Bloomberg special report on KKR

KKR Outspends Blackstone, Instills Profit-First Creed (Update1)
By Richard Teitelbaum

June 29 (Bloomberg) -- It's a great time to be Henry Kravis, as he's quick to remind people.

In April, the buyout mogul is standing in a ballroom of the Waldorf-Astoria hotel in New York, telling AIDS researcher Dr. David Ho, architect Maya Lin and Yahoo! Inc. co-founder Jerry Yang that the private equity industry he helped invent is hotter than ever.

``We're in, right now, the golden age,'' Kravis, 63, tells a gathering of prominent Chinese-Americans and Wall Street executives.

In May, Kravis is up in Halifax, Nova Scotia, saying, again, that the takeover arena has never looked better.

``The private equity world is in its golden era right now,'' Kravis tells a conference of bankers and investors. ``The stars are aligned.''

It's certainly a gilded moment for Henry Roberts Kravis. Almost two decades after his $31.4 billion takeover of RJR Nabisco Inc. rewrote the rules of leveraged buyouts, Kravis is buying companies at a record clip.

Fueled by cheap money that's now getting more expensive, private equity has ripped through public companies and ushered in what George David Smith, business historian at New York University's Stern School of Business, calls a new era of capitalism.

From Jan. 1, 2006, to June 27, Kohlberg Kravis Roberts & Co., the buyout firm Kravis co-founded in 1976 with his cousin George Roberts and one-time mentor Jerome Kohlberg, has announced deals worth $215 billion to acquire all or part of 30 companies, according to data compiled by Bloomberg.

$107 Billion Empire
In that time, KKR, with U.S. offices in New York and Menlo Park, California, outspent rivals Blackstone Group LP, Carlyle Group and TPG Inc.

Behind all of the dealmaking, Kravis and Roberts, also 63, now lord over an industrial empire that dwarfs some of the world's mightiest public corporations. As of May 31, the firm had a hand in 36 companies that together generated about $107 billion of revenue in 2006, according to figures KKR posted on its Web site. That's more than Coca-Cola Co., Microsoft Corp. and Walt Disney Co. put together.

These companies employed 560,000 people, more than either Citigroup Inc. or General Electric Co. In fact, more people work for KKR companies than live in Atlanta, Miami or St. Louis. Now that Blackstone has gone public, KKR may try to do the same, opening Kravis's realm to stock-market investors.

Kravis's Realm
After several of the firm's acquisitions began to sour in the late 1990s, Kravis and Roberts changed direction and tightened their grip on the companies they buy.

Nowadays, New York-based Capstone Consulting LLC, a consulting firm that works exclusively for KKR, measures company performance. KKR demands its managers sink their own money into the companies they run, works its contacts to find pros who can help them, sets performance standards -- and fires people who fail.

``Any fool can buy a company,'' Kravis said at a private equity conference in Frankfurt in February 2006. ``The hard and important part of our job was what we did with the company to create shareholder value once we acquired it.'' KKR executives declined to be interviewed for this story.

From his aerie 42 floors above 57th Street in midtown Manhattan, Kravis straddles the corporate and financial worlds. He's played a role in more than a fifth of the $545.5 billion in buyouts announced this year through June 27.

Setting Records
During that period, Kravis set records on both sides of the Atlantic. After KKR and TPG agreed to buy Dallas-based electric utility operator TXU Corp. in February in a record $45 billion LBO, Kravis and Italian billionaire Stefano Pessina in April agreed to buy British drugstore chain Alliance Boots Plc for 11.1 billion pounds ($22.2 billion) in the largest LBO in Europe.

Today, Kravis's reach extends from North Carolina, where KKR controls mattress maker Sealy Corp.; to Turin, Italy, where KKR owns FL Selenia SpA, which makes automotive lubricants; to Rotterdam, where KKR owns AVR Bedrijven NV, the largest waste management company in the Netherlands. In Europe, KKR owned stakes in or controlled 15 companies as of May 31.

At the center of this empire is an investment committee that meets regularly in KKR's New York headquarters high above Central Park. The group includes Kravis, Roberts and Capstone CEO Dean Nelson and vets proposed deals.

The KKR Way
A second gathering, called the portfolio management committee, also convenes to review KKR's collection of companies and reports from so-called deal teams that put buyouts together.

Twenty-five partners, or members, and more than 65 managing directors, directors, principals and associates are divided into nine industry groups. They split their time between finding takeover targets, working on deals and making sure KKR companies are being run well.

KKR usually assigns two or more of its executives to the board of a company. It deploys Capstone consultants to find ways to cut costs and boost sales.

KKR's 2006 annual review lists 14 senior advisers, including former CEOs Edwin Artzt of Procter & Gamble Co., Paul Hazen of Wells Fargo & Co. and George Fisher of Eastman Kodak Co. and Motorola Inc., who counsel dealmakers and managers and sometimes serve on boards and the portfolio committee. Former Agere Systems Inc. CEO Richard Clemmer joined in June.

RJR Excesses
``KKR is now the best private equity firm at buying companies and then making them better,'' says former partner Scott Stuart, who now runs Sageview Capital LLC, based in Greenwich, Connecticut, and Palo Alto, California, with Ned Gilhuly, another KKR veteran.

It may surprise some people that KKR cares about running companies. Its ill-fated takeover of RJR Nabisco, memorialized in the best seller ``Barbarians at the Gate: The Fall of RJR Nabisco'' (Harper Row, 1990) and a 1993 HBO movie of the same name, made Kravis a poster boy for the ``greed is good'' '80s.

The book recounts how Kravis threw a closing dinner in the ballroom of New York's Pierre hotel, where 400 investment bankers, lawyers and friends dined on lobster, veal with morel sauce and a 3-foot-high (0.9-meter-high) cake adorned with replicas of Nabisco products. The RJR LBO turned out to be a flop, generating an internal rate of return of less than 1 percent, according to a 2001 KKR valuation report.
Buyout Binge

KKR raises money from investors, typically public and corporate pension funds, and then leverages that cash with borrowed money to make acquisitions and magnify returns. For example, KKR may invest $1 of equity for every $9 it borrows.

Buying companies is the easy part. The harder part is improving them so they pay down debt more quickly and then cashing out at a profit by selling them to someone else, usually the public, in the form of an initial stock offering, or directly to another company or group of investors.

Hardly a day goes by without another marquee brand getting gobbled up by private equity these days.

From Jan. 1, 2006, to June 27, 21 companies in the Standard & Poor's 500 Index announced their sale to private equity firms. Private equity buyouts accounted for $1.2 trillion, or 20.5 percent, of the record $6.1 trillion in mergers and acquisitions announced worldwide during that period.

Now, with interest rates climbing, life could get tougher for the private equity crowd, which borrows heavily to finance acquisitions. Benchmark 10-year U.S. Treasury rates climbed to 5.08 percent on June 27 from 4.54 percent in mid-March.

Fear and Greed
A sustained rise in rates or a decline in stock prices would turn up the heat on KKR -- and the managers who run its companies.
Buyout firms have already hit a rough patch. Blackstone stock, initially priced at $31, fell as low as $29.13 on June 27. The stock was trading at $30.03 in New York today. Carlyle Group this week cut the size and price of an IPO of a fund that invests in bonds backed by mortgages as damage from the U.S. real-estate slump spread.

How KKR manages its companies is more important than ever. The firm usually lines up top people and makes them scared to fail. Joseph Welch, chief executive officer of electric utility company ITC Holdings Corp., says KKR ensures its managers stay focused on the bottom line by making them invest in their own companies.

When KKR bought Novi, Michigan-based ITC in 2003, it offered Welch a chance to run it -- provided he put about $1.5 million into it. Welch ended up emptying his savings account, mortgaging his house and taking out a loan.

``KKR didn't want to have trouble sleeping at night,'' Welch, 58, says. ``They did that by making sure I had trouble sleeping at night.''

No Losers
KKR sets benchmarks for everything from the amount of scrap produced to safety records and then holds managers accountable.

At Princeton, New Jersey-based Rockwood Holdings Inc., which makes specialty chemicals and advanced ceramics, CEO Seifi Ghasemi, 62, used such benchmarks to turn around the company during the 2001 U.S. recession. He fired 10 percent of Rockwood's workforce.
``We are trying to make people rich -- and rich people even richer,'' Ghasemi says.

KKR has zero tolerance for money losers. Eckard Heidloff, CEO of Paderborn, Germany-based Wincor Nixdorf AG, which manufactures automated teller machines, discovered that when Gilhuly told him the firm was considering selling a Wincor division that was in the red.
Kravis's team makes sure managers understand that customers -- not KKR -- will pay down debt.

The Capstone Edge
Marc Tellier, CEO of Montreal-based Yellow Pages Group, which distributes telephone directories across Canada, says Capstone helped improve a system that employs the Canadian consumer price index and a half dozen other variables to better price ads and stoke sales.
Power grids, advanced ceramics, ATMs, Ottawa telephone directories -- it's all a long way from the world of Henry Kravis. He and his wife, economist Marie-Josee Kravis, form one of New York's ultimate power couples.

A regular at black-tie galas, Henry serves on the boards of the Metropolitan Museum of Art, Mount Sinai Medical Center, Columbia University's Graduate School of Business and Rockefeller University. Marie-Josee, a senior fellow at the Washington-based Hudson Institute, is president of the Museum of Modern Art. Roberts, whose wife of 35 years died in 2003, keeps a lower profile than his cousin. Kohlberg, 81, left after a falling-out in 1987.

30 Percent Returns
The private equity boom that Kravis and Roberts are fueling has implications not just for Wall Street but increasingly for every executive, investor and retiree. U.S. public and corporate pension funds are looking to boost returns so they can keep their promises to aging workers.

Kravis's aim is to earn his investors fatter returns than they could get in the stock market.

The $245 billion California Public Employees' Retirement System says on its Web site that from its start in 2001, KKR European Fund LP generated a 30.7 percent internal rate of return through December 2006. KKR Millennium Fund, which was started in 2002, posted a 39 percent internal rate of return.

Back in the '80s, private equity firms produced most of their investment returns via the leverage they employed to acquire companies. Now, they're making more of their money by overhauling business practices and improving productivity.

For their efforts, buyout firms collect fees in all shapes and sizes. Firms such as KKR typically charge management fees of 1-2 percent and collect 20 percent of any capital gains when they sell a company.

Fees, Fees, Fees
On top of that, KKR collects fees from its companies for advice on mergers and acquisitions as well as for management consulting and other services.

When KKR bought Sealy from a group led by Boston-based Bain Capital LLC in 2004, for example, Kravis's firm and Bain shared $31.8 million of M&A advisory fees.

Do private equity firms earn their money? NYU's Smith, co- author of ``The New Financial Capitalists: Kohlberg, Kravis Roberts and the Creation of Corporate Value'' (Cambridge University Press, 1998), says well-run buyouts have helped liberate companies from the rubber-stamp boards that have long dominated much of corporate America.

``Most boards at public companies have been captives to the CEO,'' he says.

Michael Chu, a former executive and limited partner at KKR, says managers at public companies can muddle along, even prosper, simply by not rocking the boat. That doesn't work at KKR companies.

The LBO Effect
``You don't have the luxury of managing issues at the margin,'' says Chu, a founder of Buenos Aires-based Pegasus Venture Capital.
``If the market changes, you change the strategy,'' he says. ``If the CEO doesn't work out a year into the deal, you never shy away from the tough questions. You change the CEO.''

Measured by stock performance, LBOs have made many companies better, according to a 2006 study by Jerry Cao, a doctoral candidate at Boston College, and Josh Lerner, a professor of investment banking at Harvard Business School.

The pair examined almost 500 companies that went private in LBOs and subsequently went public again from 1980 to 2002. They found that these companies beat their IPO peers in the stock market: Companies that had undergone LBOs posted an average, cumulative three-year return of 57.9 percent compared with 20.5 percent for conventional IPOs and 33.4 percent for the Standard & Poor's 500 Index.

Who Gets Hurt
Lerner says the disciplining power of an LBO forces managers to make tough decisions.

``There is a process of refocusing the company, disposing of divisions that aren't central to its mission,'' he says.

Even so, when KKR pulls the levers, someone usually gets ground up in the gears. By leveraging companies, KKR encourages managers to cut costs and, often, that means jobs.

KKR bought Evansville, Indiana-based Accuride Corp., which makes truck parts, in 1997 and sold the last of its shares in early June. In April, the International Brotherhood of Teamsters agreed to lay off 64 of about 350 workers at Accuride's Plant No. 1 in Elkhart, Indiana.
Matt Sandefur, a machine operator who works on brake drums for big rigs at the plant, says managers have frozen his pay for 2007, doubled health insurance deductibles and cut coverage. He's looking for a new job.

New Concern
``I say KKR hates unions,'' Sandefur, 41, says. ``I used to feel secure in my job.''

Workers aren't the only ones worrying these days. As private equity deals get bigger and bigger, some investors see trouble brewing. Wall Street, after all, tends to get carried away. The LBO boom of the '80s ended with an implosion in the junk bond market and a wave of corporate bankruptcies.

``Everybody thinks private equity is the panacea,'' says Jim Leech, senior vice president of Teachers' Private Capital, part of the Ontario Teachers' Pension Plan. ``In our opinion, it's getting scary.''

Lately, acquisition prices have been rising along with borrowing costs. Competition for deals pushed the average price paid for companies in LBOs to 8.5 times cash flow in the fourth quarter of 2006 from 6.4 times in 2001, according to S&P.

``It's a case of a lot of money chasing after deals,'' Chu says. Ultimately, private equity returns are likely to falter, he says. ``Maybe you don't get 25 percent returns; you get 12 percent or 10 percent,'' he says.

Regal Debacle
Kravis and Roberts have been through rocky times. Starting in the late '90s, KKR stumbled as a string of its companies began to fail, most notably Knoxville, Tennessee-based Regal Cinemas Inc., which filed for Chapter 11 in 2001.

It was a costly mistake that changed the way Kravis and Roberts operate. KKR had led a buyout of the movie theater chain in 1998 for $1.58 billion, only to see its value plummet amid a glut of multiplex theater construction.

``George Roberts and I sat down and said, `Look, we've got to change the way we're doing business,''' Kravis said in April at the Waldorf-Astoria, where he was addressing the Committee of 100, a group of Chinese-American leaders that includes cellist Yo-Yo Ma and architect I.M. Pei.

After the Regal Cinemas debacle, KKR created its investment and portfolio management committees, organized its dealmakers into industry groups and formalized 100-day business plans: playbooks that spell out what actions are supposed be completed by specific dates in the early months of a buyout.

Harnessing Greed
Kravis tapped Nelson, a senior vice president of Boston Consulting Group Inc., to build Capstone in 2000.

To run its companies, KKR harnesses the forces that drive financial markets: fear and greed. At ITC, all of the executives that Welch hired also had to invest their own money in the company.

The son of a Kansas laborer, Welch joined Detroit-based DTE Energy Co.'s predecessor, Detroit Edison, in 1971, fresh out of the University of Kansas, where he earned a bachelor's degree in electrical engineering.

When he was put in charge of DTE's power transmission infrastructure in 1999, Welch discovered that it was dilapidated. Transmission corridors were overgrown with vegetation, generators were leaking fuel and breakers were rusted, he says.

``The thing had been lost in the amorphousness of the parent, and it had been run ad hoc,'' Welch says of ITC. Underinvestment in the power grid is a national disgrace, he adds.

ITC Vision
Welch had a vision: A separate ITC would have the incentives to invest in the grid, improve reliability -- and help solve America's energy crisis by enabling renewable energy to be transmitted efficiently. He urged DTE to establish ITC as a separate unit. DTE did, and decided to sell it.

KKR, New York-based Trimaran Capital Partners, the state of Michigan and ITC management teamed up to buy ITC for $610 million. The $650 million financing package consisted of 35 percent in cash and $425 million of term loans.

Regulators wanted ITC to be untangled from its parent in 12 months. At first, Welch had a steel desk -- and no chair or corporate checking account. The local OfficeMax wouldn't even let him buy paper clips on credit.

Welch and KKR set to work. Their first task was to hire 17 executives. KKR required all of them to sink their own money into ITC. Welch offered Edward Rahill, director of planning and corporate development at DTE, a job as chief financial officer - - and gave him less than 24 hours to think it over.

`Long-Term Story'
Rahill, 54, says he ultimately joined for the opportunity to help fix America's crumbling power grid.

``It's the greatest team-building exercise you can have,'' Welch says. ``And that, fundamentally, in my mind, is why KKR is so damned successful: They invest in and motivate people -- they align people.''

Stuart, the former KKR partner, was Kravis's point man on ITC. His job was to explain the company's business plan to state and federal regulators.

``It was a great long-term story,'' says Stuart, 48. ``The grid in the U.S. needs a lot of investment to handle the demands.''

KKR put its contacts to work. Deloitte & Touche USA LLP, KKR's preferred accounting firm, helped ITC set up a new accounting system within four months. London-based Willis Group Holdings Ltd., a former KKR company, arranged insurance for ITC transmission lines.
Top of the List

Law firm Simpson Thacher & Bartlett LLP, whose chairman, Richard Beattie, worked with Kravis on the RJR Nabisco buyout, provided legal advice.

``When you're a KKR company, people come in and put you at the top of their lists,'' Welch says.

Rahill agrees. ``You get the A teams, no if's, and's or but's about it,'' he says.

ITC went public at $23 a share in July 2005. According to a May supplement to KKR's 2006 annual review, the firm initially invested $128.7 million. By the time KKR sold its last shares in February for $316.7 million, it had generated gross proceeds of $664.4 million, or five times its invested capital.

ITC shareholders have made money, too. Through June 27, the stock had posted an annualized return of 40.4 percent since the IPO. Welch's stake, 1.7 percent as of May 14, was worth $30 million as of June 27.

Like Welch, Heidloff at Wincor Nixdorf, the ATM maker, sees KKR as a liberator.

Wincor Buyout
Heidloff joined a predecessor of Wincor Nixdorf in 1983, after graduating from the University of Paderborn with a degree in business administration.

During the '90s, the company missed out on international growth opportunities as part of Munich-based Siemens AG, Heidloff says. While Wincor had 60 percent of the German ATM market, its global share was 8 percent, he says.

Because Siemens was organized by geography and along product lines, country managers could reject Wincor proposals to expand outside Germany.

``I spent two days a week convincing headquarters and country managers to get approval to grow the business,'' Heidloff, 50, says.
In 1999, Heidloff, then CFO, and Karl-Heinz Stiller, CEO at the time, drafted a plan with Siemens's management to set Wincor free. Siemens put Wincor on the block.

KKR teamed up with Goldman Sachs Group Inc. to buy Wincor Nixdorf for 736 million euros ($789 million) in late 1999.
Flying to Frankfurt

As a condition, KKR demanded Heidloff and Stiller stay on. KKR bought 71.3 percent, Goldman Sachs bought 17.8 percent and more than 100 Wincor executives purchased a total of 10.9 percent.

``We didn't want a situation where just two or three people got rich,'' says Heidloff, who became CEO when Stiller retired this year.
In the beginning, KKR's Gilhuly and Johannes Huth, then a managing director, flew weekly to Frankfurt to check on the progress. It was impressive from the start, with cash flow rising 11.2 percent annually between fiscal 2000 and fiscal 2003.

When it became clear that Wincor's retail computer unit was losing money, Gilhuly, Huth and their counterparts at Goldman Sachs told Heidloff it was time to consider a sale or other options.

``They really wanted to be in that business,'' Gilhuly says. ``We turned up the heat.''

Model LBO
The Wincor unit sharpened its focus on high-margin software components and emphasized consulting services. The division, which had a 7.6 million euro loss on a cash flow basis in 2000, earned 12.8 million in 2002.

``They turned out to be an exceptional team,'' Gilhuly, 47, says.

Heidloff says it was a model LBO. ``If you do a budget and deliver every quarter, your life is very easy,'' he says.

Wincor Nixdorf went public in a May 2004 IPO that valued the company at about 1 billion euros. KKR reduced its stake to 28.8 percent.
Heidloff and other Wincor executives largely held on to their stock, figuring KKR was selling too early. They were right. Through June 27, Wincor stock had posted an annualized return of 47.9 percent since its IPO.

Even in the post-Regal Cinemas era, KKR has run into trouble. When acquisitions go sour, KKR steps in -- fast.

Changing Tack
After KKR bought Rockwood Holdings from Laporte Plc in November 2000 for $1.18 billion, putting down $282 million in cash and financing the rest with a mix of loans, a U.S. recession sent prices of Rockwood's chemicals sinking. By late 2001, the company was losing money.

KKR tore up its business plans for Rockwood's various units and drew up new ones. It dispatched Capstone's Eric Daliere and Nelson to set new benchmarks and improve productivity at scores of factories around the world.

KKR was running Rockwood with what it considered interim management. Kravis wanted a new CEO and zeroed in on Ghasemi, who was a former executive director at National Iranian Steel Industries, the country's state-run steel company under the late shah. Ghasemi fled Iran after the 1979 Islamic Revolution and eventually went to work for Redditch, U.K.-based GKN Plc, a maker of car and airplane parts.

Shaking Up Rockwood
When Ghasemi walked into Rockwood's Princeton headquarters in October 2001, a fellow executive apologized for not having prepared an office for him.

``I don't need an office,'' Ghasemi recalls saying.

Then the executive told him that Rockwood hadn't lined up a secretary for its new CEO either.

``I don't need a secretary -- and neither do you,'' Ghasemi said.

Before long, the executive, and his secretary, were gone.

Ghasemi, who has a master's degree in mechanical engineering from Stanford University, says he spent as many as 28 days a month on the road. He visited Rockwood plants around the world to find ways to squeeze costs and boost efficiency.

At a factory in Gonzalez, Texas, he went through plant schematics and figured out that the company could rearrange production lines to operate with fewer people. He ultimately fired 400 people companywide, or 10 percent of the workforce.

``I'm not too shy to say Rockwood exists to make money,'' says Ghasemi, who wears a lapel pin inscribed with Rockwood's motto: ``Cash, Customers, Commitment.''

Ghasemi knew how to fire up a sales force.

Darwinian Management
He offered them a 10 percent cut of any price increases they negotiated on Rockwood chemicals. Lo and behold, prices stopped falling.
The overall strategy was Darwinian. The company would unload any division that wasn't No. 1, No. 2 or No. 3 in its field.

Ghasemi freely tapped into KKR's brain trust. KKR had explored acquiring Frankfurt-based engineering company MG Technologies AG. Ghasemi and KKR used that knowledge when deciding to buy MG Technologies' Dynamit Nobel chemicals unit in 2004 for $1.98 billion. Rockwood and KKR then worked to unload part of that company in 2006.

With Capstone's help, Ghasemi devised spreadsheets so plant managers could keep track of which customers bought what chemicals as well as customer complaints and product returns.

Each month, Ghasemi now thumbs through a thousand-page printout comprising such stats from every plant around the world.

KKR Clout
``That's how you know what's going on at a company,'' Ghasemi says. In all, KKR poured $572.6 million into Rockwood in exchange for common and preferred stock, much of that going to bankroll the purchase of Dynamit Nobel.

In Rockwood's August 2005 IPO, KKR garnered $36.7 million of the proceeds from the redemption of convertible preferred stock it held, plus sundry fees. It also shared $131.9 million with Credit Suisse Group's DLJ merchant bank unit, which had invested $159.4 million in the Dynamit Nobel purchase.

The offering left KKR with 51 percent of the company, which was worth $1.37 billion on June 27. As of that date, the stock had returned an annualized 38.1 percent since the IPO.

KKR uses its clout to help its companies recruit executives in a hurry. After KKR and the Ontario Teachers' Pension Plan bought 90 percent of Yellow Pages Group in November 2002 for 3 billion Canadian dollars ($1.92 billion), KKR's Joseph Bae and Alexander Navab retained Marc Tellier as CEO.

KKR bought Yellow Pages from BCE Inc., Canada's largest telephone company, where Tellier had spent his entire career.

Luring Executives
In late June, three separate groups of investors, one of which included KKR, had either submitted bids for BCE or were considering doing so.

Tellier, 38, says he relied on Capstone and KKR to fix Yellow Pages.

``This was not a well-run business,'' Tellier says. One obvious sign: The Yellow Pages directories bore blue covers because blue was BCE's corporate color.

``The critical element was to get the management team in place,'' says Tellier, whose father, Paul, served as CEO of Bombardier Inc. and Canadian National Railway Co.

Tellier needed a head of sales, a chief information officer, a chief financial officer, a general counsel and a head of human resources. Bae and Navab, members of KKR's communications team, gave five executive search firms one week to come up with plans to find the executives.

Tellier and KKR reviewed the proposals and hired Toronto- based Caldwell Partners International. Four weeks later, Yellow Pages Group had its executives.

Spurring Sales
Tellier says Capstone's Nelson and other consultants helped the company zero in on its customers, set prices for Yellow Pages advertisements and ramp up sales.

Nelson suggested Tellier use a range of variables, from the Canadian CPI to the directories' market penetration in a given region, to help set ad prices. Capstone helped upgrade management software so executives could track sales more effectively.

Today, Tellier can monitor weekly sales by province, sales manager or salesperson. With a click of his computer mouse, he can locate the person who can tell him why sales are up or down in a particular area or category.

Salespeople also began tracking how customers responded to pitches over time. Yellow Pages urged sales reps to push larger ads, which cost $156 a month, rather than smaller ones, which cost $24.

Another IPO
Tellier increased the proportion of salespeople who make face-to-face pitches rather than phone calls. Reps who used to sell six area directories sometimes had the number cut to, say, three. That way they'd be less likely to let sales lag in any one sales region.
Once a week, Tellier parks his GMC Yukon at a local coffee shop and hits the road with one of his 500 salespeople.

``You've got to understand the psyche of a small-business owner,'' Tellier says. ``One hundred percent of the dialogue is helping the customer be more successful.''

Yellow Pages Group went public in July 2003, selling its equity via Yellow Pages Income Fund, an income trust. The structure is similar to that of a real estate investment trust and enables companies to pass on earnings untaxed. The deal took advantage of investors' hunger for high-yielding securities at the time and valued Yellow Pages at C$4.7 billion. Through June 27, Yellow Pages units had returned an annualized 14.4 percent since trading began.

`Having a Ball'
Kravis and Roberts, each man now in his seventh decade, are more powerful than they've ever been. Stuart, the KKR veteran, says his former bosses show no sign of slowing down.

``My sense is, they're having a ball,'' he says.

No party lasts forever. Kravis captured the euphoria of his golden age last November, before financing costs began rising, when he addressed newly minted partners of Goldman Sachs.

At the Ritz-Carlton hotel in lower New York, Kravis told the crowd that KKR and Goldman had worked together and made money together for three decades. Their lucrative partnership would endure, he said.

Kravis paused. ``Just don't do anything to screw it up,'' he added. The partners laughed. As the deals -- and potential dangers -- of the private equity boom keep multiplying, Kravis might want to heed his own advice.