Description

Investment Structure

Long Brookfield Corporation (BN) and short Brookfield Asset Management (BAM) in a 1:0.75 ratio. 

Background

On December 9, 2022, Brookfield completed the distribution of a 25% interest in its asset management business, which established two publicly traded companies - Brookfield Asset Management (BAM) and Brookfield Corporation (BN). The purpose of the transaction was to highlight the value of the asset management franchise as a stand alone entity, which would be a catalyst for re-rating and allow BAM to use an “appropriately” valued share currency for M&A. For example, prior to the distribution, the market valued the former Brookfield combined entity at $70-$80bn. However, post the transaction, management expected that shareholders would own 1 share of BAM that represented a 25% interest in the asset management business, worth +/- $20bn (or $80bn implied value for the asset management business in aggregate), plus 1 share of the corporation that would then hold +/- $135bn in investments (of which the retained 75% share in the asset manager would be roughly $60bn). 

In other words, move some assets around here, carry the one… boom, you have a doubling in value for shareholders. 

Of course, it didn’t exactly play out that way. Instead, on the day of the distribution, Brookfield Corporation (remainCo), took a $15bn hit in market capitalization (~20% step down) while the new Brookfield Asset Management began to trade at an implied $60bn value. I believe this has created a very interesting set up for shares of BN. 

The Manager Distribution

Alternative asset management platforms with long dated capital commitments and a track record of investment success are often wonderful assets to own. However, at a $55bn valuation, I believe Brookfield Asset Management is overvalued. While this transaction was headlined as the distribution of a pure play asset management business, it’s not that straightforward. Brookfield Corporation (BN) retained all carry from the existing funds (2021 vintage and prior), and BN is entitled to receive 1/3rd of carry from all new funds. As a result, management expects BN to earn ~95% of the gross carry realized over the next 5 years and ~75% of all gross carry realized over the next decade. As can be seen by the graphic below presented at the Brookfield 2022 investor day, this is a substantial dollar value. 

Putting this aside for a moment, Brookfield Asset Management (BAM) still trades at a substantial premium to relevant comps on an FRE basis. BAM trades at 26x FRE, compared to 25x FRE for Blackstone, 14x FRE for KKR, 15x FRE for Carlyle, and 11x FRE/SRE for Apollo. Thus, on a pure FRE basis, BAM trades at a 60% premium to a blended multiple of these comps. However, again, all these comps are entitled to meaningful carry revenues. Recall that for a typical PE fund charging 1.5% and 20%, a 2.0x gross MoC outcome would imply gross carry revenues that are double that of management fee revenues. These alt platforms have been growing rapidly, and carry lags by 5+ years, which is why one might at first glance think that carry is not a super relevant factor for the comp set. There are of course a lot of factors in play, and the market hates that uncertainty, but I would expect on a no-growth basis that carry revenues/earnings are between 50-125% of management fee revenues for many of the scaled alts. Therefore, I believe BAM is more realistically trading at a ~100% premium to the relevant set of comps. 

Reported Values

There are currently ~1,635 million shares outstanding of both Brookfield Corporation (BN) and Brookfield Asset Management (BAM). (note: float for BAM is 409 million shares). BN currently trades for ~$33.8/share, while BAM trades for $33.4/share. Thus, both entities currently have a ~$55bn market capitalization. One can isolate Brookfield Corporation’s non asset management balance sheet exposure by shorting 3 shares of BAM for every 4 shares of owned BN. The result would be recreating BN’s other balance sheet investments for ~$14 billion, which I believe is a highly attractive proposition. 

Here is what that looks like using management’s reported “blended” values, which I believe are aggressive, but nonetheless are an interesting place to start. For those less familiar, Brookfield’s balance sheet assets largely consist of controlling stakes in perpetual listed partnerships. Today these consist of a ~48% ownership interest in Brookfield Renewable Partners (BEP), a ~27% interest in Brookfield Infrastructure Partners, a 65% interest in Brookfield Business Partners, a 100% interest in Brookfield Property Group (BPG - acquired the entirety of BPY in 2021), and a near 100% interest in Brookfield Reinsurance. In addition, BN has ~$3bn in cash and other investments and ~$5bn of accumulated net carry. The result is $67.2bn in assets offset by $11.4bn of term debt fixed at 4.2% with 13 years of average term, plus 4.4% of perpetual preferreds. Or, $51.4bn of net assets, which is 3.6x higher than the implied non-BAM stub of $14bn. Note that the analysis above does not factor in BN’s central corporate costs of ~$600m per year, but it also does not include BN’s share of 1/3rd of future carry which is likely to offset this and more over future years. For instance, Brookfield Asset Management estimates that BN’s 1/3rd share of current “Target Carried Interest” is $465m annually. This of course won't be realized for some years, but it is a figure that will be growing, a likely at a faster pace than centralized costs. 

Valuation Adjusted

We can build an independent view on the value of BN’s balance sheet by focusing on cash flows. For both BIP and BEP, I believe it is reasonable to use distributions per unit as a conservative proxy for earnings power. Note that over the last 22 years BEP has grown its distributions per unit by ~6% per annum, and over the last 14 years BIP has grown its distributions per unit by ~9% per annum, while both have maintained payout ratios between 70-80%. We must then adjust the current distributions of $1.53 and $1.35 respectively for the IDRs that BAM owns. At current distribution rates, BAM takes approximately 17% of all BEP distributions, and 10% of all BIP distributions. The result is that Brookfield Corporation receives $628m in net annual distribution from its owned BEP and BIP shares.

BPG is the vehicle that is likely to garner the most debate. Its assets largely consist of assets at BPY prior to Brookfield’s take private in 2021. Immediately before the takeout offer, BPY traded at $14.4 per unit, which implied a ~$15bn market value. Today those assets are held by Brookfield at a valuation near $30bn. With the direction of interest rates since, it’s hard not to feel like there might be a dose of fantasy here. That said, assets like RE are a bit of a catch-22. If one only considers the cash flow you take home as an owner of the asset, it's likely to often seem unattractive to public equity investors. However, it's an asset class where many will sign up for a lower return, and pay up a good bit for trophy assets. Perhaps reality is somewhere in between. I think using the average distributions paid over the last three years is a reasonable proxy for earnings power, as it is 25% lower than the distributions paid in 2022, and implies a 3.9% yield on where Brookfield marks BPG. The result is $1.3bn in annual distributions. For those wanting to double click on the real estate assets, I recommend you review the recently filed annual for BPY (https://otp.tools.investis.com/clients/us/brook_bpy/SEC/sec-show.aspx?FilingId=16433505&Cik=0001545772&Type=PDF&hasPdf=1)   

I use a 50% discount to headline FFO as a proxy for earnings power for BBU and BNRE, which I believe is highly conservative. BBU has compounded value at attractive rates for several years, and its embedded deployed capital is likely to produce substantially more on an annualized basis than our rough estimate over the coming monetization cycle. The estimated annual earnings power for BNRE implies an ~8% ROE for the capital Brookfield has deployed in insurance solutions, which is approximately half of the ROE figure that both Apollo and KKR expect to generate with their own controlled platforms. The result is $428m in contributed annual earnings from BBU and $349m in contributed annual earnings from BNRE. 

Finally, I believe a $500m run rate in carried interest is a reasonable figure for BN. Of the ~8bn in retained gross carried interest ($5bn net), Brookfield expects that this will be 90% realized over the next 7 years. On a straight line basis, this would $640m in net carry per annum. By the end of this period, BN’s 1/3rd interest in new fund carry would have scaled into a meaningful number. Consider that if the current “target annual carry” figure compounds at 10%, it would reach ~$820m annually for BNs share by the end of the 7 years. 

Finally, we back out corporate costs and the $671 of interest costs which are entirely fixed and have an extremely long duration. The outcome is $1.94bn in earnings against $14bn in stub equity value, or an implied 7.2x multiple. Notably, there is tremendous upside here in the event that Brookfield can monetize assets anywhere near where they have them marked and redeploy into higher yielding investments. 

Risks

The big risk here is obviously basis risk. I believe the relative valuations of BN and BAM are highly irrational, but there is nothing that could keep them from getting even more so. I also think an outright long position in BN is attractive at these prices, or a short that hedges out less than the entire BAM exposure.

Catalyst

-share repurchases