Brookfield Q2 notes

Investment Analysis Clubs Manlobbi's Descent
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I listened over the earnings call and just point out some of the interesting parts, and updated the IV10/price ratio at the end.

Bruce flatt:

  • Even with rate hikes, they remain lowish historically and expect them to settle in a historically lowish range.
  • Record fund inflows ($56 billion) over the quarter
  • All underlying business are “essential” in nature, highly cash generative, high margins and inflation protected.
  • Sold $21 billion of assets at premium valuations and half of these sales were in real estate, generating exceptional returns.
  • Distribution of fee business (as a publicly traded entity) going well and on track.
  • “Brookfield Asset Management” will be renamed “Brookfield Corporation”. The fee business, which they own 75% of, will be called “Brookfield Asset Management Limited”. Think of “Brookfield Corporation” as the main business. Expect the fee business to continue growing well and important part of Brookfield Corporation.

Q&A (paraphrazing)

  • Flatt explained that we will possibly add businesses into Brookfield Corporation at times, where we would not have been able to add them in with our previous structure. Our job is to deploy cash into the various parts of our business for the best return, and we have more flexibility by having publicly traded entities. Continue to think of the Brookfield Corporation as a co-investor for the funds that they have, continuing BAM’s traditional way of operating.
  • Flatt commented that there is an enormous amount of capital required for critical infrastructure (including energy for Europe) - governments don’t have it, and institutions do.

Manlobbi:
Despite the positive words, when looking at the raw data there is excellent year-on-year improvement, but not an important improvement over the previous quarter. The trailing fee related earnings were $2 billion which is unchanged from last quarter. Shares outstanding were about the same. Intrinsic value is going up (for example assets under management are growing, and cash is rolling in) but my model looks at capitalised fees plus the book value, and that hasn’t risen over the quarter. I agree with Bruce Flat that rates are likely to remain historically low for very long. Rates are are not decided by market forces but simply selected, and there is far too much private debt today around the world to allow high rates to be selected, unless debt jubilees are permitted to be discussed, which they are not.

What has changed lately is that BAM’s quote has risen 21% over just the last month, resulting in a major deterioration of the IV10/price from over 4.2 down to 3.5. BAM is now great to own (anything with a ratio over around 3.2 I generally consider “great”, but BAM is longer “fantastic” as they were four weeks ago).

Supplimentary info used for these calculations:
https://bam.brookfield.com/sites/brookfield-ir/files/BrookFi…


BAM – Brookfield Asset Management				
	Shares outstanding					1638
	Book value per share today				24.16
	Fee business (25 x “Fee related earnings” excl. carry)	30.53
	IV0. Total value, 1.0 x book, plus fee business 	54.68
	Accumulated annual value generation including dividends	13.00%
	IV10   							185.62
	Price today						53.5
	IV10/price						3.5

Did anything in the earnings release cause the business to be worth 21% more than it was 4 weeks ago? Absolutely not, and that is the nature of publicly traded markets.

  • Manlobbi
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Shares outstanding were about the same

Basic shares went down from 1566.3 million to 1561.9 million. They repurchased 5.1 million shares for 237 million averaging 46.47 per share.

Did anything in the earnings release cause the business to be worth 21% more than it was 4 weeks ago? Absolutely not, and that is the nature of publicly traded markets.

Market gyrations are caused by several factors. One of them seems to be the benign July CPI print. Could be just noise or inflation has really peaked. We will have to wait and see. Can be sure only in hindsight.


		CPI

June 2021	270.955
July 2021	272.184

June 2022	295.328
July 2022	295.271

[https://fred.stlouisfed.org/data/CPIAUCSL.txt](https://fred.stlouisfed.org/data/CPIAUCSL.txt)

So, month over month, it did not go up. Year over year, the rate of increase came down from 9% in June to 8.48% in July. If we really are at the peak, then the Fed doesn’t need to raise as much, and that is good for earnings and asset prices.

Rates are are not decided by market forces but simply selected

Selected yes, but not arbitrarily. High inflation is not good for various reasons and does need to be controlled. Central banks will keep increasing rates till this happens.

Bonus link <:-)
https://www.youtube.com/watch?v=MKz8Gf-W3eY

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The good thing about Brookfield - BAM - is that the share price often falls to less than 50% of Bruce’s plan value.

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Brookfield Corporation (I’m going to start using this new name even though it will not be renamed for another month or so) reports the rough value of their business using their internal metric “Plan Value”, because the book value contains about half of their value but doesn’t capture the value of the fee business.

Another way to look at their Plan Value, rather than comparing the quotation to the Plan Value and buying when their is a discount, is to think of the Plan Value as a reasonable model for the change in value over time. Think of the Plan Value not as a way to work out the quote discount (Ben Graham --style) but as a way to see the engine mechanics of how the business is growing each year, which is what we care about the most also as very long–term investors).

If the quote is a 30% discount to the Plan Value, but remains a 30% (on average) over many years, the you still receive the investment return of the change in Plan Value. Brookfield Corporation generally traded around the 50%-100% of their Plan Value (which also gives you a model to adjust your holding based on the changing discount if you are inclined to try to boost your returns in that way). For this reason, it doesn’t have to be accurate regarding the multiple, but has to be fairly realistically capturing the various parts of the business so that the change in Plan Value gives us a very good ideas as to how the business is progressing.

Over the past 5 years the Plan Value has fairly consistently grown in the 15%-20% range. I think this is realistic, and largely reflected by the ballooning fee earnings in recent years.

Brookfield Asset Management (BAM) will later this year trade under a different symbol, and the BAM ticket symbol will be used to represent the fee business (about half of Brookfield’s composite value).

The composite business will be renamed from Brookfield Asset Management to Brookfield Corporation. We will receive shares of BAM as a dividend (similarly as in the past we received shares of BBU, etc, when they were spun off), but our main holding will not be BAM but Brookfield Corporation which will have a different ticket symbol (the symbol not announced yet as far as I know).

I’m very happy with this business move and have been thinking about it quite a lot. It is not a business restructure, as some are calling it, and all business (and client relationships, etc) will continue as usual; it is just that the book value of Brookfield Corporation will much better reflect the real value, because BAM (which will become just the fee business) will have a 90%+ dividend payout ratio and likely be priced fairly realistically.

The fees business (when including carried interest) have been growing over 15% for the last 5 years, and the BAM anticipate this sort of growth to continue for a long time. Question: If the dividend (remaining with about a 90% payout ratio) is growing at this 15%, what sort of dividend yield would you like to have. A 2% yield? Even the NASDAQ index’s earnings have grown much slower than Brookfield’s fee business but commands a dividend yield under 1% (!). Think about that this comparison for a moment (as a related reference, the S&P500 underlying real earnings rose by 2.7% per year over the 50 years since 1973t).

Note that if the dividend yield is fairly stable, then your total return is the dividend paid out plus the growth of the dividend. Maybe you will only buy BAM if it trades at such a low quite that it has the higher dividend yield such as the 4% yield of BEP (with its free cash flow growing slower than BAM’s fee business).

In any case, the new BAM publicly listed business will have a market cap that fairly realistically reflects their free cash flow from their fee earnings, and the quote will fairly quickly settle somewhere. I expect BAM’s will (but please correctly me if I am wrong) be marked on Brookfield Corporation’s book using the BAM market capitalisation. Consequently Brookfield will for the first time (at least, since the old days when it was Brascan Corp prior to 2005 and did not even have fee earnings) have a published book value that reasonably reflects the true value of the business. Of course, the BAM quotation might be too high or too low (I am very skeptical about market efficiency), but when the dividend yield for BAM is to high investors will see it right in front of them, become greedy, and bid the price up and the dividend yield will back down. In any case, Brookfield Corporation’s book value will be far, far closer to the Plan Value than presently with the fee earnings not capitalised.

– Manlobbi

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In a world where we routinely Bar-B-Q Buffett for not outperforming Mr. Market it seems the BAM prosecution is on hold. Still interested in the FFO accounting, seems the bad stuff is left standing or whatnot. Interest in BAM…or is it plain and simple interest…that’s rising with billions, or maybe I’m not reading the financials correctly and should as usual leave that part out.

Owner of BAM since it was Brascan, actually it was Edper when I bought. But that’s a long-long-long time ago when the business routinely sold for less than 8 times generally accepted accounting principles figures.

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In comparing Berkshire and Brookfield, is helpful to pay attention to what the underlying business is doing regarding tracking both past success and giving an indication as to what to expect in the future (for predictable business models). We look at quotes only to work out viable entry and exit points in relation to value.

Over the last 5 years, Berkshire has grown its book value fro 233 to 360 per B share. That’s a growth of 9% per year, versus 8.5% for the S&P500. As a reasonable proxy for the change in value of the S&P500 we can use sales per share plus dividends of the S&P500 (sales growth of 7% and the dividend yield around 1.5%). Earnings growth is more important, but as margins fluctuate when looking at the relative change it is more useful to use the sales per share. So Berkshire’s business essentially matched the average S&P500 (both about 9% per year) the last five years.

How much premium to book would you pay for merely matching the market, if that was to continue into the future? In the case of Berkshire much of the business is not capitalised, so it is rational to pay around 1.5 x book value, and then expect a similar return to the S&P500.

If you expect (and you don’t have to) the forward change in book value plus dividends to be similar between Berkshire and the S&P500 , then you could view Berkshire as an “alternative index fund” (given my expectation of long-term return prospect being similar) which you can buy into when the price/book is particularly low. Your goal would be to outperform the S&P500 by holding a similar investment that you can purchase and sell opportunistically. The trouble is that the price/book is only low when the market as whole is selling cheaply, so it is difficult to take advantage of Berkshire even as such a “trading vehicle”.

How about holding something that has expectations for a significantly higher long-term business increase in observable value (let’s separate this from the quote for now, and look just at the grown in the business itself). What about Brookfield Corporation’s change in observable intrinsic value over these same 5 years? Book value per share has only grown 60% (at about 10% per year) however it gave out about 2% in dividends and stocks over the time, so we are up to 12% per year, and finally the fee earnings and cash flow grew over 16% per year, which comprises have of the present intrinsic value if capitalised. So Brookfield as a whole grew over 14% per year in value. That was 7.5% ahead of the S&P500 and 7% ahead of the Berkshire.

The quote for BAM, however, has not grown so well as the value over these 5 years - the gain in the quote for Brookfield has been very similar to that of both the S&P500 and Berkshire accounting for dividends, so that means that it has been becoming increasingly cheap over this time. BAM can’t keep getting cheaper forever, and at some stage the quote has to catch up with the change in value.

– Manlobbi

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Subject to the norm of “if you own it you must flood discussion with praise” and/or “all things must be interpreted as positive” is the way of forums. As an owner of BAM I come to a forum mostly for a discussion of the financial statments, an independent one. That generally doesn’t happen with BAM, there’s cut-'n-paste of presentations and whatnot and there’s overly detail wild guesses to the grand sure-to-enrich you future stock price.

When I read the financial statements and then listen to Bruce I get two different views, at times now pretty drastically different. I do not get that with Berkshire, Markel, Fairfax, AJ Gallagher, Brown and Brown, Aon, Marsh, Willis, Norfolk Southern…or any of the other businesses I own stock in. Not even with Blackstone.

I am well known in some parts for my understanding of detailed financial statments.

Down the road we go.

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Fee earnings? Cash flow? Interesting choices. Let’s interpret the bottom line and include the interest expense and such. We all can grab some cash flow, right on down to bankruptcy.

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But anyway, my long ownership of the Flatt story tells me it is ok…but not anywhere as close to superior as Bruce promotes. Down the road we go without some fantastic market beating IV 10 or whatnot.

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I found the following a good summary and introduction if anyone needs one:

In particular, it renewed my appreciation for Brookfield’s use of responsible leverage in combination with non-recourse debt at the level of the partnership entities. As with all things BAM-related, this is a dance of many veils, but there’s a great deal of information available in the partnership filings that many people who are interested in BAM (the parent) seem to ignore. It will be interesting to get filings for both the asset manager entity and Brookfield Corporation after the spinoff.

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That was a great summary by Nima Shayegh, thank you for finding it - many might not have seen it otherwise as Google’s indexes are presently missing it. He largely repeats points made during the Investor Day presentations, so whilst not anything new for a lot of investors, he did cover everything very broadly in a way that is useful for investors.

The last Investor Day presentation, by the way, is here:

By the way, the old BAM traded ex-dividend exactly today (BAM spinoff, whilst the BAM ticker will be renamed BC) thus the 3% quote decline.

If you do nothing at all, the economically you will own the same as did before with just BAM. If you originally had 100 shares of BAM, after the spinoff you will have 100 shares of BN, and 25 shares of BAM. If you keep these 100 shares of BN and 25 shares of BAM, then economically it will be as if nothing changed for you.

The new BAM and BN will begin trading on 12 December.

Whether you sell the new BAM and allocate the money back into BC, or keep BAM and BC separate, might depend on whether you think BAM is not trading in a way that reflects the new BAM’s intrinsic value.

Note also that the new BAM’s first dividend will be small, so you need to wait for the second dividend to observe the actual dividend yield for the new BAM. It will have about a 90% payout ratio (90% of Brookfield original fee earnings). It will be very interesting to see what yield the new BAM commands - rationally it should be lower than the yield of BEP and BIP given how fast the income is like to continue growing - but investors may take a while to become comfortable with BAM, so it might trade at a high yield for quite a while.

Long term I intend to hold only BN, and not new the BAM because of its capacity to allocate capital between the publicly traded partnerships, but I will only move the capital from the new BAM back to BN if I’m fairly sure that that the BAM is not trading particularly cheaply relative to its own value (technically we want BN to be less cheap than BAM is cheap when moving capital from BAM back to BN). Let’s see how the market appraises the new BAM’s market cap, and we can then compare that to its distributable earnings.

– Manlobbi

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Manlobbi - how do you think the new BAM is trading? Was it what you expected on share price?

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A review of the two companies following the spinoff. The analyst Alexander Steinberg thinks BAM is currently a better value than BN.

BAM might go down further in the next few days as some investors may not want to hold a small position and prefer to retain their original investment in BN. Often spinoffs go down for several days but then stabilize and go on to outperform their parent.

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