The aim of this article is to update my valuation of Brookfield Asset Management (NYSE:BAM). Albeit not much has changed, there is one important component of value ignored before that is becoming increasingly important: carried interest, i.e. BAM's share of profits generated for its clients.
The business strategy of BAM has not changed at all since my last article on the company, so I will not repeat the description of the business. The transformation of the parent company to a pure asset manager has moved forward by spinning off its private equity operations under the ticker BBU; now they are working on spinning off Trisura Group which will combine their insurance operations which no longer fit the strategy. The company is continually improving its competitive strengths, especially its global reach: among many other transactions, they acquired real estate in Mumbai and Seoul (entering those markets for the first time), telecom towers in India, a large hydroelectric portfolio in Colombia and wind power projects in Europe (Ireland, Scotland and Portugal).
Fee-bearing capital has increased 16% from $94B to $110B in the last year, well above management's projections. Free cash flow reached about $1.5B, or about $1.50 per share, so the yearly dividend of $0.56 is covered very well. The following charts show diversification of fee sources.
Let's get to the valuation. The management provided a detailed valuation computation in their 2016 Investor Day presentation. I do not find their projections unlikely, but the shortcoming is that they only reflect rather optimistic scenarios and thus give too little information regarding risks. I have deconstructed their approach and came with a model which estimates the value of the company depending on two input factors:
- amount of fee-bearing assets under management (AUM) after 5 years (ranging from $100B to $200B),
- returns on invested capital obtained during the next 5 years (ranging from 0% to 16%).
There is one important thing to note: the input factors are clearly not independent, so some of the entries in the following table are almost irrelevant. (Returns around 0% would strongly discourage new clients, and thus AUM of $200B is very unlikely). Since I believe most readers are not primarily interested in the technical details, let's present the results first.
The current stock price is about $36. Apparently, even in case of miserable 5-year returns (0%) and a decrease of AUM by 10%, your capital is almost preserved (at least nominally). I am almost sure they will increase AUM to at least $150B over the next 3 to 5 years. If it is true, then just 10% returns are sufficient to double the value of the business.
After computing the per-share value at the end of 2021, I have discounted it to the present at a 10% discount rate (which I usually use to compare opportunities) so that I can determine the margin of safety.
In most likely scenarios you have a nice margin of safety and can expect returns exceeding 10% p. a. One has to go more thoroughly through the list of risk factors, but this margin of safety protects against most of typical business fluctuations and non-critical management blunders.
The crucial question is the staying power of the company. The management seems quite prudent in structuring their deals (which is not at all surprising as they own about 20% of the company). The capital sourced from clients is typically locked in for about 10 years. Usually they use 50% equity and 50% long-term asset-level debt to finance projects. The debt is non-recourse not only to the parent BAM, but also to the subordinate listed partnerships (BIP, BEP, BPY). In recent years, they have been diligently refinancing all they could to get current low interest rates fixed for as long as was reasonable.
BAM's operations are global, so life-threatening risks only come from things like a global credit freeze where they would not be able to roll over the debt at most of their assets on reasonable terms. Short-term problems of this type seem to be mitigated by the fact that they tend to operate with plenty of liquidity ($9B at present, $3B of that at the parent level). With regard to a longer credit market collapse, I believe their business connections will save them even in this case: they have plenty of institutional and government partners which would be able to provide the necessary several billions of capital (e.g. Qatar Investment Authority).
Assumptions and details
Finally, the technical details. The value of the company is determined as the sum of
- invested capital at the end of 2021 minus debt (assumed to be just rolled over) and preferred,
- value of accumulated base fees over the next 5 years,
- value of base fees stream starting after 5 years,
- value of target carry after 5 years,
- accumulated carry (now $1B, growing by $0.5B a year if 16% returns are realized, or proportionately less if lower returns are achieved).
In addition, I employ the following facts and assumptions:
- invested capital at present $31B;
- the sum of parent-level debt and preferred stock at present $9B;
- shares outstanding 1.002 billion;
- accumulated carried interest at present $1B,
- net carry ratio 65% (i.e. direct costs are 35% of carry, source: company estimate);
- base fee rate 1.0%;
- net target carry multiple 10x;
- fee-related earnings multiple 15x.
The 10x multiple at (7) is in line with the multiple used by the management; the 15x multiple at (8) corresponds to further perpetual growth of 3% discounted at 10% (the management uses 20x multiple). The fee rate of 1% in (6) is the present value; it is likely to increase slightly in the future since more AUM leads to margin improvements (see the following table).
Disclosure: I am/we are long BAM, BIP, BPY, BEP.
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.