Event
Late last week, BAM hosted a well-attended Investor Day in New York
Impact: POSITIVE
■ In an environment where interest rates across all major
capital markets are low or negative, alternative assets have arguably become
the only way to earn a reasonable return with modest risk, and, against that
backdrop, the already powerful flow of funds into alternatives could
substantially increase, which should disproportionately benefit top-tier managers
like BAM, in our view. With the addition of Oaktree's premier credit franchise,
the company believes that its next round of flagship fundraising could reach
$100bln in size.
■ BAM has been preparing to capitalize on the next downturn
for some time, but the company continues to deploy capital cautiously, and
outlined four key investment themes: 1) special situations in North America,
where valuations are high (e.g. Forest
City , Westinghouse); 2) interest rate
inversion, particularly in Europe; 3) banking stress in India ; and 4) balance sheet reorganization in China
■ BAM's investment performance has been strong, and the
company's projection of carried interest generated has increased and shifted
forward vs. 2018. The company expects to realize $15bln of cumulative carried
interest (gross) during 2019-2029, up substantially vs. its 2018 projection of
$10bln. Including that increasing stream of realized carried interest, BAM expects
free cash flow to increase by 2.5x to $6.3bln in 2024 vs. $2.5bln in 2019, and
we expect capital allocation to pivot towards share buybacks over time, as the
company signalled in its Q2/18 letter to shareholders.
■ As usual, BAM provided a five-year outlook, which outlined
potential upside to ~ $141.00/share for a total potential annualized return of
22% vs. the current share price (including dividends).
TD Investment Conclusion
We believe that an investment in BAM provides exposure to a
very high-quality portfolio of real assets, with the added leverage of a
rapidly growing asset management franchise, which is clearly established as one
of a select group of institutions capable of raising very large pools of capital
to invest in real assets. We have increased our target price based on higher
target prices for BEP and BIP, and the inclusion of Oaktree, among other
adjustments.
Details
Alternatives Becoming a
Necessity
Last year, BAM was anticipating that interest rates would
move higher but remain “low-ish”. The company now believes that we have likely
entered a new phase in which interest rates across all major capital markets
are low or negative.
BAM projects that allocations to alternatives could reach
60% by 2030 vs. its previous view of 40%, because against that backdrop,
alternatives have become the only way to earn a reasonable return with modest
risk.
An increase in allocations to 60% would imply $25tn of
inflows to alternatives by 2030, which should disproportionately benefit
top-tier managers like BAM.
The Oaktree acquisition is timely, because it gives BAM
immediate scale in credit, and enables the company to provide clients with one
of the most comprehensive offerings of alternative investment products.
We also see good scope for the companies to expand their
combined client base, with Oaktree having very high penetration among the
largest U.S.
The company anticipates that its next round of flagship
fundraising should raise $100bln (including Oaktree) vs. ~$50bln for the
current round.
Investing Cautiously
BAM is still cautiously optimistic about the business
environment, but has been preparing to capitalize on the next downturn for some
time, and ended Q2⁄19 with a record $49bln of available liquidity.
The acquisition of Oaktree will reduce the corporate cash
balance by $2bln-$3bln, but BAM’s annual free cash flow run-rate is ~$2.5bln
(including realized carried interest), and the company believes that having
access to Oaktree’s premier credit franchise will be a distinct advantage when
the cycle turns.
BAM deployed ~$33bln of capital over the last 12 months, and
highlighted four themes that it expects will drive future investments: 1)
special situations in North America, where valuations are high; 2) interest
rate inversion, particularly in Europe; 3) banking stress in India ; and 4) balance sheet reorganization in China
Delivering Strong Investment
Returns
BAM's investment performance has been strong, with most of
its funds tracking to meet or exceed their target returns, which means that
they are performing well above the preferred return (~5%-9%), and should
generate carried interest.
The company's projection of carried interest generated has
increased and shifted forward vs. 2018.
Carried Interest Projection
BAM now expects to realize $15bln of cumulative carried
interest (gross) during 2019-2029, up substantially vs. its 2018 projection of
$10bln.
Importantly, the $15bln projection is based on existing
funds only and excludes Oaktree funds; future fundraising should be
incremental.
Including this increasing stream of realized carried
interest, BAM expects free cash flow to increase by ~2.5x to $6.3bln in 2024
from $2.5bln in 2019, which should enable the company to return more capital to
shareholders through share buybacks.
Free Cash Flow Projection
As usual, BAM provided a five-year outlook, outlining
potential upside to ~$141.00/share, which represents a total potential
annualized return (including dividends) of ~22% vs. the current share
price.
These projections assume that fee-bearing capital compounds
at a 12% CAGR to $396bln (including 62% of Oaktree), and invested capital
compounds at ~11% to $75bln vs. $45bln in Q2/19 (a blend of quoted and IFRS
values).
Key Risks to Target Price
Key risks to our target price include: 1) global economic
risk; 2) rising interest rates; 3) sovereign/regulatory risk; 4) counterparty
risk; 5) variable hydroelectric generation; 6) financing risk; 7) significant
FX movement; and 8) corporate governance considerations related to
non-proportionate Class A share voting rights to appoint the Board of
Directors.
Resources,
TD Securities Inc.
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