Brookfield Asset Management (BAM) Investment Thesis, Part I

Brookfield Asset Management is criticized at times as being a company too complex to understand. Well, it is diverse but not too complex to understand. Management helps us with levels of disclosures and clarity of communications that can only be considered outstanding when compared to others. In the upcoming posts we will break the company down into understandable pieces. Those who make the effort to follow and understand this diverse company, I believe, will likely be rewarded over time.

In this first part of the Brookfield Asset Management (BAM) Investment Thesis we discuss the characteristics, investment attributes and catalyst of the parent company. In the following posts we review the characteristics, investment attributes and estimate the intrinsic value of its’ major publicly traded and privately held platforms. Concluding with “Brookfield Asset Management Investment (BAM) Thesis, Part II” where a sum of the parts approach ties it all together.

Why in pieces instead of one post? As prospective investors to get a true appreciation of the company, it’s value, risks and potential rewards the underlying business needs to be understood. It’s not really all that hard but it’s important. It always takes some effort to understand enough to make reasonable judgements on where to invest our hard earned money. As Thomas A. Edison said, “Opportunity is missed by most people because it is dressed in overalls and looks like work.”

Company Overview

Brookfield Asset Management is a global alternative asset manager with $181 billion in Assets Under Management (AUM). They have a 100+ year history of owning and operating assets with a focus on renewable power, property, infrastructure and private equity. The business model is to utilize a global reach to identify and acquire high quality real assets at favorable valuations, below replacement costs, finance them on a long term, low risk basis, and enhance the cash flows.  Improved cash flows increase the value of the assets while they earn reliable, attractive long term risk adjusted total returns for the benefit of shareholders.

Summary Table Platforms Global Presence

[Source]: November 2012 Corporate Profile

Five Sources of Value Creation for Shareholders

Value through Operations:

Brookfield Asset Management is a value investor with a proven track record. Their objective and operational approach is described as follows [Source]:

“Our primary financial objective is to increase the intrinsic value of Brookfield, on a per share basis, at a rate in excess of 12% when measured over the longer term.”

“We create value for shareholders in the following ways:

  • As an owner-operator, we aim to increase the value of the assets within our platforms and the cash flows they produce through our operating expertise, development capabilities and effective financing;
  • As an investor and capital allocator, we strive to invest at attractive valuations, particularly in distress situations that create opportunities for superior valuation gains and cash flow returns, or by monetizing assets at appropriate times to realize value; and
  • As an asset manager, by performing the foregoing activities not just with our own capital, but also with that of our clients. This enables us to increase the scale of our operations, which differentiates us from others, and enhances our financial returns through base management fees and performance-based income.”

Value through Restructuring:

The company recently announced the spinoff of the global commercial property assets into a new publicly traded entity named Brookfield Property Partners (BPY) as a special dividend to Brookfield Asset Management’s shareholders [Source].

The commercial property spinoff completes a multi-year transformation from a sprawling international conglomerate formerly known as Brascan Corporation to a global asset manager focused on real assets. The prior spinoffs of infrastructure assets (Brookfield Infrastructure Partners, BIP) and renewable energy assets (Brookfield Renewable Power, BREP) into publicly traded holdings have worked well for unit holders of those entities and BAM shareholders.

This last step of the transformation to a global asset manager is viewed as a catalyst to further unlock value. Brookfield Asset Management’s restructuring is similar to what Kinder Morgan Inc. (KMI) initiated years ago to unlock the value of pipeline assets in the United States and Canada. It is anticipated Brookfield Asset Management will unlock the value of real assets but on a global basis.

Like the very successful KMI, BAM uses a structure known as a master limited partnership (MLP) to hold long life income producing assets. Brookfield Asset Management holds all the general partner units and substantial portions of the Limited Partner (LP) units of these flagship entities; Brookfield Property Partners (BPY) holding 92.5% of the LP units; Brookfield Infrastructure Partners (BIP) holding 28% of the LP units; and Brookfield Renewable Power (BREP) holding 68% of the LP units. Holding the LP units align BAM interests with unit holders of the partnership units. BAM also owns Brookfield Private Equity Partners a non-public private equity business.

Value through Capital Allocation:

The transformation provides a long term competitive advantage in capital allocation important to all companies but only enjoyed by a few when deciding where to re-invest cash flow. It is similar to what Berkshire Hathaway has enjoyed for years and summarized in their recent 2012 annual letter to Berkshire Hathaway shareholders [Source] on page 19 as only Warren Buffett can: “And here we have an advantage: Because we operate in so many areas of the economy, we enjoy a range of choices far wider than that open to most corporations. In deciding what to do, we can water the flowers and skip over the weeds.”

Bruce Flatt, CEO of BAM explains the advantage in their 1Q11 letter to shareholders [Source] this way: “Our third competitive advantage is that we are global and diverse, with established operations in many major economies, enabling us to be selective as to where we invest, how we invest (distressed debt, equity, private markets, public markets), and in what we invest in. This increases the number of opportunities we consider, and often allows us to avoid the pitfalls that come from being sector-specific, and forced to invest capital into investments which may be great at a point in time, but dangerously over valued once too much capital starts chasing too few opportunities. This global scale provides us with a much broader range of investment alternatives and therefore allows us to pick our spots and shift our resources to the places where we believe the best long-term returns will be derived, enhancing overall returns, and hopefully avoiding trouble spots as they come along.”

The increase in capital allocation choices enables Brookfield to move investment dollars to the best area of opportunity in a timely manner as they occur. In the 2008-2010 it was the United States and Australia in real estate and infrastructure respectively. Recently, Europe has been an area of value opportunity as European companies sold infrastructure assets owned in South America to raise cash. Now an opportunity exists in North America with hydroelectric and natural gas facilities becoming available at bargain prices in depressed energy price markets.  Tomorrow it will likely be a different sector located somewhere else.

On rare occasions, a large opportunity for a financially strong global player occurs that will add significantly to per share intrinsic value. General Growth Properties one of the largest mall operators in North America and the Babcock & Brown acquisition along with the merger with Prime Infrastructure in Australia are examples. Large transactions of this kind are infrequent but when they occur they can be company or operating platform makers.

Value through Asset Appreciation:

High quality real assets purchased at favorable valuations with relatively low maintenance capital requirements, financed (or refinanced) with historically low interest rates and improving cash flows are likely to appreciate significantly over time. Should the macro-economic environment deliver higher inflation rates in the future, as many expect, real assets with inflationary indexed long term contracts like many of BAM’s platforms will provide a hedge against inflations. This is especially true with real global assets providing the basic essentials of modern life including transportation of natural resources, energy, power generation, and prime commercial real estate.

Value through Outstanding Management:

Good operations, insightful restructuring, prudent capital allocation and appreciation are of course the products of sound management. The executive team at BAM consists of 16 senior managing partners led by Bruce Flatt appointed CEO in 2002. This team has been consistent and outstanding over the years through the best and worst investment environments. They produced a compounded annual total return of 19% over the past 20 years. Communications are consistent, open and honest with shareholders. Senior managing partners and the board of directors own Partners Ltd., a private company that holds about 20% of Brookfield’s shares, closely aligning management’s interests with the shareholders.

In a letter to shareholders of one of BAM’s large holdings, General Growth Properties (GGP), Management outlined their view on investing: “In essence, we subscribe to the Berkshire Hathaway view of investing: If a business is a quality business that has an irreplaceable franchise, then one should continue to hold the investment, as compounding at significant rates of return on your capital over a long time can make shareholders very wealthy.”

Management rarely appears in public and seems to shun publicity. Their culture emphasizes logic and discipline while management is refreshingly willing to walk away from a deal if cost or risk escalate. The quiet, low profile, strong work ethic and perhaps their location in Toronto away from the bravado of Wall Street works well. Brookfield’s 19% compound annual return for common shareholders over the past 20 years approaches the performance of better known Berkshire Hathaway’s 19.7% compounded annual gain from 1965-2012.

Management explained it this way to the GGP shareholders: “The common shares of our company, Brookfield Asset Management, are illustrative. Over the past 20 years, our compound annual return for common shareholders has been 18% [actually now 19%]. For those who were fortunate enough to own shares over that 20 year period, their capital has multiplied by 27 times. This multiplier far outweighs any premium that could have been received on the sale of the company at any juncture along the way, in particular when taxes are taken into account. As an illustration of this, $100,000 invested in Brookfield shares 20 years ago would be worth approximately $2.7 million today. You can see the effect of long-term compounding which far outweighs any 30% premium (i.e. an extra payment of $30,000 on [a] $100,000 investment for example), which may have seemed large at the time, but seldom so in hindsight. That same $30,000 or 30% premium would be approximately $800,000 today.”

Historic Performance:

Although past performance does not guaranty the future; the long term total annual return results are impressive and demonstrate an encouraging track record. As prospective investors a first question to ask is; how have they performed against their objective historically? 

Investment Performance

[Source]: BAM 4Q12 Letter to Shareholders

Profile

BAM has three major publicly traded “flagship” entities (public entities): Brookfield: Property Partners (BPY); Infrastructure Partners (BIP); and Renewable Energy Partners (BREP) and the privately owned private equity business; Capital Partners. The private funds, consisting of sovereign and institutional clients, invest alongside the flagship public entities providing additional funds for opportunities as they occur. The structure creates a tremendous advantage in the capital markets to be able to raise cash and capital to be able to take advantage of value opportunities. An overview is provided in the graphic below followed by a summary of the operating platforms.

 BAM Structure

BAM Platform Table

Brookfield Asset Management is now set up with a structure designed to deliver cash flow and growth to both public market and institutional investors. And with excellent historical returns as a tail wind they will be able to generate new growth:

BAM Funds Table

[Source]: Brookfield Asset Management Investor Day Presentation page 30

Valuation:

Historically cash flow improvement and value were created from internal investment results and operating activities. The realignment as an asset manager, coupled with the world wide increase of investor’s interest in alternative real assets, provide further growth potential with the third party assets under management. We use Brookfield’s business plan highlighted in the Investor Day Presentation and a few assumptions to calculate the intrinsic value of the company.

The general assumptions include:

  • Listed fund capital increases with target distribution growth and issuance of equity to fund the growth.
  • Target fundraising goals for private funds are achieved with current fee structure.
  • Target returns are achieved in capital invested.
  • There is no major reallocation of invested capital.

It is comforting to note these assumptions are within BAM’s historic performance and at a rate that Brookfield has exceeded in the past.

We use a sum of the parts approach similar to that presented in the business plan with our own estimate of the intrinsic value of the components. We’ll examine the investment attributes and assumptions in more detail for each major platform over the next few posts. It is then pulled together in “Brookfield Asset Management (BAM) Investment Thesis, Part II” where the intrinsic value of Brookfield Asset Management configured as a global alternative asset manager is estimated.

Up in the next post, Brookfield Infrastructure Partners (BIP)

Disclosures: Long BAM, BIP, BREP, BEP

Comments

  1. Nicely done. I wrote a few posts defending BAM over at seeking alpha. Look forward to the second part of your report.

    • Nat, thank you for the feedback. I did see your SA comments on BAM and thought they were well done. Led me to visit your site and sign up for updates there as well. Keep up the good work!

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