Brookfield Asset Management…Q4 2019, Letter to
Shareholders
When I started to read
Bruce Flatt’s letter to the shareholders I stopped reading newspapers and
listening to media-darling economists. And it affirmed my belief in ‘bottom-up’
investing…In other words concentrate on the business your company is in and
ignore the chaotic short term focus of the financial media which most of the
time is full of fury but in the end signifies nothing…sorry Bill…
Overview
Stock market performance was very strong in 2019. Our shares
in particular generated an overall return of 50% during the year. While this
was due in part to the overall market performance, it was also the result of
our strong operating results. Fundraising for alternative investments, which are
becoming more mainstream every day, remains strong. Post year end, we closed
our latest flagship fund of $20 billion for Infrastructure. We also continue to
fundraise for our perpetual core-plus funds which today near $8 billion in
total size. With interest rates continuing to be very low, these funds should
attract greater amounts of capital as the strategies mature.
We invested over $30 billion during 2019 and sold $13
billion of investments. Our investment
strategies are focused on a few themes: the global build-out of renewables,
data infrastructure, high-quality property developments, and global businesses
where our operating expertise helps generate returns greater than might
otherwise be expected. With our franchise continuing to globalize and the scale
of our capital growing, we see no reason 2020 won’t be as good a year
operationally as 2019.
Much attention is being paid these days to sustainability
and carbon footprint. As many of you know, we have been very active in this
area without much fanfare. The sheer scale of our renewables business and its
avoided emissions eclipse our estimates of emissions across all our other
businesses. On this basis, we believe Brookfield’s
overall carbon profile today is very low, if not neutral or possibly even negative.
We intend to further enhance that profile as we build out our vast development
portfolio of renewables.
We have decided to
split our shares again on a 3-for-2 basis, and in conjunction with this,
increase the dividend by approximately 12% – which will therefore be 18
cents per share at the end of March, and 12 cents per share on a quarterly
basis, post-split. While splitting the shares has no effect on the value of the
company, it costs us virtually nothing to do, and it has been our practice to do
this, as it keeps the share price within a reasonable range for investors.
Stock Performance
While we manage our underlying business for the long term,
we realize that you are also interested in our stock performance. Its 50%
increase in 2019 was an anomaly; at the same time, the previous year the share
price was down, which we also viewed as an anomaly. We estimate that we earned
approximately 20% annual returns on our intrinsic value over the two years. As
a result, over the two years combined, our stock had a return that was about
the same as what we generated in the business.
Most importantly, our view of the intrinsic value of the
business continues to increase. This is because most of our businesses
performed well, and because we raised significant capital to deploy into new
opportunities. This should enable us to deliver favorable results well into the
future… $1,000 invested 25 years ago in Brookfield Asset Management is today
worth just over $62,000.
Market Environment
The global economy is still very constructive, in spite of
the fact that we are in the later stages
of a bull market. With interest rates very low around the world, we think this cycle could last longer
than anyone expected. Regardless, we are ensuring that we are not complacent
at this point in the cycle.
Developed economy markets show no signs of stress. However, the fact that equity markets have
been very strong for the last year in itself is worrisome. The corporate
credit markets also are performing well, but we believe this is where the great value will be found in the next
downturn. We are positioning ourselves to capitalize on this – both through
our Brookfield
funds, and through Oaktree.
The United States,
Canada, and Australia have
strong economies, but assets are more fairly priced. As a result, we continue to be selective with
opportunities, looking for transactions in out-of-favor sectors and
focusing on opportunities that play to our operating strengths.
Europe is slower but still
resilient. Opportunity lies in the fact that 60% of the capital
invested in an acquisition can be borrowed at virtually no cost. The United Kingdom
seems to have pushed past its Brexit crisis, which should be positive for
businesses making long-term commitments
Companies in India
and China are under stress
(the latter compounded with the recent virus issues) – banks in India are dealing with non-performing loans, and
in China
they are pushing borrowers to sell assets. This
has led to significant investment opportunities that we think will continue for
the foreseeable future.
Brazil
looks to be back on track to continued recovery, with interest rates now under 5%, down from close to 15% in its most
recent financial crisis. As a result, fixed income and equity investors
have had excellent returns, and private assets have followed suit.
A Summary of
2019
Total assets under management are now $545 billion
(including Oaktree), as we continue to raise and deploy additional capital
across our businesses…
Asset Management Activities
We now own 61% of Oaktree, with the balance continuing to be
owned by the Oaktree partners. Joining
with this premier credit franchise deepens the capabilities we offer our
clients, positions us even better across market cycles, and expands our breadth
as one of the world’s largest alternative asset managers. While Oaktree
will continue to operate as a standalone business, the world-class management
team and credit expertise they bring have already had a positive impact on our
business, and the benefits should continue to compound over time.
Organic growth within
our existing asset management business was very strong. In January 2019, we
closed our latest flagship real estate fund at $15 billion, an increase of over
65% from its predecessor fund. We also held the final close of our latest
flagship private equity fund at $9 billion in October, more than double the
size of its previous vintage. Finally, we recently held the final close of our
latest flagship infrastructure fund at $20 billion, making it one of the
largest global infrastructure funds ever raised.
Together, this round of flagship fundraising raised over $50
billion, including co-investment capital, and is already approximately 45%
deployed. Our flagship Oaktree distressed debt fund is also over 40% deployed,
and all of the capital committed to it became fee earning as of January 1,
2020. As a result, it will begin to
fully contribute to results this year. Our focus for 2020 will be on
growing our other strategies, while also
deploying the latest round of flagship capital. If successful, we
anticipate that we will be back in the markets with our next launch of flagship
funds late this year or in 2021.
Fundraising for our
specialized strategies had strong momentum in 2019. We raised $3 billion of
capital within our perpetual private fund strategies across our super-core
infrastructure and core and mezzanine real estate funds. We also recently
launched the second vintage of our private infrastructure debt fund in the
fourth quarter.
With respect to fund distribution, our high net wealth
channel is growing steadily and today accounts for approximately 10% of funds
raised on an annual basis, making a
meaningful contribution to our latest round of flagship funds. While the
geographical split of capital raised across all channels has remained largely
consistent with the prior year, the number of LPs and total dollar value of
capital raised from target geographies, including
Asia and Europe, is growing.
Growth in the asset management franchise drove fee-related
earnings prior to performance fees to $1.2 billion, a 41% increase from the prior year. We also realized a greater level of carried interest in 2019. We
recorded in income approximately $600 million of carried interest during the
year, reflecting the completion of a
number of asset sales within our earlier vintage flagship private funds, which
crystalized investment gains and the associated carried interest. We expect
continued realizations in 2020, as we progress planned asset dispositions in each
of our flagship fund strategies.
Operating Activities
Despite the record levels of capital flowing to alternative
asset managers in 2019, we found many opportunities to deploy capital for
value. We invested over $30 billion of capital across our business groups by
leveraging our key strengths of access to diverse pools of capital, global
scale and operating expertise. We also
realized $13 billion of proceeds from the sale of mature assets.
Our
real estate operations made many investments globally, including an
investment in the hospitality sector in India, and one in the retail sector in Dubai. We also
acquired a business in the senior housing and assisted living sector in Australia. We
progressed on our redevelopment and
densification strategy within our core retail portfolio, and completed over
4 million square feet of office developments in New York
and London. Average rents across our office portfolio
increased 2% since this time last year. With significant developments and
acquisitions coming online in the near term, we expect growth to continue in
2020.
Our
renewable power operations continued to grow in scale and reach. We partnered to acquire a 50% interest in
one of the world’s largest solar developers. We doubled both the size of our
Asian operations, and our distributed generation businesses. We also made a
sizable investment in a utility company, with an option to acquire an interest
in their hydro portfolio. At the same time, we progressed our capital recycling program, selling wind portfolios in
Europe, as well as the majority of our South
African solar and wind assets. From a green financing perspective, we
issued in aggregate $1 billion of green financings, including the largest-ever corporate green bond in Canada.
Lastly, since year end we announced the combination of Brookfield Renewable and
TerraForm Power in an all-stock deal.
Our
infrastructure operations continued to deliver strong results, increasing normalized FFO by 12% from the
prior year. Results were driven by organic
growth and the acquisition of a number of businesses, including natural gas
pipelines in North America and India,
and data infrastructure businesses in India,
South America and New
Zealand. At the end of December, we also
closed on the acquisition of one of the
largest short-haul rail operators in North America, a cell-tower business in
the U.K.
and a portfolio of pipeline assets. These latest acquisitions will begin to
contribute FFO in the first quarter of 2020.
Our
private equity operations continued to grow in scale, with the
acquisition of a number of high-quality businesses. Most notably, we acquired a leading global supplier of
advanced automotive batteries and the second-largest private healthcare
provider in Australia.
We also acquired a controlling interest in a residential mortgage insurer
in Canada
and announced an investment in a leading provider of work access solutions to
industrial and commercial facilities. On the disposition front, we sold our global facilities management
business, our executive relocation business, a palladium mining company, and a
cold storage business, each for very strong returns.
Our
credit operations delivered good results during the year, especially in
the Oaktree franchise. Our Brookfield
infrastructure and real estate debt funds also continued to perform well, with
significant capital deployment. The
economic outlook currently warrants a disciplined approach, with a measured
pace of lending across the debt funds. We continue to deploy capital the
same way we always have – with an
emphasis on fundamental analysis and downside protection of capital.
Overall, our share of the underlying funds from operations
from our invested capital increased 9% over 2018, to $1.7 billion before
disposition gains. The growth in FFO from our invested capital, combined with
the earnings from our asset management franchise, generated $2.6 billion of
free cash flow to BAM in 2019. As our
free cash flow has more than doubled over the past five years, and we expect it
to do so again over the next five years, we continue to evaluate the best use
for this cash flow – whether that be re-investment within our business; seeding
new strategies; opportunistic investments such as the Oaktree acquisition; or
returning value to shareholders through other means such as share repurchases
or increased dividends. Rest assured we think all the time about the best
use for your capital.
The Advantage of Asset-Level
Non-Recourse Financing
Like many other investors, we utilize debt to optimize our
capital structure and fund our business. However, unlike many others, as both
an asset manager and investor, how we report the debt in our financial
statements is different from most other businesses. For that reason, we think
it important to devote a few paragraphs to this.
We take a bottom-up approach to financing the investments we
manage. That means that the vast
majority of our debt is at the individual asset (or portfolio company) level.
Each loan has recourse to only the specific asset that it finances – and importantly,
gives lenders no recourse to BAM or our listed partnerships. As a result,
the risk of anything going wrong with any financing is limited solely to the
equity invested in that particular asset. No
single loan can ever create a forced liquidity event for the broader franchise
or even parts of the franchise.
Despite the foregoing, we structure our financings to stand
the test of time and withstand adverse circumstances, and we have a strong
track record that proves this out: we
fared well in 2008/2009, which demonstrated the strength of our prudent
approach to financing. We take pride in being one of the highest-quality
borrowers in the capital markets.
As a Canadian firm, international accounting principles
require us to consolidate many of these investments, including their
borrowings, in our consolidated financial statements for reporting purposes –
even though our proportionate economic ownership of the investment is in most
cases well below 50%. The requirement to
consolidate is due to the combination of (1) the control over these activities
that we exert; (2) compensation we receive as the manager; and (3) our economic
interest in the assets. This results in the appearance that Brookfield has more debt outstanding than it
actually has.
The debt that is most
relevant to Brookfield
shareholders is the debt issued directly by the Corporation. This debt
currently totals $7 billion – a significant sum to be sure, but it is all very long-term in nature and
modest relative to Brookfield’s
$72 billion capitalization of common and preferred equity.
In a similar vein, each of our listed partnerships utilizes
modest amounts of corporate debt to manage its capital resources for its
unitholders. We manage these entities to
have investment grade characteristics which enables them to finance their
activities on a standalone basis, without any recourse to BAM. Currently
our four listed partnerships combined have $6 billion of corporate debt
compared to an aggregate equity capitalization
of $69 billion.
With this context in mind, we encourage you to look at the
disclosures in our MD&A that present the corporate, listed partnership and
asset level debt in a way that is more consistent with our approach to
leverage, as described above
The United Kingdom is Stronger
Than it Seems
Our view is that the
long-term effects of Brexit on the City of London will be negligible. Despite that,
we were pleased that the Conservative Government in the U.K. received a
clear mandate to leave the E.U., and can now proceed with the logistics of the
process. While years ago we would not have wished for this, the only scenario
that was truly negative for the U.K.
was the ongoing indecision.
Overall, our businesses across the U.K. – which include office buildings, ports, utility businesses and student
housing, among others – have performed well to date despite the headlines and
politics. A great example of this is our 100 Bishopsgate development. We
acquired 50% of the land at 100 Bishopsgate in 2010, then acquired the remaining
interests from the partner in 2014, and planned a 950,000-square foot office
tower with associated retail. We began construction in 2015, and our total
acquisition and construction costs were approximately £850 million.
In June 2016, when the Brexit vote occurred, we were 50%
complete on construction, with 38% of the space leased to tenants. Since Brexit
(about 3½ years), we have completed the construction on budget and leased
nearly all of the balance of the tower on a long-term basis. More importantly, that additional space was
leased at or above the rental rate levels we expected when we started.
As a result, we will soon have annual cash flows from 100
Bishopsgate, net of costs, of £70 million. We recently refinanced the property
with a loan for £875 million, essentially our cost. The interest rate on the
recourse-only mortgage is 3%, or £27 million annually. We now have no remaining equity investment cost, and we enjoy cash
flows net of interest of £40 million annually. Capitalization rates for this
type of property would today be between 3% and 4%. At the low end of this
range, the value created is £900 million over our cost. At the high end, it is
£1.5 billion of profit over our cost. This
was a good outcome under any circumstance, but given the backdrop of Brexit, is
exceptional. Most importantly, this
gives an indication of what is occurring in the real economy in the United Kingdom.
The Sun is Shining Even Brighter
We have been invested in renewable power in a significant
way for 30 years, as a result of our original ownership of hydro facilities
associated with industrial facilities we owned. We expanded the operations into wind, and more recently into solar, as
technological advances and scale manufacturing enabled the costs of production
to decrease below those of traditional forms of electricity in many parts of
the world.
While the renewables sector has had its share of turmoil
over the years as it matured, our private clients and listed partnership
investors have all done extremely well financially, as we continued to adhere
to our investment principles. As an indicator of these returns, our stock
exchange-listed partnership, Brookfield Renewable Partners (BEP), has generated a
compound annual return of 18% over the past 20 years.
Today we are a leading renewables investor globally with $50
billion of solar, wind and hydro facilities in 17 countries. As the global energy supply continues a
slow shift to renewables, we are ideally positioned to capitalize on
opportunities in the renewable market.
Since we wrote about this two years ago, the transformation
has increased, and today everyone seems to be interested. We think we are still in the early stages of this transformation, and
it will require very substantial capital investment over multiple decades.
Renewables still account for less than 30% of the global
electricity production, of which wind and solar account for less than 25% of
the current renewables in place. Accordingly,
even if the world maintains its current $300-$400 billion of annual investment
into renewables, the level of penetration will remain modest for years.
Retail is Evolving
There are many views around the world about how the retail
landscape will shake out. Last year we took private our retail mall property
business which had been listed in the public markets. In the process we
acquired 125 incredible parcels of land in major cities across the U.S. We plan on developing these into many tens
of thousands of residential apartments and condominiums, office properties,
hotels, warehouses and self-storage locations. With these land parcels, we
acquired a premier retail business that generates over $2 billion of EBITDA.
While this is broadly seen as a contrarian investment, our
views are very simple. First, the
internet and physical retail will ultimately merge into one delivery network to
customers, and as a result, great retail will get even better. Second, retail
real estate presents redevelopment opportunities – and with our strong
development capabilities, we will be able to add income to these sites for
decades to come.
It is very important to distinguish between the different
types of retail. Our view is that good
retail, focused on ‘experiences,’ will only get better – real estate is always
about location and what can be done with that location. On the other hand,
average-to-poor retail will continue to struggle. Our retail mall portfolio is
one of the highest quality portfolios in America – and as a result, we are 96% leased on a long-term basis.
Furthermore, retailers are consolidating
stores into the best malls. In time, like almost all industries, consolidation
will end and the survivors will be stronger for it.
Part of our
confidence comes from the fact that we are dealing with a growing number of retail
brands that started life online but are now are opening stores at a record
pace. Even Amazon is opening stores to attract customers. This is because the most inexpensive way to
attract customers once sales achieve any scale is to open stores. In the
last year, over one-third of our new leasing activity was completed with
emerging retailers. Among these growing
brands, 60% are digitally native retailers that started with online operations
only – sometimes referred to as ‘clicks to bricks.’ As this plays out, good
retail will only get stronger.
Lastly, these retail centers sit on 100+ acre land parcels
which happen to be located in the most densely populated and wealthiest cities
in the U.S.
We are only starting to redevelop the land around them with offices,
apartments, condominiums, hotels and other property uses. The next 50 years will offer us significant upside in what we view as
one of the highest-quality land redevelopment portfolios ever assembled in the United States.
Our Partnership Approach
As many of you know, our senior management team has operated
as a partnership for over 25 years. This approach has, first and foremost,
provided important stability and continuity to Brookfield over the years – and
we believe is one of the reasons we have been able to generate compound returns
of approximately 20% for ALL shareholders over that period. We took great care
in structuring the partnership, and it has been a driving force in how we run
the business – and, in turn, has had a very positive impact on our culture. We have always managed Brookfield in a
non-hierarchical and collaborative way, working to make the whole greater than
the sum of the parts by operating as a team, sharing credit, methodically
planning and managing succession, and promoting from within wherever possible.
Brookfield
is a public corporation that has many important benefits for shareholders
including stock market liquidity and high
levels of governance standards and transparency. At the same time, the capital structure, which was
established in 1995, facilitates maintaining our partnership approach and
enables long-term decision-making. Through
this capital structure, a group of current and former executives of Brookfield have joint
control, and are key stewards of the company. This control takes the form
of ownership of the Class B shares of Brookfield,
which entitle the partnership to elect half the Board of Directors. Owners of
the Class A shares elect the other half of the Directors. Our partnership considers the Class B shares to be essentially held ‘in
trust’ for the next generation of partners, which makes our focus on teamwork
and succession even more important.
The partners
collectively also own or have beneficial interests in approximately 20% of the
Class A shares of Brookfield.
This substantial economic ownership interest, built up over the last 50 years,
today amounts to an investment in Brookfield
of over $10 billion. It ensures that our
interests are strongly aligned with yours. We are also always working through
the planning for the next generation in
order to ensure continued and seamless succession in the partnership.
In summary, we are focused on ensuring that control of the company will always rest
with partners whose interests are fully aligned with all Brookfield shareholders and investors. They
are the leaders of our businesses and have very meaningful ownership interests
in the firm. We think this has been – and will continue to be – critical to our
business success. It provides important continuity and stability, and the meaningful equity ownership in turn
fosters a long-term commitment to our business by our senior executives, and
management of Brookfield.
Closing
We remain committed to being a world-class alternative asset
manager, and to investing capital for you and our investment partners in high-quality assets that earn solid cash
returns on equity, while emphasizing downside protection for the capital
employed. The primary objective of the company continues to be generating increased cash flows on a
per-share basis and as a result, higher intrinsic value per share over the
longer term.
On a more personal note, Brian Lawson who has been our CFO
since 2002, will transition out of that role to become a Vice Chair, working a
bit less but still watching over risk management for us. Brian has made a
significant contribution to our business over many years, so on behalf of all
of us here at Brookfield,
I want to thank him for his years of dedication. Nick Goodman, who has been
with Brookfield for nearly a decade, will
replace Brian as Brookfield’s
CFO. Nick, currently Treasurer and Head of Capital Markets, has broad
experience across our businesses and regions and has been working directly with
Brian and me for a number of years. We look forward to introducing Nick to you.
Please do not hesitate to contact any of us should you have suggestions,
questions, comments, or ideas you wish to share. Sincerely
J. Bruce Flatt
Chief Executive Officer
February 13, 2020
