Brookfield Corporation (Excerpt From Our Recent Letter)
The following is an excerpt from Eagle Point Capital’s Spring 2023 letter to clients. Every six months, EPC writes to clients to explain what they own and why they own it. The portfolio-specific portion of each letter is for clients and prospective clients only. To read EPC’s entire letter, including an update on each of our investments, please contact us directly.
Brookfield owns assets that form the backbone of the global economy. The company is best thought of as two pieces: asset management and investment assets. We purchased shares late last year ahead of the company’s spinoff of 25% of its asset management business.
Post spin, Brookfield Corporation, ticker symbol BN, owns $57 billion of assets and 75% of its asset management business. BN’s assets consist of trophy real estate, insurance, and mission-critical infrastructure, like ports and pipelines. BN owns many of its assets via stakes in perpetual limited partnerships traded on the NYSE (BEP, BIP, & BBU).
Brookfield Asset Management, ticker symbol BAM, owns 25% of the asset management business, has no debt, and pays out 90% of earnings as dividends. BAM earns 25% of management fees and two thirds of future carried interest. BN earns 100% of legacy carried interest and one third of future carried interest.
The spinoff served to showcase the value of the asset management business and make the whole company easier to value on a sum-of-the-parts basis. We continue to hold both and continue to think of them as one entity and a single investment.
Asset management earnings are simple and predictable. Earnings come from management fees on capital that is locked up for decades — 83% of fee-bearing capital is long-dated (10+ years) or perpetual. Unlike public securities managers like T. Rowe Price and Diamond Hill, AUM is neither subject to volatile mark-to-market changes nor rapid outflows. AUM is invested alongside BN’s capital.
Asset management growth requires no incremental capital so earnings are like an annuity growing 15%+ per year. The business has a long lead time, so growth is highly visible. CEO Bruce Flatt has said that BAM’s 15% annual growth is already locked in through 2025 and that their focus is now on 6-10 years from now. We expect growth will continue into these out-years.
Brookfield’s largest investment is its $33 billion of real estate. $15 billion of that is core buy-and-hold investments in irreplaceable trophy properties, $8 billion is in private real estate private funds, and $10 billion is invested in developments and non-core assets that will be sold over the coming years. Brookfield expects to earn 9-12% per year for many years from its core portfolio and higher but shorter duration returns from the rest.
In February Brookfield elected not to extend the maturity of its loans against two office towers it owns in L.A. (the Gas Company Tower and 777 Tower). Brookfield also declined to purchase interest rate hedges against its floating-rate debt. These actions put the mortgages into default and the towers could face foreclosure. So far the lenders have not taken action. As they say, if you owe the bank $1 million, you have a problem. If you owe the bank $784 million, the bank has a problem
While a default isn’t good news, it’s not catastrophic either. Brookfield finances its properties with non-recourse debt to prevent problems at an individual property from affecting Brookfield as a whole. According to Brookfield, a flight to quality has been a net benefit to the company’s portfolio. The default is likely a calculated bet to gain negotiating leverage with lenders who’d prefer not to take possession of the towers.
Brookfield’s second largest investment is shares of publicly traded perpetual limited partnerships managed by Brookfield Asset Management. These trade on the NYSE (BEP, BIP, & BBU) and have an $18.4 billion market value. The funds invest in renewable energy, infrastructure, and private equity.
Last, Insurance Solutions has $4 billion of permanent equity and $40 billion of assets. It provides annuity-based products to insurers, reinsurers, and pensions. Insurance Solutions’ portfolio of predictable, long-duration assets pairs well with Brookfield’s equally long-duration real estate and infrastructure assets.
Last year Brookfield’s asset management business increased fee-bearing AUM by 15% and grew fee-related income by 26% to $2.1 billion. Brookfield’s other assets earned $2.7 billion last year, for a total of $4.8 billion for the combined entity. Together BAM and BN have a market capitalization of $62 billion and a P/E of 12.8. We think the combined entity is worth substantially more.
BAM trades for 24x earnings, which is in the realm of fair value. Brookfield thinks BAM is worth 25-35x earnings and we agree. BAM deserves a premium multiple because it has stable earnings, predictable growth (15%+), and no debt. It is asset light and returns 90% of earnings to shareholders as dividends. We expect forward returns to approach 20% per year driven by a 4% dividend yield and 15% growth.
There is meaningful upside to these returns if the asset management business earns performance fees on its AUM. Target carried interest is roughly equal to fee-based earnings, which means that if funds perform as expected earnings could double.
BN trades for 11x earnings, which includes its 75% stake in Brookfield Asset Management. Backing that out reveals BN’s other assets trade for $11 billion and just 4x earnings. BN estimates these assets are worth $56.9 billion, over five times more than their current look-through market value. BN’s stakes in publicly traded assets alone total $18 billion. We think this is a substantial mis-pricing driven by excessive pessimism over commercial real estate.
BN aims to produce 15% long-term growth and has a 30+ year track record of exceeding that high bar. We anticipate mid-teens or higher growth and think the stock could outperform the business if the earnings multiple re-rates higher. Brookfield is repurchasing shares while they trade at a discount and plans to commence a tender offer if the undervaluation persists.
For a more detailed look at Brookfield, check out our post from December 2022. There’s also a recent write-up about it on VIC from February.
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Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.
Truly remarkable recap of the company. Impressively comprehensible and straightforward to follow.