Can voracious buyout firms like Kohlberg, Kravis & Roberts earn big returns from simply buying a stake in a public company? KKR thinks so.

On Jan. 23, KKR, for one of its publicly traded funds, bought $700 million of Sun Microsystems Inc.'s convertible debt. Sun was gratified by the deal, hoping it would send the message to Wall Street that the tech outfit would emerge from its struggles. Both KKR and Sun should be pleased: Shares in Sun have risen 7% since the announcement, compared with a 3% drop for the Standard & Poor's 500-stock index. It's the sort of halo effect usually reserved for the likes of legendary investor Warren Buffett, and it may signal there's a new player to mimic in the market. "I think Buffett's record is unmatched," concedes Bret Schaefer, a vice-president for Sun. But "KKR offers a range of relationships that brings unique value." KKR declined to comment.

As private equity giants with bulging war chests race to buy ever-larger companies, a growing number of players ranging from boutiques to major buyout firms are acting like hybrids of passive mutual fund managers and activist hedge funds. In the quest for extraordinary gains, private equity players like KKR are taking minority stakes in public companies, often through private placements, and working with management teams to enact change. But unlike agitating shareholders, they aren't hedging their positions or launching hostile proxy fights.

At Sun, KKR is a cheerleader, chatting up other major investors on conference calls about the hidden value in the software maker. With this new relationship, KKR can play matchmaker, giving Sun a shot at being a supplier to its 37 portfolio companies, a group with $97 billion in revenues. Sun will likely also elect a KKR executive to the board, and the private equity firm will serve as counselor for the tech outfit's upcoming acquisition spree. "They will give us free advice that we would have otherwise had to pay investment bankers for," says Schaefer.

In some ways, it's a natural brand extension for private equity. Most firms look at hundreds of potential buyout targets before taking only a dozen or so private. But in separating the wheat from the chaff, they miss out on more traditional stock and bond opportunities. If they invested in public markets, they would not only expand their horizons but also avoid paying a fat premium, as they do in a buyout deal. Extra bonus: If things don't work out as they predict, the funds can pull out of the investment more easily.

MIXED RECORD
Still, this tack sparks controversy. Some private equity investors resent paying 1% to 2% management fees and giving up 20% of profits for what they perceive as mutual-fund-like moves. "Most of our clients on the pension side say the fees are too much," asserts Mario L. Giannini, CEO of money management and advisory firm Hamilton Lane.

Private equity outfits, which usually pitch the advantages of making changes in a private setting over a public one, also have a mixed record when they stray from their expertise. Blackstone Group bought a 4.5% stake in Deutsche Telekom (DT) last April, but so far its $3.5 billion investment is down $315 million. On the other side of the spectrum, private equity giant Warburg Pincus has made at least $390 million, or 118.45%, on its private placement investments in public companies since 2005, estimates PlacementTracker. Blackstone and Warburg declined to comment.

Some boutique firms, such as Blum Capital Partners and Sageview Capital, think there are so many opportunities in the markets they don't need to play in the traditional private equity space. Says N. Colin Lind, a managing partner at Blum Capital: "We're in the business of influence, not control."

That's the kind of relationship some companies cozy up to. Says Sun's Schaefer of KKR: "It's almost like having an extra staff member on my investor relations team."

By Emily Thornton