No. of Recommendations: 15
seems to be a decent amount of cases where SoTP conglomerate discounts don't close faster than inflation. would be great to hear thoughts on why this may (finally) no longer be the case for Brookfield in the next decade.
Brookfield is not a conglomerate in the traditional sense. I don't think it suffers from the traditional conglomerate discount, which is often permanent. There was no talk of a conglomerate discount when it hit $60 a share before the 3:2 2020 split or when it exceeded those highs post-split in the fall of '21. Its 20-year CAGR at that point was ~20%.
A traditional conglomerate acquires lots of unrelated businesses based on their individual characteristics. Berkshire Hathaway is a current example. Brookfield is a physical asset owner/operator and investment manager in a handful of well-defined verticals. Its listed subs were not acquired; they were created by the parent to house the various asset verticals. It does make acquisitions, but they are all related to the verticals they join. These days, it packages most of what it does in co-investment deals with institutional and sovereign funds, turning those investor shares into fees. All the verticals contribute to the fee business, which now overshadows everything else.
Berkshire and Brookfield have some investors in common because their leaders share an ingrained value sensibility, but their corporate structures are not comparable. Investors in the alternative asset space would compare Brookfield to Apollo or Carlyle before Berkshire -- old private equity shops that took acquisitions onto their balance sheets. That too is an inexact comp -- Brookfield was never in the LBO space. It has a private equity arm, but it's a very small part of the business. Brookfield presents a complexity issue for retail investors, but that is not the same as a conglomerate discount.
Within the alternative asset universe, valuation distinctions are more often attributed to being "asset-heavy" or "asset-light." The latter category, which includes Blackstone and Ares, enjoyed relatively higher valuations during the last bull market. This was part of Brookfield's motivation in spinning out the new BAM, which now qualifies as an "asset-light" alternatives play -- collecting fees for managing alternative asset investments, but not holding the assets themselves. For BN, the combination of being asset-heavy and many of those assets being in commercial real estate is the central explanation in this universe for its current modest valuation.
It is not a permanent state of affairs. Memories are short.
sentiment; although some significant number of investors bought into Brookfield Property at a discount, it was taken out at even a greater discount.
(this i see more of a case where losses have outsized sentiment for those that favored greater discount arbitrage within SoTP, rather than the impact of sentiment towards the entirety of Brookfield. however, i dont want to understimate how brookfield's identity was tied to RE for a long time, and small failures here still outshine media coverage of Brookfield's larger success elsewhere.)
My guess would be that this gets closer to Brookfield's current problem. An instructive comp here is Blackstone, which operates an enormous private REIT that has limited redemptions for several months in order to avoid forced asset sales at fire-sale prices. Investors don't like hearing their investments have become illiquid, even if it's temporary and well-advised, and Blackstone's share price has suffered as a result. Despite its asset-light balance sheet, it is trading much nearer its 52-week low than its high. (In fact, if you've ever been interested in BX, the leader in the alternative asset space, now would not be a bad time to have a look.) Similarly, the RE market has prevented Brookfield from maintaining the pace of asset sales that is usually a part of its business model.
Doubts about the IFRS values Brookfield has relied upon for its real estate portfolio were validated in the Q1 report, when the company wrote down the value of BPG, the private version of BPY, by 27%. With office defaults rolling across the Bloomberg ticker on an almost daily basis, the suspicion is that those write-downs may be just the beginning -- depending, of course, on the macro economic story and ever-imminent recession. This problem extends to multiple vintages of Brookfield's private real estate funds, from which it is expecting to collect carried interest.
Bruce Flatt has done a series of interviews trying to assuage these concerns, quoting rising lease rates at trophy properties. In one, he claimed that Two Manhattan West is leasing for one-quarter or one-third (I can't remember which) higher rates than One Manhattan West, which opened pre-pandemic. He continues to say that Brookfield holdings of "commodity" office space, properties presumably now underwater and subject to default, represent maybe five percent of the portfolio. Most of the GGP retail portfolio is still in there as well. Simon Properties, the leader in that space, is likewise trading toward the bottom of its 52-week range.
The market has been skeptical of the real estate port for a long time, going back to the days when it was publicly traded. Flatt's numerous attempts to jawbone the BPY share price upward were unsuccessful. It took a tender offer to do that, and only to the level of the offer, which Brookfield thought still enough of a discount to be a good deal for it as the buyer. Eventually, he gave up and took the whole thing private. My guess is the reported book value of the real estate port will have to stabilize at a level the market believes before BN gets back into its good graces.
An obvious question: Wasn't all this true of the RE port when BN (then BAM) was hitting new highs in the fall of '21? The answer is yes. But the astonishing trajectory of the fee business, all housed within the parent at the time, trumped everything. It was a growth story. Post-spinout, growthy investors have flocked to the new BAM. For now, Mr. Market views BN as the asset-heavy, stodgy remainder of the business. The fact that it still owns 75% of the fee business will occur to him at some point (one hopes). No telling when that might be, but I'm guessing it's when the RE overhang eases.
On the bright side, this process has hastened the decline of real estate's role in the Brookfield galaxy of assets. As the fee business grows, and as they methodically sell off RE when the market improves, it will recede further. As Brookfield pivots toward financial assets with its acquisition of Oaktree and development of an insurance operation, the boom-and-bust cycles of real estate should eventually influence its fortunes less than they do now.
