Brookfield: Offer Gets Raised, Dividend Gets Razed

Summary

• 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 »

Photo by DakotaSmith/iStock via Getty Images

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.

Source: Brookfield Property: Get Extra Income While You Wait

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.

Source: Brookfield

BPY shares yawned in response and stayed stuck at $17.72.

Data by YCharts

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.

Source: BPY

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.

Source: Brookfield

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.

Source: Fitch

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.

Source: TMX

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.

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.

Comments

[Frank M. Pryal]

I hold shares at a higher price so this deal undervalues what it was worth from a few years back. Lower dividend rate forsure

[comeinvestwithme]

An idea why BPYUP is so much down and below par today?

[2whiteroses]

@comeinvestwithme Trying to follow what's going to happen to BPYUP after this BAM transaction gets completed is not very easy, but unless things have changed, BPYUP is expected to be redeemed according to April 1 press release
www.sec.gov/... says, "Following approval of the Arrangement and related transactions by unitholders of BPY, it is expected that the BPYU 6.375% Series A Cumulative Redeemable Preferred stock (NASDAQ: BPYUP) will be redeemed at its par value of $25.00 per share, plus any accrued and unpaid dividends, at or around the closing of the Arrangement."

That seemingly was reconfirmed on p76 of the June 8 invitation for unithholders to vote at the July 16 scheduled special meeting
www.sec.gov/...
which says, "On or immediately prior to the Effective Date, the Purchaser Parties will deposit or cause to be deposited with the Depositary, for the benefit of the Unitholders and BPYU Stockholders who will receive the Transaction Consideration in connection with the Transaction (i) sufficient cash to pay in full the aggregate amount required to satisfy (x) the Cash Consideration, which the holders of Acquired Units are entitled to receive under the Arrangement in accordance with the Plan of Arrangement (calculated without reference to whether any holder of BPY Units has exercised Dissent Rights) and (y) the redemption of the BPYU Preferred Shares in accordance with the Arrangement Agreement...." What exactly "in accordance with the Arrangement Agreement" means is a nightmare to track down exactly... I couldn't do it, but you would think this is enough info to expect BPYUP to be redeemed upon closing of this transaction I would think.... If that's true, then this sell-off should represent opportunity... Wish I was more certain.....

[comeinvestwithme]

@2whiteroses Thank you, 2whiteroses !

[comeinvestwithme]

@comeinvestwithme It's still below par. So one could currently get a 6.41% annualized return between now and when the preferreds are redeemed, correct?

[User 53196230]

Sort of an easy choice for me. I bought this for slightly over $10, so I think I will just take the money and run. I'm confident that what I do with the proceeds will turn out better than the BAM offer.

[36510]

There is an offer to exchange BPYPN for BPYPO. Should you accept it?

[jasonasdecker]

Why the heck is BPY trading above the buyout price today?

[Trapping Value]

@jasonasdecker BAM price conversion possibility

[UncleLongHair]

@jasonasdecker Yep it now becomes a less expensive way to buy into BAM, you can buy BPY and convert it during Q3. But I am guessing the conversion to BAM is not guaranteed, other options are cash or preferred so it doesn't move in tandem.

[PC95]

So you can cash out now of BPY at whatever market price between now and transaction, or wait to get a ratio of:

50% cash @ $18.17 per share, 42% BPYUP, 8% BPO.PR.......

When will the transaction occur? Do you only have that ratio at transaction?

[Toofuzzy]

@Trapping Value

What will BPYU holders be paid from the buyout ?

Trying to decide when to sell.

[Trapping Value]

@Toofuzzy Same as BPY.

[Toofuzzy]

What is this offer worth to BPYU owners ?

[Dividend Digging Armadillo]

Sold one-half of my BPU position at $17.95,
with one-half to go.

[Dividend Digging Armadillo]

Correction- BPYU position.

[Spud111]

Why are the preferred shares sp declining. Mabee dbrs cut rating to 3L. Mabee will raise rating after deal is done?

[BillFenn]

Why isn't BPYU trading at $18.17 ( the new offer price) currently?

[wbrad90]

@BillFenn @I love capitalism
Because it's a long time until the closing and time is money. The price will slowly climb to the offer price as we get closer to the closing date.

[Capitalism is terrific]

If they offer us 18.17 per share, how can it be that it trades below that threshold?

[manuvns]

@I love capitalism because you can sell them now at market price and make more than 2% selling AAPL covered calls in 6 months.

[jasonjones]

Wow. I remember several SA writers touting BPY. They made Brookfield seem like gods in a can't lose investment in offices and high end retail.

I almost bought some but thought better of it. This article shows good reasons for not doing so. Excellent properties in this REIT but not enough to pay off.

Brookfield specializes in acquiring things cheap then fixing them up. They are still trying to do so with this deal. I guess it's better than a bankruptcy (see the SA article on CBL). Only the institutional investors get out with some funds in a bankruptcy. One SA writer says REITs have never experienced a bankruptcy. LOL. Not true. I remember Koger properties years ago. BPY wasn't a bad idea just poor timing. Gives Brookfield a temporary black eye. They will probably manage their way out of it in coming years at considerable expense.

[UncleLongHair]

@jasonjones I am not sure about SA writers but I was never that excited about BPY until the price fell to $8-12 at the onset of the crisis. Commercial property has always been my least favorite of Brookfield's businesses, I always thought it was competitive, cyclical, and fraught with disasters. But at $8-12 buying BPY was a no brainer, specifically because of the support of Brookfield. It's one thing to buy an office or mall REIT during a crisis, but it's another to buy one of four subsidiaries of a diversified global asset management company with over $500 billion to work with. There was never any doubt in my mind that they would support BPY as necessary. The go-private did surprise me somewhat but of course I'm happy, having purchased at bargain levels. As with all investing, price matters, a lot.

[Sebas_49]

I have been trading the preferred for a while now and still hold substantial position in the C,P and N. As BAM takes a lot of debt, in what kind of premium do you see the BAM and BPY ( BPO) preferred trade? The BPO preferred with a minimum clause gives a whole 1% extra than the BAM. The Fixed to float is 1-1.5% extra for BPO compared to BAM. The fixes ones are also 1-1.25% extra.
I was expecting some kind of a quick raise in the BPY preferred but we saw a slight decrease instead. What is your take on this? Cheers

[Spud111]

@Sebas_49 i think these preferred-shares bpo and bpy are going down now because of dbrs ratings cut to 3 L but after the deal closes ratings should go to 2L like bam and trade price according

[Sebas_49]

@Spud111 You see the BAM and BPO preferred being roughly equals in the future?. My question remains, would they go and trade at BAM's yield or somewhere between BAM and BPY yield? Is there an historical comparison that could be looked at?

[Spud111]

I have a couple questions that I will be asking bpy investor relations
1 who is going to back or guarantee the prefered shares after the takeover
2 if bam does not aquire the prefered shares who pays the dividends.
If bam pays and guarantee the bpo shares they should trade about the same as bam preferred

[olde1two]

Is it worth more probably but they already own it and no one is going to raise the offer. Already sold off a good chunk got my dividends in March.
Just been waiting to dump the rest. The time is now the outcome really isn't going change. Want to say it's been fun but it hasn't.
Good luck on the longs but it's like getting blood out of a rock from BAM.

[manuvns]

will BPY trade at 18.17 on monday ? Should i buy hell lot of BPY at 17.75 or less ?

[Trapping Value]

@manuvns To make 2% over 6 months? Assuming you get all cash? If that floats your boat, go for it.

[manuvns]

@Trapping Value thanks i am selling 17$ naked puts exipiring jan 23 , collecting between 90-100$ making 25%. so far collected 1000$

[Trapping Value]

@manuvns Those will transfer onto BAM dear and become atypical options. You won't "pocket that" when transaction closes.

[Nunthia]

It's pretty bad when you headline an article and say the word "Razed"
Instead it should be "Raised" Raze means to destroy.

[Trapping Value]

@johnny corsaro Possibly read it (and the article) a few more times before commenting. Might help.

[Wilbodave]

@johnny corsaro

"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."

[Nunthia]

@Trapping Value i read it 10 times and cannot understand. Of course I am not a Stock Broker just an investor. BPY sells for 25.4 a share and BAM which pays a dividend of 1.16% us buying out the unites of BPY for 18.17 a unit. Maybe you can explain? If BPY is partnership then what does that mean to investor buying into a partnership rather than a regular stock like BAM? Why is BPY 25.4 and BAM offering 18.17 a unit to get rest of company? Now it goes from Razed to dazed.

[Jstic]

I'm staying away from any Brookfield stocks after watching BEPC lose 30% of it's value in a rising market this year. BAM will dump millions of shares of any one of it's companies on the market at any time when they need cash. These secondary offerings are stock price killers.

Now to be fair, the entire renewable section took a hit this year, but none as bad as BEPC and BEP.

[Trapping Value]

@Jstic BEP=Bubble
seekingalpha.com/...

[Nunthia]

@Jstic and all BAM pays is just over 1% dividend. I don't understand

[HaBo]

I have read your interesting and informative article and the comments, i am unclear about the conclusion; Should I sell, hold my shares of BPYU(REIT) or buy more of them.
Thank you very much,
HB

[LikesToLearn]

@HaBo the choices are to 1) wait for the buyout and choose which of three payouts you want (BAM stock, cash, or preferred) and hope you get that choice, 2) sell your shares on the open market, 3) engage in an artbitrage trade idea as the author explored. Technically you could also buy more common stock but I don't see much of a reason to do that.

[HaBo]

@LikesToLearn Thanks
HB

[NorthZorro]

If BPY indeed got the short end as some seem to believe, then shouldn't buying BAM be a good idea? Not entirely comparable, but I remember a few years ago ENB bought one of its subsidiaries (forgot the ticker) on the cheap. I was not happy since I owned the subsidiary, but I started buying ENB. ENB has done reasonably well since.

[Trapping Value]

@NorthZorro BPY got a very generous offer. You are thinking of EEP being bought by ENB. Starting multiple of ENB was fairly modest then. Not at all true for BAM.