2nd UPDATE: KKR 2Q Core Earnings Down 25% As Gains Moderate

--Shares fall as earnings miss analysts' expectations

--Its earnings miss highlights volatile marked-to-market values

--Choppy market may continue to hurt earnings

--Market volatility will accelerate investors' shift to alternative investments

(Adds share price in the first two paragraphs, details to financials in the fifth and sixth paragraph, comments from earnings call from ninth paragraph onwards.)

By Amy Or

Of DOW JONES NEWSWIRES

KKR & Co.'s (KKR) share price dropped nearly 6% as its second-quarter core earnings fell 25% and missed analysts' expectations.

Its shares were down 5.9% at $13.30 in recent trading.

Economic net income--a metric analysts monitor that reflects private-equity firms' underlying operations and excludes special charges such as those linked to KKR's initial public offering--fell to 36 cents a share from 48 cents. Analysts polled by Thomson Reuters had expected earnings of 40 cents a share on revenue of $195 million.

Profits calculated on generally accepted accounted principles rose 32% to $ 39.6 million on higher assets under management and a 35% rise in revenue to $ 117.6 million.

KKR's earnings miss highlights volatilities in reporting marked-to-market values of portfolios at a time when markets have steadied following the huge plunge and rebound of the financial crisis.

Gains from KKR's investments in underlying funds and co-investments fell to $ 150 million from a $255 million a year ago on "less significant appreciation" in assets than in the year-earlier period, thus hurting economic net income.

Its private-equity portfolio appreciated by 3.8% in the second quarter and 10.1% in the first half, coming off the extremely high returns of more than 30% last year.

"Our private equity investments outperformed the S&P 500 by nearly 400 basis points for the quarter," said Henry R. Kravis and George R. Roberts, co- founders, co-chairmen, and co-chief executives in a statement.

But recent market volatilities may spell further woes in upcoming earnings, as share prices of publicly listed portfolio companies take a hit.

During a conference call to discuss the results, executives said hospital operator HCA Holdings Inc.'s (HCA) 30% plunge in share price since the end of the second quarter, if booked on the balance sheet right now, would be reflected as a loss of around $150 million in fair value and $69 million in performance fee or "carry."

"HCA is still well over three times its cost," said Craig Larson, KKR's head of investor relations.

But overall, KKR said it expects to benefit from choppy market conditions as institutional investors switch to alternative investments from traditional means of trading.

"Maybe it's counterintuitive. But when everybody's scared, we get pretty excited," said Scott Nuttall, KKR's head of global capital and asset management. "This environment is creating some pretty interesting supply-demand imbalances and we're stepping into that imbalance and making some pretty investments."

He highlighted opportunities in European banks' sales of assets and lending to middle-market companies, where banks and traditional sources of financing are " gone or impaired."

The company, which switched the listing of its shares to the New York Stock Exchange in July 2010 from Euronext Amsterdam, had $61.9 billion in assets under management as of June 30, up 14% from a year ago, on continued investment appreciation and new capital raised.

Since March 31, KKR disclosed 12 new investments whose enterprise value totaled $11 billion.

It also reported seven sales of companies, expected to realize more than $2 billion, or 2.4 times its initial investments. Executives said an announced sale of Hilcorp Resources Holdings LP is expected to generate a cash distribution of 6 cents a share in the fourth quarter.

KKR, which still has $13.7 billion in uncalled commitments or "dry powder" for future investments, said its new long-short equity hedge fund started to accept investors' capital this month. The team is run by former Goldman Sachs Group Inc. (GS) proprietary traders.

-By Amy Or, Dow Jones Newswires; 212-416-3142; amy.or@dowjones.com

--Nathalie Tadena contributed to this article.