Brookfield Asset Management - CASE STUDY
Eric Schleien, Portfolio Manager
Q4, 2018 —
Brookfield Asset Management (BAM) is the industry leader in managing real assets.
The business consists of two parts: 1) their asset management arm; 2) their invested capital. Their model is unique and is one of the few companies in the world that is in a position to pull off what they’re doing.
Publicly traded real asset companies are often given a bad name and deserve to trade at low multiples. If we look at the company as a pure asset management business, that industry has been hurt due to the large amounts of capital going into passive investments. However, Brookfield Asset Management is immune from this trend (which I will explain more later).
On the other hand, publicly traded listed assets, especially in partnership form, are also often unattractive to investors. Many of these companies have egregious management compensation schemes and will often value empire building over increasing shareholder value through the use of selling stock to buy new properties. Brookfield’s publicly listed partnerships are instead incredibly well managed and I believe their private market value is higher than what the units currently traded for in the public market.
Asset Management Business
Their asset management business has a few important facets to its operating model:
Global Reach + Scale. Brookfield has a value investing culture with a global reach. Due to their scale, this allows Brookfield to buy into opportunities without a lot of competition leading to more opportunities for deployment of capital at high yields.
Operation Experience + Relationships. Brookfield has operating experience and relationships on the ground that far surpass almost any other asset manager. This enables Brookfield to manage assets they purchase better than most firms. Due to their reputation of being a quality operator, they’re more likely to get the upper-hand in deal-flow far out into the future.
Alignment of Interests + Capital Deployment Flexibility. Brookfield invests alongside their funds. This gives management skin in the game as management owns ~20% of Brookfield. This also gives Brookfield flexibility to deploy capital in a way that most asset managers won’t. Since much of their invested capital is publicly listed through spinoffs, they can use their own funds as currency when making new acquisitions and they can also buy back their own partnership units when they deem that to be the best use of their capital. Their asset management business (which this year was the first time that the intrinsic value of their asset management business surpassed their listed investments) creates an asset-light growth engine with cash flow that can be used to seed new funds and invest more capital, buy back their own stock, or make acquisitions. This flexibility allows for enormous cash flow generation and allows a model where capital doesn’t have to stay tied up in illiquid assets.
There are several ways to value Brookfield. Brookfield’s management uses a sum-of-the-parts valuation for valuing its equity when making business decisions. While many management teams use aggressive assumptions, Brookfield’s business has a high degree of predictability baked into it due to the purchasing of stable cash flow producing businesses. Brookfield has a history of making assumptions which turned out too conservative. For example, five years ago Brookfield projected that their fee-related earnings would grow from 302 million in 2013 to 675 million in 2018. The actual number turned out to be 861 million for a total annualized growth rate in their fee-related earnings during the past five years of a 23.31% CAGR. Brookfield projected that their target carried interest would go from 263 million in 2013 to 427 million in 2018. The actual 2018 number was 808 million producing a CAGR of 25.17%. What’s mindblowing is that their runway for growth and capital deployment at high rates of return is huge. Their asset management business even using conservative estimates leads to continued double-digit growth in their asset management business and a high single to low double-digit growth in their listed partnerships. This can be a bit daunting to grasp at first as Brookfield is not a small company. However, Bruce Flatt has talked about this for years now and he brings up the point again in this year’s shareholder letter:
“We are often asked why we do not have the same issues that some public equity managers have investing funds as they grow larger. The difference is that infrastructure (as well as real estate and private equity) usually becomes more attractive as investments get larger. The competition for larger acquisitions is less and the sophistication required to operate these assets increases because of their complexity, therefore favoring large and experienced managers. Lastly, the larger assets acquired are generally also higher quality – they often have better counterparties, and stronger management teams. As a result we believe that our infrastructure business can scale to many times the size it is today.” — Bruce Flatt
Without getting too into the weeds into each of their listed partnerships (which I believe are currently generally undervalue), Brookfield values their fee-related earnings on their asset management business at a 20x multiple. I believe this is appropriate as their asset management has a huge runway for growth. Management predicts institutional investments into real assets are on track to double over the next decade. Unlike many asset managers whose business models are being put under pressure towards a trend which I believe is long-term into passive investing, the CEO, Bruce Flatt makes it clear that ETF’s have not been able to replace Brookfield’s investment model:
“Another major trend affecting the financial markets is that large sums of capital are being allocated from active public equity mandates towards passive strategies (through ETF’s and other means). This shift is being driven by passive products offering low, sometimes no, fee alternatives and the perception (rightly or wrongly) that the returns, after fees, on passive funds can match or exceed those of active public market equity strategies. In the face of this pressure on active mandates, private investing continues to grow rapidly – for many reasons, but primarily because private asset investing simply cannot be done passively. The good news is that ETF’s cannot replace what we do! More specifically, it takes a lot of time and skill to acquire assets, and a lot of time, expertise and effort to operate and optimize these types of assets.” ~ Bruce Flatt, 2018 Brookfield Asset Management’s Letter to Shareholders
As of February 2018, management lays out in plain sight their own internal estimates of a SOTP analysis:
If we value the business on an FFO basis, the company trades at ~10x FFO. Current FFO sits at 4.3 billion. In 2012, FFO was 1.4 billion: a ~17% CAGR in FFO.
Any way you look at it, Brookfield has been firing on all cylinders and their large runway for growth and capital deployment makes this security attractive today at $44 with a 40% upside just from the current SOTP. Even if we assume the company should be worth 12-15x FFO, that brings us to a share price of 17% - 46% upside based off today’s numbers.
As I said before, management has been conservative on all fronts with their guidance in the business and their assumptions for future metrics have always been below what they actually ended up achieving.
The company expects to more than double their private fund fee bearing capital over the next five years. They’re projecting $121 billion dollars in fee bearing capital within 5 years which would equate to a 16% CAGR. Historically, this guidance has been conservative. The management also believes that their listed partnerships will grow by 13% CAGR to $101b over the next five years. I don’t think this number is conservative but I see it as a likely ballpark of what they’ll actually do based off the kinds of opportunities the listed partnerships get to invest in.
Overall, Brookfield expects to increase its fee bearing capital to $245 billion in the next five years when you combine the 101b for their listed partnerships, the 121b in their private funds, and they expect their public securities to go from 16 to 23 billion over the next 5 years which I would guess to be on the conservative side. The company projects that $245 billion in fee-related capital would equate to fee-related earnings of 1.9b. At the time of this projection, their estimated fee-related earnings for 2018 was 861 million. The 2018 shareholder letter ended up showing fee-related earnings of 1.129 billion! Again, the trend towards conservatism continues.
Brookfield also estimates that their net-carry generated will equate to $1.75b over the next five years.
If we use the numbers that management uses (which I deem to be on the conservative side to realistic side), we get the following over the next five years.
Fee-related earnings: $1.9b x 20 multiplier
Generated carried interest, net: $1.75b x 10 multiplier
Accumulated carried interest, net: $7b
Invested Capital: $66b
= Total Market Value of Brookfield Asset Management in 5 years = $119b or $118/share.
This equates to a 170% return over the next 5 years.
Intelligent Allocation of Excess Capital
The company has invested capital at incredibly high rates over the past decade. I won’t get into each fund specifically but the returns have mostly been extraordinary and have all ranged between high single digits to low double digits. The company has an internal IRR goal of producing returns in excess of 12% - 15%. Over the past 10, 20, and 25 years, the stock performance which has been a rough proxy for investment performance has returned 17%. Most of their funds meet or exceed their IRR targets.
Going forward, the company will be planning on return massive amounts of cash to shareholders. This should pique interest to any value investor. The company projects that over the next 10 years they’ll be able to conservatively generate 20b in fee-related earnings and produce $25b in cash from net invested capital, and another $15b in cash from realized carried interest. Out of that total of $60 billion, the company assumes they’ll be able to invest about $10 billion of that into their listed partnerships, return $10 billion of that through dividends, and then buyback stock when they deem Brookfield shares to be undervalued (like they do now) with the remaining $40 billion.
Long Growth Runway
So here we have a company with a huge runway for growth ahead of them based off large macro trends in infrastructure, a low valuation whether you look at it from an FFO perspective or a SOTP perspective and the company expects to generate cash over the next decade that is in excess of the entire current market cap of the business. As the company continues to grow and build their reputation, their competitive moat will only increase over time.
One risk is interest rates spiking. However, this is mitigated by the fact that the business is conservatively financed, and that cash flows should increase as rates rise. In addition, this will lead to more deal-flow as over-levered assets will be put on sale for Brookfield to take over at even better prices than are available today. Also, because of Brookfield’s global scale, they are able to move capital to the countries they deem to have the best value opportunities. This is an industry leader that is only just getting started and I believe that an entry point at today’s $44 will allow an investor to hold this security for a very long time (a punchcard bet for me and a current 20% allocation for my investors) while being able to also defer taxes for many years (which is also a real asset in it of itself and an interest free loan from Uncle Sam).
There is also a risk that Bruce Flatt gets hit by a bus. However, the Brookfied team has been together for a very long time and the management bench is deep. Bruce Flatt has said that any of the CEO’s of the listed partnerships would be just as capable to run the business.
Best of breed company with incredible business headwinds for most likely many years. Incredible capital allocation with a long runway for growth through the deployment of capital at high growth rates and the ability to buy back loads of stock with large cashflow generation. Even if the future projections are wrong, they have to be wrong by A LOT to lose money on this over the next ten years.