Brookfield Infrastructure Partners, L.P. (“BIP”) is a NYSE listed publicly traded partnership (PTP) based in New York, which was spun out of Brookfield Asset Management (“BAM”) in January.  BIP is a PTP, not a MLP, so it is a little complex in terms of organizational structure, but I believe it offers a very strong risk reward here at $18.90/share, as it is 19% below book value of $23.29 (as of 3/31/08), has superior timberland and transmission assets and a 5.6% yield.  I believe the downside is very little, but the upside is 30%+ over the next 2 years as BIP proves its assets are superior, grows it transmission business and finds accretive acquisitions to diversify its portfolio, as it has historically done at BAM. 

 

 

BIP is a publicly traded partnership, externally managed by BAM with a small team of 20 assigned to work exclusively on BIP and its assets.  BIP has no direct employees.  Its only material asset at this point is a 60% interest in an infrastructure partnership (“IP”) that is externally managed by BAM, which owns the other 40%.  50% of BIP was spun off to BAM holders on 1/31/08, 40% is still owned by BAM, and BAM management and directors own 10%.  BIP’s mandate is to grow and harvest its strong transmission and timber assets, as well as look to diversify in other areas of infrastructure, just not real estate or power generation, which BAM continues to pursue.  BIP has stated it wishes to grow ANOI (their FFO) at 6-8% per annum and earn an unlevered return on equity of 11-15% per annum.

 

BAM gets an annual 1.25% management fee as a % of equity value of BIP, plus an incentive distribution equal to 15% of distributable cash flows above 30.5c/unit per quarter (now at 26.5c/unit) and 25% of distributable cash flows above 33c/unit.  In terms of ECI and UBTI income, you should consult with your accountants but BIP does not generate either as of now, but may have UBTI in the future, not ECI. 

 

BIP’s ownership of the IP’s assets is as follows:

 

 

 

Island and Longview both are very high quality douglas fir and hemlock timberlands, which historically have yielded the highest prices and experienced less price volatility.  However, timber is very much tied to residential construction and those with the ability to ship overseas to Asia and other still growing markets are benefiting on a relative basis.  BIP is doing just that and has diversified its customer base to Asia and is now shipping roughly 30% of harvest to Asia.  This has muted the pricing and demand issues some, but 07 was weak and 08 will likely be the same on a ROE basis for the timber businesses. 

 

Island consists of 635k acres in coastal British Columbia, and it was purchased from Weyerhauser in 2005 for $950mm.  The purchase price also included a struggling paper converting business that BAM kept to try and turn it around.  BAM was not the highest bidder but their ability to close the deal quickly and their relationship with Weyerhauser got them the deal.  (This is an important M&A advantage for BAM/BIP and something they often allude to)  Given it is on the coast, its distribution flexibility is relatively high and it is in close proximity to several large customers.  Island expects 900k cubic meters/year for the next 9-10 years for its harvest.  Island is also working on monetizing its 33k acres of HBU land.  Island has 58mm cubic meters of merchantable inventory, which is 45% douglas fir, 30% of hemlock and rest is cedar and whitewood (lower quality).  Island harvests and hauls its logs vs. selling them at the stump.  Its margins are in the 30-40% range on an operating basis.   Island sells mainly to the US, Canada and Japan.  It has to sell first to Canadian users under Canadian export rules, but given recent beetle infestation problems this regulation hasn’t hurt pricing much, or Island’s ability to sell overseas for higher margin.  It sells roughly a third to each country, so currency impact is muted.  33k acres within Island is designated as Higher and Better Use land (HBU).  These were valued last on 12/31/06 at $320mm, so BIP’s 37.5% interest is equal to $120mm assuming that appraisal is still accurate.  A haircut is necessary given the date of appraisal and a time value discount, but management has said it wants to increase the monetization of this HBU land to enhance cash flows.  I have valued it at $80mm.

 

Longview consists of 588k acres in Washington and Oregon.  It expects 800k cubic meters/year for next 10 years and is increasing its international exports.  Longview was acquired by BAM in 2007 for $2.15BB, valuing the land at $1.85BB and the manufacturing facilities at $300mm.  Longview has 37.5mm cubic meters of merchantable inventory, which is all high quality douglas fir and hemlock.  Contrary to Island, Longview sells its timber at the stump, allowing for much higher margins in the 60% range. 

 

Pricing in 2008 has been weak due to the significant weakness in US housing, but supply has also been down, affected by the pine beetle infestation in Canada.  The infestation has not occurred at Island’s timber yet and they don’t expect it to, but it could happen.  Also, Russia has initiated large export tariffs over the next few years, which will make its timber more expensive to Asia, allowing others to ship more to Asia.

 

These assets are rare and there still exists a decent acquisition environment for high quality timberlands.  Transactions for this high quality timber have been in the $3000-4000/acre range for last 18 months, even with low ROIC’s currently being earned given environment.  More on that in the valuation section but a deal was just done at $4000/acre by Rayonier.  In recent PCL write-up on VIC, gearl alludes to strong TIMO demand still driving prices, but we don’t know how long this will last and timber historically has done OK in inflationary environments. 

 

 

BIP has a crown jewel in Transelec, which BAM acquired in 2006 as part of a consortium.  BIP now owns 17.8% of Transelec after it completed on April 7th its additional $111mm investment to buy an additional 7.1%.  This has proven to be a very good deal for BAM/BIP as Transelec is projected to do over $400mm in 2008 EBITDA…

 

Transelec is a regulated electricity transmission company in Chile and controls 100% of the high voltage lines and 50% of the low/mid voltage lines.  Transelec gets a guaranteed 10% real return on the regulated business, which is calculated by the Chilean government based upon the replacement cost of the assets, and Transelec must keep up with the maintenance capex.  So if the replacement cost of the assets (currently at $494mm) goes up faster than the needed maintenance capex (currently at $7-10mm per year for BIP), Transelec’s return moves higher from the 10% base.  So the current math is that the asset base rate increase would need to grow only by 1.7% per annum ($8.5mm avg maint capex / $494mm asset base) to equal their maintenance capex costs.  In 1Q 2008 for example, the periodic rate review produced a 4% annualized rate increase while capex remained flat, illustrating the attractiveness of the Transelec asset.  Seems very likely to continue but I have assumed they equal out to be conservative.

 

On the non-regulated contract business, the revenues are fixed based on the RFPs and have inflation kickers.  So on the contract business it wins to build more lines or stations, given its history with Chile and dominant market position, it is capable of being accurate on its margin forecasts.  Management is very confident it can continue to achieve 10%+ real returns on this business as well and is clearly the probable winner on any project it bids on given its scale, relationships and history with Chile.  Basically have a monopoly here with strong real returns and the ability to grow with any projects it wishes to bid on.   Additional capital projects will come up for RFP the next few years and BIP has earmarked $30-40mm per year of capex projects for its transmission businesses. This could provide strong growth for BIP and its unlevered cash flow.  60% of 2008 capex goals have been committed already.  The debt related to Transelec is all at Transelec, not at BIP, and is $1.5BB.  60% of this debt is in UF Bonds, similar to US TIPS in Chile. 

 

BIP recently completed its Ontario Transmission purchase on March 12^th for $91.6mm funded by cash on hand supplied by BAM, and it is also a regulated electricity transmission provider in Canada.  The regulated return on this business is 8.61%, however it includes depreciation and is adjusted based upon future expected capital outlays, even if they are not done when the rate base is changed.  The net effect is a higher ROE vs. the assumed return, and lately the ROE has been above 13% for 2007 and 08 YTD.  Not as strong a “guarantee” as Transelec but still a good business for BIP.  Like Transelec, a lot of capital projects could increase earnings for this business and there are over a $1bb of projects that Ontario Transmission is considering. 

 

Lastly, BIP has ownership in TBE, which operates transmission lines in Brazil.  BIP carries this investment at cost on the balance sheet and uses the cost method for recording dividends from TBE as income on its P&L.   BIP has $163mm in TBE as cost, and it received $11mm in 06 and $16mm in 07 as dividends.  These don’t fully reflect the ROIC though, as TBE used some cash flow to pay down debt.  The key on TBE is that in the 4^th quarter of this year, BIP can exercise a put back to TBE for its interest, calculated using a 14.8% return on its cost, in Brazilian reals which is a coup given the real’s strong move vs. the $.  Management estimates the value at $240-250mm and $210mm after tax, and all signs lead to them putting it to build more liquidity for future deals.

 

 

$920mm of debt and all is non-recourse, based at the project level.  They are comfortable with as much as 60% debt to capital – it is now at 50% given book value is $900mm as well.  They want to match the fixed rate debt to the underlying assets of each project to minimize local currency and interest rate risk given projects are inflation adjusted.  They have benefited greatly from the Chilean peso and Brazilian real, so have 100% hedged the equity portion going forward.  All debt carries no maintenance covenants and is sized to provide BBB-/BB+ ratings.

 

They just closed on a $440mm credit facility, for acquisitions and working capital.  The TBE put most likely will be exercised, providing another $210mm roughly of liquidity.  Lastly, at BIP’s discretion, it can put $200mm of equity to BAM at market prices.  Obviously, at $18.90/unit, it is not compelling to do so.

 

Unit distributions are expected to be 60-70% of adjusted NOI (management’s calculation which is essentially FFO) going forward, initially set at $.265/unit per quarter.  Management’s goal is to be over $.30/quarter by the end of 2009. 

 

 

I have decided to illustrate valuation in 3 ways:  dividend yield, DCF and NAV/sum of the parts.  Like other public REITs, including PCL written up recently by gearl, it is not prudent to expect the stock to trade near its underlying NAV unless a liquidity event is forthcoming. 

 

2008 headline #s will not fully indicate earnings power of the current assets as Ontario transmission was transferred in March and BIP boosted its Transelec stake in April.  An indication of business trends can be taken from Aaron Regent, who heads the infrastructure group for BAM, in his 1Q comments:

 

"The electricity transmission segment delivered strong results for the quarter, benefiting from favorable foreign exchange rates, higher revenues associated with commissioning of upgrades and expansions of our system and inflation indexation of revenues," said Aaron Regent, Co-Chief Executive Officer of Brookfield's infrastructure group. "The timber segment continued to feel the impact of the slowdown in the U.S. housing market. As a result, we shifted our product mix to products whose prices have remained strong in the current environment. We also continued to leverage the coastal location of our timberlands through increased sales into the Asian markets where demand remains stronger."

 

Timber – This is the most difficult to project given tough end markets in the US and variability in pricing.  However, the company illustrated an ability to export more to Asia where prices are strong and use a higher % of harvest less affected by pricing issues.  In particular, BIP’s timber ops did adjusted NOI (ANOI essentially equals FFO or Net Income plus D&A) of $4.7mm in 1Q08.  Given horrible 1Q conditions, it is prudent to annualize this # and not to assume any growth towards management’s stated annual NOI goal of $40-42mm, which is what they expect eventually under normal operating and harvest conditions.  My annualized assumption leads to $18.8mm of timber ANOI for 2008, roughly half of timber’s earnings power, and $53.2mm in EBITDA using $8.6mm in 1Q08 D&A annualized.  Further sales to Asia or any bump in US trends is upside.  Of course, it could get even worse. 

 

Transmission did $9mm of ANOI in the quarter but $18mm of proforma ANOI if you include a full quarter of operations for the Ontario transmission business and assuming 17.7% ownership of Transelec for the first quarter, even though this ownership increase too place in April.  If you take out $2.8mm of non-recurring revenue and $1.6mm of higher than normal TBE dividends (came in at $5.6mm vs. managements’ expectations of $4mm per qtr), you get an adjusted 1Q proforma ANOI of $13.6mm.  Again, a conservative assumption is to runrate this and assume a $54.4mm of ANOI for the transmission operations, and $73.6mm of EBITDA using the $4.8mm in 1Q08 D&A annualized.   In the supplemental financial information released in May for the 1Q08 results, the company mentions it has committed 60% of their 2008 capex plans for transmission projects.  This is positive but hard to determine its impact on 08 results so I excluded the benefits.

 

These ANOI #s include the D&A and interest expenses associated with each business.  I have chosen this method to try to and moderate the complexity of this company and its quirky accounting and structure.

 

So in 2008, I am assuming ANOI of $73.2mm and $126.8mm in EBITDA, which is a run rate # off 1Q proforma #s.  60-70% payout ratio that the company is guiding to going forward allows for $44-51mm in dividends, or $1.14-1.32/share, using 38.5mm shares outstanding.  We are currently receiving $.265/share per quarter, or $1.06 per year, illustrating plenty or room for the company to boost the dividend.  Again, these #s assume no comeback in timber volumes/prices or further gains in transmission. 

 

For 2009, although a crude analysis, I assume 5% growth in ANOI and EBITDA.  I simply applied a 5% increase in transmission earnings due to rate increases and 0% growth in timber operations. 

 

 

Assuming the average of $1.14-1.32/year calculated above, a 5% yield would equal $25.40/share, or 34% upside.  I use 5% as BIP wishes to payout 60-70% allowing for growth capital, which typically translates into a lower necessary yield by the market. 

 

 

Using the above assumption of $73.2mm for ANOI and maintenance capex of $15mm (per management guidance), I get $58.2mm of FCF, or $1.51/share.  Assuming 4% terminal growth for inflation and a 11% required rate of return by investors, plus adding back the HBU land value of $80mm (33% below 12/31/06 appraisal), this yields a valuation of $23.67/share, or 25% upside. 

 

 

This analysis yields the largest upside given a large discount to NAV, but I will try to illustrate using very conservative assumptions that BIP has limited downside and significant upside to a reasonable discount to current NAV. 

 

First using peer group EV/EBITDA multiples (below, based on Bloomberg Best estimates) yields a NAV of $28.01/share, or 48% upside, calculated by applying ITC’s multiple to the transmission ops and a blend of RYN/PCL multiple to the timber ops, plus the HBU land value of $80mm (33% below the 12/31/06 appraisal) and TBE put value of $210mm, minus $920mm in debt.  Transelec is economically a better business model than ITC holdings due to better economics on their regulated business, so applying an ITC multiple is conservative if anything.  PCL and RYN both have timberland that is of much lower quality mixed in with their high quality timber and HBU land, and they may already be at 20%+ discounts to NAV if you listen to the analyst community (gearl’s quality writeup disputes this). 

 

		7/3/08 Closing						LTM	EV/LTM		08E	08E EV/	09E	09E EV/
Company Name	Symbol	Price	Shares	Mkt Cap	Net Debt	TEV	LTM Rev	EBITDA	EBITDA	Margin	EBITDA	EBITDA	EBITDA	EBITDA
Plum Creek Timber	PCL	$  42.52	171.109	$  7,275.55	$ 2,420.00	$ 9,695.55	$ 1,669.00	$ 551.00	17.60	33.0%	$ 514.00	18.86	$ 546.00	17.76
Rayonier	RYN	$  41.65	78.44	$  3,267.03	$ 548.00	$ 3,815.03	$ 1,209.00	$ 398.00	9.59	32.9%	$ 393.00	9.71	$ 402.30	9.48
									13.59			14.29		13.62
ITC Holdings	ITC	$  52.19	49.4	$ 2,578.19	$ 2,005.00	$ 4,583.19	$ 467.00	$ 282.00	16.25	60.4%	$ 362.00	12.66	$ 408.00	11.23
							50/50 avg		14.92			13.47		12.43
Brookfield Infra	BIP	$ 18.90	38.5	$ 727.65	$ 630.00	$1,357.65	N/M	N/M	N/M	N/M	$ 126.80	10.71	$ 133.14	10.20
										Using 50/50 Blend		$   28.01		$   26.61
											Upside	48.2%		40.8%

 

The above may still seem high but consider the following:  If you use 13.5x ITC multiple for 2008 BIP transmission EBITDA of $73.6mm to get $994mm of value, that implies a $375mm valuation for the timber assets, or $905/acre given their effective ownership of 414k acres (Island 635k * 37.5% + Longview 588k * 30%).  As the below illustrates, this is substantially below their cost:

 

Island acreage – 635k.  BAM cost $950mm in 2005, or $1500/acre

Longview acreage – 588k.  BAM cost $1.85B in 2007, or $3140/acre

Average cost is $2300/acre. 

 

Rayonier just paid over $4000/acre for very similar timberland to Longview’s in May.  Applying $3500 to BIP’s timberland, as Island has some lower quality lands, would enhance value by $1.07B or $28/share!  That is a great margin of safety and gives me comfort in buying these timber assets at a ¼ of what TIMOs and others are paying today.

 

-         Stronger analyst coverage, allowing for greater investor awareness

-         A deal announced by BIP to diversify operations and prove the business model

-         Increase in the dividend

-         Any improvement in timber ops

-         Winning new business in Transelec or Ontario transmission ops

 

-         Unable to find any accretive acquisitions to diversify operations, or it takes much longer than expected

-         Doing a dilutive deal to just do a deal (very unlike BAM historically)

-         Further weakness in timber ops