2015 Intrinsic Value For Brookfield Asset Management

| About: Brookfield Asset (BAM)

Summary

The asset management franchise value is increasing substantially.

The BPY office properties are a large part of the valuation.

Adjustments are needed if a liquidation viewpoint is used.

Introduction

Brookfield Asset Management (NYSE:BAM) calculates intrinsic value in the 2010 and 2011 annual reports. In 2012 they show intrinsic value in the Q4 supplemental. We calculate it ourselves from 2013 to present. We continue to use their framework of adding net tangible asset value and the asset management franchise value. Apart from incremental value, the company still provides the numbers needed in order to calculate intrinsic value.

Over the years the company has discussed the following with respect to intrinsic value:

  • Common Equity
  • Deferred Taxes
  • Incremental Value [we use $0]
  • Asset Management Franchise Value
  • Overall Business Franchise [we use $0]

We break out Common Equity, Deferred Taxes, and Incremental Value above even though the company considers them all to be part of their first component, Net Tangible Asset Value. The 2010 annual report sums up this first component as follows:

This is based on the appraised value of our net tangible assets as reported in our audited financial statements, with adjustments to eliminate deferred income taxes and revalue the assets which are not otherwise carried at fair value in our financial statements.

Valuation is subjective and Bruce Flatt talks about one of the key factors in the 2009 Q2 letter to shareholders:

You may also wish to adjust our underlying values up or down based on whether you assess the company on a liquidation basis, or as a long-term going concern. On a liquidation basis (which we do not intend to undertake) in today's relatively illiquid markets, you may take the view that realized values would be less than the underlying values. Alternatively, if you believe that a company should be valued as a going concern in a normal market at the value willing buyers and sellers would pay for assets or businesses, then you might conclude that achieved sales prices should be above their appraised values (this has been our experience in the past).

Market cap was $30.18 billion as of December 31, 2015. This article shows that if we agree with management's framework apart from some adjustments then the 2015 intrinsic value is about $38.2 billion plus incremental value.

The 2015 investor day presentation shows what the company will look like once the 2016 Brookfield Business Partners [BBP] spin-off is complete. Our valuation is through December 2015 so we show BBP under the "other" group. This slide on page 81 provides a nice overview:

We abbreviate International Financial Reporting Standards as IFRS.

Brookfield Property Partners (NYSE:BPY)

BAM has approximately a 62% interest in BPY. Established in January 2013, BPY is the primary vehicle for BAM to own and operate commercial property operations. BAM spun-off its commercial property operations to BPY in April 2013.

BPY participated in a joint venture that acquired 100% of the Canary Wharf in April 2015. BPY owns 50% of the joint venture.

General Growth Partners (NYSE:GGP)

In March 2010 BAM managed a consortium that invested in the recapitalization of GGP. As of February 2015, BAM's potential ownership of GGP including warrants is 39.8% and most of this is through BPY. The 2015 GGP balance sheet shows $8.3 billion in equity. Brookfield is well represented on the GGP board with Bruce Flatt, Richard Clark, and Brian Kingston.

Rouse Properties (NYSE:RSE)

RSE was spun off from GGP in January 2012 at which time BPY and other members of Brookfield's consortium acquired an interest. BPY owned a little over 33% of the RSE common stock through January 2016. In February 2016 Rouse and a real estate fund managed by BAM entered into a merger agreement for the remaining shares at $18.25 per. The transaction is valued at about $2.8 billion including indebtedness. When this closes, BPY's ownership in GGP will increase because they are participating in the real estate fund managed by BAM. Our valuation is through December 2015 so we don't show these January 2016 developments.

Brookfield Infrastructure Partners (NYSE:BIP)

BAM has approximately a 29% interest in BIP. The BIP spin-off occurred in January 2008.

A March 15, 2016 6-K filing describes the agreement for a BIP consortium to acquire Asciano with an enterprise value of approximately A$12 billion.

Brookfield Renewable Energy Partners (NYSE:BEP)

Note that the ticker symbol is BEP but management abbreviates the name of this listed partnership as BREP and we use this same abbreviation throughout the article.

BAM has approximately a 63% interest in BREP.

The business is 80% hydro focused with much of the balance being wind. The company has explained that one of the reasons they have stayed away from solar is because the economics are unpredictable without government incentives.

Brookfield Business Partners [BBP]

BAM will have approximately a 65% interest in BBP once the 2016 spin-off is complete. When talking about BBP in the BAM 2015 Q4 supplemental, the company notes that their interest in Norbord Inc (OTC:OSB) is 41%. The 2015 Norbord annual report says that Brookfield owned about 53% of the issued and outstanding common shares as of January 2016.

The 2015 investor day presentation states that BBP will be externally managed. It goes on to say that this is different from other holding companies and it lists them along with their market caps at the time of the presentation: Berkshire Hathaway: $321.1 billion; Loews Corporation: $13 billion; Leucadia: $7.4 billion; HRG GROUP: $2.3 billion; Icahn Enterprises LP: $8.5 billion; Pershing Square Holdings: $5.2 billion; Third Point Re: $1.4 billion; Fortress: $1.2 billion

Our valuation is through 2015 and we don't show the BBP segment separately.

Common Equity Under IFRS

Unadjusted

The common equity from the consolidated BAM balance sheets is straightforward. The key is to remember to look at common equity and not confuse it with total equity which includes preferred equity and non-controlling interests.

The balance sheet common equity is $21,568 million.

Adjustments

We use a fee based multiplier to value the asset management franchise. As such, an argument can be made that we should not combine that with its balance sheet equity. The balance sheets have asset management equity of $216 million, $323 million, and $328 million for 2013, 2014, and 2015 respectively.

The balance sheet uses IFRS values instead of quoted values for listed partnerships and other listed investments. The equity sub total is $925 million higher than the quoted sub total. We're not making an adjustment due to this IFRS vs quoted difference but it is noteworthy. A recent Barron's article spot checks some valuations used by BIP and raises questions.

Deducting $328 million of asset management equity above, we are not using the balance sheet equity of $21,568 million but $21,240 million instead.

Deferred Taxes

As we saw in the introduction, the company does its valuation on an ongoing basis. The 2010 annual report explains management's perspective with respect to taxes:

We utilize net asset values on a pre-tax basis in assessing the performance of our business. We do this because the tax liabilities established under accounting guidelines are calculated on the basis that we were to liquidate the business based on the same underlying values at the balance sheet date, whereas we have no intention to do this. To the contrary, we expect to hold most of our assets for extended periods of time or otherwise defer this liability. We note that the deferred tax liability is similar in this sense to the float in an insurance company which is available for investment to the benefit of shareholders for an extended period of time or even indefinitely.

If we take the same viewpoint as management then this is added back into intrinsic value and the amount from the balance sheet is $4,904 million.

Adjustments

Analysts assessing the company on a liquidation basis will not add back deferred taxes and the dollar amount is large so this is an important item with respect to valuation totals. We'll keep things pre-tax but this choice is debatable.

Incremental Value

The company has been conforming to IFRS since 2010. Some assets are not re-valued under IFRS such that they are not carried at fair value. The company uses the "incremental value" component to bring assets up to fair value.

The 2011 annual report talks about incremental value items:

These include items carried at historical book values, such as the values for our property services and construction businesses, certain of our renewable power and infrastructure assets, assets acquired at distressed values that are not otherwise revalued and development land carried at the lower of cost or market.

Management shows incremental value as $3,400 million, $2,850 million and $3,250 million for 2012, 2011 and 2010 respectively. Historically much of this has been under private equity and asset management. Notable amounts have also been seen in infrastructure and renewable power.

The 2014 Q1 letter talks about incremental value with respect to the General Growth Properties Ala Moana mall expansion in Honolulu, Hawaii. The Sears outlet was demolished and the luxury wing of the mall was extended in its place. The investment is said to represent over $1 billion of incremental value. During 2015, GGP sold a total 37.5% interest in Ala Moana Center to joint venture partners for $2 billion. GGP recognized a $584.4 million gain on change in control regarding the sale of 25% interest in Ala Moana. They recognized a $295.9 million gain in Unconsolidated Real Estate Affiliates upon the sale of the 12.5 percent interest.

The September 2014 BPY investor day presentation shows incremental value of $5,159 million for mark-to-market of expiring leases. It shows another $2,306 million of incremental value for occupancy gains in the office platform.

The 2015 BPY annual report says that they raised more than $2 billion from asset sales in 2015 and that they plan to sell about the same amount in 2016. On average the sales were 13% above IFRS values. If we assume the 2016 sales will also be about 13% over IFRS values then it is another example of incremental value.

Incremental value is no longer consistently spelled out by management in a complete fashion on an annual basis. It is beyond the scope of this article to calculate it for 2015. Readers have to make their own judgments as to what assets are not carried at fair value due to IFRS limitations.

We are using $0.

Asset Management Franchise Value

The October 2015 investor day presentation discusses asset management franchise value. It shows a franchise value of $9,260 million through June 2014 and $11,890 million through June 2015. The $9,260 million is made up of $6,820 million from fee related earnings and $2,440 million from target carried interest, net. The $11,890 million is made up of $8,800 million from fee related earnings and $3,090 million from target carried interest, net. The fee related earnings multiplier is 20x. The target carried interest multiplier is 10x and there is a 65% gross margin assumption. The October 2015 investor day presentation estimates that the franchise value will grow to $27,300 million by the year 2020.

We can easily understand the concept of "carried interest" if we think of it as the 20 with respect to a hedge fund that has a 2 and 20 fee structure. What isn't as clear is the way in which BAM measures target carried interest and its contribution to the company's intrinsic value.

CFO Brian Lawson has been giving helpful presentations regarding the asset management franchise value in investor day meetings over the last few years. I highly recommend reading his explanation of target carried interest on page 32 of the 2015 investor day transcript. He starts by explaining that realized carry is reported on the financial statements and that realized carry has to be earned without clawback in order to be reported there. As such, realized carry is mainly carry that is towards the end of the fund. Most of their funds are 10 years so the realized part that qualifies for the financial statements can be far out there.

Every quarter the MD&A section shows how much carry would have been generated had the funds been wound up on the closing date of the reporting period. This is the unrealized carried interest.

Next comes the target carried interest number. The funds tend to be like J curves such that the carried interest is not seen in the early years. The target carry metric gives investors a straight-lined view of the carry over the life of the fund. It tends to come out to around 200 basis points. Target carry is an important metric because the financial statements alone don't show the true carry potential during the early years of the funds.

The May 2015 annual general meeting presentation goes through target carried interest saying it is a mechanical calculation that shows the annualized carried interest the company would earn on third-party private fund capital assuming the targeted returns are reached. They multiply four numbers together:

The amount of third-party capital. Times the target gross return of a fund, less the base management fee. Times the percentage carried interest to which we the company is entitled. Times the utilization factor.

The utilization factor is used because it is not realistic to expect 100% of the capital of each fund to be fully invested 100% of the time.

We see annualized target carried interest broken down on page 10 of the 2015 Q4 supplemental:

Looking at the numbers above, it appears they are using the low end of the target return. For example, they come up with $200 million for Core and Value Add. We can get close to that using 10.5% as the target gross return less the base management fee while they show 10% to 15% as the target return:

$12,300 million * 0.105 * 0.18 * 0.85 = $198 million

They come up with $360 million for the Opportunistic and Private Equity above. We can get close to that using 19% as the target gross return less the base management fee while they show 18% to 25% as the target return:

$12,700 million * 0.19 * 0.20 * 0.75 = $362 million

2013 Calculation - Unadjusted:

$300 million fee related earnings

[2013 Q4 supplemental - Fee Related Earnings section page 9]

$350 million target carried interest

[2013 Q4 supplemental - Annualized Fees and Carry section page 13]

300*20 + 350*.65*10 = 6,000 + 2,275 = $8,275 million

2014 Calculation - Unadjusted:

$378 million fee related earnings

[2014 Q4 supplemental - Fee Related Earnings section page 5]

$375 million target carried interest

[2014 Q4 supplemental - Annualized Fees and Carry section page 8]

= 378*20 + 375*.65*10 = 7,560 + 2,438 = $10,000 million

2015 Calculation - Unadjusted:

$519 million fee related earnings

[2015 Q4 supplemental - Fee Related Earnings section page 4]

$560 million target carried interest

[2015 Q4 supplemental - Annualized Fees and Carry section page 9]

= 519*20 + 560*.65*10 = 10,380 + 3,640 = $14,020 million

Adjustments

Page 40 of the 2015 annual report says that there is $79 billion of fee bearing capital from clients and $20 billion from the Corporation. About $18 billion of this Corporation capital is in listed partnerships and about $1.9 billion is in private equity.

Something about putting a multiple on the portion of fee related earnings that comes from our own capital above feels bizarre. We will make adjustments and back out the fee related earnings on BAM capital. This includes both the BAM capital in listed partnerships and the BAM capital in private equity. BAM does this themselves when looking at their own private equity capital for 2020. Page 109 of the 2015 investor day presentation excludes $50 million of 2020 fee related earnings on BAM direct capital invested in private funds.

The asset management fees have been growing rapidly and the multiplier is based on trailing 12 months instead of being forward looking. Still, some folks may conclude that the 20x multiplier is a bit rich. We'll leave it as-is for this article but I wouldn't quibble with others using a slightly lower multiple.

2013 Calculation - Adjusted:

Page 9 of the 2013 Q4 supplemental notes that $172 million of the $617 million fee revenues came from base management fees from Brookfield's own capital. The $172 million is made up of $101 million on listed partnerships, $65 million on private funds and $6 million on public securities. The $617 million in revenue resulted in earnings of $300 million so the margin was 49%. If we use this same margin for the $172 million revenue on BAM capital then the earnings from this should be about $84 million. Backing out this $84 million of fee earnings from the company's own capital, we can use $216 million on the 20x multiplier instead of $300 million.

$216 million fee related earnings excluding fees on the company's own capital

$350 million target carried interest

= 216*20 + 350*.65*10 = 4,320 + 2,275 = $6,595 million

2014 Calculation - Adjusted:

Page 6 of the 2015 Q4 supplemental notes that $141 million* of the $763 million in 2014 fee revenues came from base management fees from Brookfield's own capital. The $763 million in revenue resulted in earnings of $378 million so the margin was 50%. If we use this same margin for the $141 million revenue on BAM capital then the earnings from this should be about $71 million. Backing out this $71 million of fee earnings from the company's own capital, we can use $307 million on the 20x multiplier instead of $378 million.

*Page 5 of the 2014 Q4 supplemental has this as $214 million instead of $141 million but we're going with the $141 million number. This is because in 2015 the company adjusted the way in which they define Brookfield capital.

$307 million fee related earnings excluding fees on the company's own capital

$375 million target carried interest

= 307*20 + 375*.65*10 = 6,140 + 2,438 = $8,578 million

2015 Calculation - Adjusted:

Page 6 of the 2015 Q4 supplemental notes that $177 million of the $943 million fee revenues came from base management fees from Brookfield's own capital. The $943 million in revenue resulted in earnings of $519 million so the margin was 55%. If we use this same margin for the $177 million revenue on BAM capital then the earnings from this should be about $97 million. Backing out this $97 million of fee earnings from the company's own capital, we can use $422 million on the 20x multiplier instead of $519 million.

$422 million fee related earnings excluding fees on the company's own capital

$560 million target carried interest

= 422*20 + 560*.65*10 = 8,440 + 3,640 = $12,080 million

Overall Business Franchise

The 2011 annual report says that this component may be the most valuable part of the business:

The foregoing does not include our overall business franchise, which to us represents our ability to maximize values based on our extensive operating platforms and global presence, our execution capabilities, and relationships which have been established over decades. This value has not been quantified and is not reflected in our calculation of Intrinsic Value but may be the most valuable part of our business.

The 2010 annual report mentions the same factors above along with the quality of the company's people. In my opinion Bruce Flatt is a fantastic CEO and he excels at allocating capital. Still, this is a very subjective area and it is difficult to come up with an exact number here.

Calculating this component for 2015 is beyond the scope of this article.

We are using $0.

2015 Intrinsic Value

$21,240 million Common equity per IFRS financial statements less a $328 million deduction of asset management equity.

$4,904 million Deferred income taxes net of noncontrolling interests

$12,080 million Asset management franchise value

--------

$38,224 million + Incremental value + Overall business franchise value

Equity Details and Yearly Comparisons

Drilling down on the common equity helps us see that the BPY office properties are especially important.

Looking at the listed vs unlisted table on page 14 of the 2015 Q4 supplemental, we see that listed BPY equity is $14,888 million:

Note that part of the BPY interest is unlisted so some tables in their financial documents have different sub totals when the unlisted portion is included. The $14,888 million listed BPY equity is broken down on page 20 of the 2015 Q4 supplemental:

This spreadsheet puts the above numbers together and shows previous years. The numbers are in millions of U.S. dollars apart from the first row with the year headings:

2013

2014

2015

notes

BPY unit office

7,201

16,003

18,189

Q4 suppl. pg 20

BPY unit retail

7,704

9,171

9,365

Q4 suppl. pg 20

BPY unit other

1,042

1,590

2,847

Q4 suppl. pg 20

*BPY unit corporate

-2,323

-6,556

-8,443

Q4 suppl. pg 20

*BPY unit non-cont.

-1,444

-6,527

-7,070

Q4 suppl. pg 20

BREP

3,534

3,806

3,405

Q4 suppl. pg 14

BIP

1,478

1,390

1,585

Q4 suppl. pg 14

Other

4,188

2,828

2,744

Q4 suppl. pg 14

Unlisted

3,198

5,398

5,687

Q4 suppl. pg 14

*Capitalization

-7,013

-7,273

-7,069

Q4 suppl. pg 14

Deferred Taxes

3,737

4,781

4,904

A.M. Franchise

6,595

8,578

12,080

Sub total

27,897

33,189

38,224

Click to enlarge

*We adjusted asset management balance sheet equity above by removing $216 million, $323 million, and $328 million for 2013, 2014, and 2015 respectively.

*We adjusted the asset management franchise value by backing out fees on BAM capital. This meant using $6,595 million, $8,578 million, and $12,080 million instead of $8,275 million, $10,000 million, and $14,020 million.

The intrinsic value components can be easier to visualize in a chart:

Click to enlarge

*A.M. above stands for Asset Management.

*BPY unit non-cont above is BPY unit non-controlling.

My 2014 intrinsic value article has more details on some of the 2013 and 2014 numbers above. Note that the 2014 article uses unadjusted numbers so there are some differences.

Page 22 of the 2015 Q4 supplemental shows that most of the BREP equity comes from hydroelectric as opposed to wind. The $3,405 million total for 2015 is $6,916 million hydroelectric, $668 million wind, $209 million facilities under development, -$2,350 million corporate/unallocated and -$2,038 million non-controlling interest.

The $1,585 million BIP total for 2015 is broken down on page 25 of the 2015 Q4 supplemental as $2,002 million utilities, $3,220 million transport, $1,009 million energy, $438 million communications, -$1,290 million corporate, and -$3,794 million non-controlling.

It is important to note that these numbers are on an IFRS basis as opposed to a quoted basis. We see this on page 15 of the 2015 Q4 supplemental:

The differences above between IFRS and Quoted are not trivial. The overall subtotal is $925 million higher because IFRS was used as opposed to Quoted.

Closing Thoughts

I don't think the liquidation viewpoint and the 100% ongoing viewpoint are the only vantage points. My view is somewhere between these two points. For example, I think that adding back 100% of the deferred taxes might be a bit too optimistic. Perhaps it is better to add a percentage of them back. Also, the 20x multiplier for the fee value of the asset management franchise might be a bit lofty. Still, we're leaving out incremental values as well as the overall franchise value and the $38.2 billion total is in the right ballpark in my opinion.

Special thanks to Joel, Rishi, Karly, Matt, Ka, and Stephanie.

Sources

Annual Reports, Supplementals and Presentations/Transcripts for BAM, BPY, BIP, and BREP

GGP 10-K Filings and Annual Reports

Norbord 2015 Annual Report

Rouse Properties 10-K Filings

Disclosure: I am/we are long BAM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Any material in this article should not be relied on as a formal investment recommendation.