BAM - Brookfield Asset Management

[giofranchi]

Two worrisome articles on BAM.

 

giofranchi

 

Gio, thanks for posting these.

 

Worrisome is a good word to use in my opinion as, while I am inclined to temper the tone of both articles, nevertheless they raise a flag or two.

 

Regarding the "Second Wave" article, without knowing the full facts (which we'll probably never know), it would appear that the author is venting frustration at the poor share price over the last year or so.  Brookfield may have been fully justified in calling off a sale of the asset based on a "good faith" assessment by management of its long-term worth.  That the share price is (greatly) lower today could simply be a combination of changed facts in the intervening period plus a depressed Mr. Market, or perhaps just a mistake!  I would add too that Brookfield's Private Equity Group has an excellent long term track record and is motivated to generate long-term value for its investors.  Now if Brookfield was trying to engineer it so that Second Wave will ultimately be forced into bankruptcy (allowing Brookfield to pick up the pieces on the cheap), well that's a different story.  If anyone has evidence of the latter I would be very interested to hear about it.

 

As for the "Paper World" article, the author has obviously done a lot of work and has highlighted some "worrisome" issues.  However, I think it's a pity that he decided to take such a definite negative line of argument throughout the article, because it just looks like he's got an axe to grind (company said considering legal action would do that to you I suppose).  Anyone who's studied the Brookfield / Brascan / Edper story will know it has a history of wanting control for limited capital (Jack Cockwell, current board member and the driving force behind the group from the 70s through to the early 2000s, was the brains behind this strategy).  So the accusation of a pyramidal control structure, is well, about 40 years old.

 

The focus on the lack of cash flow relative to net profit, particularly in the last 3 years, is just too myopic in my opinion.  Net profit / total return is simply the amount that flows through the P&L to the balance sheet / intrinsic value of the company.  In assets such as real estate / infrastructure etc., cash flows do not typically reflect an increase or decrease in value.  If Brookfield buys a distressed asset on a 10% yield and a year later it's yielding 5%, with no change in cash flows, does this indicate a paper world in a sinister sense?  In my view, the pertinent questions are: can the company fund its obligations (mainly interest as capex tends to be minimal), how predictable are its cash flows and obligations and for how much could the company sell its assets, given a reasonable amount of time to find buyers.  As a reminder, management believes both book value and its estimate of intrinsic value are understated versus what it could achieve in an orderly wind-down of the company.

 

The author does however raise some interesting points about BIP and BREP, the infrastructure and renewable energy businesses, which I admit I haven't looked at in as fine a detail as BAM.  For instance, the renegotiation of the two power purchase contracts with related parties.  And they are playing silly games by suggesting that Trevor Eyton is independent, because he most certainly is not!

 

Neither do I much like that Brookfield decided to go down the legal route with the author.  Without knowing the specifics of this case, Brookfield has a history of secrecy and are prone to aggression when questioned about their integrity.  From Peter Bronfman to Jack Cockwell and then to Bruce Flatt, everything that I've read about them would support the view that Brookfield's culture is one of hard work and high integrity, although there's no denying that for many years they've pushed the "maximum control, limited capital" strategy aggressively, which a lot of people may not ever be comfortable with.

 

Bottom line: do you trust management to "do the right thing"?  I do.

 

Thoughts?

 

WhoIsWarren,

I like your analysis very much (as always!! :) ) and I definitely agree with it.

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[WhoIsWarren]

Paperworld is the reason why I never got comfortable with BAM.  It was way too difficult for me to put my arms around it and just say "look at the P/B, look at the jockey, get comfortable"

 

So many entities, complicated org structure, lots of financial engineering. 

 

I'm not saying it's a fraud, just very difficult to invest for me not knowing all the moving parts.  MKL has family connections though, so they got comfortable.

 

Yep ShahKhezri, I get what you're saying.

 

However, I believe most investors suffer from an illusion that they understand more than they really do.  Most companies are highly complex and we just don't understand the minutiae of what makes the company really special or indeed those at risk.

 

For example, take Coke.  A great brand right?  But how much is the brand and how much is distribution and other factors that we can't quite put our finger on?  Neville Isdell headed up Coke's Philippines operations in the early 1980s.  At the time, Pepsi dominated the Philippines and looked to have an unassailable lead.  Within a couple of years Isdell had turned the situation on its head and it is certain that his success had a lot to do with figuring out Coke's distribution (which I think involved poaching a few of Pepsi's larger distributors).  A more current example is how Pepsi looks to have lost its dominant position in Thailand because its distributor Serm Suk has stopped distributing its products and has instead launched a new cola brand Est.  Of course, it remains to be seen how Est fares in the long run, but my point is that companies are generally complex and our "System 1" (from Daniel Khaneman) is prone to jumping to overly-simplified analysis.

 

Brookfield Asset Management is in-your-face complex, but in reality perhaps not any more so than your average company.  And given how much stock that management owns, I judge that this complexity is for my benefit as a shareholder alongside them.

 

This is more than you can say for most companies!

[WhoIsWarren]

 

WhoIsWarren,

I like your analysis very much (as always!! :) ) and I definitely agree with it.

 

giofranchi

 

 

Thanks Gio, kind words!

[Yours Truly]

I'm patiently waiting on their upcoming commercial REIT spin-off :)

[blainehodder]

Yes.  I am interested in examining the spinoff. Does anyone know any details on the spin? 

[menlo]

Anyone know anything about Dialectic Capital?  Looks like they've been short BAM for at least a few months:

 

[ftp=ftp://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/]http://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/[/ftp]

[thepupil]

I hope this gets totally blown out of proportion so that BAM can fall to more attractive prices.

 

Brookfield's "paper" gains represent real value creation. They buy from distressed sellers, own excellent assets through cycles, and create "pure-play" funds with generous (for the holdco) GP/LP structures.  What is not to like?

 

Their asset values are supported by market valuations as well as armies of creditors who lend to their subsidiaries on both a single-asset and company level.

 

If you think trophy real estate, utilities, and the like are expensive because of the search for yield, that is fine. But the author is not seeing the forest through the trees, in my humble opinion.

 

The spin-off is coming soon (see below). This will create the premier publicly traded property company in the world and will be used as expensive currency to grow BAM's franchise.

 

If a holder owns Brookfield Asset Management Class A limited voting shares or Class B limited voting shares as of the close of business on the record date of the special dividend, which is expected to be March 26, 2013, a certificate reflecting the holder’s ownership of our units will be mailed to the holder, or the holder’s brokerage account will be credited for our units, on or about April 15, 2013.

 

http://www.sec.gov/Archives/edgar/data/1545772/000119312513092088/d498243d20fr12ba.htm

 

 

 

[giofranchi]

Paperworld is the reason why I never got comfortable with BAM.  It was way too difficult for me to put my arms around it and just say "look at the P/B, look at the jockey, get comfortable"

 

So many entities, complicated org structure, lots of financial engineering. 

 

I'm not saying it's a fraud, just very difficult to invest for me not knowing all the moving parts.  MKL has family connections though, so they got comfortable.

 

Yep ShahKhezri, I get what you're saying.

 

However, I believe most investors suffer from an illusion that they understand more than they really do.  Most companies are highly complex and we just don't understand the minutiae of what makes the company really special or indeed those at risk.

 

For example, take Coke.  A great brand right?  But how much is the brand and how much is distribution and other factors that we can't quite put our finger on?  Neville Isdell headed up Coke's Philippines operations in the early 1980s.  At the time, Pepsi dominated the Philippines and looked to have an unassailable lead.  Within a couple of years Isdell had turned the situation on its head and it is certain that his success had a lot to do with figuring out Coke's distribution (which I think involved poaching a few of Pepsi's larger distributors).  A more current example is how Pepsi looks to have lost its dominant position in Thailand because its distributor Serm Suk has stopped distributing its products and has instead launched a new cola brand Est.  Of course, it remains to be seen how Est fares in the long run, but my point is that companies are generally complex and our "System 1" (from Daniel Khaneman) is prone to jumping to overly-simplified analysis.

 

Brookfield Asset Management is in-your-face complex, but in reality perhaps not any more so than your average company.  And given how much stock that management owns, I judge that this complexity is for my benefit as a shareholder alongside them.

 

This is more than you can say for most companies!

 

I think the idea very well expressed by WhoIsWarren here is extremely important. And I couldn’t agree with him more! I think many business owners understand this, but among investors it is more easily overlooked. Imo, with the consequence of running unjustified risks. That’s why my circle of competence is still so much narrow and limited!

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

[WhoIsWarren]

Anyone know anything about Dialectic Capital?  Looks like they've been short BAM for at least a few months:

 

[ftp=ftp://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/]http://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/[/ftp]

 

Not much, but here's a bit of background on Dialectic Capital from Valuewalk (including a short synopsis on the BAM short).

 

http://www.valuewalk.com/2012/05/dialectic-capital-short-cast-hlf-bam-china-and-canadian-housing/

 

 

[WhoIsWarren]

Anyone know anything about Dialectic Capital?  Looks like they've been short BAM for at least a few months:

 

[ftp=ftp://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/]http://www.valuewalk.com/2012/11/dialectic-presents-the-confusing-case-of-brookfield-asset-management/[/ftp]

 

Not much, but here's a bit of background on Dialectic Capital from Valuewalk (including a short synopsis on the BAM short).

 

http://www.valuewalk.com/2012/05/dialectic-capital-short-cast-hlf-bam-china-and-canadian-housing/

 

 

Doh!! Sorry Menlo, just realising that you already posted the valuewalk link!!  That's what happens when you try doing things in a hurry.

 

According to Bloomberg, there were 3.4 million shares reported short, or 0.7% of total outstanding, as of end-Feb 2013.  That's double the short interest as of 15th Feb.  Still small, but worth watching.

 

 

[giofranchi]

Is It Fair To Attack Brookfield

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

Is_It_Fair_To_Attack_Brookfield.pdf

[giofranchi]

I would like to remember that from page 149 to page 153 of “There’s Always Something to Do – The Peter Cundill Investment Approach” Mr. Risso-Gill describes Mr. Cundill’s large investment in Brascan, the former Brookfield Asset Management.

It seems that in 2000 and 2001 Mr. Cundill had great confidence in Brascan management.

Of course, I cannot say if in the 10 years since then things have significantly changed for the worse…

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

[giofranchi]

WhoIsWarren,

what bothers me about BAM is that I do not understand why it takes so much time to answer SIRF… I mean, BAM should understand how difficult it really is to know the true market value of the great majority of their assets, right? The market values of an office tower in Texas, a railroad or a port in Australia, an highway in Brazil, or an hydroelectric power plant in Canada, are not simply quoted on a stock exchange, right? So, their market values, estimated and reported by BAM, cannot easily be checked. Com’n! I have a hell of an hard time estimating the market value of a flat in downtown Milan… because it depends on a lot of different variables (the quality of the building, the development of its neighborhood, etc.). BAM should know that, if there is one thing which could attract criticism, it is how they estimate and report the market value of their assets. Therefore, if some doubts are raised, BAM should hasten to quell them! So, why are they so slow in answering SIRF publicly?

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

[berkshiremystery]

Is It Fair To Attack Brookfield

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

 

 

 

Gio,...

 

I hadn't the time to read all of the most recent posts about BAM in this thread, but only seeing in the second paragraph of your uploaded file the author name "Roddy Boyd" of this mysterious research study send all my common sense alarm signs on. All old board members might still remember, that this Roddy Boyd was one of the reporters in the short and distort smear campaign of criminal hedge funds against Fairfax years ago. It seems to me that Boyd and his friends just try to hunt for an easy victim, a company with a complicated structure, that is for outsiders difficult to understand. You should make at first some deep research into the persona Roddy Boyd himself and his old activities in the Fairfax campaign years ago before you make any conclusion about BAM. To me Boyd's integrity seems tarnished forever with the same behavior patterns that he had in his old Fairfax campaign. Maybe he seems to stage another "Project Fairfax", only this time it's called "Project BAM", and Boyd's  hedge fund friends might have already profited handsomely by driving the share price down.

 

You might search his name on this board...

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/deepcapture's-final-chapters-on-dendreon/msg8008/#msg8008

 

http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/ffh-news-on-lawsuit/msg86436/#msg86436

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/another-overstock-hatchet-job/msg14675/#msg14675

 

http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/the-miracle-on-wellington-street/msg78352/#msg78352

 

 

-----

 

Here I might add the links to Body's report about BAM

 

http://seekingalpha.com/article/1263461-the-paper-world-of-brookfield-asset-management?source=yahoo

 

http://sirf-online.org/2013/03/11/paper-world-of-brookfield-asset-management/

 

 

[Christopher1]

Attached the detailed answer to Mr. Boyd by BAM.

F-Roddy-Boyd-letter-Feb15-2013-PR-2.pdf

[giofranchi]

Thank you berkshiremystery and Christopher1! You both have been very useful to me and to all BAM shareholders on the board!

Very much appreciated!  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[Sportgamma]

Should you require any further information, we would be pleased to put you in touch with an accounting professional that is knowledgeable in equity accounting matters.

 

haha

[berkshiremystery]

Should you require any further information, we would be pleased to put you in touch with an accounting professional that is knowledgeable in equity accounting matters.

 

haha

 

1+

 

LMAO,... you made my day...

[giofranchi]

Attached the detailed answer to Mr. Boyd by BAM.

 

As it should be very clear reading their answer to question n.4, one must completely trust management in their assessment of the market value of many assets owned by BAM.

And I was getting a bit nervous, when it seemed they were putting back a very important, at least imo, answer to Mr. Boyd…

Now that I have read their answer, I know they have done the right thing, and I am much more comfortable.  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[WhoIsWarren]

WhoIsWarren,

what bothers me about BAM is that I do not understand why it takes so much time to answer SIRF… I mean, BAM should understand how difficult it really is to know the true market value of the great majority of their assets, right? The market values of an office tower in Texas, a railroad or a port in Australia, an highway in Brazil, or an hydroelectric power plant in Canada, are not simply quoted on a stock exchange, right? So, their market values, estimated and reported by BAM, cannot easily be checked. Com’n! I have a hell of an hard time estimating the market value of a flat in downtown Milan… because it depends on a lot of different variables (the quality of the building, the development of its neighborhood, etc.). BAM should know that, if there is one thing which could attract criticism, it is how they estimate and report the market value of their assets. Therefore, if some doubts are raised, BAM should hasten to quell them! So, why are they so slow in answering SIRF publicly?

 

giofranchi

 

Hi giofranchi, apologies for delay in responding (St. Padrick's day here yesterday so I was off work!).

 

Well I guess berkshiremystery and christopher1 have suggested one good reason why BAM have been slow to respond to SIRF  ;D ;D  Thanks for highlighting this, really appreciated!

 

I also hadn't previously seen the Brookfield response to SIRF (I printed the article and missed the hyperlink).  The answers are comprehensive in my opinion, fully explaining any and all Boyd's concerns.  In fact, having received that response, Boyd should have at that point realised he didn't have a (negative) article anymore!

 

Anyway gio you're right -- of course it's got to be pretty difficult to estimate market values for their assets! Brookfield shouldn't be shy about admitting so -- and to be fair I don't think they are really.  Fair value is generally calculated by taking 10-20 years of expected future cash flows, thereafter applying a terminal cap rate, and discounting everything back.  They can project cash flows out 10-20 years with reasonable certainty because of the long-term, high-quality nature of their tenants / contracts, but then......what discount rates, what terminal cap rates?

 

Not only that, but their auditors are the ones that determine the fair value of their assets, with the help of outside valuers of course.  But the outside valuers will certainly not know the assets as well as management.  And auditors (should) always go for the most conservative estimate.  This is why the 2011 shareholder letter stated "we estimate that the underlying value of the assets of our business is conservatively valued...."

 

But even at that, chances are that Brookfield management don't know the 'value' of each of their assets to within plus or minus 10% or more, because it depends on the number of potential buyers and the general availability of credit.  And we shouldn't forget that Brookfield is roughly 2x leveraged......

 

 

 

 

 

 

 

 

[WhoIsWarren]

While we're on the subject of valuation, anyone have any thoughts about how Brookfield values their asset management business ($4.8bn, or 17% of intrinsic value at year end 2012)? 

 

Just for a bit of background, management fully recognises that this number is finger in the air stuff, that they're just putting a number down in order to highlight the issue to analysts.  In fact they've more than hinted that they believe a more realistic valuation of the AM business would be much higher.

 

The basic assumptions underlying their valuation are that capital under management grows at 10% a year for 10 years and that the gross margin increases to 150bps without a commensurate increase in expenses.  It then capitalises the resultant earnings ten years out, applies a 15x multiple and discounts the cash flows and terminal value at 15%.

 

How reasonable is this?  It would appear that management believes there is still a lot of runway ahead of them, speculating that “real assets” is becoming a significant asset class in its own right for pension and investment funds.  While I’m sure Brookfield gets a lot of feedback from clients / potential clients, that’s really just a guess on their part.  If they cannot entice new equity and debt investors to put money into its four platforms, Brookfield will not likely grow at 10% a year for 10 years.

 

I’ve tried to backing out the underlying performance / performance fee assumptions of management’s appraisal value.  Using the 10% growth for 10 years assumption, I calculate an implied gross fund performance of around 12.5% (hurdle rate of 10%) and a net performance fee of 0.4% (after direct expenses of c.15%, which is roughly what they accrue for bonuses).  That doesn’t sound totally outrageous, certainly not in the context of their historic numbers.

 

In calculating a ‘base case’ value for the asset management business, I have to take into account the stickiness of their client base.  Using 2011 numbers (I haven't got around to updating for 2012), of the $40bn of 3rd party fee-bearing AuM, $10bn was from the listed issuers – perpetual clients!  Also, don’t forget that BPY is being spun out and over time will be sold down (that’s $11bn net asset value – and growing – of perpetual money). The remaining $30bn is from funds with around 8 years or so of committed capital.  Even if they end up generating mediocre returns over the next 5 or 10 years I would speculate that they’ll nevertheless mange to grow their asset base on the back of their excellent track record to date.  Putting that all into the mix – assuming no performance fee, 3% annual growth for 10 years and discounted at 15% (as before) yields a valuation of $1bn, or about $1.5 a share.  Chunky, but no death nail.

 

The 'bull case' is simply that they gather more AuM, at higher margins. I haven't spent any time on this scenario.

 

Anyone anything else to add?

 

[giofranchi]

Anyone anything else to add?

 

Nope! It seems you always have the “bad” habit of writing everything, so that there’s nothing left to say!!  ;D ;D

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes

[WhoIsWarren]

:)

 

Yeah, I probably do have a tendency to rabbit on......

[mankap]

I do not know if you have looked at BIP, a sub of BAM.

I bought it two years ago.It has steady and growing cashflow and has been increasing dividend.

The company's stated goal is to increase dividend by 7% every year, they have been increasing dividend by 15% every year.

Many of their project will go live soon and cashflow will start flowing in soon.

[WhoIsWarren]

I do not know if you have looked at BIP, a sub of BAM.

I bought it two years ago.It has steady and growing cashflow and has been increasing dividend.

The company's stated goal is to increase dividend by 7% every year, they have been increasing dividend by 15% every year.

Many of their project will go live soon and cashflow will start flowing in soon.

 

I haven't given BIP (or BREP, the renewable energy entity) a thorough going over, because their partnership structures causes me too much of a tax headache (same story for OAK unfortunately), though I quickly read their 10-Ks as part of my BAM research.

 

However, quite apart from the tax issue, I think I would be more comfortable holding BAM than the listed funds.  I haven't really figured out for whom the incentivisation structures on the partnerships is advantageous, but I strongly suspect BAM holds the better cards.  I prefer to align myself alongside the insiders!

 

As a reminder to those less familiar with the incentivisation structures, BAM gets paid 1.25% of BIP/BREP's EV (market cap plus non-recourse debt).  In addition, it receives 15-25% of distributions above pre-determined hurdle rates.

 

All said and done however, I'm sure all of the listed funds will do just fine over the long term.  And for investors who need income (without tax issues!), BIP, BREP and BPY (the upcoming global property entity) are probably an excellent choice.