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Brookfield Asset Management / Infrastructure Privatization


EricSchleien
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Hey All --

 

I own a lot of Brookfield and is one of my largest positions at my firm. I've been doing some thinking recently on what Brookfield could look like in 10, 20, 30 years down the line and think at these prices it has the potential to be possibly one of the most no brainers in hindsight, kind of like buying Berkshire below book value.

 

The thinking is around the privatization of infrastructure. I don't have any data to back this up but rather seeing the mass decentralization taking place around the world and I believe will only continue, I think it's possible that infrastructure is mostly private in our lifetimes or at least MUCH more than it is today. If that's the case then the amount of assets in this industry will be pennies compared to what it will be in a few decades from now. If that's the case, Brookfield could be WAY less than a 50 cent dollar.

 

I'm sort of just rambling here but I tend to see things as very big picture. Of course the world isn't linear and many things and many unknowns can happen and will happen, I just have this feeling this could be a huge driver of Intrinsic Value going forward that isn't really being spoken about much. Bruce Flatt talks about it a little but seems less excited about it than I am. Of course I could be totally wrong but I do feel that the probability of this is not low. Seems the risk/reward for Brookfield is even higher than the company alludes to in their investor presentations.

 

Anyone else been thinking along these lines?

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Couple of question here.

 

Why would Brookfield earn outsize returns if infrastructure is privatized& Don't you think that when the government puts a project for bid that other player's like retirement funds, private asset managers, engineering firms, will not bid till the return are merely meeting the return on capital?

 

Why would Brookfield get better returns on infrastructure than others?

 

Do you think their current portfolio is worth multiples of what it is currently valued at? Why would it be a multiple of what it is today?

 

BeerBaron

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If that's the case, Brookfield could be WAY less than a 50 cent dollar.

 

I think a privatization of infrastructure should benefit BAM.  More opportunities should generally help them even if there are competitors in the space.  Not everyone has the scale of BAM and if the market grows then BAM should be able to continue to grow.

 

I would be very interested if you would provide a brief valuation of BAM.  What CAGR do you believe BAM could achieve over the next 10-20-30 years?  Why?

 

Thanks.

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Couple of question here.

 

Why would Brookfield earn outsize returns if infrastructure is privatized& Don't you think that when the government puts a project for bid that other player's like retirement funds, private asset managers, engineering firms, will not bid till the return are merely meeting the return on capital?

 

Why would Brookfield get better returns on infrastructure than others?

 

Do you think their current portfolio is worth multiples of what it is currently valued at? Why would it be a multiple of what it is today?

 

BeerBaron

 

Several reasons why Brookfield is able to make higher returns on infrastructure than others - (i) Brookfield is a value investor that is provider of capital in times when capital is scarce. Last year, they did a bunch of infrastructure deals in Brazil when no one wanted anything to do with Brazil. Lately, they have been doing deals in India when foreign investment in India is on the sidelines. This is how Brookfield has operated ever since Bruce Flatt took over. (ii) Other financial players with capital don't compete with Brookfield because the projects that Brookfields bids on requires real operating expertise that financial players don't necessarily have. Brookfield has been in Brazil for decades. Similarly, Brookfield has been in India for over a decade and only recently started doing deals when capital dried up. I don't think there are many firms that have the patience and long-term orientation to do this. (iii) Brookfield is probably the only infrastructure that is global - that can go wherever there is fear.

 

In terms of valuation, what most investors miss is that BAM is transforming itself into an asset manager that is growing its fee income very rapidly. As sum of parts (asset manager making fee income + book value of invested capital) BAM is trading at a very reasonable valuation.

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If that's the case, Brookfield could be WAY less than a 50 cent dollar.

 

I think a privatization of infrastructure should benefit BAM.  More opportunities should generally help them even if there are competitors in the space.  Not everyone has the scale of BAM and if the market grows then BAM should be able to continue to grow.

 

I would be very interested if you would provide a brief valuation of BAM.  What CAGR do you believe BAM could achieve over the next 10-20-30 years?  Why?

 

Thanks.

 

Here is how I value BAM:

 

TTM Fee Earnings:        $660M x 20  = $13.2B

Target Carried Interest: $540M x 10  = $  5.4B

Invested Capital:          $29.7B x 1  = $29.7B

Borrowing:                                      =($ 4.5B)

Working Capital:                              =($  .2B)

Preferred Shares:                              =($3.7B)

Total:                                              =$39.9B

Shares Outstanding:                          =1B

Intrinsic Value per share:                  =~40$

Current share price:                          =32.5$

Share price / Intrinsic value                =80%

 

Note that the fee income has grown from $180M 4 years ago to $660M today - CAGR of 38%. Even if interest rates go up, and assets move from bonds, not all the assets are going into equity.

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You are really talking about P3 Private/Public Partnerships.

They have always been part of the financial picture, & are almost exclusively the preserve of pension funds & life insurance (airports, ports, hospitals, sewage/water treatment, etc. - endless list, & no shortage of available capital). Today, we just have a catalyst.

 

It's highly BAM gains, simply because the pie gets better; 1 slice of a large pizza is a lot more area than 1 slice of a medium pizza.

Cant invest in a pension fund though.

 

But every one of those infrastructure projects required engineers to design them, & construction companies to build them - no matter who funded them.

Look at the service providers, not the funders.

 

SD 

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What do you think the risks are here? Would higher interest rates impact the business since these investments use a lot of leverage? Also, would there be an impact from potential changes to carried interest taxation?

 

BAM has very little corporate leverage. The leverage at the level of listed entities is also limited. Most of the leverage you see in the consolidated balance sheets is on a per project level. Also, BAM is very conservative in its financing - most of it is quite long term and fixed. Most of the carried interest is unrealized.

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I really like this company.  They are incredibly well run.  I hold Bep.un as a yield play, run by its own CEO, but answerable to Flatt.   

 

I would buy BAM on a pullback.  Its on my target list. 

 

Long term infrastructure investment and operation is a high level, tricky, and complex business.  Being really good at it is hard, and BAM is good at it.  It has taken Bruce Flatt years to assemble the skill levels necessary to do this well.  It can be done badly so easily - Just ask the operators of Highway 407 across Toronto.

 

The skills needed at a high level encompass financial, engineering, political, and legal.  As long as management remains intact and keeps building a deep team they will do well.  I think the CEO is humble enough to do this.  And he has a really long runway if he stays on, at 51 years old.  Dude apparently eats lunch when he's around, in the mall food court below the office building, with any employees who may be there. 

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I really like this company.  They are incredibly well run.  I hold Bep.un as a yield play, run by its own CEO, but answerable to Flatt.   

 

I would buy BAM on a pullback.  Its on my target list. 

 

Long term infrastructure investment and operation is a high level, tricky, and complex business.  Being really good at it is hard, and BAM is good at it.  It has taken Bruce Flatt years to assemble the skill levels necessary to do this well.  It can be done badly so easily - Just ask the operators of Highway 407 across Toronto.

 

The skills needed at a high level encompass financial, engineering, political, and legal.  As long as management remains intact and keeps building a deep team they will do well.  I think the CEO is humble enough to do this.  And he has a really long runway if he stays on, at 51 years old.  Dude apparently eats lunch when he's around, in the mall food court below the office building, with any employees who may be there.

 

Thanks for the color, Uccmal.  You do a nice describing the strengths.  The one that I would add, which may be implied in your list, is access to capital.  BAM and the subs have been hitting it out of the park over the past decade building relationships across the globe.  Having a long-established relationship goes a long way to making capital sticky, which should prove a huge advantage over later entrants into the space.  That makes their capital access more akin to the insurer companies and pension funds than other private equity.

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What is stopping governments from selling for cash and then turning around and restricting price gains in the face of inflation? Brookfield seems to operate in many developing nations but also in developed ones. Either way, I'm not sure it's much different than a leveraged fixed income portfolio held inside an insurer, but there at least there are no cranes, no construction, no overhead, and if run right no interest expense, just paper and brokerage account.

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It can be done badly so easily - Just ask the operators of Highway 407 across Toronto.

 

What's wrong with 407?

 

Badly may be overstated.  It makes money, but I cant get clear how well it does.  The numbers are published.  To me it looks like it is being bled dry.  Mostly, I have been working on the premise that SNC is, and has had trouble getting out of it.  There have been various attempted sales.  The CCPIB has picked up stakes over the years but their target return is lower than a private company, and I expect they have reached their buying limit. Anyone who buys it doesn't get the same returns the initial buyer (SNC, Cintra) assumed they would get from the asset.  So, they are stuck with it, and have no option but to make it work.  In this low interest rate environment that is okay for now, but if their bonds have to be issued at a higher price then the squeeze could start.  Since we have been operating in a declining interest rate environment since 1999 it hasn't been overly painful but the lack of buyers stepping forward to buy part of Cintra and SNC's stakes, that have been shopped, kind of indicates that they cant get the prices they want. 

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It can be done badly so easily - Just ask the operators of Highway 407 across Toronto.

 

What's wrong with 407?

 

Ontario doesn't permit an operator to put a toll booth on the road; you have to sell a transponder plate &/or rely on collection backed by photo-radar - & the honesty of the public driving the road. At the time it was built, the business model also assumed that if you didn't pay, your licence plate could not be renewed until you paid the outstanding fine. Turned out that for a province to collect on behalf of a private company in this manner - is illegal; however were the province to own the asset, it would not be a problem. Hence, it's a 'stranded' asset.

 

The operator is permitted to raise tolls to maintain the road & 'lock-in' a reasonable profit spread on its investment; hence it remains an attractive infrastructure investment - offering a large, reliable, & long term stream of cash flow attractive to pension funds & life insurers. If you want 'out', you essentially have to keep your ownership interest & 'securitise' the cash flow. Limited appeal.

 

SD

 

 

 

 

 

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It can be done badly so easily - Just ask the operators of Highway 407 across Toronto.

 

What's wrong with 407?

 

Badly may be overstated.  It makes money, but I cant get clear how well it does.  The numbers are published.  To me it looks like it is being bled dry.  Mostly, I have been working on the premise that SNC is, and has had trouble getting out of it.  There have been various attempted sales.  The CCPIB has picked up stakes over the years but their target return is lower than a private company, and I expect they have reached their buying limit. Anyone who buys it doesn't get the same returns the initial buyer (SNC, Cintra) assumed they would get from the asset.  So, they are stuck with it, and have no option but to make it work.  In this low interest rate environment that is okay for now, but if their bonds have to be issued at a higher price then the squeeze could start.  Since we have been operating in a declining interest rate environment since 1999 it hasn't been overly painful but the lack of buyers stepping forward to buy part of Cintra and SNC's stakes, that have been shopped, kind of indicates that they cant get the prices they want.

It's a (mostly) unregulated infrastructure asset that is increasing revenue, and CF at 10% per year and will continue into the future. It is a fantastic asset. The reason why it looks like it's being bled is because the shareholders dividend out all excess cash. Keep in mind that it's more of an asset than a company.

 

There have been several sales of stakes in 407. CPPIB has indicated that it is willing to buy more. There's also the option of one of the stakeholders to independently list their shares. The company is probably worth about $15 Bn so it wouldn't be a small cap or anything like that. It's true that it has been a great investment for the initial buyers. But then you can say that about a lot of stuff. Sure it would have been better to buy BRK in the 80s instead of the 2000s. But you still did well if you bought BRK in the 2000s.

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Ontario doesn't permit an operator to put a toll booth on the road; you have to sell a transponder plate &/or rely on collection backed by photo-radar - & the honesty of the public driving the road. At the time it was built, the business model also assumed that if you didn't pay, your licence plate could not be renewed until you paid the outstanding fine. Turned out that for a province to collect on behalf of a private company in this manner - is illegal; however were the province to own the asset, it would not be a problem. Hence, it's a 'stranded' asset.

In Ontario you still can't renew your plates if you have outstanding balances with 407 greater than 150 days.

 

I think what you may refer to is a ruling that the gov't can't refuse to renew your plate if you go through bankruptcy. Instead in that case 407 just becomes another one of your creditors.

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