Brookfield Asset Management: Massive Opportunity Ahead

Summary

• BAM is trading close to its fair value which is far lower than the "plan value" promoted by Brookfield.
• BEP is not appealing at the current price level.
• BIP will grow faster and is less expensive than BEP.
• The expected Brookfield Reinsurance spin-off should be of interest to investors in BAM.

Source: Brookfield. After a very successful year for BEP, some investors anticipate its endless expansion and publish articles with enticing titles such as "Brookfield Renewable Sees a More Than $100 Trillion Opportunity Ahead" (I have not read it). Who could be the ultimate beneficiary of this expansion?

It has been about half a year since I posted about NYSE:BAM. Meanwhile, the company and its subsidiaries reported their tumultuous 2020 and outlined further plans. I guess it is time to revisit.

"Plan Value"

As usual, BAM calculated its own "plan value" for its shares. The latest figure came up at $66 vs. about $40-42 quote at the time of writing. You may ask: Why wouldn't BAM snap its undervalued shares with about $70+B of group-wide liquidity? Well, the answer is obvious: BAM is not relying on the "plan value". In the past, I explained several times why the "plan value" has little to do with the company's intrinsic value - please refer to my previous publications for details.

The "plan value" is a good PR tool that makes BAM's shares perennially undervalued. Brookfield talks up its shares but is not in a hurry to repurchase them materially. Berkshire Hathaway (BRK.A) (BRK.B) is doing exactly the opposite: instead of talking up shares, it buys them back. Otherwise, BAM is a value investor no less than Berkshire. What can explain the difference? Besides motives related to the management compensation, BAM as a company benefits from high share prices in two ways.

Under certain circumstances, BAM is ready to issue additional shares. This is something that Berkshire is reluctant to do and has not done for many years. The last time BAM issued shares was for the Oaktree acquisition in 2019 making the deal palatable for certain Oaktree shareholders. It was Mr. Flatt's masterstroke that helped BAM a lot in 2020 and will remain a growth lever for many years to come.

Secondly, BAM's subs constitute a significant part of the company's value. It is twice beneficial for Brookfield to talk up its own price by talking up subs' valuations in the process: BAM's management fees are proportional to subs' market caps. As many BPY shareholders have learned the hard way it is not profitable to trust "plan values". To value BPY, BAM used its IFRS book value instead of the market price. For all other subsidiaries, it was exactly the opposite. In other words, measurement rulers varied depending on which one would produce the highest number.

When BAM shares are truly and significantly undervalued over some prolonged period, the company will not hesitate to buy them back big.

Another Way to Value BAM

As my readers know, I am using TTM operating FFO for this purpose that BAM updates every quarter in its Supplementary. This is not the only suitable metric but I will again refer to my older publications for explanations.

The table below can help us to gauge what is going on (the Quote column is not adjusted for the 2020 split).

Source: author's calculations and BAM's filings

The average P/Oper. FFO multiple is about 17 and based on this static measure, BAM seems to be overvalued. However, we have to consider important circumstances specific for the unusual 2020:

1. Interest rates are currently lower than at any other point in the table and justify higher multiples.

2. The pandemic has negatively affected the cash flows and valuations of certain parts of the Brookfield empire in 2020. BPY immediately comes to mind but the same is true about BBU and, to a much smaller extent, about BIP. It also slowed some dispositions that were supposed to happen in both private and public investment vehicles. So, both invested capital and asset management FFO (as well as realized carry) were affected. This situation got mostly normalized towards the end of 2020 but is still present in full-year results.

3. 2021 may become a record-setting year for raising third-party fee-bearing capital.

I am hesitant to slap hard numbers on these factors. But when you take them into account, BAM, in my opinion, is trading close to its fair value. It might be slightly undervalued but is not a screaming bargain. When buying BAM at its fair price you can count on a 12-15% annual return that the company promises and delivers. Alternatively, you can wait for a moment of undervaluation like last October when BAM was available below $30. But it might be a long wait.

BPY

The story of BPY is not finished yet. It is currently trading at $17+, above $16.50 that BAM offered. Based on previous similar transactions, BAM will bump up its offer but not by much. So, the final offer may be close to BPY's current price and the shareholders are expected to accept it. Their alternatives are not very exciting: if the offer is not accepted, BPY shares are likely to plunge. I am not sure that BAM's offer is so bad for BPY's shareholders despite some publications (and even lawsuits) claiming it. It will take a lot of effort within the more forgiving private environment to do something constructive with former GGP.

Recently, Bloomberg came up with some interesting material:

U.S. mall values plunged an average 60% after appraisals in 2020, a sign of more pain to come for retail properties even as the economy emerges from pandemic-enforced lockdowns.

Surely, mediocre properties were affected more than top malls. However, the article quotes significant haircuts for some of Simon's malls that are similar to BPY's in terms of quality. Eventually, BAM is expected to profit from the deal but this profit will be hard-earned.

Some limited arbitrage opportunity exists in BPYUP - preferred shares of BPYU, BPY's corporate twin. They are trading at about $24.75-24.85 and pay a 6.375% dividend. If the deal goes through, BAM will pay $25 within the next half a year or so. Not something particularly appealing but, perhaps, better than cash on a risk-adjusted basis.

Overall, BPY has been a failure for BAM. Since Bruce Flatt used to run BPY's predecessor before becoming BAM's CEO, it is probably a disappointment for him. Several years ago, it would have been a major blow to BAM but today, it is definitely manageable. In my older publication, I analyzed ramifications quantitatively and will not repeat them here. BAM is likely to adjust its real estate strategy based on Mr. Flatt's quote on Q4 20 earnings call:

And I think over time, we hope as we've communicated, to reduce our exposure to real estate over time, and it will be a combination of outright sales and creating new products.

BEP

In the absence of significant price dislocations, BAM should be a better stock than its subs since BAM receives management fees that subs pay. But sometimes, subs enjoy fantastic runs as happened with BEP in 2020. Renewable energy revolution, Mr. Biden's agenda, and TerraForm Power (TERP) acquisition propelled BEP units (and even more so BEPC shares) to unbelievable heights. Brookfield Renewable has become a household name and it is not uncommon to see publications with titles like "Brookfield Renewable Sees a More Than $100 Trillion Opportunity Ahead".

For BEP, all $100 trillion or whatever are concentrated in one number: distribution growth rate. This is a very important number since we expect a long-term return to be equal to distribution yield plus distribution growth rate. Multiples expansions or contractions can significantly distort this idyllic picture within shorter time frames.

In 2015, Mr. Sachin Shah became BEP's CEO and held this position until promoted to BAM's Chief Investment Officer towards the end of 2020. In my opinion, Mr. Shah was an outstanding CEO. During his tenure, he made BEP more dynamic by enabling development capabilities and diversifying from purely hydro into the wind and solar energy. The distribution growth rates during his tenure are presented in the table below (I am using historical figures from brookfield.com before adjusting for the 2020 split).

Source: author's calculations using BEP data

Now, what about $100 trillion? BEP has already utilized enormous opportunities in the renewable space and will utilize more in the future but the main beneficiary will be BAM. A lot of additional capital will be needed to build renewable facilities and this capital will be supplied by either BEP issuing additional units/shares or third parties via private funds. BAM, of course, will charge management fees on all this capital. I would not bet on BEP to increase distribution growth considerably and will explain more in the next section.

Let us now take a look at Mr. Shah's holdings within Brookfield's universe as presented below. Please make your own conclusions.

Source: marketscreener.com

BIP and BEP

Does BIP differ from BEP? Structurally they are very much alike and both have enjoyed excellent management. But there are two important differences.

Being involved with oil, gas, and even coal, BIP is less "progressive" and fashionable than BEP. Its transportation segment was affected by the pandemic in 2020 while BEP was unscathed. Both factors make BIP cheaper than BEP currently while most of the time it was the opposite (please note that both companies are extremely expensive per traditional metrics).

As I showed in one of my previous articles, BIP can be easily valued by its distribution yield provided fundamentals are in place. By fundamentals, I mean primarily AFFO and return on invested capital. At the time of writing, BIP's distribution yield is 4.0% vs. 3.8% on average over the last 10 years at higher interest rates (for comparison, BEP's distribution yield is about 3%).

At the same time, BIP's distribution growth is higher when compared with BEP. Please take a look at the slide from BIP's corporate presentation below:

The last increase was only 5%, on par with BEP, because the pandemic affected BIP's transportation segment in 2020. Due to growing IDR payments to BAM, it is not realistic to expect historic 10% distribution growth in the future. Perhaps a more modest 7% or so is achievable though.

Why do I expect BIP to grow faster than BEP? Primarily due to its mandate: BIP can invest in many different industries while BEP is limited to renewables only. And this is a very expensive segment.

BIP can sell businesses in slower-growing industries at, say, 15-20 times FFO and invest in higher growing industries at 10-12 times FFO. For example, BIP recently partially exited the coal terminal business in Australia and closed the acquisition of mobile infrastructure in India. Surely, the difference in growth between the two is humongous. From time to time, Mr. Pollock (BIP's CEO) announces multiyear IRRs realized upon exiting and they are typically above 20%. For BIP, capital recycling is more profitable and easier to achieve than for BEP.

So, we have more dynamic BIP trading at lower valuations than less dynamic BEP. Which one is a better investment today? The answer is obvious unless you want to bet on another multiples expansion for renewables.

Conclusion

Besides traditional lines of business, BAM is in the process of entering new ones. Hi-tech is one of them and you can find a good review of this effort here. It sounds very promising but the scope, at least initially, will be very limited. Brookfield is not yet an expert in software and hi-tech in general.

We can expect quicker results in areas that Brookfield knows well: secondaries, energy transition, residential real estate development (this is not a new business but the presentation during Q4 20 call was impressive). But I am particularly interested in Brookfield Reinsurance. Several months ago, I published an article attempting to evaluate returns that BAM is counting on in the reinsurance business and they turned out higher than I expected. Moreover, Brookfield can achieve scale in this industry relatively quickly. We still do not know details about the spin-off of Brookfield Re expected shortly but this is something that can potentially influence BAM shares.

Analyst’s Disclosure: I am/we are long BAM, BIP, BPYUP. 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.

Comments

[kalu0003]

Putting valuations aside and focusing on the quality of the business. Also taking a long term view. Suppose one can buy only ONE and ONE only: which is a better play BRK.B vs BAM (I am not looking for a both type of response!)? Thanks

[Alexander Steinberg]

@kalu0003 It depends on your objective. If you want to have better total returns you should bet on BAM. If you want to sacrifice several points of return but be on a safer side, it is BRK.b. In real life, this is the wrong type of question to ask - the alternative is artificial and the answer depends on your set of circumstances.

[UncleLongHair]

@kalu0003 I have held Berkshire since the 1990's and been to many meetings and have been a Buffett fan boy. But honestly I have trouble seeing the future for the company. They have very few avenues for meaningful investment. The energy business is one of the few. Almost all of their other businesses are not growing and many stagnated long ago. They have never done much internationally. The cash just keeps piling up and of course they won't pay dividends. And there is such huge key person dependency risk, not only Buffett and Munger, but Abel once he takes the helm. I have never understood why they have never developed a bench of talent, they hire people for one purpose and leave them there. And just seem to deliberately shrink their options for investments.

Compare this to Brookfield which is very active in numerous asset classes in 10+ markets globally. The management team is about 10-15 people in their 50's and 60's with different skill sets. Renewable power and infrastructure are trillion dollar growth markets. With Oaktree they are getting into the credit markets, and then reinsurance. It is easy to see where future growth will come from. And they are about half the size of Blackrock and about 1/10 the size of Berkshire. Seems like they have plenty of room to run.

[Ján Mazák]

@UncleLongHair Yes, judging from their results, asset managers like BAM, BX and KKR have done a great job in selecting and developing talents. With BRK, it's much less clear, they might have some great employees with specific but limited skill sets in most of their operating businesses, but on the highest level, I am doubtful, too.

The lack of international investments is also a quite a drag on performance, U.S. markets have been richly valued for a decade, and I don't think risks would be that great outside of USA to warrant accepting much lower returns.

[Exile of the Mainstream]

Funny how the market has not fallen for the plan value ever.

[Alexander Steinberg]

@Exile of the Mainstream In a way, it is a moving target that you can never reach - they tweaked their formula a couple of times during the last 2-3 years. And I would not be surprised for BAM to issue shares if the market value starts approaching the plan value...

[Exile of the Mainstream]

@Alexander Steinberg If BAM raises capital through stock issuance, do they then use that capital to invest alongside LPs in various funds?

[UncleLongHair]

@Exile of the Mainstream It has, or at least come close a few times. They used to report this as "underlying value per share" back in the day and when the stock got hot for whatever reason it would get pretty close to that.

It does irk me that so much of their business is about rosy assumptions. They buy an asset and put it on their books with their rosy assumptions and immediately it is more valuable. Simply going from a conservative or market valuation to a Brookfield valuation boosts its value. Nice work if you can get it.

[Bag Man]

Comparing BAM with BKS isn't very fair. BKS has a huge source of capital from its insurance float that BAM doesn't have. BAM has to instead issue debt or stock to raise capital.

[Alexander Steinberg]

@Bacon Slicer This only seems to be correct. First of all, BAM has a lot of third-party capital that pays fees to BAM. Not unlike float. Secondly, cash on Berkshire's balance sheet almost never (except for the financial crisis) in 2008 exceeds float. So, in effect, the float is not invested as productive capital. You can check my article on BRK about a year ago where I showed it.

[severance26]

Rational analysis. Will follow

[canadians.1982]

What do I do with my BPY.UN I am on the tax. If I don't do anything it will become Bam at a lower price than current market value? Should I just take the cash and buy the dip on bam or bip? I also have lots of BEP but I am in the red with the recent plunge.

[Alexander Steinberg]

@canadians.1982 I do not know your tax situation and portfolio but it is too early to make the decision anyway - we need to wait for the final offer.

[SmilinJack99]

Enjoyed your thoughtful piece on BAM! We became a shareholders last year when it plunged during the pandemic. I had looked at it over the years, but took a serious review when it acquired Oaktree where we had been long term investors. I especially like the corporate form and do not wish to acquire any LP interests, but expect to be long term investors.

[Alexander Steinberg]

@SmilinJack99 Good timing! I cannot prove it but my gut feeling is that Howard Marks and Co benefited from the acquisition more than anybody else)

[UncleLongHair]

Thanks for the thoughtful article. I've owned BAM and different subs for many years since it was known as Brascan.

Their "plan value" is simply an optimistic valuation. It is high but not completely unrealistic, just like the IFRS carrying value of their assets. The asset values and cap rates look very optimistic but they do in fact occasionally sell assets at or above those values. So they are essentially peak market valuations. The same of their "plan value". The stock usually trades below this value but does occasionally trade at or above plan value. BAM stock is marked to market every day but their assets are only marked to market when they are bought or sold so this is not as obvious. I think the current price of BAM at $41 is on the low side, not as much of a bargain as the inexplicable drop to $30 we saw in November but still cheap. There have been sources of cash flow such as carried interest that have been building for years and I think are going to mushroom over the next 5+ years which will make the current share price look especially cheap. They will have so much surplus cash at the corporate level that I think BAM might change its tune regarding dividends and buybacks.

BEP gets a lot of hype but I tend to agree that it has more reached critical mass than the end of its growth curve. Reportedly the cost of developing renewable plants has fallen to be competitive with fossil fuels for the first time, many analysts say we crossed that line in 2020. People have been talking about "peak oil" since the 1970's but I honestly believe that we have reached the inflection point from fossil fuels to renewables and that a major invewsthemt theme of the next 10-20 years will be renewables, not only the plants and equipment but innovations in storage and distribution technologies, recycling, electric vehicles, etc.

I also think that the opportunity for BIP is huge. I agree with Flatt's analysis that there is going to be a major shift globally moving infrastructure assets out of governments into corporations, and like BEP, BIP has reached critical mass to be the beneficiary rather than the end of its growth. Historically they have bought "old school" assets like pipelines and coal terminals but have started to buy things like cell tower networks and water processing. They might not all be cool/fashionable but I don't think there will be any shortage of assets at a large scale for many years.

I also agree with your underlying point that the BAM subs can often provide a better investment opportunity than BAM, based on valuation and their own markets. There were times to buy BIP and BBU well below liquidation value.

Regarding BPY, I agree overall that its performance as a separate entity has been poor, but BPY has really just been a source of cash for BAM. All of its value was sucked out by BAM in the form of distributions, fees, and preferred stock. The value of real estate assets was extracted through financings and dispositions and upstreamed to BAM. This is why it has looked like a highly leveraged shell, which it was. 

BPY has always seemed to have a tragic attraction to the wrong deal at the wrong time. Its previous incarnation BPO consummated the Trizec deal in 2006 just before the financial crisis and surely took a beating on some of those assets. Just like what is happening now, they took parts of it private and we never saw the shell game they played with the assets to sell them and come out whole. The newer version of this story is stretching into the GGP acquisition just before the pandemic. There is little doubt that many of those mall assets have underlying value but not at the moment, meanwhile the bottom 1/4 to 1/3 of those assets are probably worthless. Given enough capital and time they will probably be able to turn them around but it would be a painful thing to watch and a publicly traded high yield vehicle is not the right place for them.

Like you, I was struck by their comments in the shareholder letter and quarterly call that it seems like they are looking to permanently reduce their exposure to real estate assets. Commercial property has always been a cornerstone of the business so this marks a big shift, but I think it is long overdue. Commercial property simply never had the same opportunities as infrastructure, renewables and alternative credit. The commercial property was always my least favorite business, it is competitive, cyclical, and fraught with disasters. So they sucked all of the blood out of the commercial property business and used it to build the others. Which, if it works out, will be Flatt's most brilliant insight.

I own a lot of BAM, and bought a bunch of BPY and BPYU when it was at $8-12 and will convert it to BAM. I bought a bunch of BBU when it was at $18 and have been holding. I have been watching for an opportunity to buy BEP or BIP but don't think it is time yet.

[Alexander Steinberg]

@UncleLongHair Thank you for your good review. Out of all Brookfield subs, BPY's management impressed me the least. There were two telltale signs: the most opaque accounting and the highest optimism expressed during presentations. Sam Pollock, Sachin Shah, and Cyrus Maddon seemed more reserved to me. Certainly, it is subjective and others may not necessarily agree with me, but when several years ago it became difficult for me to understand BPY's Supplementary, I closed this book.

[UncleLongHair]

@Alexander Steinberg Not to make excuses for them but I think the BPY CEO's always had a bad hand to play. They had to create value in excess of the potential of the underlying assets. There were some amazing successes though. Like the major commitment they made to downtown NYC after 9/11 or the creation of One Manhattan West which created over $1 billion of value literally out of thin air. Or the relentless commitment to Canary Wharf when so many people said it was dead. But there were also boners like Trizec. I am not sure I understand GGP, the top assets there will be trophies, but they are going to have to figure out how to divest themselves of 50 mediocre assets.

BPY, BPO, BRP and all of the different incarnations just always seemed like a big shell game to me. They move assets and liabilities between them, they are simultaneously public and private. I think the death knell was that they could never successfully tap the capital markets with them. There's no way to use your stock as currency if it perpetually trades at half of fair value.

I am not a fan of private equity in general but there are some interesting things happening at BBU which could be home runs. Westinghouse was an amazing buy, they bought the best assets out of bankruptcy and if sentiment changes towards nuclear power over the next 5-10 years that will be a home run of epic proportions. Like BPY they run quite a high level of leverage there but I guess always count on a backstop from BAM if things get weird. Their ROE will be quite impressive when they can pay themselves back their full equity investment in a year and everything else is all gravy.

The Oaktree, reinsurance and alternative credit is a little financial engineering for me but also shows great potential. Flatt does have a knack for identifying huge markets to get into, and insurance float is certainly one of those. Hopefully the reinsurance sub will be a broken IPO like their other spin-offs and be available at 50-65% of spin value. It is amazing to think of now but BIP was first spun at $25 but traded down to $15-18 when nobody knew what it was or where it was going. Exact same thing happened with BBU. You need to have a little faith but it is an easy double assuming that the organization will develop and improve the subs after spinning.

[Alexander Steinberg]

@UncleLongHair Agree about BBU but their successes will be siphoned out to BAM primarily in the form of cash!

[puck61]

very good take on BAM and its babies. I'm long on BAM, have also BPY, but think to replace the last one by BAM

[Keep it Country]

Good article. Thank you. I am long BPYUP for same reasons noted in article. It goes ex div on 3/12 that will pay 0.40/share. I also held BPY thru the latest ex date and have sold most of it this week.

[Alexander Steinberg]

@Jackson Falls NH Thanks!

[Keep it Country]

@Alexander Steinberg

It will be interesting to see the outcome of BPY. Would think that they will need to pay a slight bump to the stock price that seems to be holding $17/share. Although unlikely the deal doesn't go thru, I agree it would drop substantially. 

The preferred's that will not be redeemed and become a BAM liability are interesting here as well, especially BPYPN(I hold some) trading under par at 22.42.

[Alexander Steinberg]

@Jackson Falls NH Three of BPY preferred will remain outstanding (not counting Canadian). I do not like their yields, though I have a very small position in one of them. The problem is that once interest rates go up, they will go down and BAM may never redeem them. Unless I see yields of 8%+, with upside potential and good credit, I avoid fixed-rate preferreds today.

[Valueish_Investor]

Thanks Alexander for your insights. Seems Brookfield's is like our central bank in its behavior- out to manipulate small, retail investors, no?

[Alexander Steinberg]

@Valueish_Investor If you hold long and do not buy PR, BAM can be an outstanding investment. With subs - it varies.

[puck61]

@Alexander Steinberg
my personal experience with BAM and its subs are inline with your opinion

[puertoescondidan]

@Valueish_Investor Under prior management, and in its previous reincarnation as Brascan, the company was very much out to manipulate smaller investors. Under Bruce Flatt and as BAM, less so. At least they simplified the corporate structure and made their financial structure understandable, but some of that culture is still there.

[ferraridriver]

Fully agree on BIP vs BEP. I always also avoided BPY and used to get into torrid comment arguments with people on Seeking Alpha about it. I was one of the few who would counsel to avoid. Other commenters would always say that BPY only had high-end malls and they would be fine. When I actually looked at the malls and went to their websites I would often find JC Penney and other marginal entities.
I have always preferred BIP over BAM due to the dividend being much higher. I can’t retire on BAM dividend rates unfortunately.

[Alexander Steinberg]

@ferraridriver Good judgment, in my opinion. I have been holding both BIP and BAM for almost 10 years. BIP delivered better returns for me, but it is way riskier. Yield is not for free.

[teemacsj]

@Alexander Steinberg Why do you deem BIP way riskier. I recall another of your write-ups where you praised BIP as the best in the Brookfield group? Personally, I like the diversity of BIP cash flows, which demonstrated resilience in 2020.

[Alexander Steinberg]

@teemacsj I positioned BIP in one of my posts as the best of subs. It is quite possible that Sam Pollock is the best investor in Brookfield's lineup. As I mentioned, BIP delivered better returns for me personally but my position in BIP is smaller than in BAM. BIP has high leverage and keeps paying growing IDRs to BAM. Leverage is the main source of risk. Another one is political and currency - BIP is significantly invested in many countries where instability is quite possible. BAM is far better diversified in this regard. Even BPY failure - the biggest sub until recently - has not rocked the boat too much. Adding reinsurance will increase this stability further.

[Finding Value]

Thanks.

I found your article interesting and helpful. I have held BEP in the past, but sold it some time ago. I am a long-time owner of BIP and have not been disappointed. I also hold some BPY (at a profit). Would you simply take the cash, or the BAM shares? Any thoughts?

[Alexander Steinberg]

@Finding Value A lot depends on your tax situation and whether you already own BAM stock but it is too early - let us wait for the final offer.

[galicianova]

@Alexander Steinberg with so many flies in the honey, when there is a question there is no question, rather than mall, b-mall, etc i settled for their preferred BTO-T, with bep, bam and bip squaring the quartet .

[Alexander Steinberg]

@galicianova you might have done very well if you have been holding BEP materially for more than a year)

[JBL/NYC]

Again, very thoughtful analysis.
Love your insights. Thank you.

[Alexander Steinberg]

@JBL/NYC Thanks!

[j84r88]

BAM plan value subsumes BPY inflated valuation of $27 per share.

[Azred]

The latest “gotcha!!!” Stock. Just what I need. NOT!!!!