Brookfield Renewable: Stay Away As Brookfield Is Channeling Fees To The Top

Summary

• I've covered BEP before and was quite bullish on the company.
• But recently I discovered just how much upside the fund gives up in fees to Brookfield.
• I take a deep dive into Brookfield fee structure, discuss management incentives and present my playbook for the company.

cagkansayin/iStock via Getty Images

Dear readers/followers,

I've written quite extensively about my bullish outlook for renewable energy and consequently I've covered a number of interesting renewable energy plays here on SA. Some of my favorites include traditional utility giants with a significant and growing exposure to renewables, such as Enel (OTCPK:ENLAY) and others were simple green energy pure-plays such as NextEra Energy Partners (NEP) or Brookfield Renewable Partners (NYSE:BEP). Today I want to do an update on BEP, which has returned about 10% since my last article. Bear with me as I will get to the discussion of Q1 results and my updated outlook for BEP in the second half of the article. But first I want to describe my thinking, which caused me to sell my BEP shares and swap them for shares of the parent company. Spoiler alert, it has to do with management's incentives.

Let's talk about Brookfield's incentives

Recently it occurred to me, that not all Brookfield's funds are created equal. This might sound obvious, after all real estate is definitely not the same thing as a solar power plant or a port, but I'm not talking about the assets they hold here. What I want to focus on is the "seniority" of individual Brookfield funds (entities) within the Brookfield group. Understanding this, management's incentives and the various fees that are channeled from one entity to another is crucial to making an investment decision. Some of what follows are straight up facts and some are my opinions where I'm trying to connect the dots. I'm happy to hear your comments below on how you see it.

Let's first briefly describe the structure of the group. At the very top, we have Brookfield Corporation (BN) which is the parent company, a HoldCo. As a HoldCo it simply owns shares of other Brookfield's publicly traded entities plus other private investment (mainly real estate). What's important though is that this is the entity that the majority of senior management's wealth is tied to (mainly that of the CEO Bruce Flatt) so it's clear what they are incentivized to do here - increase the share price of BN.

They've already done a major step in trying to increase the share price of BN, which was of course the recent spin-off of 25% of their asset management business which is now publicly traded as Brookfield Asset Management (BAM). Management has been open about the fact that the primary reason for the spin-off was for the market to recognize the true value of this easy to understand and asset-light part of their business. Individual investors celebrated the fact that they can now invest into an asset-management pure-play, but let's not kid ourselves, Brookfield didn't do this to make people happy, but to increase the value of BN which still owns 75% of BAM. So far this hasn't entirely materialized. While the market has priced BAM at a pretty high FRE multiple of about 23x, BN's stock price has continued to fall, likely due to their have commercial real estate exposure. In either case, the spin-off confirms my thinking, which is that management will do everything to maximize the value at the HoldCo level.

Moving several levels down, we get to the YieldCo level, which is where you find BEP, as well as the rest of Brookfield's publicly traded funds. BN owns significant stakes in all of these funds which should theoretically give it some incentive, but looking at the big picture I'm going to make the argument that in reality the goal of these funds is to produce a return that is simply large enough (and ideally with a nice dividend, because who doesn't like that) so that investors in those funds are happy. If those funds, could continually deliver 20% returns, why give that to investors when you can introduce a complex set of fees to move some of this excess return to a place where it benefits the HoldCo more. BAM is the best place for that, because it's priced at the highest multiple, meaning that a dollar of earnings in BAM has significantly higher value that a dollar of earnings elsewhere (especially on the YieldCo level with lower multiples and only partial ownership). And indeed, this is happening as all YieldCos pay significant fees to the asset manager. The asset manager provides services in return, such as sourcing capital for the funds, but if I were in management I would surely be thinking of ways to increase the fees, run them through BAM and therefore increase the price of BN.

Is BEP still worth it?

None of this is meant to discourage you from investing to BEP, I was a shareholder myself before I switched to BN. It's simply to encourage you to think about the big picture and make the best decision for yourself. So without further due let's look at BEP. I covered the basics in my original article here, but to sum up the basic Brookfield Renewable is a green energy pure-play with 25,000 MW of installed capacity, mainly in hydro (53%), followed by wind (20%) and solar (15%). Their portfolio is primarily located in North America (62%), followed by South America (20%) and Europe (16%). The company targets a 10% FFO growth which should be fuelled by a vast pipeline of new projects. Notably half of the growth for the next five years is already locked in with 19,000 MW of capacity under construction or construction-ready.

In Q1 they certainly delivered, as their quarterly FFO increased by 13% YoY to $0.43 per share. The growth was driven by favorable hydro generation which increased by 26% YoY, increased prices (inflation driven) and a 23% increase in installed capacity (thanks to acquisitions and mainly 3,600 MW of newly commissioned projects over the last 12 months). Management has also stated that they remain committed to delivering 12-15% returns to shareholders over the long-term and growing their distributions by 5-9% annually.

Now let's have a look at the fees I've talked about to help you understand why further upside (beyond management's growth targets) is nearly impossible and why we might be better off investing in BAM which targets 20% shareholder returns and has a much better position within Brookfield corporate structure. The "incentive distribution" mechanism is explained in their materials as follows:

BEP Quarterly Report, note that Brookfield here stands for BAM

At first glance the fee may not seem that high. But the current distribution is nowhere near $0.20 per unit, in fact the recently declared distribution for Q2 2023 stands at $0.3375 per unit. That's well above the threshold which means that the fees are high and BAM (not BEP) captures 25% of all growth from here. I've put together a chart which shows the split between what BEP retains and what it has to pay out. The red line represents the current level of distributions. While it may not seem like BEP is taking a big haircut, the $27 Million paid in incentives distributions to Brookfield in Q1 2023 was more than 10% of total distributions paid to LP unit holders. Going forward, as distributions grow further beyond the $0.20 per share threshold, Brookfield as the GP will continue to capture 25% of all growth and the proportion of distributions that goes to Brookfield as an incentive distribution will increase from about 10% today to about 13% in 5 years. That's by no means insignificant.

Author's analysis and calculations, note that Brookfield here stands for BAM

The way I see it, this has a major impact on shareholders of BEP and while I recognize that Brookfield does bring value by sourcing capital, the fee heavily burdens the YieldCo to a point where returns beyond the 12-15% that management is guiding for are highly improbable. Combined with management's clear incentives to prioritize value creation "at the top" I've decided to exit my BEP position. That's not to say, it can't be a good investment for some. If you're ok with the above and for some reason don't want to invest in the asset manager or the corporation, then by all means go ahead and buy BEP as it is a solid business, but for me it is a HOLD at this time.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[UncleLongHair]

Ask yourself this question. Where would BEP and the other publicly traded subs be if they were not affiliated with Brookfield? If they did not have the deal flow, financing, third party capital, brand, and leadership?

In other words, what does BEP get in exchange for the fees it pays to Brookfield?

The answer is: a lot. The various Brookfield businesses work in concert, when they make a deal for commercial property it leads to deals in renewable energy and vice versa. The same banks and lenders provide money to all of the businesses, and money raised from institutional investors gets invested in all of the subs.

If BEP tried to establish and grow their business without these benefits they would be at a major disadvantage, and this may explain why there are not other companies like BEP and BIP in the market, they have not been able to get established or grow as fast without a sponsor.

Your analysis is not wrong that a significant percentage of the cream from the returns gets upstreamed to the mother ship but the subs have all done quite well in market terms since inception. The main reason to invest in one sub rather than BAM or BN is to have exposure to a specific market segment, or perhaps to avoid exposure to one such as commercial property.

[SmilinJack99]

@UncleLongHair UNC. Well put!

[Sleepless in Seattle]

@UncleLongHair Thanks for the very clear reasoning. I'm long BAM, but also BIP and BEP. One for asset management, one for infrastructure, one for renewable energy. I like the clarity, and the dividends.

[comeinvestwithme]

@UncleLongHair I respectfully disagree. You don't need brand, financing, sourcing, or leadership (lol) and what not for operating a solar plant. My rooftop solar on my house for example might well have a higher return than BEP. Because my management is much leaner, it doesn't need all that crap and overhead. I'm not making a case or comparison of home solar vs utilities, but a case for the fact that maximizing returns is different from maximizing asset base. There are little to no economies of scale with power plants. Clearly, BN/BAM/BEP are incentivized to maximize the asset base and returns for BN/BAM first and foremost, not returns for BEP unitholders. They managed to harvest the captive capital somehow, and now it's time to squeeze the most juice out of others' capital with limited risk on their own. And hopefully they do it efficiently, because I own BN shares ;)

[Ján Mazák]

There's a management fee, too. Roughly, let's say BEP manages to get 15% ROE on its investments. ~350 bps of that goes to incentive fee, ~125 bps goes to management fee, you are left with ~10% return as a LP. Not great. BAM consumes about 30-40% of the present value of the total cash flow of BEP, unitholders only get the rest. It's in line with historical returns: ~5% growth + 3-6% yield.

And I doubt it will be easy to get 15% ROE; solar and other renewables are likely to become rather commoditized or new projects bid up to prices resulting in measly returns (at least in safe countries).

[comeinvestwithme]

@Ján Mazák Well said; what I've been speculating for years in comments to Brookfield articles that cite investor presentations with idiotic ROE projections. If someone can generate 15% return on capital with some power plant, then sooner or later someone else will pay whatever money it takes to generate 10% returns. Game over for the 15% returns. You don't need to be an expert in the industry; you just need a brain to know that there is no risk-free excess return in the long run.

[36510]

Should the situation regarding the rise of management fees also be a concern for owners of BIP?

[dcpope58]

I own shares in all Brookfield companies except for BBU. I was an early investor. I find it interesting that theres not much chatter about their insurance business and subs like Trisura. I’ve tripled my money invested in Trisura. Brookfield managers are some of the best in the business. And yes following the money flows is time consuming and complicated. But I am an investor and not an analyst. I focus on simple things. Am I getting the promised dividends? Are the companies growing and delivering on their financial plans? Do they have sufficient cash or access to it to fund their growth? If so I’m less concerned about inter company flows. It helps to own them all.

[initforthelonghaul]

I just can't get on board with Brookfield companies anymore...I sold out of BEPC, BIPC, BN, and BAM and converted it all over to BX.

[Yakspeare]

@initforthelonghaul I love BX too. I don't think either way you would go wrong

[David Ksir]

@initforthelonghaul what made you bail on Brookfield?

[initforthelonghaul]

@David Ksir I've owned BEP, BIP, BAM, and BN...the yields are fine, but the appreciation is awful the last few years. I see Brookfields intention with the recent reorganization, but it just isn't translating. I hear the argument of yield, but I'm not willing to put dollars at yield when my capital continues to deteriorate.

[User 58804746]

I invested $1,000 in BEPC recently. How long should I let it sit, and should I feel concerned about it? This whole thing is mostly experimental to me, at this early stage in my investing life. I looked into BEP, but decided to avoid it for tax reasons. Also considered BAM, but decided against on a hunch. Here's to hoping I made a good decision! :'D

[David Ksir]

@MatiasNeedsMoney I wouldn't be overly concerned, the target is still 12-15% annual returns to shareholders. Depends on your strategy. Just understand what you're buying and if you like it, keep it :)

[terlen]

I bought BN in 2013 and added in 2018 - my entire investment is up 12% (plus dividends) to Today - i bought BEP in Oct '19 - that investment is up 58% (with both i have the spinoff as well) - from the day i bought BEP in 2019 BN is down 15% and BEP is ahead 36% - again - both not counting the dividends nor spinoffs - and -the dividends are larger for BEP - i don't think you can take one negative and make an investment decision based on it - certainly with a company like BN that is complex enough to make forecasting harder it is unwise - a holding co - like our own portfolios - will have some winners and some also rans - if you are invested in one of the winners you will in all likelihood be better off than were you in the holding co regardless of fee structure - could work the other way also - the point is that one negative doesn't make an investment decision for me

[Celt14]

@terlen I'm not sure how you're calculating your BN returns but everything I've seen says you should be way further up that 12%. In 2013 BN was about $12.50 and in 2018 it was around $22. If you bought in equal portions your cost base would be $17.50 and you'd be up 80% without counting dividends and spinoffs. If you were only up 12%, your cost base would have to be around $28 which is not accurate. I think you haven't accounted for stock splits.

[terlen]

@Celt14 you are right - i just picked the number off my Fidelity Account - something wrong - i will check that - however that doesn't change my point - i wouldn't decide on an investment because of one data point like the fee structure in this case

[Celt14]

@terlen True. If the fees are accurately quantified and included into the valuation calculation, the price could still make sense to invest in BEP.

[A Thomas]

A couple comments. When looking at the fee arrangement associated with BEP should it be compared to other private partnerships in private equity and real estate. These type of hurdle rate then upside sharing arrangements with the GP are common so knowing it BEP is in line with the industry would be helpful. It could also indicate if being a publicly traded entity is there a premium in fees for that characteristic. Your analysis seems to be looking at two separate investment ideas BAM is a different business model than BEP. BAM is an upside driven investment, if BEP gets above its LP investor hurdle rate then the participation increases in percentage. Below that hurdle rate and the participation is at a minimum. One can look at BEP as having some downside protection with a lower upside potential and BAM being the opposite. For this reason are they in fact two separate investment decisions focused on two different risk components of an investor's portfolio.

[David Ksir]

@A Thomas Thanks for insightful comments. Yes, these fees are fairly common in these types of structures and I wouldn't say that Brookfield's are particularly inflated compared to peers. The aim of the article is to make investors aware of these fees that are not insignificant. BEP can still make sense for some portfolios, after all 12-15% target is still nice, but I don't think the downward protection you mention outweighs greater 15-20% return potential for BAM.

[comeinvestwithme]

@A Thomas You can also look at it in a way that BEP has lower upside potential and higher downside risk. There are fixed fees too, not just incentive fees.

[Jacob Olson]

Publicly traded partnerships are an anachronism. Most publicly traded partnerships eliminated IDRs years ago. More recently sponsers have been internalizing the partnerships as the seperate public company costs are not worth it.

[Delray Al]

I also recognized the income sharing approach of the Brookfield entities, but have dealt with it by owning units in BIP and BEP and shares of BAM. That way, I capture the income on both sides. I have stayed away from BN due to its real estate exposure. I prefer to own only specific areas of realty.

[scottiebumich]

@Delray Al I would agree with you about their class B and C office building and their current low valuation it is much more attractive today. Class b n c and of their real estate business, and then when you factor in only North America is having office issues you're looking at 5 or 6%. In Europe and the rest of the world where people don't have mcmansions working from home isn't attractive and possible

[comeinvestwithme]

@scottiebumich I need only about 2 sqm for my desk and my laptop. Like most work-from-home former office workers. I think they have that much space in Europe ;) Actually in Germany for example, typical single family houses are larger than in the U.S.

[Shamanski]

I have a pretty good entry on the recent dip.
If BEP can give me the targeted 12-15% annual return with 7+% of that in a distribution, I will be happy.
BAM has a high valuation and the dividend yield is not that incredible so i hesitate to load up unless it dips more.

I like BX for the best overall asset manager, BX is deep state. OWL is an intriguing value play that has been growing their AUM rapidly.

[Sleepless in Seattle]

@Shamanski Interesting that you'd mention OWL here. I'm long OWL as well as BAM. But I'm still holding BIP and BEP. I like the (relative) transparency of knowing that BEP is renewable energy, BIP is infrastructure and BAM the asset manager. No BN even though it seems undervalued. Good luck.

[NextGenInvest]

@Shamanski How does BAM have a high valuation? At what price would you buy it?

[Shamanski]

@NextGenInvest
I believe the multiple is above 20, below 20 would be cheap. Doesn't mean it will happen though.
I have good exposure to asset managers and own a very small amount of BAM already so I am in no rush to jump in.

[Yakspeare]

I love Brookfield, I like their timelines and capital recycling and love both BIP for diversity in assets of toll roads, midstream, ports and tech. Love BEP for its novel power generation, knowing where the growing trend is and where governments encourage investment. They are both quite reasonable set and forget investments.

I look at BN, and I like much of its structure and all the ancillary things like real estate and insurance that are basically included for free. But I like my yield and though the sum of its part should mean considerable capital appreciation, the market doesn’t want to reward it on its own.

That’s where BAM comes in, it is one sweet vehicle of asset light and has a matching yield to BEP and BIP or close enough. It’s growth potential is enormous and yes, then, that would help bring BN up finally.

So those days I only invest in BAM. If I had a second choice it would be BN.

[scottiebumich]

@Yakspeare BAM is really quite expensive when you compare it to its competitors (also those also receive carried interest, which BAM won't for 5+ years).

[36510]

@scottiebumich What competitors are you referring to?

[scottiebumich]

@36510 The Blackstone Group, Apollo, KKR, TPG, Onex,

[The Quant Investor]

You forgot to cover the additional management fees based on each dollar of market cap beyond a certain level. Pretty sure all the LPs have it as well.

[mdfuller_OR]

@David Ksir well put (pun not intended). I realized awhile back (after reading a great BAM analysis here on SA) that the 'spokes' (BEP, BIC, etc) are in place to make the wheel (BAM) money moreso than common shareholders. That's the priority of the spokes. I've sold all common in the wheels, but gladly accumulate preferred offerings at right price / yield and take advantage of that cash flow, just not tied to common (BEP-A and BIPH).

[Common Shares]

@mdfuller_OR you know they use the pref market to generate alpha for BN as well right? A lot of their prefs were bought back in at big discounts to par periodically.

[mdfuller_OR]

@QAAP yep they’re BN tools for sure, but it’s an easier game to play along with while keeping my toes and fingers compared to common - imho - used to own common and learned my lessons… you know, fool me ….

[Common Shares]

@mdfuller_OR panic sold the common?

[Spanishmoss]

@David Ksir your article just confirms what I think about the complex structure of (once BAM) BN, BLK and other similarly structured private equity groups. They are comprised of the smartest, best connected and greediest investment professionals on earth and to invest with them is tantamount to riding a tiger. I wouldn’t compare them to ENRON except to say I’ll bet the managing partners of their accounting firms are reluctant to cause waves (cause they are being paid a fortune) and are probably not as smart (certainly not as knowledgeable) as the numerous YieldCo managers. GLTA!

[David Ksir]

@Spanishmoss Thanks for commenting! It’s quite complex, no question about it, which is why I really want to be on the same side as management.

[Spanishmoss]

@David Ksir good call!

[scottiebumich]

@Spanishmoss I'm not quite sure I understand why I've been thinks these companies are so complicated start at the top structure look at their balance sheet and then look into each individual security that they own which is a subsidiary and has their own reporting and you could dive in and understand each one separately. Then understand the incentives distributions financing of debt structuring New Deals and it's actually pretty straightforward

[GMakdo]

Thanks for another great Brookfield read! I'm enjoying your articles! Just waiting BEP to climb another 7 or 8%, so I can break even and sell into BAM as well. Been thinking of doing what you've done for a while, just waiting for the price to be right!

[David Ksir]

@GMakdo Happy to help. Always nice to hear good feedback! Good luck with the switch.

[Tino1108]

What about BEPC?

[David Ksir]

@Tino1108 most likely the same thing as shares are supposed to represent the same economic interests as BEP.

[wdjax0n]

@Tino1108 BEPC always sells at a premium over BEP because of general dislike for the partnership hassles and K-1s. Many institutions cannot invest in limited partnerships but like the entity. BEPC's premium is about 8% just now for what is supposedly an identical economic interest in its business. No thanks, going for BAM.