Description

Business overview

Brookfield Asset Management is an owner & asset manager with $509 bn in assets under management, of which $227 bn is fee-bearing capital (pro forma for the Oaktree acquisition).  Of the $227 bn of fee bearing capital, $65 bn is in listed partnerships (BPY/BEP/BIP/BBU, of which it owns 51%/61%/30%/63% respectively), $53 bn is in flagship private equity funds, $26 bn is in core and other funds, and $83 bn is in Credit & public securities.  Brookfield currently has $50 bn in liquidity to deploy into potential opportunities.  Brookfield primarily focuses on industries with hard assets, specifically real estate, infrastructure, and renewables.

Thesis

You can buy BAM and hedge out its public holdings to create the Brookfield asset management stub.  I think the stub has 30% upside to conservative fair value based on LTM earnings (20x FRE + 8x incentive); framed another way, my one-year price target on the stub is ~53% higher than where it currently trades. 

BAM currently has a $53 bn market cap, of which $28 bn is invested capital, resulting in a stub value of $25 bn.  I think the stub will be worth $38 bn in one year.

1.       BAM’s current fee-related earnings (FRE) are $1.2 bn. Assuming FRE compounds at 8% for 2 years (BAM is guiding to 16% per year), 2021 FRE will be $1.4 billion.  I think this deserves a 20x multiple and should be valued at $25.0 bn (net of a 10% tax rate).  My choice of 20x multiple is driven by both the stickiness of private assets as well as BAM’s future growth. 

a.       BAM currently plans to increase its fee-bearing capital from $227 bn currently to $396 bn in 5 years or a 12% CAGR. It’s important to note that the 20x multiple I use only requires BAM’s asset growth to come in at a fraction of this rate.

                                                              i.      This forecast assumes:

1.       Listed partnership AUM to increase from $65 bn to $103 bn over 5 years. This comes from:

a.       $17 bn of value creation from distribution growth (inflation + capital retention)

b.       $13 bn of market value growth (a somewhat aggressive assumption)

c.       And $8 bn of issuances. 

2.       Private Funds and Public Securities AUM to increase from $162 bn to $293 bn over 5 years. This is driven by

a.       Raising an additional $53 bn for Brookfield’s flagship funds in 2021-2023,

b.       $17 bn for the subsequent round of flagship fundraising,

c.       $27 bn growth in Core & Other,

d.       $56 bn in Credit & Public Securities,

e.       The above are offset by $22 bn in realizations.

f.        I don’t think these fundraisings are controversial because competitors have gone through significant fundraisings recently – CG just recently eclipsed its $100 bn 3.5 year fundraising goal, while BX raised $100+ bn in 2017/2018 and most likely will exceed that in 2019.

b.       It’s helpful to note that BAM is currently outperforming its 2018 investor day FRE projection by about 5%.

2.       The incentive run-rate is ~$1.2 bn and deserves an 8x multiple, which gives it a value of $8.4 bn.

a.       The incentive earnings of a long-only, diversified asset manager with very sticky capital is a valuable asset, because over time, the assets both grow in value and produce cash.

b.       The value of this income stream also benefits from BAM’s future growth as discussed in the above FRE section. 

c.       I realize that incentive earnings are risky and cyclical, but I think the relatively low multiple for the incentive adjusts for this factor.

3.       There is an additional $1.8 bn of net accrued incentive at BAM and $380 million at Oaktree.

a.       The combined valuation of these assets is $32 bn, or a forward value of $34 bn including 1 year of FRE and Incentive generation taxed at 10%. 

4.       Additional Points:

a.       The invested capital is reasonably hedge-able: it comprises $41 bn of assets, less $11 bn of liabilities with some minor pro-forma adjustments for the Oaktree acquisition. Of the $41 bn in invested capital assets, $29 bn is listed and hedge-able, and another $4 bn is cash/financial assets. This means that most of BAM’s underlying holdings can be hedged and have little volatility.

b.       I assume a 10% tax rate for conservatism even though BAM currently is guiding to a 3-4% tax rate on FRE. This is driven by BAM’s significant NOLs, continual acquisition of businesses with NOLs, and other favorable tax attributes in its business.

c.       The combined company shouldn’t have a discount to fair value because the parent company does not improperly enrich management and it has demonstrated that it can compound capital well.

Managing private market assets is an attractive business

1.       The size of the business benefits from capital markets’ secular growth over time.

2.       Unlike other balance sheet-heavy financials, asset management is very capital light and requires little incremental capital to grow.

3.       Pricing is reasonably stable:

a.       While LPs like lower fees, having low fees alone doesn’t allow a firm to raise assets and alternative asset managers don’t try to gather assets on the basis of low fees.  Brookfield’s base management fee rate has remained almost entirely flat since 2013 (92 bps LTM vs. 93 bps in 2013)

4.       Margins are high:

a.       The large sums of money involved mean firms can pay employees well while retaining a large percentage of the revenues.

b.       Employees have somewhat limited bargaining power because at any one time there are few senior open seats available that would pay reasonably better than a senior position at a large asset manager.

5.       Investors are allocating more to private assets because of their perception of higher returns.

a.       Pension funds are underfunded.  The easiest way to try to solve the problem is by allocating to a higher targeted return asset class (even if its leverage is higher).

b.       According to consultants, private equity has beaten public-market-equivalent returns.

c.       Some LPs like the perception of less risk driven by both private marks and the GP’s control over the investment.

d.       Even if forward returns on private markets are unattractive on a risk-adjusted basis, it will take a long time for investors to realize this, and an even longer time for them to act on it.  

Brookfield vs. other private asset managers

Brookfield’s asset management business is better in many key aspects than competitors’:

1.       A high percentage of well-structured permanent capital AUM.

a.       $65 bn of the $227 bn of the fee-bearing capital is in listed partnerships or effectively true permanent capital.  The earnings from this asset stream should deserve a high multiple because they are perpetual and invested in high-yielding assets (real estate, infrastructure, etc.) that can afford to pay high fees. This is different than what other asset managers call permanent capital.

                                                              i.      For example, APO refers to the assets it manages for Athene as “permanent capital” but annuities eventually expire.  Also, managing insurance money in a high-risk way is a regulatory tricky proposition.

                                                            ii.      Other asset managers refer to their BDCs as permanent capital, but frequently onerous BDC fees prevent BDCs from raising additional capital and the underlying assets are reasonably risky (debt in levered LBOs that is levered at the BDC level).

2.       Brookfield benefits from its significant scale in its funds. While scale is often the enemy of returns in public markets, in private markets reasonable scale (less than what Berkshire has but more than a low-billion dollar PE fund may have) has several advantages:

a.       Ability to operate a multi-strategy multi-country investment platform that allows for capital allocation to the most attractive investment area at any given time

b.       The ability to look at large transactions with limited competition, as well as to not need co-investors or require fewer of them:

c.       Funding to incubate new strategies in attractive areas

3.       Given its background in real estate and infrastructure asset ownership, BAM has unique capability in developing assets. For example, its listed BPY partnership has a $5.1 bn development pipeline.  I view this as an attractive way to deploy capital in a high valuation environment.

Management

1.       Management has been working together for a long time:

a.       Bruce Flatt joined Brookfield in 1990 and became CEO in 2002.

b.       Brian Lawson joined Brookfield in 1988 and held a number of senior management positions in Brookfield’s investment and finance operations before becoming CFO in 2002.

c.       Brian Kingston is the CEO of Brookfield Property Group and Brookfield Property Partners. He joined Brookfield in 2001 and was named CEO of Brookfield Property Partners in 2015.

2.       I think the compensation levels for top management (mid-single digit millions per year, per the proxy) are very reasonable for a giant asset manager.  I also like the long-term share ownership orientation of the compensation plans, the fact that escrowed shares generally must be held until the fifth anniversary of the award date, and that deferred share units can only be redeemed for cash upon cessation of employment through retirement, resignation, termination or death.

Risks

1.       A prolonged market downturn results in no incentive earned.

a.       Mitigant: The stub currently values the incentive at only $1 bn so there shouldn’t be significant value impairment if this scenario occurred.

2.       Poor underlying fund performance vs. competitors.

a.       Mitigant: Given how slowly institutional investors re-assess managers and BAM’s operational ability to try and improve the performance of its assets, I think it’d take a very long time for investors to become dissatisfied with BAM.  

3.       Higher interest rates that depress long-duration asset values

a.       Mitigant: Higher interest rates are likely to come with higher economic growth which is usually a tailwind to fundamental performance and valuations.

Disclaimer: This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation.  This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Waiting for Brookfield stub to reach fair value as investors appreciate the stability of FRE and see incentive continue to accrue through-cycle.