- Brookfield Property Partners got a stronger offer from Brookfield Asset Management.
- This was about in line with our expectations.
- We dissect the key questions that may be on investors' minds.
- I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
When we last covered Brookfield Property Partners L.P. (NASDAQ:BPY) and its REIT entity counterpart, Brookfield Property REIT Inc. (NASDAQ:BPYU), we suggested that investors capitalize on the option premiums. The logic being that there was very little chance that Brookfield Asset Management Inc. (NYSE:BAM) would dole out an additional premium considering the properties were worth far less than the official "NAV". Specifically, we said:
Assuming you buy our valuation logic, you should realize that BAM is not being fair, it is being extremely generous to you. While a higher offer can come, it likely will not be a big jump. The best way to deal with it in the interim is to sell covered calls on your position. Remember that the stock is already trading higher than the offer price. By selling the $17 calls, you are harvesting additional income and creating a total price that is hard to beat. At the time of writing this, the $17 calls for June 2021 were going for 75 cents and that gets you to a price of $17.75 total, assuming it is called by then. That is going to be hard for BAM to beat with its starting offer at $16.50.
April 1 morning, an agreement was struck between the two parties.
Unitholders can elect for each BPY unit $18.17 in cash, 0.3979 of a Brookfield Class A Share or 0.7268 of a BPY preferred unit, subject to pro-ration, for an aggregate consideration mix of approximately 50% cash, 42% Brookfield Class A Shares and 8% BPY preferred units.
BPY shares yawned in response and stayed stuck at $17.72.
In a way, BAM did beat the offer but did so in an unusual way. We go over the key considerations for shareholders with this new announcement. We will do this by trying to answer some of the questions investors may have.
Why Are They Not Paying Me Fair Value?
BPY's latest presentation shows the NAV a wee bit higher than the current price.
While investors may fret that BAM did not pay them what the NAV was valued at, we think this offer is extremely "over-the-top" generous. BAM's cap rate assumptions on retail and office space are unlikely to be close to accurate in today's markets. In fact, the independent valuator placed the fair value between $14 and $18.50/share.
Lazard Frères & Co. LLC (“Lazard”), acting as independent valuator and financial adviser to the special committee, has provided an opinion to the special committee that, as of March 31, 2021 and based upon their analysis and subject to various assumptions, qualifications and limitations to be set forth in its written valuation report, in addition to other factors that it considered relevant, the fair market value of a BPY unit was in the range of $14.00 to $18.50, implying a total enterprise value of $67.6 to $72.1 billion.
A really interesting portion of that appraisal comes from showing just how much debt is being carried by BPY. Reducing the fair value of properties by just 6.25% ($72.1 billion to $67.6 billion) drops equity value by about 25%. A further 20% drop would create a zero equity value for BPY shareholders, a prospect that would be more than likely if assets had to be sold today.
What Should I Select?
BAM shares likely have a reduced value today as they are absorbing BPY into the fold. In our view, BAM is overpaying here and the management fee disappears from its coffers. It is instead left saddled with a lot of assets that will require a lot of work. Fitch opined over this aspect as well.
However, Fitch believes the acquisition will result in reduced downside cushion to BAM's rating given the decline in balance sheet liquidity and the potential mix shift in cash receipts from BPY, depending on the magnitude of third-party investor participation in the proposed acquisition. Still, Fitch expects total cash earnings to BAM from BPY to be relatively unaffected and balance sheet liquidity to re-build over time, given the cash-generative nature of the business and the below-peer pay-out ratio.
Fitch believes the new structure could enhance the stability of the management fee stream, as it would no longer be subject to BPY's trading price, but it would still be expected to have greater variability than fees for most peers, which are more heavily based on committed capital structures.
Even outside the work required on BPY, do note that BAM's internal self assessed valuation is based on some sky-high multiples.
Source: BAM Presentation
Cash here is perhaps the best choice but it is limited to a maximum of 50%. However, considering that BAM has a legion of admirers, it is probable that enough investors will choose BAM shares as they might consider them undervalued. In that case, all those who choose the cash option will get it allocated to them.
When Does This Close?
Third quarter appears to be the likely timeline and we would wager that the vote goes without a hitch.
Process and Related Matters The Arrangement and related transactions are subject to approval by a majority of the public unitholders of BPY, in addition to other customary closing conditions including the approval of the Ontario Superior Court of Justice. Assuming these conditions are met, the Arrangement is expected to close in the third quarter of 2021.
Source: BPY SEC Filing
Most BPY shares are controlled by funds and they know the huge premium BAM is shelling over realistic property values.
Will I Still Get Dividends?
Nope. You are out of luck on the common shares.
Pursuant to the terms of the agreement governing the Arrangement, BPY unitholders and holders of shares of BPYU Class A stock and exchangeable limited partnership units of Brookfield Office Property Exchange LP will not receive further quarterly distributions on their securities.
Source: BPY SEC Filing
When we recommended the covered calls, we felt that BAM's offer would not exceed $17.50. BAM did land up offering $18.17 but that includes cutting investors out of two dividends totaling $0.67. We want to quickly point out here that the preferred shares will continue to get paid of course.
What's The Best Trade Now?
On January 5, 2021, we had suggested that investors ignore the BPY shares and jump straight into the TSX listed preferred shares. The rationale was that these would become BAM's liability and would outperform anything you could get from BPY shares, even if the offer was bumped up.
While BPY shares are up 5% since then, the preferred shares (BPO.PR.N) are up an amazing 22%. That trade still has some more room to go but we are about two thirds of the way through.
BPY shares are trading at a mild discount here to the closing price. However, since you won't get any dividends in the interim, this discount is warranted. Investors certain about the acquisition going through can still consider moving to the TSX listed preferred shares as they have a better upside than BPY shares.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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This article was written by
Trapping Value is a team of analysts with over 40 years of combined experience generating options income while also focusing on capital preservation. They run the investing group Conservative Income Portfolio in partnership with Preferred Stock Trader. The investing group features two income-generating portfolios and a bond ladder.
Trapping Value provides Covered Calls, and Preferred Stock Trader covers Fixed Income. The Covered Calls Portfolio is designed to provide lower volatility income investing with a focus on capital preservation. The fixed income portfolio focuses on buying securities with high income potential and heavy undervaluation relative to comparatives. Learn more.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
We are long BPY preferred shares listed on TSX.
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