Brookfield Property Partners (BPY): What’s Going On?

Brookfield Property Partners (BPY) is a leading global commercial property company with operations that include premier office, retail, multi-family, industrial and hotel assets. The company was spun off from  Brookfield Asset Management (BAM) and began trading independently early in 2013 with a 23 year pro forma history of 15.4%/year total returns.

Since the high of $23.99/unit in May, the month after the spinoff, some wonder why BPY’s price at $20/unit has been less than overwhelming. Our estimate of BPY’s underlying or intrinsic value is about $50 per unit in a 3-5 year time frame [Source] based on demonstrated performance over the past 23 years. The company remains well positioned to deliver outstanding risk adjusted returns to the patient investor. Nothing has transpired in the past few months to change those prospects or the intrinsic value.

BPY

Brookfield Property Partners Corporate Profile [Source]

In a prior response to a question on the price of BPY [Source] I wrote: “Your assessment is correct in my view; Brookfield Property (BPY) is trading below its book value and well below my estimates of intrinsic value. It’s not unusual for recent spinoffs to drop in price before the market begins to understand the value proposition. My investment time frame is usually 3-5 years, for many reasons, so price drops create buying opportunities.”   

We went on: “For example, after the Brookfield Infrastructure (BIP) spinoff in 2008 the price dropped, helped along by a falling market, but the patient investors have been well rewarded and likely will be for years to come. Just so you know, after the BPY spinoff I bought more shares of both BPY and Brookfield Asset Management (BAM).”

More Questions on Brookfield Properties from Readers:

“I just wanted to check up if you had any updated thoughts on BPY post the BPO offering? I can see the value proposition clearly for BAM however the price action in BPY continues to disappoint. Thanks!”

“Are you concerned with BPY’s use of cheap equity to purchase GGP?”

Referring to this comment below by Horizon Kinetics’ value investor Murray Stahl in Value Investor Insight. A reader asks; “I was just curious what your thoughts are on that point, is it a value trap; no float=no catalyst?”

Murray Stahl’s comment in part [Source]: “…BPY owns trophy assets that would stand up well against any entity held by an index of commercial real estate investment trusts. But it isn’t included, or included in only a small way, because BAM still owns 90% of it and the float isn’t sufficient for the index. So the value-realization catalyst of the spinoff for both BAM and BPY has so far been much less operative than it would have been in the old days.” 

Good questions; let’s see if we can better understand Mr. Markets reception and the implications on our investment.

Price and Value:

You may recall in an earlier post “Risk and Investor Discipline” [Source]  we discussed intrinsic value as the measure of the underlying economic value of a business regardless of what the stock price happens to be at any point in time. Intrinsic value is important because it enables us to do our job in a disciplined manner. It is the key to knowing if we are taking advantage of Mr. Market or being taken advantage of. If we buy the business at a discount to its intrinsic value we reduce risk by building in a margin of safety and improve returns.

Remember price is what you pay and value is what you get. Having an estimate of  intrinsic value lets us  determine quantitatively if we are buying a business at attractive price. The margin of safety is needed to cover the potential errors we will make in estimating intrinsic value and any unforeseen changes in the business. Eventually the stock price will approach the intrinsic value of the businesses, we may not know exactly when, but it always happens.

I agree the BPY price is disappointing if you wish to sell today but it is a pleasant surprise if you are looking for an attractive price at which to buy today. In his book “The Intelligent Investor” Benjamin Graham, the father of value investing, offered some powerful advice: “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.”

That is why it is so important to invest with a 3-5 year time frame in mind; so we don’t get stampeded. But why is there a disconnect between Brookfield Property Partners market price and intrinsic value? Sometimes it is hard to tell but in this case I think Mr. Stahl is onto something with his inference to trading volume. BPY management has also alluded to volume as an issue; “Furthermore, we will increase BPY’s public float to approximately $5 billion.”

Insufficient Float for Institutional Buying:

The largest sources of buying and selling in the markets are large institutions such as mutual funds and pension funds. The price of a stock (not the value) simply follow the laws of supply and demand. As the demand for shares increase so does the price and when demand falls the price weakens. Institutions have significant buying power so if they view BPY as an attractive investment (as I think they must) they will increase demand and price when they buy.

Institutions  also require sufficient trading volume, to be able to buy and sell without unduly affecting the price. Without sufficient volume (or float) the large institutional buyers are reluctant to buy even if they view a company as an attractive investment.

As an example, if the average equity mutual fund with a little over $1 billion in assets wants to take a typical 2% position (in Brookfield Property Partners) they must invest $20 million in the company.  At BPY’s trading price of $20 per unit that is 1 million units and at BPY’s average 3 month trading volume of about 100,000 units per day that’s the equivalent to 20 full days of trading volume or about 100% of a month’s volume. It would take months to establish the desired 2% position without affecting the supply and demand of a stock (and then the price).

A Catch 22?

“Catch 22” is a circumstance from which there is no escape because of mutually conflicting or dependent conditions. The Brookfield Property Partners dilemma is that the relatively low trading volume is a deterrent to institutional investors (and also inclusion into stock indices). Until the volume increases the unit price will likely remain below the true (intrinsic) value of the company due to lack of institutional sponsorship.

You can imagine the conversation between Brookfield and institutional investors: Yes we’d like to invest in BPY, the economics look attractive to us, but we need more trading volume to do so. Brookfield responds, of course, so if you (institution) invest we’ll get the volumes needed, right? Well, yes, but,  I don’t want to be the first one in, come back when you have more volume.

However, issuing more BPY shares at the current price of $20 per unit or about 80% of book value and 40% of intrinsic value (in 4-5 years) is costly to current unit holders.  Issuing additional shares without the institutional demand would further depress the price: Catch 22. Fortunately management’s historic focus on capital allocation and returns make this short term costly solution of “dumping” shares on the market unlikely because of the enormous long term cost for us existing unit holders and the negative impact on future total returns.

Management  is the Catalyst :

Good fundamental performance through good management is the only “catalyst” needed to increase the intrinsic value of a company over time. The market price always eventually follows.  Like in chemistry though, an additional catalyst in investing to make things happens sooner and more completely is always nice and management is providing a couple.

Brookfield Property Partners announced [Source] a proposal to acquire Brookfield Office Properties (BPO) in a tender offer for all of the common shares it does not currently  own.  BPO shareholders can choose receiving cash or BPY units (on a tax-deferred basis), subject to pro-ration based on maximum cash of $1.7 billion and a maximum of 174 million BPY units. The transaction is valued at $5 billion and increases BPY’s ownership in this premium office property portfolio to 100%.

BPO

Brookfield Office Properties Corporate Profile [Source]

Brookfield Property Partners also announced [Source] that it  has agreed to acquire additional shares and warrants of General Growth Properties (GGP) for total consideration of $1.4 billion. The acquisition will be funded through the issuance of $435 million units of BPY to Investment Corporation of Dubai and other institutional investors and $995 million of redeemable-exchangeable units of a subsidiary of Brookfield Property Partners to Brookfield Asset Management.

GGP

General Growth Properties Investor Presentation [Source]

Following completion of the GGP transaction, the public float of Brookfield Property Partners will increase by 28% ($435 million). The offer to acquire the shares of Brookfield Office Properties (BPO) that it does not already own if fully successful will increase Brookfield Property Partners’ public float to over $5 billion from about $1.6 billion today for a threefold increase. This is a huge step in the right direction of increasing the public float and trading volume sooner rather than later.

Are we paying too much?

The transactions involve three companies in the commercial real estate business that Brookfield Property Partners’ management knows very well. Ric Clark, Chief Executive Officer of Brookfield Property Group stated on the Brookfield Office Properties (BPO) purchase ; “The combination of these leading commercial real estate platforms will create a diversified portfolio of best-in-class real estate for investors seeking attractive risk-adjusted returns, through income and capital appreciation.” On the General Growth Properties transaction he observed; “increases BPY’s exposure to one of the highest quality shopping center portfolios in the world at an attractive valuation.”

Let’s Look at some numbers:

Comparative Table

Brookfield Office Properties (BPO) Shareholders are getting a reasonable deal in my view. It  includes a 15% premium to the price prior to the announcement; a 17% premium to the prior 30-day volume-weighted average price; a dividend increase by 79%; an 18% increase in book value; and one of the largest global commercial real estate companies in the world. Prior to the announcement BPO was selling at a deeper discount than BPY on a price to book value basis. It appears our undervalued BPY currency (the BPY discounted units) are purchasing BPO shares at an equivalent discount to book value.

This brings us to the question: “Are you concerned with BPY’s use of cheap equity to purchase GGP?”  I was initially surprised to see below value equity being used for an acquisition (especially by Brookfield). I had a similar reaction to the proposed BPO acquisition. In our valuation of BAM we estimate that BPY will be worth about $50 per share in 3-5 years. You can read the post [Here] if you want to see  the rationale behind it.

The General Growth Properties share purchase is at the market price of $20.39/share ($1,076 million for 52.8 million shares) but on the basis of our undervalued BPY currency of $26.36 ($1,392 million) we appear to be paying a 30% premium. That is unless GGP is also selling at an equivalent discount. Management says it is at a discount to peers and compared to its closest rival, Simon Property Group (SPG) that may be the case. Even when factoring in our undervalued BPY currency, management’s outlook is an “expected returns [to] exceed the 12% to 15% targeted range.”

We know what we are spending (the price) but what are we really getting (the value)? In both the BPO and GGP purchase the only way to know for sure what we are getting is to estimate the intrinsic value of the companies being purchased (which I have not done). I am confident however that the management teams at both Brookfield Property Partners and Brookfield Asset Management as majority owners understand the underlying value of the purchases, that’s what they’re good at.

Based on the cursory look here it appears BPY unit holders are getting a reasonable deal with the BPO acquisition. The GGP deal, although murkier, the reasonableness is supported by the ongoing process of debt reduction. The debt refinancing at near historic low interest rates has already showed the debt to equity ratio dropped from 2.5 to 2.1 from 4Q12 to 3Q13. The refinancing and growth pipeline will likely continue to show value creation with attractive returns on what was paid for these assets. As an investor in GGP immediately before and through its bankruptcy emergence I paid close attention to Brookfield bringing these premium mall assets back to life. They know when they have a good thing.

Is it a Value Trap?

The term “value trap” is over used and ambiguous. “Value trap” seems to be a convenient excuse for a botched up investment analysis. If an investment doesn’t work as anticipated, probably someone missed something. Rather than accepting responsibility for the error (and maybe lose a job) the investor or analyst  blames the bad results on some mystical force out there called the “value trap” . It can haunt someone for years, but that’s the subject of another post.

Maybe the underlying question is: Was a significant factor missed in the analysis of BPY where the anticipated returns cannot be achieved? Or worse, will we experience zero or negative returns? Only time will tell for sure, but I think the likely hood of that outcome with BPY is nil. First, because we actually analyze companies and although we certainly can make mistakes or miss something; there is a stronger second reason. BPY is being managed by a group of astute investors, with compounded returns of about 20% per year for two decades, are very familiar with the companies involved and real estate is their core competency.

So where does that leave us?

On the surface it may appear we are paying more than we should. Even a “reasonable price” is below my expectation of a “good price” providing an adequate margin of safety and an above average return. This takes us back to the difference between value and price. Price is what you pay, value is what you get. We know what we are paying but do we really know what we are getting quantitatively? What if we net a greater value from BPO and GGP?  What if the experienced capital allocators and property investors at Brookfield see opportunity for greater value creation that we can’t see as outsiders?

Since BPY already owns substantial stakes in GGP and BPO in a sense we can think of these transactions as stock buybacks. Companies can use the low market prices to either buy back their own shares/units or make offers for others. Buybacks get mixed reviews because at times they are done at prices in excess of intrinsic value. Buybacks are only beneficial to the current shareholder if they occur at prices below intrinsic value; Brookfield’s primary method of generating returns.

Stepping back for a moment let’s review Brookfield Asset Management’s investment  record and consider that management invests their own money alongside of ours. At the end of 2012 the company generated 10 and 20 year compounded annual returns of about 20%.

BAM 2012 YE Returns

Isn’t that why we invested with them in the first place; to benefit from their decades long record in excellent capital allocation and total returns compounding at about 20% per year?

The Brookfield companies also have a goal to simplify its corporate structure. The BPO and GGP transaction are another step in the restructuring direction that had been underway for several years. It simplifies the BPO structure almost immediately.

Would cash be better than our undervalued currency, the BPY units?  Yes, from the BPY owners perspective but not as much for the GGP and BPO sellers who would then have to pay tax on the cash portion of their gains.  A deal has to be sufficiently beneficial to all parties involved or they don’t happen. Rather than ask for a bigger piece of the pie, lets make the pie bigger so we all get a bigger piece.

And back to the question on trading volume, the bonus for us BPY owners is Brookfield Property Partners” float increases about 3 times the current float. That will likely allow for more institutional sponsorship and improved unit pricing for both current and new BPY unit holders.

There is a caveat though, you have to trust that this management team is not departing from their decades long excellent record of capital allocation. I do, until they prove themselves differently.

Buying opportunity:

Mr. Market continues to provide us an attractive entry point. If we liked the business prospects before when it was favorably priced, why wouldn’t we like it more at an even better price now with greater opportunities? I like to think of these things as extended buying opportunities.

Trading below book value and well below our estimate of intrinsic value in 4-5 years [Source] of about $50/unit. The estimate is based only on the company continuing demonstrated past performance, so no heroic assumptions are made. On that basis a reasonable entry price would be up to $38/unit. The current market price is about $20.00/unit so BPY is offering a 60% margin of safety.

While we wait for the potential 150% capital appreciation we are paid an additional return of 5% per year as income in the form of quarterly distributions. The BPO and GGP purchases will only help us get there.

Disclosure: Long BPY, BAM, BIP, BEP

 

 

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