'The Only Thing I Collect Are Shares' - Put Your Money Where Brookfield's CEO Is

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About: Brookfield Asset Management Inc. (BAM), Includes: APO, BBU, BEP, BIP, BPY, CG, CLNY, ENB, KKR
by: Steve Brodrick
Summary

Brookfield has a proven track record of creating value for shareholders; since 1998, shares of BAM have grown at CAGR of 19%.

High quality, real assets provide Brookfield with steady and growing cash flow, expanding fee bearing capital and significant carried interest.

Brookfield will benefit from the tail winds of rising interest rates and the insatiable demand institutional investors have for real assets.

Brookfield is trading at a discount to its fair value offering investors substantial upside and a growing dividend.

CEO Bruce Flatt was named by Forbes as one of the best CEOs in the world in 2018. He and other insiders own 20%, giving management skin in the game.

Investment Thesis

Brookfield Asset Management (BAM) combines industry-leading management, high quality assets and a great business model. BAM's model for growing cash flow comes from its expanding fee-related revenue derived from managing assets as well as from its tremendous exposure to accumulated carried interest. Brookfield has been creating value for investors by increasing its earnings profile as well as increasing the value of its invested capital. Its growing free cash flow and great asset base make it well positioned to benefit from a number of global trends, including rising in interest rates and institutional investor demand. With $33B in liquidity, Brookfield can acquire assets opportunistically creating great value for its shareholders. Its current discount to fair value, coupled with its long track record of out-performance, offers investors confidence and a margin of safety. With the recent turbulence in global markets, Brookfield's high quality assets and durable business model will add safety and growth to your portfolio.

Company Profile: Quality Assets

Brookfield manages 2,000 projects across 30+ countries on five continents, encompassing $330 billion in assets and 80,000 employees. Brookfield manages a massive portfolio of assets in private equity, real estate, infrastructure and renewable power. BAM acts as the parent company for a number of publicly listed sponsored vehicles, including Brookfield Property Partners (BPY), Brookfield Renewable Partners (BEP), Brookfield Infrastructure Partners (BIP), and Brookfield Business Partners (BBU). Brookfield uses these vehicles to organize its funds and businesses. The company holds some assets directly through BAM and others through its subsidiaries, in most of which BAM is the majority owner.

BROOKFIELD ASSET MANAGEMENT (<span>BAM</span>) BROOKFIELD INFRASTRUCTURE PARTNERS BROOKFIELD PROPERTY PARTNERS BROOKFIELD REAL ESTATE FUNDS BROOKFIELD RENEWABLE PARTNERS (BEPJ BROOKFIELD INFRASTRUCTURE FUNDS BROOKFIELD BUSINESS PARTNERS (BBL" BROOKFIELD PRIVATE EQUITY FUNDS DIRECTLY HELD INVESTMENTS

Source: Brookfield

Around the world Brookfield owns or manages: 400 million square feet of commercial space, 218 hydroelectric plants on 82 river systems, 36 ports, 3600 kilometers of toll roads and 14,200 hotel rooms. It owns some of the highest quality real estate assets in New York, Toronto and Sydney and is the largest office landlord in London and Los Angeles. Brookfield owns iconic assets such as the telecommunications infrastructure in the Eiffel tower, Potsdamer Platz in Berlin and Canary Wharf in London (two of the biggest real estate developments in Europe). In countries like Chile, Brookfield's electric power lines serve 98% of the population. In Ireland, it owns 20% of the country's wind-farm capacity. Brookfield's asset base is of the highest quality and its global footprint gives it geographic diversity across its business units. According to Forbes, Brookfield Asset Management is larger than KKR & Co (KKR) Apollo (APO), Carlyle Group (CG) and Colony NorthStar (CLNY) combined giving it scale to pursue big opportunities.

Canary Wharf, London

Management with Skin in the Game

Bruce Flatt has been the CEO of Brookfield Asset Management since 2002 and has led the company through tremendous growth over the last 16 years. In 2018, Harvard Business Review named Flatt one of the best performing CEOs in the world. In a 2017 Forbes Article, the publication referred to him as the "Billionaire Toll Collector of the 21st Century". In an interview with a reporter, he once quipped that he has no hobbies and said "I don't collect anything but shares". Flatt is singularly focused on finding value for investors with a passion for infrastructure developments and a contrarian lens.

「고하냐노

Brookfield CEO, Bruce Flatt Source: Forbes

There are a few things about the culture of Brookfield that set it apart from its competition. BAM harnesses its global reach to attract entrepreneurial managers who aren't afraid to go against the grain. Brookfield has done well buying assets out of favour with this contrarian slant to acquisitions. Brookfield stresses a culture that promotes from within and its managing directors enjoy long tenures with the firm supporting trust among senior leadership and the nimbleness to move quickly when opportunities are presented. From a corporate governance perspective, compensation for executives is set up in a way that incentives long term thinking, helping to align the interests of management and shareholders. At Brookfield Asset Management the long-term interests of investors are well represented by management who owns ~20% of the company. This high degree of inside ownership ensures that management has skin in the game when looking for value and performance. This high degree of inside ownership is another reason why I like the parent company BAM over some of its fantastic subsidiaries and sponsored vehicles such as BIP, BPY, and BEP. Although there are some great investment opportunities in the subsidiaries, I like to invest in BAM directly as that is where management has its money.

Results that Speak for Themselves

In the recent Q3 letter to shareholders from November 8th, 2018, CEO Bruce Flatt detailed the success that Brookfield has had this year. The results for this past quarter and year extend a long record of out-performance and pleasing shareholders. Since 2014, assets under management have grown at a compound annual rate of 15%, while fee related earnings are up 37% in the same period. Brookfield is now delivering $2B in free cash flow annually and accumulating $800M in carried interest (a key value driver) annually. Brookfield is pursuing growth on all fronts and achieving outstanding results in its business units. As of March 31, 2018 Brookfield achieved a year over year increase of 12% in fee bearing capital and a 56% increase in fee related earnings. In the same period, Brookfield grew funds from operations 34% and cash flow available for distribution 53%. Since 1998, shares of BAM have grown at a compound rate of 19% compared to ~7% for the S&P 500 over the same 20 -year period. This record of out-performance is attributable to Brookfield's opportunistic management, focus on high quality assets and a rock solid business model.

1998 1999 2000 2001 2002 2003 2004 2005 2006 •-BAM returns 2007 2008 2009 2010 2011 .--U.S. 10-yearyields 2012 2013 2014 2015 190/01 40/02 2016 2017 2018

Source: Brookfield

Value: Brookfield is Trading at Discount

Over the last 6 months, shares of BAM are trading up 11.3% while the S&P 500 has gained 1.5%. Over a 5-year period, BAM has outpaced the S&P 500 by almost 26%.

Source: Yahoo Finance

Despite this strong performance, analysts still think that Brookfield has plenty of room to run. Shares of BAM are currently trading around $44 while Brookfield estimates their own value at $56/share, suggesting that the stock is currently undervalued by approximately 27%. Brookfield looks at its value as the sum of its fees and carried interest from its assets under management plus the value appreciation and cash distributions from its invested capital.

By using a 10x multiple on net target carried interest and a 20x multiple on annualized fee related earnings plus the total capital invested, Brookfield would have a market capitalization of approximately $56B.

($ millions) Asset manager plus invested capital (plan value)12 Implied equity market capitalization4 Discount to plan value Total 56,422 42,477 13,945 Per Share3 $ 56.21 42.32 25%

Source: Brookfield

According to Reuters, of the 9 analysts who cover the company, 2 have a "buy" rating and 7 have an "outperform". This analyst outlook has improved even over the last month, with another buy rating and another outperform being added to the analyst consensus. Even with the positive expectations that analysts have for Brookfield, the company has beat on EPS consensus the last 4 quarters in a row.

ANALYST RECOMMENDATIONS AND REVISIONS 1-5 Linear Scale (1) BUY (2) OUTPERFORM (3) HOLD (4) UNDERPERFORM (5) SELL No Opinion Mean Rating Current 2 7 0 0 0 0 178 1 Month Ago 6 0 0 0 200 2 Month Ago 6 0 0 0 200 3 Month Ago 5 0 0 0 200

Source: Reuters

From a price target perspective, the street appears to have a similarly positive valuation estimate, suggesting that there is credibility in Brookfield Management's valuation of $56/share. The mean analyst price target is $52.61, implying a upside of ~19%.

Analyst Price Targets (9) > Low 47.00 Current 43_52 Average 52.61 Hign 57.00

Source: Yahoo Finance

Brookfield stands to profit tremendously from the carried interest in the assets it manages. Carried interest is earned not just on profit above the preferred return, but on total profits provided the preferred return is met. BAM earned $1.007B on carried interest in 2018, well above its target of $808M. By 2027, Brookfield expects to earn over $10B by 2027 on carried interest based on current assets alone. Adding in acquisitions and additional assets under management should result in carried interest proceeds growing substantially in coming years. This carried interest growth is an overlooked factor in how the market currently values BAM. A fuller realization by investors of how Brookfield stands to profit from the value of its carried interest will help propel the stock to the target estimates that management insiders and analysts have for the company.

Dividend Growth

Brookfield Asset Management is not as well known for its yield as some of its high yielding subsidiaries. While investors seeking higher yield would benefit by checking out BIP, BEP or (NYSE:BPY), investors with a focus on long-term dividend growth will see tremendous value in BAM's record of dividend increases. With a current payout ratio of 32%, Brookfield is paying out $600M in common share dividends out of $2B in free cash flow. This low payout ratio creates a long runway for dividend increases while still allowing for the firm to focus on investing significant capital back into the business to drive future value creation.

Over the past 5 years, Brookfield has grown its dividend per share an average of 15.80% per year. This healthy growth rate, combined with a low payout ratio and strong free cash flow generation, will result in predictable dividend growth for years to come. Over the next 5 years, Brookfield expects to return $10B in dividends to shareholders and spend up to $40B buying back shares and funding dividend increases. Brookfield uses cash to buy back shares opportunistically when they see an opportunity to create value. For example, over the last year, Management has spent $200M buying back shares of BPY, as they see the current ~$18 price as discounted by $10, (36%) to the fair value.

Creating Value for Shareholders

While focusing on its operating performance, Brookfield has also been busy making acquisitions. At current pace, management expects to double the size of the BAM over the next 5 years. Brookfield has deployed $33B in the last 12 months with 86% of capital deployed in North America. Despite this allocation, Brookfield still maintains significant liquidity to pounce on opportunities should they arise. As basic as it sounds, Brookfield is excellent at creating value for its shareholders by buying low and selling high. Brookfield is known for its capital discipline and employs a contrarian lens to identify assets that are out of favour and can be picked up for less than their true value. Brookfield made some great acquisitions in 2018 including: TerraForm (NASDAQ:TERP); a solar provider, Enercare (OTCPK:CSUWF); a residential service provider, Forrest City (OTCPK:FOCF); a realty trust and some midstream natural gas assets from Enbridge Inc (ENB).

One of the recent acquisitions that stands out as a great example of creating shareholder value by going against the grain was the $4B purchase of Westinghouse, a nuclear power service company. Westinghouse has struggled since the Fukushima disaster that soured investors outlook on the entire the nuclear power industry. Westinghouse currently services 65% of the nuclear power plants in the world under long term contracts. The company does not own or operate nuclear facilities, it just performs contract service on the facilities. Westinghouse gets paid to perform contracts in a market characterized by highly inelastic demand and long life assets, creating a very stable and growing cash flow profile. Brookfield expect to grow EBITDA at Westinghouse from $440M to $550M in the next few years on an equity investment of only $900M.

This is a textbook example of an opportunistic acquisition that creates value for shareholders by looking beyond the noise to an asset's future potential. Brookfield has a successful track record of "capital recycling" where they acquire an asset like Westinghouse for below its true value, work on improving its operating efficiency and sell it for a profit at a later time. Brookfield will often hold an infrastructure asset for an average of 7 years, dispose of it and use the proceeds to find an alternative investment that offers a higher return on equity. For an in-depth explanation of how Brookfield takes advantage of capital recycling, see section "A Formula for Cash Flow Growth" in my recent analysis of Brookfield Infrastructure Partners L.P. (BIP)

Image result for westinghouse nuclear

Source: Westinghouse

Tailwinds

As an alternative asset manager, Brookfield is well positioned to benefit from a number of macro-economic tailwinds. Two key trends that will benefit Brookfield are rising interest rates and growing demand from institutional investors for alternative assets. Brookfield expects that rising interest rates globally will be positive for their cash flows, as many infrastructure investments are tied to inflation. These linked cash flows will increase as inflation rises and interest rates move up globally. The positive correlation of infrastructure yields and U.S. Treasury notes over the last 10 years suggests that investors can expect improving cash flows from real assets classes as interest rates rise.

EXHIBIT 9: GLOBAL INFRASTRUCTURE DIVIDEND YIELDS VS. 10-YEAR U.s. TREASURY NOTES 7 6 5 4 3 2 Sep 2008 Jun 2010 Jun 2012 Jun 2014 Jun 2016 4.90% - 4.59% 2.85% - 2.50% Jun 2018 -Dow Jones Brookfield Global Infrastructure Composite Index -U.S. 10-Year Treasury Yield

Source: Brookfield

Due to this inflation hedge, institutional investors see real assets as a good place to allocate capital in rising interest rate environments. According to CEO Bruce Flatt:

"We still believe that alternative assets are the place to be for at least another 10 years. These private assets generate cash flows that are stable, they continue to expand with GDP growth, there is significant positive leverage compared to fixed return assets, and the margin of safety is significant."

Globally, there is a growing appetite for institutional investors to seek out real assets for their funds. Brookfield estimates that institutional investors are currently $3T underweight real assets. In 2018, more than 530 institutional investors participated in BAMs private funds. By 2023, Brookfield expects to grow that number by 89% to over 1000. Of the 530 institutional investors, that BAM currently manages assets for, the average institution has increased their investment by 28% since 2013.

+84% 280 20151 +94% 515 20182 5-Year Target -1,000 2023

Source: Brookfield

Capital available to institutional investors is expected to grow from $52T in 2017 to $100T in 2030. These institutions expect real assets to return between 7-20% versus 6-8% for global equities. Real assets offer predictable cash flows, diversification, above average returns and less volatility than equities. This growing demand for real assets creates tremendous opportunity for a worldclass alternative asset manager such as Brookfield. According to a recent survey of over 100 institutional investors, 39% were planning on increasing their exposure to real assets in the next 12 months, with 51% planning to add infrastructure investments in particular. With real assets (real estate, infrastructure and private equity etc.) expected to reach 40% of institutional investors portfolio weighting by 2030, the market opportunity for BAM and their competitors will surpass $40T. This growth in market opportunity and institutional uptake will drive more growth in fee related revenue and fee bearing capital, allowing Brookfield to return more capital to shareholders through dividend increases and share buybacks.

Investor Takeaways

Brookfield Asset Management enables retail investors to invest alongside institutional investors and management in a business that combines high quality assets and an effective business model focused on creating shareholder value. BAM's model for growing cash flow comes from both its growing fee related revenue from managing assets and from its undervalued exposure to accumulated carried interest. Trading at a sizable discount to its fair value, Brookfield has a strong record of growing free cash flow and building out a quality asset base, leaving it well positioned to benefit from a number of global trends for decades to come.

With $33B in liquidity, Brookfield can acquire assets opportunistically creating great value for its shareholders. Brookfield is poised for tremendous growth in developing countries where the demand for infrastructure spending is significant. With massive growth in the number of institutional investors investing in Brookfield's funds, growing fee revenue will enable Brookfield to simultaneously continue to expand their fee bearing capital and return value to shareholders. As a beneficiary of rising interest rates, Brookfield's high quality assets will provide investors with safety and growth to counter turbulence in global markets.

Disclosure: I am/we are long BAM, BIP, ENB.

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.