(Back) By Popular Demand, BAM (Brookfield Asset Management)

I’m not sure what happened but a previous version of this post was deleted so I’m reposting it. As I said before, a reader saw my mention of BAM in the post about David Winters’ portfolio and asked if I had done any research, which I had. Unfortunately, I didn’t have the discipline to buy when it hit my target price. Chalk it up to an unfortunate case of market-timing, bottom-calling, poor discipline, etc.

03/30/2008

Brookfield Asset Management is an international investment and management firm with core operations in commercial property, power generation & transmission, timberlands, property development, private equity and financial services. The bulk of their assets are located in North America with some diversification into South America and Australia.

Intrinsic Value: $40 – $50 per share

Accumulate: $26 or better

RISKS

  • BAM is significantly leveraged, with over $31B in debt against $7.5B in equity. Management has separated debt into non-recourse corporate debt ($2B) and mortgaged/property recourse debt that doesn’t come back to the corporate level ($29B). However, it’s unclear whether this distinction is pertinent as BAM’s operating model benefits from low cost access to debt, which would probably be curtailed in the event of default in any of these borrowings.
  • Large real-estate exposure. Real-estate (both commercial & residential) along with property development comprised 38% of gross operating cash flow. While the US residential component is a small portion of the this segment (only a few hundred million at most), US office properties account for ~50% of total commercial square feet managed and for about 66% of net owned area. If a prolonged recession were to hit the US, even these prime properties may see declines in cash flow.
  • As was the case in 2007, Brookfield’s power generation operations are beholden to weather patterns as low water levels curtailed cash flow, with hydroelectric generation down 7% YOY due to water levels being 10% lower than average.
  • 2 major refinancings due by 2009: a) $1.9B loan secured against timberlands in the Pacific NW and b) $1.6B loan against Aussie Multiplex operations due 03/2009. The current credit crisis could impede the company’s ability to refinance or to do so at attractive rates, forcing the company to allocate capital to repay the loans.
  • Complex company could hamper the market’s ability to price the company at fair value, hampering investors’ realization of full economic benefit.
  • Company’s ability to exit private equity investments or realize value on their other assets may be impaired during this prolonged credit crisis. As the company admits that realizations are important and are considered part of their normal operations, this could have an adverse effect on results.
  • The company’s transformation from unfocused holding company to its widespread reputation as prudent allocator of capital (i.e. the Canadian Berkshire Hathaway) coincided with the elevation of Bruce Flatt to CEO in 2001. If Flatt were to leave the company, there is no assurance or long track record to indicate that Brookfield Asset Management would continue to live up to this reputation.

UPSIDE POTENTIAL

  • Good, consistent cash flow generator based on long-term, quality assets with an inflation elevator (i.e. prime business district property, power generation & transmission, timberlands). Company generated $1.9B in cash flow in 2007 ($1.8B in 2006).
  • The nature of BAM’s assets allows them to lever up their assets (4x according to book value) fairly safely. Many of the assets are tied to long-term contracts (i.e. rental leases, electricity contracts, etc.) so future cash flow visibility is robust and allows them to match long-term outlooks with similar timeline financing.
  • BAM has hidden assets littered all over their balance sheet.
    • As an example, their commercial real estate portfolio is carried at $272/sq ft. on the books. 5 Times Square in Manhattan was sold in 2007 at $1,168/sq ft. Brookfield’s portfolio may not fetch that same price but even a reasonable 50% of that is a doubling of book value.
    • Their development portfolio generates little cash flow as costs are capitalized.
    • Management also contends that their power generation assets are underestimated at book value due to depreciation schedules that do not reflect the nature of those assets.
    • I haven’t tried to put a multiple or sum-of-the-parts valuation on it but it’s clear that the debt-equity ratio is much lower than 4x (I’d hazard a guess that it’s closer to 1).
  • Management skin in the game as all directors and management are required to buy shares in the company.
  • The turmoil in financial markets and corresponding retreat by private equity and other competitors should present more opportunities to management.
  • The structure of debt (most of it longer-term) means that BAM is not as exposed to liquidity risks as other financial institutions.

VALUATION

As I stated above, I have not tried to put a sum-of-the-parts valuation on this company,. The company’s assets are clearly undervalued on a book basis but I am more interested in BAM as an ongoing concern – how much cash will BAM generate for shareholders?

Management has held up $1.5B – $2B in annual free cash flow capacity as a benchmark. This corresponds to 9-12x P/FCF which is really cheap for a quality company. Based on those figures, a quick DCF shows the company is worth anywhere from $40 – $50 per share. Throw in a 2% dividend that’s growing and I can see lots of value in these shares.

While the leverage is a bit uncomfortable, I’ve tried and failed to poke holes into their portfolio. Commercial occupancy rates stood at 96% at the end of 2007 at below-market rates and avg. 7.1% annual turnover, suggesting a cushion against the Wall Street downturn. 77% of power generation has been contracted through 2009 (and spot prices are higher than contract rates). Timber price fluctuations can be managed due to the nature of having assets that can literally keep growing if the timing is off. In all cases, operating cash flow covers interest expense by at least a 25% margin.

Ultimately, an investor must be comfortable with the management team at Brookfield Asset Management in order to invest in the stock. While the company is very transparent with its reporting, the individual investor is not going to be able to dig into every nook and cranny, every mortgage on which address, etc. to evaluate the company’s handling of operations. They also do not break out operating expenses per segment or per asset so it is hard to judge operating efficiencies. I am more than happy to delegate to this superb management team that returns 25% on book equity (5 year avg) with access to 7% debt and 9% cost of capital.

PERFORMANCE MEASUREMENTS

  • Hit cash flow targets of $1.5B – $2B.
  • Increase asset management business relative to operations.
    • Maintain or expand 50% operating margin for this segment
  • Dividend increase in late 2008.
  • Shrinking share count.
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Read more on Brookfield Asset Management at Wikinvest

5 Responses to “(Back) By Popular Demand, BAM (Brookfield Asset Management)”

  1. Randall Tidd Says:

    Excellent summary, Dave. Lots of great points that are often missed in other analysis.

    However, I think the comment about the financing on the timberland assets (Longview) is not correct. Longview was originally financed with $1.3 billion of bridge financing, which was refinanced in April:

    http://www.brookfieldinfrastructure.com/Newsroom/pressreleases/r2008/r2008-04-03.asp

  2. Davy Bui Says:

    Randy,

    Thanks for the update on the Longview refi. I originally wrote the report in late March so the refi hadn’t occurred yet.

    On another note, the Financial Post states that Calgary is the 2nd most expensive office space market in North American, behind only middle Manhattan. If true, this offers a little more downside protection in the commercial property portfolio.

  3. The Enlightened American » Portfolio Performance: -0.4% YTD through September 2008 Says:

    [...] I added BAM, NTE, FCX and INTC as well as an in-the-money put on AMAT.  With the exception of BAM (see my previous post), the other 4 positions shared some common characteristics: little to no debt, [...]

  4. The Enlightened American » Brookfield Asset Mgmt (BAM) Q3 2008 Update Says:

    [...] covered in my initial report on BAM, the balance sheet is misleading.  Without getting deep into it, the balance sheet seemed fairly [...]

  5. bob Says:

    enlightening

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