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Brookfield Corp: Stock Analysis
Is the Russian Nesting Doll that is Brookfield worth your time?
I’ve long criticized the Brookfield family of companies of being way the hell too complicated.
And thanks to a recent corporate reorganization, there’s another layer to all this. But I think I have it.
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Here goes. Brookfield Corporation (TSX:BN)(NYSE:BN) is, essentially, a holding company. It owns 75% of Brookfield Asset Management, which exited this reorganization as a pure play asset manager. Brookfield Corporation then owns various sized stakes in the operating business.
Brookfield Asset Management (TSX:BAM.A)(NYSE:BAM), meanwhile, is a pure play asset manager who gets fees from managing various entities for Brookfield Corporation.
Then there are all the subsidiaries. These are collections of assets that trade either the Toronto or New York Stock Exchanges. These include Brookfield Renewable (TSX:BEPC)(NYSE:BEP), Brookfield Infrastructure (TSX:BIPC)(NYSE:BIP), Brookfield Business Partners (TSX:BBU.UN)(NYSE:BBU), Brookfield Business Corporation (TSX:BBUC)(NYSE:BBUC) and Brookfield Reinsurance (TSX:BNRE)(NYSE:BNRE). Brookfield Corporation owns these. Brookfield Asset Management manages these assets.
It’ll be more helpful if I include a diagram which, if you’re looking for it, is on page 56 of 360 in the management circular outlining the new ownership structure. 360 pages! Anyone who says they read it is lying.
The rest of this post will focus on Brookfield Corp and Brookfield Asset Manager. Mostly because I can tell it’s going to get long even without delving into the various subsidiaries. Or the various ways you can buy the shares.
After spending an embarrassingly long time struggling with the new ownership structure, one question comes to mind. Why bother? BAM shares delivered excellent results over the last 20 years, and look poised to do well into the 2030s and 2040s as well. What’s the point of splitting the parent into two?
A few reasons include:
Separating out the ownership of the physical assets (a very capital intensive business) from the asset manager (capital lite)
Increasing the valuation of the asset manager without all the other stuff thrown in
Creating a yieldco and a growthco (more on that later)
And (this one could get me some flack) they just can’t help themselves. They’re financial engineers. Overly complex paperwork is their jam
I’ll take a closer look at both parts of this recent reorganization, but first, a primer on Brookfield if you’re not already familiar.
Collectively, the Brookfield entities have grown to dominate Canada’s stock market.
Pre-split, Brookfield Asset Management was one of the largest companies in Canada, something they accomplished by delivering excellent returns for investors for the better part of three decades.
The history of Brookfield can be traced back to 1954 when Seagrams brothers Edgar and Peter Bronfman sold their shares to other members of the family. Over the next three decades the two brothers grew Edper Investments into one of Canada’s largest holding companies. In 1979 the brothers acquired a controlling interest in Brascan which, by that point had become a holding company with investments in alcohol, mining, and Brazilian power interests.
Eventually Edper merged with Brascan and then the whole operation renamed itself Brookfield in 2005 when CEO Bruce Flatt took over.
Results since Flatt came on board have been nothing short of outstanding, and many investors have joined the ride. Assets under management grew from $3B in 2002 to $750B today, a growth of 32% annually. Distributable earnings grew by a factor of 12 in the same time period.
Brookfield took the capital generated by fees and reinvested it into the business, taking ownership stakes of various subsidiaries alongside capital contributed by outside investors. There are few things more comfortable than knowing your asset manager is investing right along you. They’re putting their money where their mouth is.
Brookfield targets 15%+ returns to its investors, an ambitious goal. The company not only hit that target over the last 20 years; it actually exceeded it. A remarkable outcome.
Simply put, Flatt and the rest of the Brookfield team has earned the trust they currently enjoy today by delivering exceptional results. Most money managers struggle with raising funds. With Brookfield, that’s almost the easy part. The challenge becomes finding somewhere to put that capital that’ll clear the return benchmarks.
Bruce Flatt is so trusted when you look for the hashtag #inflattwetrust on Twitter there’s some pretty considerable activity. It’s amazing.
So, which Brookfield should you choose? Here’s the case for both.
The case for owning Brookfield Corporation is pretty simple. It’s essentially like owning BAM stock before the split.
Remember, Corp owns everything. It has big stakes in the subsidiaries, the kinds of industries that have been carefully selected because they offer predictable growth and good economics. It owns 75% of the asset manager too, which is poised to deliver all sorts of fee income back to its shareholders.
Brookfield has also been quietly been getting into the insurance business over the last few years, a business that has grown to $10B in assets.
Put it all together and Brookfield Corporation has equity of approximately $135 to $150B, depending on how aggressively you value the asset management biz. These assets currently spin off about $5B in cash flow each year, capital that will be reinvested into various businesses along with outside capital raised.
To put this into perspective, Brookfield has a market cap of approximately $90B.
One problem is the asset split of the $60B in capital investments. Approximately $35B of that is in real estate, specifically shares of Brookfield Property Partners that were taken private back in 2021. As of Dec 31st, 2021, BPY’s portfolio consists of:
140 office properties (worth $37.6B)
115 regional malls and urban retail properties (worth $30.6B)
LP investments in various real estate assets worth $43.4B
Offset by about $67B in debt
In other words, Brookfield had $45B worth of real estate on the balance sheet (net of debt) at the end of 2021. Rates went up in 2022, meaning there’s no way that portfolio is worth as much as it was a year ago. Write down some of those assets and we get pretty close to the $35B valuation Brookfield gives us.
But is that valuation realistic? I’m not sure it is, especially when you compare it to public market REITs.
Dream Office REIT is a perfect example here. In November, Dream told investors it had a NAV of $33.15 per unit. The current price? About half that much. Shouldn’t Brookfield’s real estate be worth a similar discount to NAV?
(The funny part of that comparison is you can easily argue Dream’s portfolio is better. Its concentration on downtown Toronto, less aggressive balance sheet, and ability to buyback undervalued shares all contribute to this. Hell, maybe Brookfield’s real estate should be worth like 40% of NAV)
Or, if you think shopping malls and office towers recover, look at an investment in Brookfield today as a way to buy those assets on the cheap while offsetting some of the risk.
Essentially, the holding company will sit back, relax, and collect cash flow from all of its subsidiaries. It’ll then put that capital to work. Combine that with big increases from the asset manager’s earnings and putting dry powder already on the balance sheet to work and Brookfield sees 20% annual earnings growth through 2027.
Finally, I’ll touch a little bit on reinsurance, which is a big part of Brookfield’s new insurance business. The only real duds acquired by Berkshire during Warren Buffett’s 50+ years in charge have been reinsurance operators. It’s not an easy business. If the underwriting isn’t good these operations have a non-zero chance of blowing up.
I won’t bury the lede. I much prefer Brookfield’s asset management business as a stand-alone entity. No wonder why they went to so much trouble to spin it off.
Assets under management have grown significantly as the whole Brookfield operation gets bigger and bigger. Five years ago the company had $100B in fee bearing capital. These days it has $400B. And it projects it’ll have $1T by 2027.
That’s a lot of capital to put to work, but the asset manager is the first choice for many institutional investors for a lot of reasons. It offers all sorts of different options, all around the world, with it all under one roof. It already has relationships with these investors. It has a demonstrated history of providing above average returns. And it has already proven it can grow capital under management in a big way, as it already did from 2017 to today.
Critics charge that low interest rates have artificially buoyed all asset managers as various pension funds have to get adventurous in their search for returns in a low-rate world.
But Nelson. Why don’t these big institutional investors just put it all into index funds?
Pfft. That’s some amateur hour shit right there. Nobody justifies their job by using index funds. A big public pension fund isn’t just going to throw up their hands and throw it all in VEQT. There’s alpha out there for them to seize. And Brookfield is more than happy to help.
Take a look at all these specialty funds these guys have. Are they interesting? Yes. Will they outperform? Time will tell.
Let’s look at a couple scenarios for the asset manager — a base scenario and a bull scenario.
Starting with the base, let’s assume BAM doesn’t raise an extra dollar in AUM. They stay at $400B, which generates about $2B per year in profits.
(Edit: I wrongfully used the public share count (of around 400M) in my original post. It’s actually 1.6B shares.)
At $2B per year in profits and 1.6B shares, that gives us US$1.25 per share in earnings, or about 25x current earnings.
If earnings grow as quickly as Brookfield projects and we keep the same valuation, we’re looking at profits of $4.4B. Divide that by 1.6B shares and we get US$2.75 per share in profits. Slap a 25x multiple on that and shares are worth US$69 each, or a little more than double where they’re trading today.
Brookfield seems to think a multiple of between 25x and 35x is a reasonable valuation for its asset management business. I don’t think it’s worth quite that much (and I’m not alone in thinking so) but even if the multiple compresses to 15x over time the earnings growth helps. Shares would trade at US$41 each. That’s not a great result over five years, but isn’t a disaster either.
(Blackstone, in case you’re wondering, trades at 18x 2023’s consensus earnings estimates)
BAM has also instituted a buyback program that will allow it to buyback up to 40M shares in 2023.
But wait. There’s more. Some 90% of free cash flow will be distributed to owners as dividends, meaning investors are looking at a huge yield today, plus the potential for growth if AUM increases. Brookfield isn’t doing this to be generous to retail investors like you and me; no, they’re doing it because those dividends mostly flow back to the entity that owns 75%. Which it’ll then reinvest in various assets.
In addition, Brookfield has already declared it’ll be a variable dividend based on free cash flow. So if they stumble, so will those sweet dividends. It won’t be a managed dividend policy.
The bottom line
Brookfield was complicated before. This new wrinkle makes it all the more complex.
New spin-offs make everything all the more difficult, since things like share counts and whatnot aren’t quick to be updated. I’ve had to double check things a lot more than I usually have to and, as you saw above, I made an error.
To toot my own horn for a minute, I think I’m a lot better stock analyst than the average retail investor. And if I’m making errors, what chance does someone without any experience reading financial statements have?
I don’t care what anyone says — that kind of stuff is a negative, and so are overly complex ownership structures.
Ultimately, I still think BAM is a pretty good business. But I bought based on thinking it was trading for under 10x earnings, not 25x earnings I actually paid. Valuation matters, and I think any stumble on raising capital will really hit the asset manager hard. I’m not sure it’s something I’m comfortable owning at a higher valuation than just about any other asset manager I can name.
Disclosure: Author owns BAM and BEPC shares, but bought BAM based on his own incorrect analysis. BAM shares will be sold.
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