Brookfield's Latest Deal Potentially Makes It The Best Blue-Chip Dividend Stock In The World

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About: Brookfield Asset Management Inc. (BAM), OAK
by: Brad Thomas
Summary

I visited the Brookfield Property Partners headquarters in New York City yesterday.

On March 13, 2019, Brookfield announced it was buying 62% of Oaktree Capital, a leading credit/debt focused asset manager, for $49 per share in cash or 1.077 BAM shares per.

"When you boil it all down, it's the investor's job to intelligently bear risk for profit. Doing it well is what separates the best from the rest." - Howard Marks.

This article was co-produced with Dividend Sensei.

Long-time readers know that I’m a huge proponent of long-term, value-focused dividend growth investing. That’s because, since 1926, dividend growth stocks have tended to outperform stocks (themselves the best performing asset class in history), which means that quality income growers, bought at good to great prices, stack proven alpha-generating factors on top of each other. This usually results in the kinds of total returns that you need to achieve your long-term financial goals.

That’s especially true when the companies you buy are run by world-class management teams, with proven track records of masterful capital allocation that steadily and quickly grow shareholder value. Well, when it comes to quality management, it’s tough to beat Brookfield Asset Management (BAM), which, over the past few decades, has become the world leader in global hard asset (real estate, infrastructure, utilities) management.

That’s why it’s managed to reward long-term investors with market-crushing returns, courtesy of CEO Bruce Flatt. Flatt is a 29-year company veteran who's turned Brookfield into the Berkshire (NYSE:BRK.B) of hard asset management over his 15-year tenure in the top spot at the company.

(Source: YCharts)

Since he took over as CEO, Brookfield Asset Management has delivered 17% CAGR total returns, doubling the market’s 8.9% performance.

I recently explained why BAM is one of the four “must own” companies in what’s arguably the greatest dividend empire on earth, but since then, Brookfield has announced another major deal, the taking of a 62% stake in Oaktree Capital (OAK) in what’s effectively a take-private deal.

So, let’s take a look at what this deal entails for investors in both companies. More importantly, learn why this deal is a brilliant strategic move that will make Brookfield Asset Management an even better long-term dividend growth investment, especially at today’s attractive valuations.

In fact, buying BAM today could result in up to 25% long-term CAGR total returns, making it not just one of the best dividend investments you can make right now, but one of the best investments in the world, of any kind.

Why Brookfield Is Buying Oaktree Capital

On March 13, 2019, Brookfield announced it was buying 62% of Oaktree Capital, a leading credit/debt focused asset manager, for $49 per share in cash or 1.077 BAM shares per OAK share investors own. The $4.7 billion deal is structured so that, pro-rated, it will be a paid 50% in shares (51.4 million new BAM shares representing 5.3% dilution). But, as I’ll soon explain, the deal is highly accretive to earnings, in addition to being a fantastic strategic move.

Co-Chairmen Howard Marks and Bruce Karsh (who is Oaktree’s CIO) and other OAK insiders (including the founders and employees) will be retaining 38% of the company and operating control, and Oaktree will continue to operate independently.

Essentially, Brookfield is buying the publicly held shares and taking Oaktree private at a 12% to 15% premium. Howard Marks, a 50-year credit industry veteran, also will be joining Brookfield’s board. Starting in 2022 remaining Oaktree unitholders (it’s technically an LP) will be able to cash out their units by selling them back to BAM, which means, over time, BAM will end up owning more of Oaktree.

OK, so now that we know how the deal is structured, let’s discuss why Brookfield is even buying Oaktree in the first place. That would be to boost its total assets under management or AUM from $350 billion to $470 billion, via the addition of $120 billion in credit-focused portfolio run by Oaktree’s 950 employees out of 18 cities around the world.

(Source: BAM investor presentation)

Its portfolio is run by 43 managers who average 23 years of experience each and who collectively have more than 1,000 years of industry experience between them. They oversee a team of 317 analysts operating in 13 countries on four continents.

For context, Blackstone (BX) is currently the largest private equity asset manager on earth with $472 billion AUM at the end of 2018. Brookfield will now become No. 2 and roughly the 40th largest asset manager on earth (of any kind). That kind of industry-leading scale will help Brookfield take advantage of the most lucrative deals it (and Oaktree) are so famous for finding.

As BAM CEO Bruce Flatt explains, this acquisition is a great strategic fit for Brookfield.

“As we continue to strategically grow Brookfield, we are thrilled to be partnering with Oaktree and with its exceptional management team whose credit business is second to none. This transaction enables us to broaden our product offering to include one of the finest credit platforms in the world, which has a value-driven, contrarian investment style, consistent with ours.” - Bruce Flatt, emphasis added

And, Mr. Flatt isn’t exaggerating about the skill of Oaktree’s debt managers. The LP has consistently posted industry leading returns, both on an absolute and risk-adjusted (total returns/volatility) basis.

(Source: OAK investor presentation)

In fact, just 2% of the mature closed-end funds it operates have lost money since inception, one of the CEF industry’s best track records.

Howard Marks further explains why Oaktree views this deal as in the best interest of its employees and clients.

“The opportunity to join forces with Brookfield is ideal. Our firms share a culture that emphasizes both investing excellence and integrity, and our businesses mesh without overlapping or conflicting. The rest of Oaktree management and I are excited about the combination of support and independence we expect. We look forward to having Brookfield’s contribution to our ability to serve our clients, and to doing the same for them.” - Howard Marks,

(Source: investor presentation)

Brookfield has built its empire by specializing in lucrative niches, such as real estate, renewable energy, infrastructure/utilities, and most recently has been branching into private equity and credit markets.

(Source: investor presentation)

Oaktree, as a leader in credit markets and private equity financing, helps Brookfield fast track its ambitious growth efforts because now it will have $475 billion in AUM, generating $2.5 billion in fee revenues annually (and that’s growing quickly over time).

(Source: BAM earnings supplement)

As you can see, that will substantially increase both BAM’s fee-related earnings compared to 2018’s figure, as well as further diversify its revenue by asset class.

Now, it should be pointed out that Brookfield recently launched eight infrastructure credit funds which have already made more than $6 billion in loans. And management believes, eventually, those eight funds alone will grow their loan books to $160 billion. So, it’s not exactly a lightweight in this industry. But with Oaktree as part of its empire, Brookfield should easily be able to achieve its long-term growth goals.

It’s that growth potential that makes Brookfield Asset Management a must-own dividend growth stock, one that's becoming even better with the acquisition of Oaktree Capital.

A Must Own Dividend Stock Just Got Better

My recommendation to Oaktree unitholders is to take BAM shares and hold on for the long term. Selling now won’t avoid the tax hit you’ll face in this effective LP buyout (incurring past deferred ROC tax liabilities).

Now, I know that some OAK investors are unhappy that their high-yielding units are being replaced with cash and stock that yields a far lower 1.4%. But I need to point out two things.

(Source: Simply Safe Dividends)

First, Oaktree has always had a highly variable distribution meaning that it wasn’t exactly a great choice for conservative income investors like retirees.

(Source: Simply Safe Dividends)

In contrast, Brookfield Asset Management is a far better dividend growth stock, because, while its 7% average dividend growth isn’t very fast, it’s extremely stable. But owning any asset manager isn’t really about the immediate yield. Rather it’s about owning a piece of an extremely lucrative and scalable business.

BAM makes its money mainly from fees earned by its empire of private equity funds, LPs and REITs, (like BEP, TERP, BBU, BIP, and BPY/BPR).

(Source: BAM investor presentation)

Before this deal was announced, Brookfield’s long-term plan was to grow fee bearing capital from $129 billion at the end of 2018 to $245 billion over the next five years.

(Source: BAM investor presentation)

That was to drive 18% growth in fee-related revenue and cash flow. Well, thanks to buying Oaktree, BAM’s fee bearing capital almost will certainly exceed that 2023 target, because it will jump to nearly $200 billion when the deal closes in Q3 2019.

(Source: BAM investor presentation)

Even adjusting for the partial stake in Oaktree (due to insiders owning 38% of the company) and 5% share dilution this acquisition entails, BAM’s FFO/share should increase by about 17%. For context, in 2018, a record year for BAM, FFO/share rose 16%. In other words, this deal sets up BAM for very strong growth in the intrinsic value of its business.

(Source: BAM earnings supplement)

That value, based on the discounted cash flow of the various fees its empire generates, has been growing at nearly 14% annually over the past four years. That’s courtesy of BAM’s sensational long-term track record of delivering market-thumping returns to institutional investors.

(Source: BAM investor presentation)

That institutional client base has nearly tripled over the past five years, and even before Oaktree, management expected to double it by 2023. And, given that, since 2013, the average investment per institutional client has risen 60% to $230 million, you can see why I’m so excited about BAM’s future fee revenue stream and cash flow.

The reason that BAM is so trusted by so many pension funds, endowments, home offices (runs money for the ultra-rich), and sovereign wealth funds, is because of its 20-year track record of market-beating returns (the same reason I recommend you own the stock).

(Source: BAM Investor presentation)

Well, guess what? Buying Oaktree is going to allow BAM to easily surpass that goal of more than 1,000 institutional clients, thanks to OAK’s large and well-diversified collection of institutional investors.

(Source: OAK investor presentation)

In fact, Oaktree’s 885 institutional clients will mean that BAM exceeds its 2023 client base target as soon as the deal closes later this year.

(Source: OAK investor presentation)

Oaktree is currently sitting on $19 billion in liquidity ready to opportunistically invest in the most lucrative future debt focused opportunities. That will now be joining Brookfield’s $34 billion in liquidity, which is backing up $14.1 billion in organic spending plans on its real estate, infrastructure, and utility projects in the coming years.

(Source: BAM earnings supplement)

And, keep in mind that Oaktree’s investable universe keeps growing over time, because, like Brookfield, Oaktree has strategically expanded its portfolio offerings over time, but always in a methodical way that delivers great returns for investors.

(Source: OAK investor presentation)

According to Brookfield, by 2030, the total addressable size of the alternative asset market will be about $230 trillion. Analyst firm McKinsey estimates that, in 2018, 38% of all asset inflows went to the top 20 asset managers in the industry, showing that reputation and scale are crucial to winning a huge slice of this mountain of future fee generating assets.

Brookfield is targeting about 40% of that $230 trillion market, meaning it’s competing for $40 trillion in future AUM. That shows that, even at $470 trillion in AUM, Brookfield’s current size is dwarfed by its future potential growth.

And, as its AUM, fee revenue, and cash flow grow, so does the intrinsic value of the company.

(Source: BAM investor presentation)

Before the OAK acquisition, Brookfield estimated that, by 2023, its intrinsic value will have risen to $118. Today, the stock trades at about $45. Assuming the dividend grows at its historical $0.04 per year (the company is focused on retaining as much cash flow as possible to maximize growth), investors are potentially looking at phenomenal total returns over the coming five years.

  • $3.60 in dividends

  • $118 per share intrinsic value

  • Total return price in 2023: $121.6

  • 5-year CAGR total return: 21.5%

And, keep in mind that five-year forward estimate was made before BAM announced the OAK acquisition. This means that future returns could easily be as high as 25% CAGR if Wall Street closes the gap entirely between the current stock price and management’s estimate of fair value, which will surely rise significantly after acquisition is complete.

Basically, I consider Brookfield Asset Management to be one of the highest-quality companies on earth (a 10/11 on my proprietary Sensei Quality rating scale, which factors in dividend safety, business model risk and management quality), and a true SWAN.

But unlike most dividend growth blue chips, Brookfield Asset Management offers long-term investors the opportunity for mind-blowing total returns of up to 25% (and up to 30% if you buy it during a bear market), which makes this SWAN a must-own investment for anyone comfortable with its risk profile.

Risks To Consider

The same scalable business model that makes BAM worth owning in the first place (exponentially growing asset growing fee generating asset base) also creates a highly leveraged business model that’s highly sensitive to the health of the global economy and credit market.

So, while Brookfield’s dividend is safe during a recession (courtesy of a 15% cash flow payout ratio and A- rated balance sheet), BAM stock can be highly volatile (46% more volatile than S&P 500 over the past 10 years).

(Source: YCharts)

During the Great Recession, the stock plunged 72%, underperforming the market by a substantial amount. BAM froze its dividend from 2008 to 2012, though it has been paying uninterrupted dividends since 1997. Future recessions are not likely to be caused by financial crises, so the stock isn’t likely to crater to that same extent, but it is likely to decline 40% to 50% during a future bear market (from its all-time high).

Now, the thing about volatility is that for long-term investors who can avoid being forced sellers in a downturn, it’s a fantastic ally, allowing you to scoop up shares (or DRIP) at rock-bottom valuations. Then, when the next bull market kicks off, BAM’s incredibly undervalued higher beta-shares storm higher much faster, resulting in the kinds of mouthwatering long-term returns it’s famous for.

But anyone owning BAM needs to understand the economically sensitive nature of its business and plan for that via proper portfolio diversification and asset allocation (mix of stocks/bonds/cash equivalents you own). This is especially true of retirees who might be using something like the 4% rule to fund living expenses.

Remember what Brookfield’s role in your portfolio is, primarily a means of achieving long-term capital gains, as the price gap closes with its intrinsic value. The company isn’t going to be a great source of immediate income, and so you’ll want to make sure that during a bear market you have a properly designed “bunker” portfolio that has appreciating assets you can tap to pay the bills without the need to sell BAM’s quality, but sure to be crazy undervalued shares, in a bear market.

(Source: Morningstar)

Here’s a good example of a well-designed retirement portfolio which has ample cash and bond holdings that not just smooth out returns over time but, most importantly, gives you something to sell during inevitable but unpredictable corrections and bear markets.

Since 1926 (which includes the Great Depression), the average bear market has lasted three years, measured from market top to a return to all-time highs. Note the 30% average peak decline, which can reach 50%-plus in certain cases such as the tech crash and financial crisis.

But averages are just a historical guide to what usually happens, and good risk management is about being prepared for what might realistically happen. The fact is that bear market recovery times can sometimes extend to nearly six years, as occurred following the 1973 bear market, which also saw stocks basically cut in half.

(Source: Moon Capital Management) - recovery = how long it takes stocks to go from bear market low to fresh all-time high

That’s why a good rule of thumb is to own enough cash equivalents (my personal favorite is the ETF MINT) to fund three years of living expenses in retirement, factoring in Social Security and any pension you may have.

Bonds, especially long-term US Treasuries, are a great hedge against crashing stocks, plus tend to appreciate significantly during market declines, due to the countercyclical nature of bonds vs. stocks. A flight to safety and falling interest rates (plus possible future bond buying by the Fed) mean long-term treasuries will likely appreciate significantly during a recession.

My personal favorite choice for long-duration bonds is the ETF VGLT, which has a duration of 17 years, meaning that in a recession, it appreciates about 17% for each 1% decline in interest rates. That means VGLT would do even better in recession years than the above table indicates (since 10-year Treasuries have a duration of 10).

Basically, while BAM is a great business, with a bright future (and lots of steady long-term dividend growth) ahead of it, don’t forget that it serves a very specific purpose in your portfolio. While unquestionably a blue-chip SWAN, from a business model/dividend safety perspective, don’t count on being able to sell shares during a future correction/bear market.

That’s what asset allocation is all about, which will give you appreciating assets (cash and bonds) to tap in order to pay the bills, while BAM rides out whatever economic/market storm that may be coming in the future.

Bottom Line: Brookfield Buying Oaktree Makes A Must Own Dividend Growth Stock Even Better

In the modern world, few industries are as lucrative as asset managers who have a proven track record for making long-term investors rich. Brookfield, under the world-class management of Bruce Flatt, has managed to build a hard asset management empire specialized in high-margin niches that is only getting larger and better with the Oaktree Capital acquisition.

That acquisition will further add specialization and expertise in terms of a great credit business that Brookfield has recently been expanding into as it tries to break into yet another highly profitable, and fast-growing niche market. Better yet, with the addition of Howard Marks (50 years of debt market experience) to Brookfield’s board, this sets up BAM to not just profit from the rise of its new business but potentially will help it become an industry leader, as it has in so many other niches it’s targeted over the years.

While I understand why Oaktree shareholders might be upset to be getting bought out at a relatively low premium, and losing that fat yield, remember to take the long-term picture. Oaktree has always been a highly variable dividend payer, which means that it wasn’t a good choice for conservative high-yield investors, such as retirees looking to live off very safe and steadily rising income.

Rather, Oaktree, like BAM, was all about owning a piece of a world-class and industry leading asset manager. Under the Brookfield umbrella, Oaktree, run by the same management team independently, will likely continue to thrive. And with Brookfield Asset Management trading at 27% below its pre-merger estimated intrinsic value, I consider taking BAM’s share offer to be the best choice for most OAK investors.

That’s because BAM, over the long term, is likely to keep growing its profit minting business at a fast clip. And when Wall Street finally values the company closer to what management does, that could result in potentially 20% to 25% CAGR long-term total returns.

In other words, Brookfield Asset Management is one of the greatest dividend stocks in the world, and one I expect to match or even exceed its impressive 15-year performance in the coming years and decades.

How confident am I in Brookfield as a great long-term investment? Well, let’s just say that during the next bear market (which I’m financially preparing for now), I intend to make BAM 10% of my retirement portfolio, which is where I keep 100% of my life savings.

In closing, and as Howard Marks wrote (in The Most Important Thing),

"When you boil it all down, it's the investor's job to intelligently bear risk for profit. Doing it well is what separates the best from the rest."

Source: Brad Thomas

Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Disclosure: I am/we are long BPY. 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: Dividend Sensei owns BIP, BAM, BPR, BPY.