- The top two growth vehicles at Brookfield today are BAM and BBU.
- BAM gives you diversified exposure to the entire Brookfield empire, whereas BBU is a concentrated private equity fund that targets industrials, infrastructure services, and business services.
- We compare the two and discuss which is the better buy at the moment.
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Brookfield Asset Management (NYSE:BAM) and Brookfield Business Partners (NYSE:BBU) are the top two growth-oriented investments in the Brookfield franchise, whereas Brookfield Infrastructure Partners (BIP) (BIPC), Brookfield Renewable Partners (BEP) (BEPC), and - soon to be privatized - Brookfield Property Partners (BPY) (BPYU) are the dividend growth vehicles.
Both BIP and especially BEP have recovered well beyond their pre-COVID-19 highs, while growth-focused BAM and BBU have significantly underperformed their fellow Brookfield vehicles.
With this in mind, are BBU and/or BAM a buy today and, if so, which one is the better buy?
In this article, we will compare the two against each other and offer our take.
#1 - Business Model Strength
BAM gives investors a bite of the entire Brookfield empire, as it holds positions in each of the underlying subsidiaries, a large stake in Oaktree Capital (OAK), several other investments, and their large and rapidly-growing asset management business.
BBU - on the other hand - is a concentrated private equity fund that targets industrials, infrastructure services, and business services.
While BBU has made a concerted effort to diversify its portfolio in order to boost its resilience to economic downturns and certainly does possess an impressive array of competitively advantaged businesses, the edge here undoubtedly goes to BAM. Their vastly superior portfolio size, global scale, and diversification across numerous asset classes and economic sectors put them in a class of their own (aside from the fact that they themselves own a large take in BBU).
While we believe that BBU's business model puts them in good shape to generate attractive risk-adjusted returns over time, BAM's business model has a much stronger track record and appears poised to continue generating strong outperformance relative to risk starting from a similar valuation basis.
Their superior performance through COVID-19 both in terms of total returns and underlying cash flow resilience hammers this home further.
BAM ultimately relies on a broadly diversified portfolio of renewable energy, infrastructure, real estate, private equity, credit, and other business assets along with a very strong and rapidly growing stream of fees from its asset management business to generate strong shareholder returns. Given their demonstrated investing prowess and continued alignment with clients by investing their own funds into their private and public funds, BAM not only has a business model that is well insulated against economic downturns, but it has a strong moat in its core asset management business.
In contrast, BBU is strictly reliant on its private equity portfolio to generate value for shareholders. As a result, it applies heavy leverage (more on that in the next section) to its underlying holdings in an attempt to juice returns on equity and then tries to shrewdly allocate capital through timely unit issuances and repurchases (which it has done very well to date), tactical public security purchases and sales (which it has also done very well on thus far), and - most importantly - successfully identify, implement a business plan on to improve the intrinsic value of, and eventually sell - businesses.
While this is BAM's bread-and-butter business model across its investments, it fails to equal BAM's much greater capital allocation optionality across multiple sectors as well as its sky-high return on invested capital asset management business that scales extremely easily and inexpensively.
While the management of both securities has proven to be extremely shrewd capital allocators, BAM's extra ability to manipulate its private and public investment funds as detailed in The Hidden Margin Of Safety At Brookfield Asset Management adds further unmatched alpha generation capability to its business model that makes it the clear winner here.
#2 - Balance Sheet Health
Here once again, BAM wins the day handily. As a starting frame of reference: BAM's balance sheet is A- rated, whereas BBU does not seek a rating from the major credit agencies.
BAM's liquidity is quite impressive as well, with $77 billion in total deployable capital against an enterprise value of $311.1 billion.
BBU, meanwhile, ended 2020 with ~$2.5 billion in liquidity against an enterprise value of $35.5 billion, which as management stated, is:
more than enough liquidity to continue to fund the growth and support our business on an ongoing basis.
That said, their equity has enormous leverage applied to it: their market cap is only $6.3B, less than 18% of their total enterprise value. As a result, any meaningful impairment to their business model would wipe out a large amount of equity for shareholders and could potentially put them at risk of financial distress, making management's selection of investments enormously important.
Conversely, their very heavy use of non-recourse debt does insulate them quite well from financial distress, as only $610 million of their entire $7,773 million debt burden is at the corporate level.
BAM is also heavily leveraged, but its market cap is still a higher percentage of its enterprise value at just under 22% and its significantly higher levels of relative liquidity (~25% of BAM's EV compared to just 7% for BBU).
Ultimately, neither company's balance sheet is high risk, but BAM's is clearly in better shape.
#3 - Valuation
Both management teams believe their equities are significantly undervalued, with BBU's management stating in their earnings call that:
we continue to believe that the units are trading at a significant discount to intrinsic value. So, you'll continue to see [share buybacks].
Brookfield CEO, Bruce Flatt, meanwhile, claims that its shares were worth $65.90 at the end of 2020.
While we could be lazy and just take management's word for it, we know better and will therefore take our own crack at it. Both businesses are broadly diversified and require a sum-of-the-parts approach to truly analyze from a valuation perspective.
BAM's plan value assumptions are outlined below. We believe that their annualized fee-related earnings should be valued between 15x-20x and their target carry interest should be valued between 5x-7.5x given the fact that neither is based on hard assets and can be removed at the end of a fund's life and transferred to a competitor. Additionally, the target carried interest relies heavily on performance which, of course, can be fickle with macroeconomic and sectoral sentiments and other factors beyond BAM's control.
Using those numbers, values BAM's asset management business at between $32.1B and $44.2B.
Meanwhile, their invested capital will be fully valued according to their public trading values, although this might be a bit conservative for the real estate business since it will be privatized soon and management does have a compelling plan for extracting value close to or even in excess of its IFRS value. Still, to be conservative, we will stick with the publicly traded values.
source: Q4 BAM Supplemental Data
This leaves us with an invested capital valuation of ~$39.3B based on current trading prices and 12/31 position sizes.
Combining these two gives us a range between $71.4B and $83.5B, which translates to a conservative estimate of per share fair value of between $45.37 and $53.06. We could also add on ~$5 per share if accounting for proposed new business ventures like software as a service and insurance, which management is already taking steps towards initiating. Regardless, with shares currently trading at slightly over $45 per share, it is fair to say that the stock is attractively priced, though a case can be made that shares are not dirt cheap.
Given that we are applying conservative assumptions here and management has a strong track record, we believe fair value likely hovers around $50 per share.
BBU, meanwhile, requires similar guesswork. Last year during their Investor Day, management stated that it believes fair value ranged somewhere between $40-44 per unit given the following factors:
Given that this was based on June 30, 2020, numbers and the economy as a whole has picked up significantly since then and the overall stock market has risen considerably, with the Vanguard Industrials ETF (VIS) up by 48.53% since then, the S&P 500 (SPY) up 33.55%, and the Dow Jones Industrial Average (DIA) up 31.63% since then:
It is not unreasonable to apply a 10% increase to their per unit fair value estimate, placing it currently roughly between $44 and $48 per unit.
Furthermore, as of 6/30/20, management also saw ~50% upside to their current intrinsic value embedded in their portfolio based on them being able to successfully execute their business plans.
As a result, we believe that a conservative assumption of the net present value of BBU is likely quite similar to BAM's: ~$50 per share/unit. That said, given the amount of leverage employed by both businesses, there is a pretty significant variance applied to those figures. BBU's variance - given their greater concentration and leverage - is meaningfully greater than BAM's, giving it more upside, but also more downside.
Overall, we give BBU the slight edge on valuation here given that they are trading at a greater discount to their median fair value estimate than BAM is.
BAM clearly wins two out of the three comparison factors, while narrowly losing the third (though a case can still be made that they are cheaper, depending on what assumptions you use). As a result, we view BAM as the better risk-adjusted buy relative to BBU.
That said, if you want to try for maximum total returns, we see BBU offering greater upside potential assuming a very favorable case scenario plays out in the future. Additionally, for investors already possessing a broadly diversified portfolio with significant exposure to real estate, infrastructure, and renewable energy and wanting to add more exposure to private equity and industrials, BBU would likely be a better buy.
It is also worth noting that BBU - as a partnership - issues a K-1 (though it does not generate any UBTI), while BAM - a Canadian corporation - issues the easier-to-handle 1099.
Ultimately, we view both equities as attractive right now and the choice boils down to individual investor circumstances, risk tolerances, and goals.
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This article was written by
Samuel Smith is Vice President of Leonberg Capital, he has a diverse background that includes being lead analyst at several highly regarded dividend stock research firms. He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering.Samuel leads the investing group High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value. High Yield Investor offers real-money core, retirement, and international portfolios. The services also features regular trade alert, educational content, and an active chat room of like minded investors. Learn more.
Analyst’s Disclosure: I am/we are long BAM. 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.
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