- BAM plans to double its business or better in 5 years implying 15% per year growth.
- BAM also expects to generate $39B of free cash flow over the same period. If half of the cash is allocated to buybacks, the return per share may be closer to 20%.
- This growth is possible due to the introduction of new businesses, namely Insurance, Transition, Technology, and Secondaries.
- Insurance and Transition seem particularly promising because of the total addressable market, global tailwinds, and Brookfield's existing skills.
I published a similar article a year ago when Brookfield Asset Management (NYSE:BAM) was a good buy at $34. The company has done very well since but the stock may have outrun the business as I posted recently. Still, Brookfield Investor Day always provides food for thought. What follows is not an analytical article but rather quick and highly subjective notes upon watching the event.
Brookfield Asset Management
This was the first time I saw Bruce Flatt somewhat detached from his immense creation as if he were looking at Brookfield from outside. The company has become too big and diverse for a single person to know details.
In his presentation, Mr. Flatt reemphasized the topics familiar to every BAM investor: a successful track record, switch to alternative investments, strong balance sheet, growth of AUM due to both existing and new strategies. He also listed new strategies (in addition to existing real estate, infrastructure, renewables, private equity, credit) with their target AUM: Insurance ($200-300B), Growth (mostly Technology - $100B+), Transition (i.e. broader decarbonization - $200B+), Secondaries ($100B+). All these businesses were mentioned a year ago but this time the ball is already rolling with some early successes. Answering the questions he was more relaxed and, in particular, acknowledged plenty of mistakes the company made in the past though without indicating anything specific. I have never seen Brookfield acknowledge a serious specific mistake even when it is rather obvious - Brookfield Property Partners (BPY) comes to mind immediately.
Sachin Shah, who is now the Chief Investment Officer, spent more time on new strategies. The most advanced and, the most promising of them, in my opinion, is insurance. Mr. Shah, being also the CEO of Brookfield Asset Management Reinsurance (BAMR), is spearheading this effort. The advance here has been staggering: starting almost from scratch a year ago, Brookfield has signed 3 agreements to bring in $45 billion of insurance AUM. Once they close, insurance will start contributing to BAM's business in two ways: spread between interest on assets and liabilities attributable to BAMR and fee-related earnings (FRE) for the Asset Management including Oaktree.
Mr. Shah predicted that insurance AUM will exceed $200B in 5 years and indicated multiple paths to this target - reinsurance transactions (similar to the one with AEL), pension risk transfer transactions (already being implemented on a smaller scale in Canada), direct annuities, M&A, P&C operations, structured settlements, etc. In the US and Europe, there are currently $10 trillion in life and annuity AUM in-force which is a measure for the total addressable market. This figure does not include other regions, property and casualty carriers, and organic industry growth. With $45B of assets already signed up within the first year, Brookfield may considerably exceed the target of $200B in five years. In a telltale sign, Mr. Flatt described the same target as $200-300B which may be a better estimate. To get some perspective, Brookfield's current AUM is about $325B.
So far, we have considered insurance purely as a supplier of AUM for the Asset Management operations. But superior investment management is crucial for insurance operations as well. In his presentation, Cyrus Madon, Brookfield Business Partners (BBU) CEO, mentioned an interesting figure that helps to estimate this potential. BBU owns a mortgage insurance business in Canada (Sagen, formerly Genworth Canada), and here is a quote from Mr. Madon:
And in our residential mortgage insurance business, we've already improved the return on equity from 12% when we bought it to 17% and we think we can do better.
From previous BBU presentations, I know that Oaktree was supposed to manage Sagen's assets upon acquisition and the jump in ROE should be at least partially attributed to Oaktree's skills.
Considering the existing mandate from Renewables, Transition is not exactly new. Nonetheless, inspiring slogans, somewhat broader scope, and Mr. Mark Carney as the new standard-bearer will bring massive additional AUM to Brookfield.
It was interesting to hear Mr. Shah confidently talking about technology and especially software. His declaration "Software is the new infrastructure" sounds enthusiastic and very "Brookfieldish". So far, Technology has been rather smallish within Brookfield but the company is putting resources behind it. It will still take some time until Brookfield becomes as skilled with software as with infrastructure. The effort is being handled by two business groups: the one within BAM is focused primarily on venture-type activities, while the second group, within BBU, works with more mature opportunities.
Secondaries is the field in which Brookfield has all the necessary expertise right now but the addressable market may be smaller than for other new strategies.
To reach this extraordinary growth in AUM and scale up new strategies, Brookfield has to find receptive investors who will provide these precious AUM. Craig Noble, CEO of Alternative Investments, explained where these new investors will be coming from. Within Brookfield, there is a sales and marketing organization in charge of bringing investors in. This organization is separate and in addition to the investment organizations. Currently, it numbers 250 people in 18 offices around the world. Based purely on my memory, this organization was created and recognized as a special force only 5 years ago or so and initially had about 30 people. When Brookfield was working solely with a relatively small number of giant institutional investors on a few strategies, distribution was rather straightforward. The steep increase in the number of funds, strategies, regions, and investor types requires beefing up these efforts. In addition to the expanding participation of its big clients, Brookfield also plans to distribute funds to wealthy retail investors through financial intermediaries, increase participation of insurance clients (including BAMR), and attract mid-market institutions.
Brian Kingston, Real Estate (and formerly BPY) CEO, answered another important question: how Brookfield will be financing all these new strategies. Some background is helpful here. Historically, Real Estate was the biggest business within Brookfield once run by Mr. Flatt himself. After the collapse of retail real estate, BAM had to privatize BPY and ended up with too much real estate on its balance sheet. Brookfield's model generates superior ROE when the company can attract meaningful third-party fee-generating capital in addition to its own. Upon BPY privatization, Real Estate stopped fitting the model. On the slide below, Mr. Kingston showed how BAM plans to reinvent this business:
Real Estate assets are divided into three baskets based on the way Brookfield will treat them. The best assets (core, about 50 irreplaceable precincts) will be held forever but BAM will be gradually selling a partial interest in them, keeping GP interest with management fees and, eventually, about 25-30% of LP interest. For this basket, BAM intends to replace public investors in BPY with private investors in specific assets. But the all-important management fees will be retained though in a different form.
Real Estate owned by private funds (LP investments on the slide) does not require any changes in strategy as the third-party capital is already there generating fees. Upon selling the assets, this part of Brookfield capital will be recycled into new opportunistic assets together with third-party capital.
Whatever is left (transitional and development) will be treated on a case-by-case basis and eventually sold, sometimes after (re)development. Most of the malls (about 90 of them as far as I know) except for the top 25 or so are in this third basket.
Overall, Brookfield plans to source $25B out of real estate currently on the balance sheet. I do not see problems in regards to the first two baskets. The third one will require time and effort. Mr. Kingston presented two successful examples of selling non-retail assets belonging to the third basket implying similar success for the rest that may prove remote for many. However, the problem assets in the third basket (a part of $7B) seem quite manageable within the framework of today's Brookfield as a whole.
The Oaktree presentation by Armen Panossian was, in my opinion, the least interesting. This does not refer to the company itself (62% owned by Brookfield) which deserves nothing but respect for its credit strategies. But the presentation style adopted by Mr. Howard Marks and, apparently, followed by other executives is not very enticing. If you read Mr. Marks' memos you know what I mean: he intentionally avoids any specific details and examples of investments that Oaktree has handled. Imagine a business class by an outstanding professor who does not discuss specific business cases - useful, instructive, but could be more exciting.
Anyway, as expected, Oaktree has been quite successful as a part of the Brookfield family, expects more funds and strategies, and will play a crucial role in the insurance business.
Nicholas Goodman, BAM's CFO, was the last presenter of the first day. Besides reviewing, he focused on predicting the value of BAM in 5 years from now. Omitting numerous details, there were two main conclusions:
1. BAM will double its value or better in 5 years based on growth in AUM and successful investment of its capital. This implies a 15+% return per annum - a hurdle that BAM can achieve and surpass as we know from the past. What is important, however, is that due to new scalable strategies it should be possible despite Brookfield's current massive size.
2. Over the next 5 years, BAM will generate about $39B of free cash flow (including carry) at the holding level. BAM's current market cap is $84B. So BAM can potentially double the value of its business and add close to 50% on top of that in cash. If, say, 50% of this cash is allocated to buybacks, the return per share may be close to the same 20% annually that BAM has delivered over the last 20 years.
The second day was devoted to subs' presentations and since this post is primarily about BAM, I will be concise.
Brookfield Infrastructure Partners (BIP)
Sam Pollock and his team emphasized the impressive Inter Pipeline (OTCPK:IPPLF, IPL on TSX) acquisition. It is sizable - BIP alone will invest $2.5B in cash and BIPC shares with a total EV of $13B. The process (to be finished this year) will have taken about 1 year and 9 months with significant intrigue and maneuvering along the road. IPL is being acquired at 13% going-in FFO yield while funded at 5% FFO yield via selling the District Energy business and issuing BIPC shares. This should result in 12% FFO per BIP unit accretion. But it will improve further: in late 2022, IPL is scheduled to complete its Heartland Petrochemical Complex (HPC) which is the ultimate attraction. HPC will add 40% to IPL's EBITDA with 68% of its operating capacity already contracted.
Mr. Pollock expects that at the end of 2021, the FFO per unit run-rate will reach $3.85 due to the IPL acquisition and organic growth with a run-rate payout ratio of 68%. It implies that BIP's distribution bump for 2022 may be close to the top end of its 5-9% target range for distribution growth.
Brookfield Renewable Partners (BEP)
This part of the event was rather long covering everything from the global decarbonization efforts to specific repowering opportunities. It deserves a separate post and I will be short here:
- Mr. Mark Carney, currently Brookfield's Vice Chairman, was talking about the global imperative of decarbonization. As far as I remember, the word "Brookfield" did not figure prominently in his presentation if at all. But the implication was clear: Brookfield is ready to play its modest part in the global effort. As we know from Mr. Flatt, this is expected to bring more than $200B in AUM to Brookfield.
- Connor Teskey, BEP's CEO, focused on multiple tailwinds for BEP from the decarbonization.
- Further presentations added more details on BEP's development capabilities and specific repowering opportunities.
- The presentation was concluded by Wyatt Hartley, BEP's CFO who reiterated BEP's targets of 12-15% returns.
I am quite confident in BAM's abilities to monetize decarbonization and renewables on the grand scale - the company is positioned uniquely well for this. But what about BEP specifically? If the background is so favorable, why has BEP delivered only 5-6% growth in distributions per unit? And even this meager result has been aided by high leverage, low interest rates, and a high payout ratio. None of the five presenters addressed this important issue. Many BEP investors enjoyed an amazing run of shares/units in 2020 and are quite satisfied with the results. But it was due to multiples expansion which is typically a non-recurring event. What might happen with the stock if, for whatever reason, God forbid, renewables will become slightly less fashionable one day? Under this scenario, a 3% yield and the global righteous cause may be a weak consolation for investors.
Brookfield Business Partners (BBU)
Cyrus Madon, BBU's CEO, reviewed impressive results since the BBU spin-off five years ago. There were several important items in his team's presentations:
- BBU is currently focused on much bigger transactions than before.
- Healthcare and Technology present huge growth opportunities. In both segments, BBU has already made its first acquisitions. More of them are expected to follow.
- BBU will shortly launch its corporate twin - Brookfield Business Corporation (BBUC). Investors will receive 1 share of BBUC for every 2 units of BBU. Based on the success of other Brookfield corporate twins, we can expect the same for BBUC.
The market values BBU cautiously as compared with BIP or BEP and it is not accidental. While the company has operated well and even more than well in most cases (though missteps have also happened with Teekay Offshore, now Altera, as the latest example), its setup is not particularly attractive for retail investors (details are available in one of my older posts). The units may appreciate in the short run due to continuing post-pandemic recovery, the launch of BBUC (with doubling of distributions for the current holders), and valuations. After all, BBU is currently trading at levels first achieved 3 years ago despite being a much bigger company. But I do not believe the stock is suitable for the long-term position.
Imagine you find yourself in receipt of a huge (by your standards) cash gift that you should live off indefinitely long. Ignoring diversification for the purpose of this mental experiment, what would be the most suitable single stock to invest this gift into? Certainly, you would want this stock to deliver respectable real returns but the safety of principal over the long run should be also paramount. My answer today as well as 20 years ago would be Berkshire Hathaway (BRK.A) (BRK.B). Short-term (within the range of 1-3 years) volatility aside, I would not be concerned about the permanent loss of capital. At the same time, a 9% tax-advantaged return is sufficient to both compensate for inflation and provide an acceptable real income.
In this regard, today's BAM, in my opinion, is not at the same level. While delivering higher returns, BAM is still not safe enough. But the 5-year program laid out at Brookfield Investor Day may deliver better diversification of its business, increase cash flows, and strengthen the balance sheet. Once these targets are achieved, BAM will become much safer and may qualify as a worthy competitor to Berkshire in our mental experiment. The unique feature of Brookfield's business is its certain predictability due to the long-term nature of its AUM with fee-related earnings and the resilient cash flows of underlying investments. This experiment supports the case of Brookfield gradually becoming more prominent in retail investors' portfolios.
As I stated in the beginning, BAM's current price does not seem justified to me in the near term. In the longer term, the stock remains attractive.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BAM, BIP either through stock ownership, options, or other derivatives. 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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