Better Buy: Brookfield Business Partners Vs. Brookfield Asset Management

Summary

• 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.
• Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our model portfolio. Learn More »

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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.

Data by YCharts

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.

Source

BBU - on the other hand - is a concentrated private equity fund that targets industrials, infrastructure services, and business services.

Source

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.

Data by YCharts

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.

Source: Q4 BAM Supplemental Data

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:

Source

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:

Data by YCharts

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.

Given the massive leverage, this is once again very believable.

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.

Investor Takeaway

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.

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.

Comments

[kalu0003]

Samuel Smith,
It matters. If you are a USA based investor - one is better of holding Canadian securities in retirement accounts! Thanks

[Samuel Smith]

@kalu0003 except that BAM pays a very low dividend yield and you can get the withholding tax back as a tax credit.

[rdsm]

@Samuel Smith Nice article. Thanks.
Is the tax credit recapture limited to each security or cumulative? I've seen mention of up to a $300 tax credit. But, I now own several positions that should qualify (all initializd this tax year). If it is capped at $300 total, I will exceed the cap by a significant amount.
Thanks in advance for your reply.

[Samuel Smith]

@rdsm I am not a tax professional so I would rather defer on this one.

[ferjen]

Better to own BAM in a Roth or cash account?

[Samuel Smith]

@ferjen doesn't really matter.

[kalu0003]

Samuel Smith
wrote "it really depends on the rest of your portfolio. BAM is real asset focused whereas BRK.B largely excludes real assets. I would pick whichever one better rounds out your portfolio from a diversification standpoint."

Assuming the portfolio is well diversified and putting valuations aside for the analysis: you are asked to pick one and only only one between BAM and BRK.B! In your view - which one would you pick as a long term investor? Thanks

[Samuel Smith]

@kalu0003 I would pick BAM.

[UncleLongHair]

@kalu0003 There are other important differences between BRK and BAM. BAM is global, the top management team is about 15 people in their 50's and 60's, they are establishing and entering new markets every year.

BRK is primarily in the US, the top management team is 2 people in their 90's and one person apparently ready to take the reins. They have not entered a new market in 20 years.

I personally have trouble seeing a decent future for BRK and have been selling my BRK in favor of BAM and the subs. I've held both stocks for more than 15 years.

[kalu0003]

Samuel Smith
if you were a long term investor. If your were to choose one and only among these two: BAM vs BRK.B. What would you choose (Please exclude own both in your views)? Thanks

[Samuel Smith]

@kalu0003 it really depends on the rest of your portfolio. BAM is real asset focused whereas BRK.B largely excludes real assets. I would pick whichever one better rounds out your portfolio from a diversification standpoint.

[Bradley Guichard]

Thank for this article. Clearly a lot of work/thought was put in. Personally I own both. From some of the comments it seems that many investors do not take advantage of the tax advantages of owning an MLP in a taxable account (brokerage). Many want to hold in an IRA to avoid the K-1. But a K-1 is really no big deal, especially if you use a CPA for your taxes. An MLP in a taxable account allows the investor to take advantage of the structure of a partnership, the income and expenses flow through, and distributions are just treated as a reduction in basis until the shares are sold. In addition, there is the QBI (qualified business income) deduction. When you hold this type of investment in an IRA you lose these advantages.

[Samuel Smith]

@BradGu thanks for sharing!

[Carlos-Mendoza]

Thanks Samuel for the article. I currently hold BPYU and continue to look at how to reinvest. Leaning toward BAM and this article helps.

[Samuel Smith]

@Chochheiser if you have a long-term time horizon, BAM is one of the best options out there! You can check out all of our long-term top picks with a free 2-week membership at HYI: seekingalpha.com/...

[toromi]

Thanks for this article. As someone who owns shares of both BEP and BIP, I would not pigeon-hole them as Brookfield's "dividend growth vehicles." They are, and have historically been, excellent total return plays (10 year CAGR of 19%+ for BEP and 20%+ for BIP). That compares to "only" around 14% for both BAM and BBU.

[Samuel Smith]

@toromi dividend growth does not imply lower total returns. In fact, historically dividend growth stocks have outperformed the broader market handily. It is simply to classify them as being dividend growth stocks as opposed to more focused growth vehicles in BAM and BBU.

[toromi]

@Samuel Smith I think some people see "dividend growth vehicle" and assume that's the main (and perhaps only) reason to buy the stock. I just wanted to point out that BEP and BIP are excellent growth vehicles overall.

[UncleLongHair]

It is interesting to compare BAM to BBU but they are very different companies. As the overall Brookfield model matures, BAM is more of a pure play on just the capital management. Their main business is actually attracting 3rd party capital and allocating it to their public and private investment funds. They do not directly hold many assets and instead just collect fees. They are indirectly diversified across multiple geographies and industries by virtue of collecting fees from many sources.

BBU is essentially a leveraged private equity fund and is a payer of fees rather than a receiver of fees. They directly own assets and essentially strive to flip them successfully utilizing cyclicality, fixer-upper and improvements. BBU carries a much higher level of leverage than BAM, but they do so because they know they will be backstopped by BAM if necessary. They benefit enormously from the relationship with BAM because they get the deal flow, financial and management support from BAM so investing in BBU really means investing in the combination of BBU and BAM.

[Samuel Smith]

@UncleLongHair thanks for sharing!

[value_vulture]

@UncleLongHair Do you think BBU will be taken private just like BPY?

[UncleLongHair]

@value_vulture Interesting question but I don't think so. Brookfield actually has a long history of taking its property businesses alternately public and private so in that sense the BPY deal didn't surprise me.

You could ask why any of Brookfield's subs are public. The stated reason is so that they can have access to the capital markets. The question would be if Brookfield were able to get a significantly higher price for BBU or its assets in the private market. I suppose that is not completely impossible.

It is interesting to see other relatively success investment companies like Pershing Square trade at a perpetual discount to NAV. There is a question of why they bother being public. Interesting thought.

[Chalmus0]

Thanks for the writeup. I'm a big fan of Brookfield overall, and have positions in BAM, BIP, and BEP. BBU is certainly the less/least covered in the entire family, which is part of the reason I've not ever seriously considered a position in them. The rest of the reason is that I figure that I'll capture incremental gains just through owning BAM.

I have a lot of admiration/respect for Brookfield, and see them as "aggressive value investors" with an eye towards long term wealth generation. There's no denying their huge success for over a century, and it often comes out in comment sections of the news blurbs on their deals. They are superb in finding real assets selling at a discount, scooping them up, rehabbing them, and then either keeping them for the cash flow or selling them off at fair or better value and moving on. It often causes a lot of anger to the investors in whatever they are buying out, because those investors are (probably accurately) of the mind that the buyout was below fair value, but hey, that's Brookfield's mission, and their duty to me as a shareholder.

Don't hate on them for being good at business and capitalism, just buy a piece of them and let them make you money!

[Samuel Smith]

@Chalmus0 agreed. They are phenomenal capital allocators.

[Dividend Digging Armadillo]

@Samuel Smith BAM is the puppet master for Brookfield, the Man behind the proverbial Brookfield empire.

[jasonjones]

@Chalmus0 Actually they are watching out for the executives and company not shareholders (see BPY). The executives do very well no matter how the stock plays out. I am very cautious about Brookfield.

[integritycoatings]

When does new insurance focused option become available?

[Samuel Smith]

@integritycoatings I do not believe they have announced anything on that front yet. So far, the plan is just for private funds, but I'm sure they will issue a public one if opportunistic.

[UncleLongHair]

@integritycoatings I don't think they've given timing for it yet. They formally announced it in November. Based on comments they have made since then it sounds like it will be initially spun as a kind of tracking stock, like a company without its own balance sheet, which I guess will gradually be more completely spun. I would guess we'll see it in a quarter or two.

[Dividend Digging Armadillo]

High Yielder Samuel,
Thanks for the Brookfield entity analysis of BAM and BBY, Currently a holder of BPYU units,
with options to sell now @ $17.85, convert BBYU units to BAM (ratio 1 to 0.1688 units), or take part cash and part BAM units/shares.
If sell BPYU prior to 3rd Qtr acquisition closing date without divys in remaining, midstream MLP’s or WPC/O to redeploy assets. Care to opine or comment on most favored options to BPYU unit holders?
Thanks from Baja Oklahoma,
Dividend Digging Armadillo

[Samuel Smith]

@Dividend Digging Armadillo thanks for reaching out! I think it comes down to your tax circumstances and secondly your investing goals. I am not a tax expert and do not know your personal circumstances, so unfortunately I can not answer beyond that other than to say that my approach would be to determine what will be the most advantageous in terms of taxes.

[Dividend Digging Armadillo]

@Samuel Smith
Tax deferred account, so no tax issues. Thanks.

[Samuel Smith]

@Dividend Digging Armadillo "convert BBYU units to BAM (ratio 1 to 0.1688 units)" to make sure I'm getting what you are saying, how many BPYU units would you have to exchange to get a single BAM share?

[Haunted Beans]

Look deeper into BBU. They also have a 15% performance fee above a certain share price. It’s a glorified hedge fund.

[Samuel Smith]

@Haunted Beans yes, the fees are high. The bright side is that share prices have to go up for the incentive fee to kick in.

[UncleLongHair]

@Haunted Beans So is this a good thing or a bad thing? :)

I don't really disagree but it's a more of a private equity fund. The business is clearly transactional. BBU differs from the other Brookfield subs in that it has a small distribution and their incentives are primarily on unit price increases. So it seems to be more oriented towards NAV increases rather than distributions.

[Haunted Beans]

@Samuel Smith would have been good to mention in your article.

[Off-The-Run]

Quick question. Who assigned A- to BAM? Was it Fitch? I have them at BBB+.

Long BAM.

[Samuel Smith]

@Off-The-Run S&P: www.standardandpoors.com/...