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Saturday, May 27, 2023

Fall of the Experts

Fall of the Experts

The public's faith didn't match reality.

In July of 2020, I was heartened by an interview by Freddie Sayers on Unherd with Anders Tegnell, the architect of Sweden’s COVID response. The interview was full of nuanced and common-sense statements by Tegnell. For example, he pointed out the lack of evidence and precedence for draconian lockdowns and their potential for enormous collateral harm:

Of course we are trying to keep the mortality rates as low as possible, but at the same time we have to look at the draconian measures you are talking about. Are they going to produce even more deaths by other means than the disease itself? Somehow we need to have the discussion of what we are actually trying to achieve. Is it better for public health as a whole? Or is it trying to suppress Covid-19 as much as possible? Because getting rid of it I don’t think is going to happen: it happened for a short time in New Zealand and maybe Iceland and those kind of countries might be able to keep it away, but with the global world we have today, keeping a disease like this away has never been possible in the past and it would be even more surprising if it were possible in the future.

Even more impressive was Tegnell’s humility. Several times during the interview he said “we don’t know,” and he qualified many of his answers with uncertain terms such as “seems” and “might.” I thought that was exactly what experts should have been doing all along, communicating nuance and even uncertainty to a terrified public. Either that wasn’t happening at all, or the media was filtering out all the nuance and uncertainty any expert might offer and just went with certain doom.

I texted a link to the interview to my sister, who I describe in my book Fear of a Microbial Planet as a germophobe. She was obviously worried about contracting the virus early on, but recently had been showing some healthy skepticism about the doom and gloom she was seeing on the news. Interestingly, she responded with “The only thing I don’t like, but it is the truth, is that he keeps saying ‘we don’t know.’ That is what scares me, is the ‘don’t know’ part of any of it.” The humility and uncertainty on display in the interview had given me comfort, but for my sister, it had the opposite effect.

The more I thought about it, the more I realized that I was the outlier. Most people don’t want nuance and uncertainty when they are scared. They want to know that there are experts that know everything that is going to happen and how to stop it. They want to know that all risk of disease and death can be eliminated with simple and sustainable countermeasures, and they are quite willing to trade away many of their freedoms, even for an illusion of control. Many experts and the media that promote them are perfectly happy to sell that illusion when the public is frantically buying.

Because experts failed so miserably to live up to the public and media’s magical thinking the last three years, the word “expert” has lost a lot of it’s meaning, and that’s not necessarily a bad thing. Experts are terrible at predictions and don’t have much knowledge outside of their often narrow fields of interest. In a very complex situation such as a pandemic, there will not be any one person who has a deep understanding of what’s happening at any given moment, much less the ability to predict what will happen next. It’s like asking the CEO of a car manufacturer to build a car by themself from scratch—it’s nearly impossible because it requires the coordinated efforts of hundreds of people specializing in the construction of each part and assembly of the finished product. Not even a CEO could perform each step.

In Chapter 11 in my book, I explain why experts aren’t very good at predictions and don’t have as much knowledge outside of their fields as we expect of them:

In the early days of the pandemic, the amount of coronavirus “experts” was limited, and there was a lot of competition for the few that might have qualified in media circles. One of the unquestioned experts was my former PhD advisor, Dr. Stanley Perlman, a coronavirologist/immunologist at the University of Iowa. Stan had been thrust into the world of human coronavirus research after the SARS1 outbreak put the spotlight unexpectedly on human coronaviruses. He had helped start a BSL3 lab at Iowa and began working on SARS1 infection in mice, while also paying attention to other coronaviruses with potential to cause serious disease, like the Middle East Respiratory Virus, or MERS.

When only two cases of SARS-CoV-2 infection had been confirmed in the United States, an Iowa TV station sought out Stan for a prediction about how the U.S. would be affected by the novel virus. People were already seeing horror stories from China, which had just locked down the day before. They wanted some reassurance. Thinking about how SARS1 had been contained over the course of several months in 2003, Stan told the reporter he thought Iowa would never see a case. Obviously, that prediction didn’t age well.

Two years later, when I asked him about his early recollections, he brought up that interview, “The biggest mistake I made in my initial impression is that the number of cases was increasing but I thought it was still consistent with a SARS and MERS-like spread, whereas mostly lower respiratory tract. So, in the beginning I thought that this was going to be like SARS1 and MERS and that quarantining will work. And within five weeks we knew that wasn’t going to work. When you’re asked that question as an expert you really have to walk the line and not being really sure where you are with two cases, do you say, “Well, I think we all have to be really worried because it seems to be spreading quickly,” when there really wasn’t that much evidence for that or do you say, “Well, it’s only two cases.” And I opted for saying “It’s only two cases, and I think we should just see how it plays out.”” Not only were most people clueless about how SARS-CoV-2 would behave, experts like Stan didn’t know either. His expertise was actually problematic at such an early time point.

Experts are generally terrible at forecasting, as demonstrated by psychologist and author Philip Tetlock in his 2005 book Expert Political Judgement. In Tetlock’s study, when 284 experts were asked to make 27,451 predictions in areas relevant to their expertise, the results were a total bust. When pitted against “dilettantes, dart-throwing chimps, and assorted extrapolation algorithms,” experts did not consistently perform better than any of them. They were no more accurate at forecasting than the average person. However, there were some people who proved better at forecasting, yet these were not what one would traditionally label as “experts.” Instead, more accurate forecasters tended to be more well-rounded, less ideological, and more willing to challenge their own assumptions. In contrast, experts just assumed they knew everything, and were wrong as much as right.

The wildly inaccurate predictions of many experts and pandemic prediction models only confirmed Tetlock’s conclusions. Experts were repeatedly wrong in every direction. Infectious disease epidemiologist John Ioannidis, one of the most cited scientists of all time, told CNN personality Fareed Zakaria in April of 2020, ‘‘If I were to make an informed estimate based on the limited testing data we have, I would say that COVID-19 will result in fewer than 40,000 deaths this season in the USA.’’ By June 18, 2020, the estimated number of U.S. deaths from COVID-19 was 450,000. Nobel Laureate and Stanford professor Michael Levitt developed models he used to claim that the virus was already peaking in late March of 2020. At the end of July, Levitt predicted that the pandemic would be over in the U.S. by the end of August, with less than 170,000 deaths. Instead, the number was around 180,000 by the end of August, and steadily climbing.

And that was just the COVID “minimizers.” Many COVID “maximizers” were just as wrong, yet they were the ones that leaders were heeding. On March 27th, 2020, Dr. Ezekiel Emanuel, chair of the department of medical ethics at the University of Pennsylvania, predicted 100 million cases of COVID-19 in the U.S. in just four weeks. Four weeks later, on April 27th, 2020, there were one million confirmed cases. The infamous Imperial College Model, developed by Professor Neil Ferguson and colleagues, predicted over 2 million U.S. deaths within three months of the beginning of the pandemic. This was an enormously influential model, as White House Coronavirus Response Coordinator Deborah Birx admitted it was used to promote nationwide shutdowns in her 2022 book Silent Invasion.

Instead of a complete collapse of the U.S.healthcare system, three months later in June there were ~109,000 deaths. The equally influential IHME models predicted a massive, overwhelming surge in patients requiring hospital beds and ventilators. New York Governor Andrew Cuomo said on March 24th that the state could need up to 140,000 hospital beds (out of an available 53,000), with 40,000 ICU beds needed. Just two weeks later, with cases rapidly decreasing, only 18,569 hospitalizations had been reported. Although several hospitals had reached or exceeded capacity during the surges in New York and New Jersey, many remained nearly empty, with some even laying off staff. Two months later, after it was clear the predicted surge wasn’t going to materialize, Cuomo admitted the information he received from the experts was terrible, “All the early national experts. Here’s my projection model. Here’s my projection model. They were all wrong. They were all wrong.”

Once U.S. states began to reopen, models again wrongly predicted massive COVID resurgence. Georgia’s reopening was criticized in the press as an “Experiment in Human Sacrifice.” A model developed by researchers at Massachusetts General Hospital in Boston predicted that even a gradual lifting of restrictions on the planned date of April 27th would result in over 23,000 deaths, while keeping current restrictions until July would result in ~2,000 deaths. Keeping restrictions wasn’t what the modelers recommended, as additional results showed a stricter 4-week lockdown would have the best outcome.

None of that even remotely happened. One month after Georgia reopened, instead of 23,000 deaths, 896 were recorded. Georgia was not an isolated example. All over the U.S., states that reopened were predicted to have surges in cases that rarely materialized in the predicted time frame. “Just wait two weeks, and you’ll see,” maximizers would say, ad nauseum. When two weeks and more passed, maximizers would explain the discrepancy by pointing out that the apocalyptic forecasts were made to show what would happen if there were no lockdowns, restrictions, or mandates. The outcome could be therefore easily explained by “It could have been so much worse without government action.”

There was a huge, glaring problem the maximizers had to ignore to make that argument, rooted in the fact that not every country or state responded to the pandemic threat with lockdowns and mandates. Sweden did not lock down or close primary schools—forced mitigation measures were limited to gatherings of over 50 people and others were mostly voluntary, with the government emphasizing personal responsibility over coercion. When a team of Swedish researchers applied the Imperial College model to Sweden, the output predicted ~96,000 deaths for unmitigated spread. Imperial’s own numbers for Sweden came very close, topping out at over 90,000 deaths. Even with lockdowns and other forced mitigation measures, more than half that number were still predicted by the model, with 40-42,000 deaths. Yet in response to the modest restrictions that were instituted, the virus refused to follow maximizer models, and Sweden instead suffered 13,000 COVID deaths in the first year of the pandemic. This was less than half of what was projected, even with full-on-Imperial-College-style lockdowns, much less than what was projected if they did nothing at all.

In hindsight, it’s very clear that numbers aren’t substitutes for arguments, yet that’s exactly how predictions were viewed early on in the pandemic. For maximizers, cataclysmic predictions generated by models and experts served to promote lockdowns, mandates, and behavioral changes—they scared the crap out of people and made them stay home and away from others. It simply didn’t matter if the predictions were correct, the ends were justified by the means. For minimizers, large numbers only increased the potential for collateral damage, because they knew the bigger the numbers, the more draconian restrictions would be accepted. Thus, less catastrophizing would result in less hasty and damaging decisions by leaders. Ultimately, both groups were both right and wrong. COVID mortality was high in the United States, with over a million recorded deaths, but it happened over the course of two years and through several waves which few predicted.

Rather than arguing about numbers, the main arguments should have focused on what could be done to minimize the damage of a global pandemic without causing more collateral damage. The arguments were one-sided—maximizers won in many places, not through debates about evidence, but by attacking and censoring their opposition and by selling illusions of control and consensus to a frightened public.

The pandemic opened the curtain to expose the folly of expert worship. Experts are just as fallible and prone to biases, toxic groupthink and political influence as anyone else. This recognition might make people uneasy. However, it should also force a sense of responsibility to search for the truth despite what the experts might say, and that’s a good thing.

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Source

https://stemplet74.substack.com/p/twilight-of-the-experts?utm_source=post-email-title&publication_id=492358&post_id=120514525&isFreemail=true&utm_medium=email

Monday, May 15, 2023

This Stock Is a Buy: Brookfield Asset Management Looks to Credit Market for Growth

This Stock Is a Buy: Brookfield Asset Management Looks to Credit Market for Growth


Canadian alternative asset manager Brookfield Asset Management (BAM) reported its Q1 2023 results Wednesday morning. Despite a strong showing, its shares are down more than 4% in afternoon trading. 

At a time of great uncertainty in the markets and the general economy, Brookfield is confident it can grow its business significantly over the next five years. The company aims to double fee-bearing assets to at least $1 trillion.

One of the ways, but not the only way, it plans to reach $1 trillion is through the credit market. So if you’re interested in owning a well-run business, Brookfield is worth owning for the long haul. 

Here’s why.

A Rundown of Brookfield’s Latest Earnings

Before getting into the bread and butter of Brookfield’s quarterly earnings report, it's important to note that 75% of Brookfield Asset Management is owned by Brookfield Corp. (BN). In December, the former Brookfield Asset Management changed its name to Brookfield Corporation, then spun off 25% of the company to public investors.

This is a common practice within the Brookfield ecosystem. Over the years, it's spun off pieces of its various businesses, including infrastructure, private equity, and real estate. 

In the case of the asset management business, it wanted to separate the actual management advisory and fee-generating firm into an asset-light business model, where investors could value it more easily. Hence, the spinoff. 

Shareholders of Brookfield Corp. (the old BAM) got 0.25 shares in the new BAM and one share of BN for every share held in the old BAM. As a result, the new BAM will pay out approximately 90% of its distributable earnings, providing investors with a current dividend yield of slightly more than 4%. Brookfield Corp. yields less than 1% by comparison. 

So, if you’re an income or dividend investor, at the very least, BAM should be on your watchlist. Now back to the task at hand. 

There are five key numbers from BAM’s Q1 2023 results. Remember that all information is presented on a 100% basis without considering the 25%/75% split in ownership. 

1. Its distributable earnings in the first quarter were $563 million, 14.7% higher than a year earlier. Fee-related earnings accounted for 97% of the distributable earnings. For the 12 months ended March 31, they were $2.17 billion, up 10.5% from a year ago. 

2. The firm raised nearly $100 billion in capital from investors over the past 12 months ended March 31, with $19 billion raised in 2023. 

3. It finished the first quarter with $37 billion of uncalled fund commitments, not earning fees. However, once deployed, they will generate approximately $370 million annually.

4. It invested $17 billion of capital in the first quarter. Investments included Origin Energy (OGFGY), European data center owner Data4, and intermodal container owner Triton International (TRTN). 

5. Lastly, related to its credit push, it increased ownership of Oaktree Capital Management to 68% from 64%. Acquired in September 2019, Oaktree is run by legendary investor Howard Marks and specializes in distressed credit. 

It’s Expanding Its Private Credit Business

Brookfield CEO Bruce Flatt and the rest of its management team have always been good at finding ways to build its fee-bearing assets. So it goes where others won’t. Right now, that’s the credit market. 

“Our credit business is among the largest globally, with approximately $140 billion of fee-bearing capital across a diverse set of strategies. We offer private credit funds across all our verticals of real estate, infrastructure, renewable power, private equity, and corporate lending,” Flatt stated in its Q1 2023 shareholder letter. 

“With the significant market tailwinds for credit, we believe we are still in the early innings for many of these product offerings, with significant room for growth.”

Brookfield understands the current playing field. Higher interest rates make leveraged buyouts less attractive, not to mention riskier. Meanwhile, the banking troubles in the U.S. means the traditional venues for companies to turn to for financing are drying up. That’s especially true for private equity firms.

“One area of particular focus recently has been direct lending, an asset class that has expanded significantly and now represents a global market of approximately $1.5 trillion.”

“... The direct lending market has become increasingly attractive recently due to the limited availability of debt capital to finance private equity-sponsored transactions combined with the record-high levels of committed private equity capital raised for deals.”

It plans to originate senior secured loans for a minimum of $500 million per U.S. private equity-owned company. It represents a significant piece of Brookfield’s private credit strategy. In addition, it is currently raising capital for its Special Investments Credit Strategy and Consumer and SME Credit Funds, as well as for its Infrastructure Debt Fund and Real Estate Debt Fund. 

It’s going to be busy over the next five years. 

The Bottom Line

Besides dedicating much time in the shareholder letter to private credit investing, Flatt discussed the future of alternative asset management. He believes that the industry will experience significant consolidation in the future. 

As one of the world’s leading players in the alternative asset management industry, Flatt sees Brookfield taking a significant role in the industry's future evolution. While he didn’t come right out and say it would be looking to grow through acquisition, the writing is on the wall.

“Our $825 billion of total assets under management, our ability to raise $75 to $100 billion annually for investing, and our ability to offer compelling co-underwrite and co-invest opportunities at scale, makes us one of these major players,” Flatt wrote.

“We feel exceptionally privileged to be in this category and work hard every day for our clients and partners to ensure we stay there.”

I don’t think there’s any doubt it will remain a global leader in alternative asset management. 

For all you options junkies out there, I particularly like the idea of selling Oct. 20 $40 puts for income and selling Oct. 20 $30 puts for getting BAM at a reasonable price.   

Whether you bet on Brookfield Asset Management through BAM or BN is your call. But do make the call. Then, in five years, you will be happy you did.

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Source

https://www.barchart.com/story/news/16771166/this-stock-is-a-buy-brookfield-asset-management-looks-to-credit-market-for-growth

Saturday, May 13, 2023

Brookfield Corporation Shareholders, 1st Quarter Results

Brookfield Corporation Shareholders, 1st Quarter Results

Overview

Our first quarter financial results were strong, amidst a volatile market environment. We recorded strong performance in renewables, transition, and infrastructure. Our real estate business was extremely resilient, in contrast to the narrative around real estate at the moment.

Inflation and interest rates appear to have peaked in most countries, and the impact of higher rates is working its way through the system. Stock market valuations are now more reasonable, which has allowed us to complete a number of take-privates in the last few months with little competition. We invested $17 billion of equity over the quarter into a number of transactions that we expect will be exceptional in the longer term.

We closed on $19 billion of new fund commitments since we last wrote to you and continue to raise large sums for deployment.

Market Environment

Since the start of the year, it has become increasingly clear that one of the fastest monetary policy tightening cycles in history is having the desired impact, with inflation in the process of abating. While it remains above central bank targets and labor markets are strong in most major economies, inflation is generally tracking lower, reducing the risk of materially higher interest rates going forward.

However, despite interest rates still being lowish, the rapid increase in rates over the past year has had unintended consequences. After a relatively strong start to 2023, markets experienced increased volatility as concerns of stress in the U.S. and European banking sectors emerged—a direct consequence of banks’ exposure to the long end of the rapidly rising yield curve. The immediate actions taken by governments and central banks prevented these isolated incidents from spreading into a systemwide crisis of confidence, despite issues continuing in the U.S. regional banks.

Recent events have resulted in further tightening of credit conditions, making capital scarcer and more costly to access for many. However, capital markets are still open to those with strong balance sheets, high-quality assets and longstanding relationships. We are fortunate to be in this position and believe that our continued access to equity and debt financing will be a significant competitive advantage as we continue to put capital to work in this environment.

Operating Results were Strong

Each of our businesses performed well during the quarter, continuing to generate stable and growing cash flows and compounding capital in line with our objective of creating long-term wealth for all of our stakeholders.

Financial Results

The strong underlying performance resulted in distributable earnings before realizations of $945 million in the quarter and $4.3 billion for the last twelve months. This was an increase of 24% over the prior year after adjusting for the special distribution of 25% of our asset management business that we completed in December last year.

Our asset management business delivered another strong quarter, with distributable earnings growing by 15% over the prior year quarter. Fee-related earnings of $547 million in the quarter and $2.2 billion over the last twelve months benefited from strong inflows of capital, with clients continuing to have a strong appetite for our flagship and complementary fund strategies focused on investing in the backbone of the global economy.

Our insurance business had a very strong quarter, generating distributable operating earnings of $145 million in the quarter and $520 million over the last twelve months, both significantly higher than their prior year. We remain on track to increase annualized earnings from this business to $800 million by the end of 2023, as we continue to redeploy our liquid, short-duration investment portfolio into assets offering higher risk-adjusted returns. The markets are highly conducive to this activity, and during the quarter, our average investment portfolio yield was 5% on approximately $45 billion of assets, supporting liabilities that have an average cost of capital of 3%.

Our operating businesses continue to demonstrate their resilience, generating cash distributions of $304 million for the quarter and $1.5 billion over the last twelve months. The growth in cash distributions from our renewable power, transition, infrastructure and private equity businesses was supported by strong underlying earnings growth, with all of the businesses continuing to benefit from the essential nature of the services they provide, the inflation linkage in their revenues, and the high cash margins they each generate.

Distributions from our real estate businesses were stable as growth in same-store net operating income (“NOI”) across the portfolio was offset by higher interest rates on floating rate financings. Operating performance was particularly strong in our prime retail and office assets this quarter, growing by 5% over the last twelve months. Furthermore, we expect that as rates plateau (and eventually come down), the continued compound growth of the underlying operating cash flows will more than offset the impact of the recent rise in interest rates. Remember that interest rates rise once, but our cash flows can keep growing forever.

During the quarter, we re-invested $1.2 billion of our distributable earnings back into our businesses to continue to grow their operations, and we returned $404 million to shareholders through regular dividends and share repurchases. Given the current share price and our view of the intrinsic value of our business, we expect to continue to repurchase shares.

We are advancing a number of asset monetizations and continue to see a strong appetite for the cash generating businesses and assets that we own. For example, we recently closed the sale of a hospitality investment in the U.S. for over $800 million, returning a 2x multiple of capital. On top of return of capital and profit, each of these sales also generates carried interest for us from the accumulated unrealized carried interest built up over the years. At quarter end, this was over $9 billion in aggregate, of which we expect to realize over $500 million of realized carried interest into income during 2023.

Balance Sheet and Liquidity

The strength of our business and our ability to invest and grow has always been underpinned by our conservatively capitalized balance sheet, high levels of liquidity and access to diversified sources of capital.

At the end of the quarter, we had $113 billion of group wide liquidity and $5 billion of core liquidity at the Corporation. This is in addition to having one of the world’s largest pools of discretionary capital with an approximately $135 billion balance sheet of mostly liquid assets, against which we borrow only a modest amount of corporate debt of $12 billion. This affords us the flexibility to be prepared for opportunities that will inevitably arise.

We also have a very disciplined approach to financing our business which, over a long period time and across many market cycles, has ensured that we maintain strong access to capital. Over the last several weeks, during which time we have seen market volatility and constrained access to capital for many, we have closed on over $20 billion of financings across the group. A few highlights include:

  • A £650 million refinancing of a hospitality asset in the United Kingdom. The bonds priced on April 5th and were more than 3x over-subscribed with £2 billion of orders. Given the environment, it is worth emphasizing that the interest rate on this refinancing went down from 7.2% to 6.0%.
  • A €290 million financing of our Spanish Student Housing portfolio, a €330 million refinancing for our German office portfolio, a $250 million CMBS refinancing of a U.S. hospitality asset, and the €593 million financing of a retail and hospitality development in Paris.
  • A $3.5 billion refinancing and extension of maturity date of loans in our advanced energy storage business. The bonds were over-subscribed, enabling us to upsize the financing, reduce pricing, and add duration to our debt profile. This was achieved while maintaining the interest cost at the same rate for the company.
  • Issuance of over $5 billion of debt to support two new transactions in our infrastructure, and renewable power and transition businesses.
  • C$400 million of 10-year, investment grade bonds at Brookfield Renewable Partners.

These financings are examples of our strong access to capital and are testament to our approach of maintaining strong discipline within our capital structures, utilizing in-house capital market teams with deep expertise, and working with our strong global network of lending relationships built over many decades of managing assets throughout market cycles.

Our Funding Model provides Significant Competitive Advantages

Our funding model, which we have developed over the past 25 years, is designed with layers of redundant capital to ensure that in periods of less robust liquidity we can thrive and emerge from each period in a better position than we entered. We are confident that this period of market volatility will be no different.

Our financing structure is built on a few key premises: we always maintain vast capital resources at Brookfield Corporation for rainy days; we have structured access to the public markets for each of our business sectors on a standalone basis; our financings are recourse only to assets, not the company; and our access to private institutional capital provides us the ability to partner with the largest private investors in the world. Of course, this only all works if our financial results are good, and fortunately the returns we have generated over many decades have been excellent.

Three recent acquisitions demonstrate the power of the layers of our funding model and hopefully enable you to understand better how we continue to build our business.

Origin Energy

We recently agreed to take a listed Australian company private in an approximately $13 billion transaction. We formed a consortium with an energy investor where we will acquire Origin’s Energy Markets business and our consortium partner will acquire Origin’s LNG business.

Origin’s Energy Markets business generates electricity and sources gas which it supplies to 4.5 million consumers. The electricity is primarily generated by coal and natural gas, and our plan is to substantially reduce the reliance on fossil fuel generation by replacing coal with renewables, which includes building wind, batteries, and solar facilities.

We have arranged $2.5 billion of debt financing and committed over $5.0 billion of equity. We are funding up to $2.0 billion from our private Transition fund, with our listed renewable entity providing approximately $400 million of that capital, and an additional up to $350 million invested directly. Two of our long-standing partners, GIC and Temasek, are investing approximately $1.8 billion directly, and over $1.0 billion is being syndicated to other partners. Few groups have the scale and access to multiple pools of capital to complete a deal like this.

Triton International

We recently announced a transaction to take private the world’s largest intermodal shipping container owner, Triton International, a supply chain logistics business that owns over seven million shipping containers.

The transaction required $13 billion of capital, comprised of just under $5 billion of equity and $8 billion of debt. In this transaction, we required no new debt, but some of Triton’s corporate debt contains change-of-control provisions which, in certain circumstances, could come due. Because of this, most acquirors could not buy the company, as the risk of a ratings downgrade would make a purchase impossible. Instead, as the new owner we strongly anticipate an upgrade on the debt—or at a minimum, to maintain the same rating. Nonetheless, we arranged over $3 billion of backstop financing. This was an amount not easily managed by others in this environment, and as a result it provided us a competitive advantage.

The equity requirement is approximately $5 billion to close this deal, and this is once again where our franchise exceled. We committed to issue over $900 million of Brookfield Infrastructure Corporation shares (our listed infrastructure entity) as part of payment proceeds to shareholders of Triton; $2.5 billion will be funded by our private Infrastructure fund; and the balance is being offered to our clients as a co-investment. We are confident that this capital will be well subscribed by closing, but in the event it is not, we have ample backstop capacity until we find a permanent home for it. No other investment manager has access to these varied forms of capital on its own.

CDK Global

Last year we acquired CDK Global by taking a listed company private. CDK Global is a software business with a very large market share in providing its services to automobile dealerships. The company had been struggling with its operations and we believed that we could restore the profit margins to where they had been historically, while enhancing service and operating the business better.

The total purchase price was $8.3 billion, which was too large for both our private equity fund and Brookfield Business Partners, our listed private equity entity. To enable our two investment entities to complete the transaction, we agreed that Brookfield Corporation would backstop the balance of the capital.

The transaction was funded with approximately $4.8 billion of debt and $3.5 billion of equity across our private fund and co-investors. This co-investment included Brookfield Corporation initially acquiring nearly $1 billion of equity, which is expected shortly to be fully syndicated to clients; an opportunity which could not have been provided to them without our support.

Infrastructure, Renewables, Transition and Private Credit are Providing Resilience and Growth

Over the past 20 years, we have methodically widened our investment strategies to diversify our business. Our original business of private equity is very important to us and still growing, but now it is actually our smallest business. Real estate, which once was originally most of our asset management business, is today just one of six backbones of our investment business. We have achieved this by adding market leading businesses in Infrastructure, Renewables, Transition and Private Credit over the years, and each of these businesses continue to grow larger while we look for our next areas of growth.

Our infrastructure business was born out of our roots in the commodities business, where we built vast roads, pipelines, and related infrastructure in order to be able to sell commodities. Twenty-five years later, we have a dominant franchise and have become the largest private investor in infrastructure globally. Our business today is broad and vast and at over $160 billion in scale is getting bigger, with approximately $20 billion of equity invested or committed to some incredible deals in the last twelve months. Our multiple sources of capital make us different and combined with our operating platforms we have been able to earn excellent long-term returns for our investors, all the while diversifying into new forms of infrastructure with the large tailwinds of decarbonization, deglobalization and digitalization.

Our over $75 billion renewables business started from our industrial business roots and for years we built and acquired hydro (water-powered) plants globally to become one of the largest private owners of water-powered power plants. This is a great business as we enjoy approximately 70% margins because there are no input costs. Fortunately, this also enabled us to be at the forefront of both the wind and solar businesses as each became economic without subsidies over the past 10 years. And now with a global push to remove carbon from electricity generation, we find ourselves at the heart of one of the most exciting transitions taking place in the world. As one of the largest owners of renewables globally and with vast operating and technical teams to build and operate all forms of renewables, we have room to grow for decades ahead.

Four years ago, given our renewables knowledge, we recognized that the world was also pivoting towards decarbonizing all industry, so we decided to aggressively push towards transition investing. This allowed us to create a global leading Transition fund business. This culminated two years ago in us raising a $15 billion inaugural Transition fund, and we have now invested most of that capital. We are now back in the market with our next fund, which should be larger. This business did not exist five years ago, and now it has the potential to be one of our largest businesses as the world continues to grasp how to fund the transition to less carbon.

Finally, we added private credit to our franchise over the past 15 years, including a major thrust via acquisition in 2019. This enabled us to diversify our franchise, make it more resilient, and allow us to be more countercyclical. This pivot of our investment strategies to private credit has also been facilitated by the banks decreasing their corporate, real estate and buyout lending activities. We are increasingly providing loans into the buyout and new origination market. This is allowing us to take our franchise to the next level of growth, with the latest banking issues only increasing the needs of borrowers for capital from groups like us.

We continue to look for new investment verticals to add to Brookfield in order to diversify our resources, provide innovative ways for our clients and partners to invest, and make us a better company.

The Real, Real Estate Story – A Tale of Two Cities

Real estate is the largest business in the world. As a result, people spend a disproportionate amount of time trying to understand how it affects them and their investments. Its vast size and reach in turn leads to the belief or worry in each market downturn that real estate will bring significant stress to banks and investors.

The first point to note is that many parts of the real estate market are doing very well today—including hotels, industrial properties, high-quality retail, premier office and multifamily residential. At the same time, vacancies are occurring in the traditional commodity office business, largely an issue only in the United States.

We have been investing successfully in real estate around the world for many decades. Our team of almost 30,000 operating people in 30 countries, operating over 7,000 properties in every sector of real estate, gives us a unique and powerful vantage point. We use the on-the-ground data from our operations around the world to form objective views on individual properties and the broader real estate markets.

The data we see increasingly show real estate fundamentals as a tale of two cities. As with nearly every cycle we have seen previously, the highest-quality properties continue to perform well while traditional commodity properties in secondary markets or locations underperform.

Premier Office Leasing is Strong

The types of office assets that are in demand from companies seeking the benefits of in-person collaboration are evolving. Companies want office premises that provide them with options to create spaces that foster collaboration, creativity, and community among workers. This means that new modern premier office locations have never been in higher demand, while commodity office buildings in secondary locations are increasingly becoming functionally obsolete. This further drives the bifurcation in performance between premier office and commodity real estate and in our view, premier buildings are now in a category of their own and should no longer be compared to traditional commodity office properties.

We have always focused on owning premier real estate in the best locations, which is why 95% of our office portfolio is either trophy or Class A office space that continues to vastly outperform the broader market. To illustrate, we had nearly 5% same-store NOI growth last year.

We have many examples of this in our portfolio. At our soon-to-be-completed Two Manhattan West property in New York, we recently signed over one million square feet of leases at rents 35% above those at One Manhattan West, which was fully leased prior to the onset of the pandemic. At another of our prime office buildings in Manhattan, we are actively signing leases at over $200 per square foot to high-quality tenants—and in London, we recently signed leases at over £90 per square foot in a new office tower, which is a new high watermark for this submarket. Another example is our recently completed construction of the highest-quality building in Dubai that is now 100% leased, with rents almost double what we had projected.

Valuations are More Nuanced Than is Broadly Understood

All property investments are fundamentally affected by interest rates. But the impact on values of an increase or decrease in interest rates is much more nuanced than a simple headline can explain.

There are three basic inputs that go into a real estate valuation: the discount rate or unlevered return that an investor expects to earn, the terminal capitalization rate which determines the sale value of the asset and the cash flows that an investor expects to earn during their period of ownership. These cash flows and the expected sale price are discounted back to arrive at today’s valuation and the “going in” capitalization rate is merely an outcome of this process, not a relevant number always, in itself.

When interest rates rise (or fall), investors typically demand a higher (or lower) unlevered return, which is reflected as a higher (or lower) discount rate. However, this relationship is not linear. For example, in 2021 when we saw interest rates decline by 300 bps, discount rates probably only declined by 50 or 60 bps. This is due to investors expecting rates to not remain at close to zero for a long period of time. Similarly, over the past year, as long-term interest rates rose by 300 bps, discount rates likely moved up, but not more than maybe 50 to 75 bps, to settle back to where they were, not dissimilar to before the pandemic.

But that’s not the full story—the rapid rise in interest rates over the past twelve months was due to the Federal Reserve’s response to a dramatic spike in inflation. High-quality real estate is considered a good hedge against inflation as it is typically able to increase its income in line with (or sometimes in excess of) inflation. This has happened a lot in premier office properties. As a result, valuations are now discounting higher cash flows than they were a year ago, which offset the impacts of higher discount rates and supports real estate values.

And with the cost of constructing a new building now up to 40% higher than it was just two years ago, the replacement cost of prime assets is materially higher and the pipeline for new buildings limited. This is very positive for the value of existing prime assets in the longer term.

Interest Costs on Real Estate Have Not Increased as Much as it Appears

With respect to the cost of the financing of real estate, it is also worth remembering that much of the real estate in the United States is financed with fixed rate mortgages, and for those, the interest cost is largely the same today as it was a year ago. Further, not many mortgages were financed in the period when rates were extremely low—and therefore, despite rates that today are much higher than they were 18 months ago, the rates coming due on mortgages are in many cases similar to those that are expiring.

Of course, not every property in our portfolio has been unaffected by recent market volatility. When you own 7,000 properties, it is impossible not to make a few mistakes. But we have always prided ourselves on being an extremely responsible borrower, and our reputation in the capital markets sets us apart. We work closely with our lenders to resolve problems that occur, and these tend to come from smaller assets (relative to the size of our business), many of which were acquired as part of a larger portfolio.

To protect against these inevitable errors and ensure they always remain small mistakes, we have always had a policy of financing each asset on a stand-alone, non-recourse basis, which means that any issues with a specific property do not affect any of our other properties or businesses. A few such issues have recently arisen in our portfolio in Los Angeles and Washington DC, given the specific market stress in those cities, but they are discrete to those assets and not material to our overall real estate business—let alone to Brookfield as a whole.

We have also been careful to ladder our debt maturities in our property business to ensure we never have a large amount of debt coming due at any one time. We took advantage of very strong debt capital markets over the past couple of years and executed over $12 billion of U.S. office financings since March 2020. As a result, we have minimal debt maturing this year.

Opportunities are Coming for the Strong

We have invested successfully through many cycles, and our deep resources mean that we will be able to capitalize on the investment opportunities that will inevitably present themselves during this cycle. We are readying ourselves for that.

Closing

Thank you for your interest in Brookfield, and please do not hesitate to contact any of us should you have suggestions, questions, comments, or ideas you wish to share.

Sincerely,

Bruce Flatt
Chief Executive Officer
May 11, 2023


Friday, May 12, 2023

This Stock Is a Buy: Brookfield Asset Management Looks to Credit Market for Growth

This Stock Is a Buy: Brookfield Asset Management Looks to Credit Market for Growth


Canadian alternative asset manager Brookfield Asset Management (BAM) reported its Q1 2023 results Wednesday morning. Despite a strong showing, its shares are down more than 4% in afternoon trading. 

At a time of great uncertainty in the markets and the general economy, Brookfield is confident it can grow its business significantly over the next five years. The company aims to double fee-bearing assets to at least $1 trillion.

One of the ways, but not the only way, it plans to reach $1 trillion is through the credit market. So if you’re interested in owning a well-run business, Brookfield is worth owning for the long haul. 

Here’s why.

A Rundown of Brookfield’s Latest Earnings

Before getting into the bread and butter of Brookfield’s quarterly earnings report, it's important to note that 75% of Brookfield Asset Management is owned by Brookfield Corp. (BN). In December, the former Brookfield Asset Management changed its name to Brookfield Corporation, then spun off 25% of the company to public investors.

This is a common practice within the Brookfield ecosystem. Over the years, it's spun off pieces of its various businesses, including infrastructure, private equity, and real estate. 

In the case of the asset management business, it wanted to separate the actual management advisory and fee-generating firm into an asset-light business model, where investors could value it more easily. Hence, the spinoff. 

Shareholders of Brookfield Corp. (the old BAM) got 0.25 shares in the new BAM and one share of BN for every share held in the old BAM. As a result, the new BAM will pay out approximately 90% of its distributable earnings, providing investors with a current dividend yield of slightly more than 4%. Brookfield Corp. yields less than 1% by comparison. 

So, if you’re an income or dividend investor, at the very least, BAM should be on your watchlist. Now back to the task at hand. 

There are five key numbers from BAM’s Q1 2023 results. Remember that all information is presented on a 100% basis without considering the 25%/75% split in ownership. 

1. Its distributable earnings in the first quarter were $563 million, 14.7% higher than a year earlier. Fee-related earnings accounted for 97% of the distributable earnings. For the 12 months ended March 31, they were $2.17 billion, up 10.5% from a year ago. 

2. The firm raised nearly $100 billion in capital from investors over the past 12 months ended March 31, with $19 billion raised in 2023. 

3. It finished the first quarter with $37 billion of uncalled fund commitments, not earning fees. However, once deployed, they will generate approximately $370 million annually.

4. It invested $17 billion of capital in the first quarter. Investments included Origin Energy (OGFGY), European data center owner Data4, and intermodal container owner Triton International (TRTN). 

5. Lastly, related to its credit push, it increased ownership of Oaktree Capital Management to 68% from 64%. Acquired in September 2019, Oaktree is run by legendary investor Howard Marks and specializes in distressed credit. 

It’s Expanding Its Private Credit Business

Brookfield CEO Bruce Flatt and the rest of its management team have always been good at finding ways to build its fee-bearing assets. So it goes where others won’t. Right now, that’s the credit market. 

“Our credit business is among the largest globally, with approximately $140 billion of fee-bearing capital across a diverse set of strategies. We offer private credit funds across all our verticals of real estate, infrastructure, renewable power, private equity, and corporate lending,” Flatt stated in its Q1 2023 shareholder letter. 

“With the significant market tailwinds for credit, we believe we are still in the early innings for many of these product offerings, with significant room for growth.”

Brookfield understands the current playing field. Higher interest rates make leveraged buyouts less attractive, not to mention riskier. Meanwhile, the banking troubles in the U.S. means the traditional venues for companies to turn to for financing are drying up. That’s especially true for private equity firms.

“One area of particular focus recently has been direct lending, an asset class that has expanded significantly and now represents a global market of approximately $1.5 trillion.”

“... The direct lending market has become increasingly attractive recently due to the limited availability of debt capital to finance private equity-sponsored transactions combined with the record-high levels of committed private equity capital raised for deals.”

It plans to originate senior secured loans for a minimum of $500 million per U.S. private equity-owned company. It represents a significant piece of Brookfield’s private credit strategy. In addition, it is currently raising capital for its Special Investments Credit Strategy and Consumer and SME Credit Funds, as well as for its Infrastructure Debt Fund and Real Estate Debt Fund. 

It’s going to be busy over the next five years. 

The Bottom Line

Besides dedicating much time in the shareholder letter to private credit investing, Flatt discussed the future of alternative asset management. He believes that the industry will experience significant consolidation in the future. 

As one of the world’s leading players in the alternative asset management industry, Flatt sees Brookfield taking a significant role in the industry's future evolution. While he didn’t come right out and say it would be looking to grow through acquisition, the writing is on the wall.

“Our $825 billion of total assets under management, our ability to raise $75 to $100 billion annually for investing, and our ability to offer compelling co-underwrite and co-invest opportunities at scale, makes us one of these major players,” Flatt wrote.

“We feel exceptionally privileged to be in this category and work hard every day for our clients and partners to ensure we stay there.”

I don’t think there’s any doubt it will remain a global leader in alternative asset management. 

For all you options junkies out there, I particularly like the idea of selling Oct. 20 $40 puts for income and selling Oct. 20 $30 puts for getting BAM at a reasonable price.   

Whether you bet on Brookfield Asset Management through BAM or BN is your call. But do make the call. Then, in five years, you will be happy you did.

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Source

https://www.barchart.com/story/news/16771166/this-stock-is-a-buy-brookfield-asset-management-looks-to-credit-market-for-growth