. But few individuals are lithe enough to exploit such moves. And if a deal subsequently craters, it could hurt Fidelity's reputation. True, its brokerage operation leans toward the "discount" variety, meaning investors mostly make their own bad decisions. But they could still blame Fidelity for allowing them into any dodgy deals.

Since Fidelity has agreed to not work with any other buyout shops, it will have to rely on the quality of KKR's portfolio. For its clients' sake, and its own, Fidelity better hope KKR has more winners than losers waiting in the wings.