BAM - Brookfield Asset Management

[racemize]

Turns out the demand deposits run pretty deep, in Q1 2018 BAM decided to book the $535MM that BPY received from returns of capital from equity method investments in their operating cash flow at the parent level instead of in the investing section where it belongs. BPY even booked the proceeds in the investing section of their financials. BAM has always booked them in investing activities before too and appears to have gone back to this same reporting after Q1 2018.

 

Can you explain how you determined they did this?

[Normax59]

Turns out the demand deposits run pretty deep, in Q1 2018 BAM decided to book the $535MM that BPY received from returns of capital from equity method investments in their operating cash flow at the parent level instead of in the investing section where it belongs. BPY even booked the proceeds in the investing section of their financials. BAM has always booked them in investing activities before too and appears to have gone back to this same reporting after Q1 2018.

 

Can you explain how you determined they did this?

 

Look at equity accounted distributions to BAM in Q1 2018 you'll see it's positive $366MM in the cash flow statement with $288MM of earnings from equity accounted investments meaning that a total of $654MM was "distributed", this is odd since BAM never has received distributions this high before. On page 18 of their PDF you'll see they say they received $653MM of equity accounted investments from distributions and returns of capital from equity method investments. So, exactly our figure with some rounding.

 

BIP disposed of an equity method investment for about 1.28B, BPY also had distributions from returns of capital from equity method investments of $535MM in Q1 2018, if you look at BAM's figure for inflows from equity method investments in the investing section it only shows about $1.3 billion.

 

Mind you that BBU also was stuffing bank overdrafts in their working capital changes at the time, in Q2 2018 they restated their Q1 2018 operating cash flow from $130MM to -$47MM.

[Normax59]

Actually, let me put a ? on whether or not this was their first time doing this, looking at it closer now, it appears in other periods they may have stuffed returns of capital in operating cash flow.

[jfan]

The share of undistributed earnings from equity investments accounts for the cash not sent up to the parent level via distributions. The fact that the absolute amount is usually less than the share of earnings/comprehensive earnings from equity investments on the income statement suggests IMO that these are dividends from the projects and perhaps to a lesser degree from return of capital. However, they are not clear wrt what the actual proportions are. ie (- share of undistributed earnings = share of comprehensive earnings - distributions received)

 

In Note 10 of BAM's 2018 YE footnotes, there appears to be both a large amount of dispositions in 2018 as well as distributions that are greater than share of comprehensive earnings. This suggests to me that the distribution in 2018, likely consisted of a substantial amount of return on capital.

 

I think BAM has always been putting return of capital from its equity investments at the parent level glancing back to 2014. However, it appears to me that they book their realized capital gains through the investment section.

 

As to the appropriateness of Return OF Capital within the operating cash flow portion, the alternative view is that it is a reduction in non-cash working capital. If cash is returned to you so that you can lower your adjusted cost base to your asset, it is analogous to reducing your operating assets to free up cash. I don't think that this would constitute as definitive evidence of nefariousness.

 

 

[Normax59]

The share of undistributed earnings from equity investments accounts for the cash not sent up to the parent level via distributions. The fact that the absolute amount is usually less than the share of earnings/comprehensive earnings from equity investments on the income statement suggests IMO that these are dividends from the projects and perhaps to a lesser degree from return of capital. However, they are not clear wrt what the actual proportions are. ie (- share of undistributed earnings = share of comprehensive earnings - distributions received)

 

In Note 10 of BAM's 2018 YE footnotes, there appears to be both a large amount of dispositions in 2018 as well as distributions that are greater than share of comprehensive earnings. This suggests to me that the distribution in 2018, likely consisted of a substantial amount of return on capital.

 

I think BAM has always been putting return of capital from its equity investments at the parent level glancing back to 2014. However, it appears to me that they book their realized capital gains through the investment section.

 

As to the appropriateness of Return OF Capital within the operating cash flow portion, the alternative view is that it is a reduction in non-cash working capital. If cash is returned to you so that you can lower your adjusted cost base to your asset, it is analogous to reducing your operating assets to free up cash. I don't think that this would constitute as definitive evidence of nefariousness.

 

Look at it from Q to Q, not a FY basis, they re paper over what they did in Q3 and Q4.

 

 

[Gregmal]

https://seekingalpha.com/news/3531018-brookfield-temasek-team-up-for-thyssenkrupp-elevator-bid-reuters

 

These guys are quickly becoming the Softbank of real assets. To the extent that they can continue to borrow, eventually they will own everything. Its also hard to say they are getting "deals" considering the bidding process.

[peterHK]

I don't like that it's a bidding process, but the elevator business is a truly fantastic business. This isn't just any asset.

[chrispy]

Peterhk, for my understanding, can you explain what makes it a great business? Is it the recurring repair revenue?

[peterHK]

Peterhk, for my understanding, can you explain what makes it a great business? Is it the recurring repair revenue?

 

Elevator tech doesn't change much, there's only a few players (more rational competition), and once you have a product in a building you have a 100 year stream of non-discretionary maintenance revenue (if you don't do it people die), and massive switching costs.

 

They aren't high growth businesses, but they're high ROIC, and can support a fair bit of leverage and like Westinghouse if you can clean it up operationally you can do very well.

[kab60]

Take a look at Finnish Company Kone. It's a fantastic business.

[EricSchleien]

The big thing with Westinghouse was they cleaned it up culturally which had operational impacts.

 

Peterhk, for my understanding, can you explain what makes it a great business? Is it the recurring repair revenue?

 

Elevator tech doesn't change much, there's only a few players (more rational competition), and once you have a product in a building you have a 100 year stream of non-discretionary maintenance revenue (if you don't do it people die), and massive switching costs.

 

They aren't high growth businesses, but they're high ROIC, and can support a fair bit of leverage and like Westinghouse if you can clean it up operationally you can do very well.

[Spekulatius]

https://seekingalpha.com/news/3531018-brookfield-temasek-team-up-for-thyssenkrupp-elevator-bid-reuters

 

These guys are quickly becoming the Softbank of real assets. To the extent that they can continue to borrow, eventually they will own everything. Its also hard to say they are getting "deals" considering the bidding process.

 

The unit currently generates  900M Euro on EBIT, but there are probably some overhead costs on a generally corporate level that would need to be out back into the unit. A 20B Euro price would be fairly rich a 15B Euro price might be OK for a competitor with synergies.

 

This business is like an annuity, I can see why a pension fund might like it.

[John Hjorth]

Elevator tech doesn't change much, there's only a few players (more rational competition), and once you have a product in a building you have a 100 year stream of non-discretionary maintenance revenue (if you don't do it people die), and massive switching costs.

 

They aren't high growth businesses, but they're high ROIC, and can support a fair bit of leverage and like Westinghouse if you can clean it up operationally you can do very well.

 

Peter,

 

The best one-liner explanation of a good business I've read for a long time! ... -Well, almost ... - make that a two-liner explanation then! [ ; - ) ]

 

- - - o 0 o - - -

 

btw, gfp mentioned this as potential Berkshire acquisition candidate in the Berkshire forum here on CoBF.

[peterHK]

Elevator tech doesn't change much, there's only a few players (more rational competition), and once you have a product in a building you have a 100 year stream of non-discretionary maintenance revenue (if you don't do it people die), and massive switching costs.

 

They aren't high growth businesses, but they're high ROIC, and can support a fair bit of leverage and like Westinghouse if you can clean it up operationally you can do very well.

 

Peter,

 

The best one-liner explanation of a good business I've read for a long time! ... -Well, almost ... - make that a two-liner explanation then! [ ; - ) ]

 

- - - o 0 o - - -

 

btw, gfp mentioned this as potential Berkshire acquisition candidate in the Berkshire forum here on CoBF.

 

Thanks!

 

I've been waiting a while for the elevator companies to come public or go private and it looks with the moves at UTX with Otis and then Thyssenkrup that both are happening at the same time.

[peterHK]

https://seekingalpha.com/news/3531018-brookfield-temasek-team-up-for-thyssenkrupp-elevator-bid-reuters

 

These guys are quickly becoming the Softbank of real assets. To the extent that they can continue to borrow, eventually they will own everything. Its also hard to say they are getting "deals" considering the bidding process.

 

The unit currently generates  900M Euro on EBIT, but there are probably some overhead costs on a generally corporate level that would need to be out back into the unit. A 20B Euro price would be fairly rich a 15B Euro price might be OK for a competitor with synergie

 

This business is like an annuity, I can see why a pension fund might like it.

 

Another reason for the Canadian Pension guys is that they all have significant Real estate development arms. Makes a lot of sense to own an elevator company. Same for BAM with all their RE business.

[Xerxes]

Elevator business is indeed a great recurring business supported by its installed base. That goes to support the leverage. Perhaps not the same as WeWork bought with massive leverage.

 

incidentally, i follow UTC very closely and i always thought of its two upcoming spin off (OTIS and Carriers) as great mature businesses that either PE or Berkshire would be interested given that they would be large enough and that the industry is somewhat consolidated (i.e. moat). These spin off will happen in early 2020. Dont think at this point either one would be a target for PE or Berkshire. But my view was that earlier in the process, scenarios where UTC would sell the business as a whole to a third party, were considered. Perhaps too big for Brookfield

 

Going back 4-5 years ago, when UTC sold Sikorsky to Lockheed, they were able to do so given that (1) Lockheed was willing to pay a premium for Sikorsky (enough to cover UTC tax bill vs. a tax free spin off scenario) (2) anti-trust concern were minimal with Sikorsky as a new vertical for Lockheed.

 

Perhaps the merits of UTC spin off are better discussed in a dedicated thread.

[Gregmal]

The businesses themselves, not debating. You could make the argument similar to that for a lot of current companies, if you also ignore the valuations. Im just surprised its not more concerning to folks the degree to which these guys have been going hog wild with the acquisitions given where the markets are and where we are perceived to be in the cycle. If Berkshire was buying stocks with such zeal, it would likely get people riled up. I do not see, by and large that there is evidence Brookfield is getting "special" deals, ala BRK in 2008-09. So is it not kind of surprising they are levering to the gills to buy companies at market rates, given what I think most people think about current valuations?

 

I do find it ironic though, BRK won't touch anything with a 10 foot pole, meanwhile Brookfield cant find an asset it doesnt want to buy.

[Spekulatius]

You have got to dance as long as the music is playing, if you use other people’s money to invest. It’s as simple as that, if you are in the asset management business.

[villainx]

BAM has better operational experience in getting improvements? It’s hard to say as BRK touts the top people well, but operationally the competency seems more concentrated as well as less institutionalized. I’m assuming this would also go into the PE bucket? Maybe BIP?

 

At the same time, with more buckets and funds, whatever the return projected could serve different clients? But, so far, BAM invests alongside any clients so the expected returns have to be respectable.

 

And all the usual PE suspects are bidding. Seems BAM gets questioned as well as promoted the most.

[vince]

The businesses themselves, not debating. You could make the argument similar to that for a lot of current companies, if you also ignore the valuations. Im just surprised its not more concerning to folks the degree to which these guys have been going hog wild with the acquisitions given where the markets are and where we are perceived to be in the cycle. If Berkshire was buying stocks with such zeal, it would likely get people riled up. I do not see, by and large that there is evidence Brookfield is getting "special" deals, ala BRK in 2008-09. So is it not kind of surprising they are levering to the gills to buy companies at market rates, given what I think most people think about current valuations?

 

I do find it ironic though, BRK won't touch anything with a 10 foot pole, meanwhile Brookfield cant find an asset it doesnt want to buy.

 

Different business models.  Brk doesn't do a damn thing to operations, Bam does.  If you buy an asset with a 6-7% yield and see the potential for operational improvement , combined with very low borrowing cost, you can get double digit equity returns.  Brk holds forever, Bam doesn't. Are Bam's cash flow streams riskier? No question.  BRK has always been very much risk averse and you could argue it doesn't make sense.  We had an economic tsunami and the great majority of well managed, but leveraged, survived and prospered.  But let's assume it got a lot worse.  Many Many well managed company's wouldn't have survived.  What's funny though is that Buffett said "if the fed hadn't intervened everyone was going go down like dominos, Berkshire would just be the last to fall".  Berkshire and Buffett are one, and I love Buffett and Berkshire but their model is far from ideal for a profit motivated corporation. 

[Gregmal]

I get all of the above, for sure. But when viewing securities as ownership in a company, does it not bother anyone, that on a look through basis, your resources are being put to work via acquisitions, at an astounding rate, either at current market prices or in bidding contests likely translating to above market prices? By default, when you are the top bidder in a process, that means there is no one to divest said asset to, at anything but a lower price.

 

Hardly investing with a margin of safety to say the least.

[vince]

I get all of the above, for sure. But when viewing securities as ownership in a company, does it not bother anyone, that on a look through basis, your resources are being put to work via acquisitions, at an astounding rate, either at current market prices or in bidding contests likely translating to above market prices? By default, when you are the top bidder in a process, that means there is no one to divest said asset to, at anything but a lower price.

 

Hardly investing with a margin of safety to say the least.

 

Well if Bam is improving operations to the point of high single digit yields then they are creating value.  Their record (which by itself doesn't prove anything) has been great, they continue to attract enormous amounts of capital, and mgmt has a huge ownership interest in the parent.  Then you have Howard Marks, arguably one of the best credit risk professionals with a huge stake.  But to directly answer your question, it was a concern to me as well (and many analysts ask the same question on the calls) that they could purchase all these assets economically while others were twiddling their thumbs.  I'm satisfied with their operating ability to improve operations and their allocation skills in picking the assets where their operating strategy really applies.  It's kind of like when Malone, with a cable business, was able to purchase asset after asset, leverage the shit out of them and still capture enormous value.  The assets he purchased were available to anyone, within the cable industry and outside, through many business cycles.  It's just that he was skilled enough to measure the synergies that his operating machine could capture.  You could argue that's not a perfect (or even good) comparison but it's good enough to visualize what I'm trying to say.  Finding synergies that their operating skills can realize.  Comparing Buffett and Berkshire to Bam completely overlooks what Bam really does.

[peterHK]

So far nobody has looked at this correctly IMO.

 

If you're BAM, ~20% of the capital in these deals is yours. The rest is provided by large institutions who are NOT necessarily looking for 15% IRR's. Core infrastructure product is marketed at 10%, that's it. So if you can put $10 billion to work at earn 10%, that is exactly what these pension funds and SWF's want. Always remember that BAM is selling a product, and that product is not necessarily the highest IRR activity, it is the one that meets the hurdle of the product they are selling.

 

Second, lets say BAM earns 10% on its capital investment of say $2bn, so $200mn a year. The other $8bn is earning them ~1.2% in management fees (another $86 million), and then performance fees on top of that of say 15% of the amount above 8%, so another $24 million. In total, BAM is earning on its capital $200 + $86 + $24 = $310 million, or over 15%. Obviously this is gross of compensation expenses etc. so the net return is probably closer to 12%, but the point remains: taking a deal that is 10% but generates fees is still very lucrative for BAM shareholders.

 

Finally, remember that a growing asset management business has a higher multiple than NAV. So from BAM's perspective not only do they juice returns on their own balance sheet capital by earning fees from their AM business, it's also accretive to take deals to grow the AM business and increase the multiple on the stock. The value of BAM in the future is NOT going to be in the invested capital, it's going to be in the AM business, so the key variable is NOT whether deals are 20% IRR's or 12% IRR's, it's whether they can grow the AM business by selling attractive products to SWF's and Pensions.

[kab60]

I'm not saying these guys can't improve ops, but usually that's just PE hyperbole. Verdad Capital made some studies and found that historical returns (these Guys killed pubic returns from 1980-2008) were driven not my operating efficiency but buying small value (6-8x ebitda) and dropping 3-4 turns of leverage on top. While there was a big difference in private and public valuations back then, I see lots of PE investments done today at HIGHER valuation privately than publicly.

 

They're basically buying at 10-12xebitda today which increases leverage massively, and that's before all these crazy adjustments to ebitda (like adding back expected synergies in something like the 3rd year).

 

I like BAM and KKR as investments (more so before the rally), since investors love alt investments and illiquid stuff - probably some due to false perceived safety of market-to-model instead of mark-to-model. But I think some of the LP's risk being in for some massive negative surprises further down the road. Still, that could take ages to play out, and I agree with peterHK on the above. This is mostly about fees and locked-up capital.

[5xEBITDA]

Verdad's research is biased because they are trying to convince LPs to give them $ to invest in public securities with quantitative metrics of historically successful PE investments. Not saying there isn't merit to their research, but it is certainly biased.

 

peterHK is correct in his assessment of returns. The only thing I'll add on is that BAM equity invested from the parent / GP is likely levered which also increases returns further, emphasizing equity-like returns to the parent on MSD - HSD yielding infrastructure investments. This is really no different than a portfolio manager at Millennium or Citadel skimming fixed income basis points to earn a MSD annualized return on levered money which returns 10%+ to the parent.

 

There are a lot of very smart people working at BAM and KKR and it is fairly ignorant to suggest their returns come from synergies in their excel model...