Brookfield and Other Alternative Asset Managers Trading Cheap (NYSE:BAM)

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Exactly a month ago I posted an upbeat “Brookfield Asset Management Has Become A Screaming Buy” (NYSE: BAM). To save you time, I’ll recap briefly: The announced spin-off of 25% of Brookfield’s Asset Management (Manager) business made it opportune to reassess the company as the sum of the parts. My answers were ~$55B for Manager and $30B for invested capital, yielding $85B or ~$54 per share. These numbers were in sharp contrast to Brookfield’s own estimates of $80 billion and $50 billion for the same components. I was also arguing that, under certain assumptions, the Manager could be worth up to $65 billion.

Since publication, BAM has dropped from $45+ to $43+ accompanied by high volatility for all alternative managers. Coincidentally, several negative posts were published about BAM and its peers questioning its business model in the new environment.

Under these circumstances, I continue to buy and I don’t think the alternative managers’ business model is under stress. At least for the bigger and more sophisticated ones like BAM, Blackstone (BX), Apollo (APO), KKR (KKR) and Carlyle (CG).

These companies have been around for a long time, their founders and executives are well acquainted with the vicissitudes of the stock market, their leverage is well controlled, and their resources in terms of cash, human intelligence, satisfied customers and assets are enormous. . Where is the existential threat that makes them drop 5-8% on a bad day?

Rising interest rates is the first thing that comes to mind. But it does not exist in isolation from related inflation, market turmoil and possible recession. Let’s look at how these factors can affect alternative asset managers’ businesses. We will mainly use BAM (with its main public subsidiaries – Brookfield Infrastructure (BIP) (BIPC), Brookfield Renewable (BEP) (BEPC), Brookfield Reinsurance (BAMR) and Brookfield Business (BBU) (BBUC)) as an example.

Are there immediate threats?

Starting with the obvious, Brookfield and its subsidiaries are not facing an immediate need to refinance their major obligations. On the contrary: BAM and its subsidiaries are primarily using fixed-rate debt with long-term maturities. During the long period of low rates, companies refinanced most liabilities on balance sheets and extended their maturities, sometimes far into the future. Debt, with rare exceptions at the investee level, is investment grade or structured as investment grade. Neither Brookfield nor its subsidiaries are guaranteeing the investees’ obligations. The Brookfield empire carries or has access to huge liquidity at different levels to ensure security.

Consolidated Brookfield is a gigantic, well-diversified company, a kind of business empire, that operates in multiple industries and geographies and uses multiple business models and investment vehicles. Higher interest rates, inflation and market volatility are unfavorable to certain parts of the empire, largely indifferent to others and beneficial to some. Management will adapt to changes in interest rates and other factors by reinforcing the segments with the highest ROI under certain conditions.

Fee-related gains (FRE)

BAM generates large and predictable cash flows as fees on the assets it manages. Most assets represent permanent or long-term capital vehicles that guarantee rates forever or for many years. In bond jargon, BAM is a short-duration stock that should be less sensitive to changes in interest rates. This is very different from some growth stocks that are relying on money to be made in the future, if any.

FRE is the crown jewel of BAM and the same goes for other alternative managers. Its importance will be further emphasized in the spin-off of BAM’s asset manager, which should take place before the end of the year. That deal generated about $1.27 in free cash per share, growing 31% over the past 12 months. Most of the capital under management (~80%) is locked up in long-term private funds or public vehicles and investors cannot unilaterally withdraw funds in the short term – the fees will keep coming for many years to come regardless.

Whatever is happening in the economy can affect this business (at least for the next few years) in two ways. First, the market capitalization of public vehicles (think BIP, BEP, etc.) can suffer in the down market and generate lower rates. Second, the growth of FGAUM (fee-generating assets under management) may slow down.

The first factor doesn’t seem all that important. The BIP, BEP and BBU partnerships (along with their corporate twins BIPC, BEPC and BBUC) represent less than US$60 billion of the US$329 billion of the FGAUM total. Most FGAUM are in private funds and are not marked to market.

The second factor is real and the growth of FGAUM may become slower over time, but it is not certain and more remote than some people think. Here are some numbers: In Q1 2021, FGAUM was $278 billion and added $51 billion (18%) for the four subsequent quarters (I measure FGAUM representing 62% of Oaktree ownership). How much will be added to FGAUM in the next four quarters?

In response, I would like to draw your attention to 3 facts:

  • As of March 31, 2022, Brookfield had $70 billion in uncalled fund commitments, with about half not receiving fees. The market crash revealed many targets for these funds that did not exist before. During the last bear market in Spring 2020, Brookfield used a similar situation to secure a relevant position in Canadian Inter Pipeline in the open market, which was later converted into a profitable multi-billion acquisition.
  • BAM is currently marketing its flagship infrastructure fund, which is expected to bring in $25 billion. It might take longer to get to that number. For example, I read that it is taking longer for Apollo to close their main fund that they are trading now as well. But we do not know whether this delay is due to the lasting effects of the new macroenvironment or to the shorter duration effect of the market turmoil. In any case, Brookfield’s infrastructure investments, at the exit, generated IRRs above 20% and I doubt that potential customers will pass up this opportunity.
  • As of March 31, only ~$5 billion of FGAUM has been acquired from Brookfield Reinsurance. During the current quarter, Brookfield closed the acquisition of American National with another $30 billion under management by BAM. With this acquisition, BAM also obtained insurance licenses in all states and can now grow its insurance business organically. More insurance purchases are expected to follow as well. The insurance industry benefits from higher interest rates and BAM expects to get $200-300B through BAMR eventually.

These facts make it almost certain that FGAUM’s growth will continue at an accelerated pace for at least another year. While not expecting the 31% growth achieved in the previous 12 months, the FRE should grow in line with the FGAUM. Thus, the main component of the value of BAM remains unscathed.

FRE has generated ~$2 billion in free cash in the last 12 months. After the spin-off, almost all of this money will be paid out as dividends (90% payout rate by Mr. Bruce Flatt). I used 25 multiples for my base case as it corresponds to a 4% yield. Other Brookfield dividend paying subs (BIP, BEP, BIPC, BEPC) are trading at yields below 4% (up to 3.31% yield for BIPC!) SLOWER than Manager.

To charge

This part of Brookfield’s business will suffer because it will be harder to exit existing investments. It may take longer and will be done at lower prices. But the carry, in my opinion, represents a small fraction of the value of BAM. In my last post, I only allocated $5 billion to carry, which is ~10 times less than the value of FRE. A loss of, say, a billion here doesn’t matter.

invested capital

Almost all of BAM’s capital is invested through the public BIP, BEP, BBU, BAMR and the private Brookfield Property Group (BPG, formerly BPY). If we use IFRS numbers, BPG dominates. However, the market values ​​of BIP, BEP and BBU are several times higher than their IFRS values ​​and the picture becomes less distorted as depicted in the slide below.

Brookfield invested capital

Brookfield’s supplemental filings

Brookfield is shrinking its real estate footprint, but it’s still much larger than desirable. Will real estate fall in value due to higher interest rates? The answer would be unequivocally yes, unless it was for inflation. With high inflation, the picture is less clear, but this segment should still suffer. In particular, it may become more difficult for Brookfield to get out of certain properties it wants to get rid of, particularly some of its less popular malls. Brookfield’s peer in this regard, Simon Property (SPG), lost ~40% of its value in 2022. However, for Brookfield, malls represent a fraction of its real estate footprint and the company wants to sell only the weakest of them.

BEP and BIP should not be so sensitive to the new environment. Its revenues consist mainly of contractual cash flows stipulated for many years to come. The debt is fixed with remote maturities. The gradual increase in financing costs must be offset or even overcome by inflation accelerators built into many of its customer contracts.

BBU represents a traditional private equity business. Some of your weaker thrusts are likely to be adversely affected by the new environment. Exiting older forays will also be more challenging. At the same time, there must be many new targets for this business. Anyway, the BBU is too small to make a difference.

Brookfield estimated the value of its invested capital at US$50 billion, higher than the IFRS value. I was more conservative remembering well that BPY was always trading at a discount to its book. My estimate of $30 billion is based on 15 multiples of ~$2 billion in operating FFO after deducting preferred dividends, corporate costs and interest expense. $2B mainly consists of reliable long-term rents and stable cash flows from the BIP and BEP. I have avoided using IFRS data that seem of limited value: they overestimate the BPG and underestimate the BIP and BEP.

Conclusion

So far, I haven’t discovered anything new that could affect my ratings of the previous post. While volatility is psychologically unpleasant and can persist, it offers good buying opportunities for BAM and its peers.

Will BAM, APO and peers use the same opportunities for material buybacks? It depends, as alternate managers vary in terms of their cash supply, valuations, and the availability of other strategic tools at their disposal. We will give two examples.

BAM just spent $5 billion acquiring American National and expects to raise its stock price by splitting its manager. That’s why I don’t expect big buybacks from them, although some limited actions are certainly possible.

Apollo looks like the cheapest of the package. It’s a bit surprising given that half of their business is in retirement/insurance, which benefits from higher rates. Its management has announced several times that at these levels its inventory might be the best application for excess capital. They also have a significant repurchase authorization already in place. However, they are still in the early stages of generating this excess capital and may not yet have enough dry powder.

What is the biggest risk to Brookfield’s business model? In my opinion, a prolonged period of high interest rates. If investment grade rates remain high (7% or more) for a long time (more than 5 years or more), sooner or later Brookfield will be forced to refinance its substantial debt at all levels at much higher rates. and visibly affect your profitability.

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