We did very well with this from 20009 but then thought it pricey above $40.
Now it is down to $36? What’s the value? And what is it?
Here’s two articles, both by Anthony Grossi that confirm my suspicion it is trading well below real asset value.
Partly that is because it is so complex.
Spinning out all the parts will let each of them stand on their own and rise or fall accordingly.
In a recent article here at SeekingAlpha, I laid out an investment thesis for Brookfield Asset Management (BAM) focusing on the qualitative aspects of the business. Now I would like to lay out the investment thesis focusing on the quantitative aspects.
Brookfield is objectively cheap based on a sum of parts valuation. The company is comprised of a sprawling portfolio of investments of which 12 are currently publicly traded entities, one more which will be public shortly, and the actual asset management business.
If you add up BAM’s ownership interests in the publicly traded holdings, the combined market value is around $22 Billion, compared to the holding company’s current market cap of about $22 Billion. Which still leaves the rest of the company. So what else does owning BAM buy you? The two parts will we look into are the soon to be spun-off Brookfield Property Partners (BPY) and the asset management business, also called Brookfield Capital Partners.
On April 15th, Brookfield plans to distribute shares of Brookfield Property Partners to existing shareholders as special dividend units. Under the arrangement, shareholders will receive 7.5% of the company while BAM will retain the other 92.5%. The parent company has already announced that they are targeting an annual dividend policy for the new entity at an 80% pay-out ratio, or $1 per share in the first year. If valued like its peers, the new BPY should trade around $25 per share, or a market cap of $11.4 Billion. This estimated value is derived by assuming a 4% dividend yield, and one times price to book value (based on IFRS accounting reported by BAM in the most recent annual report).
Adding the value of this part of the stub back to the value of the publicly traded holdings gives us an implied value of about $34 Billion, versus the current market cap of $22 Billion, and we still have one more piece of the pie to consider.
BAM’s management assigns a franchise value for the asset management business of about $4.3 billion based on assumptions of AUM growth of about 10% per year, 1.5% gross margins, and a 15% discount rate. That’s very generous of them.
We will attempt to value the asset management business using cash flow yield based off of fee income from management and performance bonuses minus transaction costs. This is an attempt on my part to avoid double counting the many publicly listed assets that are also held by the asset management segment. Applying a 10x multiple to the two-year average fee generation of about $410 million gives a rough value of $4.1 billion for the asset management business. The 10x multiple implies a cash flow yield of 10%, which is in line with the average free cash flow yield on asset managers like Waddell & Reed (WDR), and Legg Mason (LM). While fee income is a far from perfect comp to free cash flow, it may be reasonable to use this measure as a proxy to cash flow as a backup to management’s stated value given the lack of full disclosure on how management arrives at its $4.3 billion asset management franchise valuation. At any rate, we arrived at a number which is fairly close to the supposed intrinsic valuation.
So if we take this assumption and add it back to our previous ones, we have an implied value of about $38 Billion for the whole company. At the current market cap of $22 Billion, that’s about 70% upside if the parent company were to trade up to our estimate of net asset value. That strikes me as quite a bargain.
|Subsidiary||Shares held or
% of ownership stake
(rounded in Billions)
|Brookfield Office Property (BPO)||249,362,561||4.2|
|Brookfield Residential Properties (BRP)||73,555,457||1.8|
|Brookfield Infrastructure (BIP)||30%||1.5|
|Brookfield Real Estate Services (BRE.CN)||25%||0.03|
|Brookfield Renewable Energy (BRPFF)||68%||5.1|
|Brookfield Incorporacoes (BISA3.BR)||41%||1.2|
|General Growth Properties (GGP)||357,662,764||7.1|
|Howard Hughes (HHC)||2,424,618||0.2|
|Rouse Properties (RSE)||26,580,603||0.4|
|Acadian Timber (ADN)||75%||0.2|
|Western Forest Products (WEF.CN)||49%||0.3|
|Brookfield Property Partners (BPY) *pending spin-off*||92.5%||11.4|
|Brookfield Capital Partners
(the asset management business) *my assumptions*
|Implied discount to NAV||42%|
Please take into consideration that the numbers in the table above are not exact. The point of this exercise was simply to demonstrate the implied discount. The exact percentage will fluctuate with market prices throughout the day. Regardless, BAM is trading for a demonstrable discount to its parts.
GROSSI TWO (earlier)
Legendary investor Marty Whitman of Third Avenue Value uses the term “wealth creation companies” to describe companies whose purpose is to create or compound wealth. While this may seem too axiomatic and pertain to all businesses, most companies only provide one specific product or service. For example Coke (KO) sells soft drinks and Nike (NKE) sells shoes. Successful companies do so profitably and the most successful ones grow over time, but their focus is quite specific. The focus of these conventional companies is sales and revenue growth, margins, competitive advantages and so forth.
Wealth creation companies are focused on asset allocation rather than current operations. Warren Buffett’s Berkshire Hathaway (BRK.B) is the most famous example of this concept, and currently sells everything from electric cars to candy bars. The focus for this type of company is on the management team and their capabilities. Analysis of such companies is far more subjective than that of traditional operating companies and this can lead to misunderstanding and mispricing.
Thesis Brookfield Asset Management (BAM) is constructed of two compounding companies whose operations feed each other and thus allow the company to compound at a higher rate of return. First, the company is a large collection of infrastructure and real asset investments that produce free cash flows. Secondly, the company is an asset manager that makes investments in infrastructure and real assets. On the one hand you are earning the rate of return of the investments, and on the other hand you are growing the size of the investment pool, and thus increasing the rate of compound return.
Company Overview Formerly known as Brascan, Brookfield is an immense, sprawling conglomerate with more than $180 Billion in assets under management (AUM) but is essentially comprised of four investment vehicles. The company owns
- 28% of Brookfield Infrastructure Partners (BIP)
- 68% of Brookfield Renewable Energy Partners (BRPFF.PK)
- 92.5% of Brookfield Property Partners (BPY – spinoff pending)
- 100% of Brookfield Capital Partners, a private equity fund
Funds from operations (FFO) flow from the underlying businesses up to the parent company and are then reinvested to further grow funds from operations. It is important to understand that Brookfield really creates wealth through deals and asset accumulation, not asset appreciation. Their business is generating capital and then redeploying that capital into new investments. The end result of which is a diverse stream of free cash flow. I think the assets that Brookfield owns range from pretty good to truly essential.
Risks Investment Return I think over the really long term Brookfield will only earn a return on investments roughly equal to the overall markets. This is in part because of the law of large numbers, but it is also because infrastructure investments tend to attract the attention of regulators. If Brookfield’s investments were to lag the overall market or lose money, then obviously that would impact investor returns.
Debt Brookfield makes heavy use of capital markets, third party and debt financing, and is constantly buying and selling assets. Infrastructure investments require large up-front capital expenditures and interest rates have to go up some time. A rise in the cost of debt used to fund investments will diminish long term returns.
Macro Economics Heavy infrastructure investments make more sense in an expanding global economy. A slowdown in the global economy will diminish the number of investment opportunities for the company.
Politics It is at least possible that the governments of the countries where Brookfield owns assets could decide to nationalize those assets or drastically change the terms of the original investment agreement.
Opportunity Asset Appreciation The opportunity for growth comes in three categories for Brookfield, the first of which is asset appreciation. The company should be able to roll-over existing leases and contracts at higher market rates. In other words, Brookfield’s assets should be worth more over time.
Asset Accumulation Brookfield will continue to make investments in additional assets. This is the company’s bread and butter.
Assets Under Management Brookfield’s past success should allow them to attract new capital from an expanding base of clients. This will result in an expanding base of management, incentive and performance fees.
The cash flows from these three growth categories will primarily be reinvested in further asset accumulation.
Financial Strength Brookfield is a complicated conglomerate, but they have proven the financial strength of the business model during the 2008-2009 debt crisis. After buying an asset the company will “lock in” revenues with a 10 to 20 year contract. For example, an office tower will be leased on a 10 to 20 year contract to the corporate tenant, or a hydroelectric plant will pre-sell its energy production on a similar long term contract. Once an investment has been “locked in”, it will safely and quietly generate free cash flow for the duration of the contract. These investments are staggered in such a way that no one year’s contracts will sink the ship, so to speak. So during the 2008-09 crash they retained their cash flows and thus their liquidity. While competitors were selling, they were in a position to buy.
Management Brookfield is run by a man named Bruce Flatt. While the company has many moving parts, it is run with the single-minded purpose of generating sustainable low-risk cash flows and increasing shareholder value. As a matter of fact, Brookfield has a share ownership program that requires management to own stock valued at 5 times their annual salary. By definition, if you choose to invest in Brookfield you are taking a leap of faith in the management team’s ability to continue generating results similar to those of their past. Brookfield is a “tailcoats” investment, in that shareholder success depends on management’s investment skills.
Valuation Management at Brookfield provides their own lofty evaluation model for the company, but I wouldn’t want to take them at their word for it. Once the spin-off of Brookfield Property is completed it will be easier to assess the parent company’s value by simply adding up the value of its publicly listed parts. The company can effectively be broken into two parts; the value of the investment portfolio and the value of the asset management firm. As of December 31, 2012 the company estimates the value of its net invested capital at $37.71 per share and the value of the investment firm at $7.22.
Over the course of a long-term investment, I think it is reasonable for Brookfield to earn market like returns on their investments. So that’s about 6%-7% historically. In addition to this, I think the company can grow its asset management franchise by an additional 4%-6%. Thus, my expectation is that the company will grow its net invested capital at about 10%-13% a year. If you can buy shares at a reasonable margin of safety it’s within reason to expect an annualized return of 15% or better.
While the number for net invested capital includes some fair value estimates made by the company, it is a reasonable guide of fair value. With this, investors can gauge the value of the asset portfolio and basically get the asset management franchise for free. If you can buy the company at a reasonable margin of safety to the value of net invested capital, I think Brookfield Asset Management is a high quality company that would make for a dependable core holding.
- Broad exposure to high quality “real assets”
- Outstanding long-term management
- Growing investment portfolio
- Growing asset management franchise
- Fear of future investment mistakes
- Exposed to interest rate risks
- Exposed to currency risk
- Exposed to emerging markets risk
- Complicated conglomerate structure