Brookfield Corporation $BN

Play long term games

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"We focus on acquiring high-quality assets on a value basis and then enhancing their cash flows by applying our global operating and financing expertise. This disciplined, value-oriented, and opportunistic approach to investing has served us well over the years."

- Bruce Flatt, CEO Brookfield Corporation

I recently purchased more Brookfield Corporation. It was a relatively small position that I would like to continue adding to over time.

At first glance, it would appear that Brookfield Corporation BN 0.00%↑ has essentially matched the S&P 500 index SPY 0.00%↑ . But, I don’t believe this captures the recent spin of the asset manager BAM 0.00%↑ . Regardless, a decent result amidst a recent decline in Brookfield due to a plethora of interest rate and commercial real estate fears. These fears are not unfounded either.

Long term total returns BN vs. S&P

The Business

Brookfield Corporation is a leading global alternative asset manager with a diversified business model, focusing on investing in and managing real assets. The company operates through four primary business segments: Real Estate, Infrastructure, Renewable Power, and Private Equity. It generates income through asset management fees, carried interest, and capital appreciation from its principal investments. The asset manager was recently spun out as its own public entity BAM 0.00%↑, although the parent retained ownership of 75%.

Brookfield Corp’s Ownership Interest in Subsidiaries

Asset Management

The Asset Management business BAM 0.00%↑ involves managing long-term private funds, perpetual strategies, and liquid strategies for both investors and the company itself, including their share in Oaktree Capital Management's activities. They earn base management fees, incentive distributions, and performance income, such as performance fees, transaction fees, and carried interest, from these activities.

Highlighting the progress of the asset management business

Its operations include:

1. Long-term Private Funds ($219 billion fee-bearing capital)

• Diverse range of funds in renewable power, infrastructure, private equity, real estate, and credit.

• Earns long-term base management fees, carried interest, and transaction/advisory fees.

2. Perpetual Strategies ($127 billion fee-bearing capital)

• Manages perpetual capital in affiliates and core/core plus private funds.

• Earns long-term perpetual base management fees, stable incentive distribution fees, and performance fees or carried interest.

3. Liquid Strategies ($72 billion fee-bearing capital)

• Manages publicly listed funds and separately managed accounts in real estate, infrastructure, and natural resources.

• Earns base management fees and performance income based on investment returns.

Insurance

Brookfield's insurance solutions business is a leading financial services provider offering capital-based solutions to the insurance industry. Through its subsidiaries, the business offers annuity-based reinsurance products and pension risk transfer products for pension plan sponsors. The goal is to match long-duration liabilities with high-quality investments to generate attractive risk-adjusted returns. As of December 31, 2022, the business has $4 billion in equity capital and approximately $40 billion in assets with an annualized DE of $650 million. Brookfield aims to create one of the world's leading insurance solutions platforms by growing internally and through additional capital from the Corporation and other business partners.

Real Estate

The real estate segment focuses on owning, operating, and developing commercial properties across retail, office, industrial, multifamily, and hospitality sectors. The company earns revenue through property management fees, leasing income, and capital gains from property sales. Recently there have been plenty of fears of the collapse of commercial (especially office) real estate and the impact that has on the corporation.

Brookfield's real estate business is operated through its 100% ownership interest in BPG, with assets held directly and via private funds. The business is divided into three sub-segments:

1. Core:

• Ownership and operation of iconic office assets in global gateway cities (64 properties, 33 million sq. ft.)

• Ownership of 19 irreplaceable malls with 24 million sq. ft. of retail space

• Selective development and redevelopment projects (office, multifamily, and hotel sites)

2. Transitional and Development:

• Ownership and operation of 68 office properties (59 million sq. ft.) in gateway markets with transitional operational uplift and realization potential

• Ownership of 90 retail properties (86 million sq. ft.), maximizing returns through leasing, redevelopment, or addition of mixed-use components

3. LP Investments:

• Investment in global real estate portfolios through real estate funds targeting higher returns

• Acquisition of high-quality assets at a discount, executing operational improvement strategies, and achieving opportunistic returns

• Portfolio includes multifamily, triple net lease, hospitality, office, retail, mixed-use, logistics, life science, senior living, manufactured housing, and student housing sectors

In the Q3 earnings call, Flatt characterized the US real estate market as "the tale of two cities," with high-quality assets performing well, and said Brookfield was "quite constructive and positive" about the environment. Brookfield also reported $14bn of capital raised outside of the flagship campaign, and expressed optimism for the growth of complementary strategies.

Brookfield management has a positive outlook for its real estate segment. On the opportunistic side, the company believes that uncertain environments, like the one that we are currently in, create opportunities for attractive risk-adjusted returns. The company's best in class assets and businesses are expected to hold their value in the market, making them easy to monetize. In terms of core real estate, while there may be some short-term ebbs and flows in interest in core products, Brookfield expects continued growth in demand for highly de-risked, highly regulated, highly contracted, high-quality infrastructure assets. The company is also seeing consistent demand for its real estate core products, which target institutions and private wealth channels.

Infrastructure

In the infrastructure segment, Brookfield invests in and manages assets such as transportation, utilities, energy, and communications, providing essential services to communities. This segment generates income through long-term contracts, regulated tariffs, and user fees. Its operations include:

1. Utilities:

• 60,000 km electricity lines in Australia, 4,200 km gas pipelines, 2,900 km transmission lines in Brazil

• Energy infrastructure services to 2.3 million customers in the US, Canada, Germany, and the UK

• 7.8 million connections and 1.7 million smart meters in Australia and New Zealand

2. Transport:

• 11 terminals and major export facilities

• 22,000 km railroad track in North America and Europe, 5,500 km in Western Australia, 4,800 km in Brazil

• 3,800 km of motorways in Brazil, Peru, and India

3. Midstream:

• 15,000 km of pipelines and 600 Bcf natural gas storage in the US and Canada

• 10,600 km of pipelines in Canada and a petrochemical complex

4. Data:

• 207,000 telecom towers and 46,600 km of fiber optic cable

• 880,000 fiber-to-the-premise connections and 2 semiconductor manufacturing foundries in the US

• 50 data centers with 230 MW of critical load capacity

Renewable Power

The renewable power segment primarily invests in hydroelectric, wind, and solar power facilities. The company earns revenue from the sale of electricity under long-term power purchase agreements, which provide stable cash flows. Its operations include:

1. Hydroelectric:

• 229 stations on 87 river systems

• 8,159 MW capacity, 20,085 GWh LTA generation (proportionate)

2. Wind:

• 125 facilities globally

• 6,935 MW capacity, 7,141 GWh LTA generation (proportionate)

3. Solar:

• 149 facilities globally

• 3,957 MW capacity, 2,756 GWh LTA generation (proportionate)

4. Energy Transition:

• 6,238 distributed generation facilities, 2,055 MW capacity, 912 GWh LTA generation (proportionate)

• 4,271 MW storage capacity at 23 facilities and two river systems

5. Energy Contracts:

• Purchase 3,600 GWh/year from BEP at a predetermined price (12% of BEP's power generation)

• Gradual price reduction starting 2022, with a total reduction of approx. $20/MWh by 2026

• Contract expires in 2046

• Power sold in the open market, and additional ancillary revenues earned

Private Equity

This segment focuses on acquiring, managing, and monetizing businesses across various industries, generating income through management fees and carried interest from performance-based returns.

Brookfield Private Equity Business focuses on high-quality businesses with barriers to entry or low production costs. Its operations include:

1. Business Services:

• Largest private sector residential mortgage insurer in Canada

• Healthcare services operations in Australia

• Construction operations and services to residential real estate brokers in Canada

• Cloud-based business operations software provider for dealerships

• Road fuels operation with import, storage, and distribution network

2. Infrastructure Services:

• Leading supplier of infrastructure services to power generation industry, including nuclear technology services

• Offshore oil services operations in North Sea, Canada, and Brazil

• Scaffolding and related services to industrial and commercial markets

• Modular building leasing services in Europe and Asia-Pacific

• Lottery services operation in over 50 countries

3. Industrials:

• Capital-intensive businesses with significant barriers to entry

• Advanced energy storage operation for automotive batteries

• Manufacturer of high-quality graphite electrodes

• Waste and wastewater operations in Brazil

• Manufacturer of highly engineered components for industrial trailers

• Solar power solutions distributor in Brazil

4. Residential Development:

• Brazilian residential and commercial office units development, focusing on middle-income residential units in São Paulo and Rio de Janeiro

The Competition

Brookfield differentiates itself from competitors through its diversified portfolio, robust global presence, and expertise in acquiring and managing complex, large-scale assets. Its vertically integrated approach, long-term investment horizon, and focus on sustainability further set it apart from peers. However, the company faces stiff competition from other global asset management firms, such as Blackrock BX 0.00%↑ Blackstone Group BLK 0.00%↑ KKR & Co. KKR 0.00%↑ Apollo APO 0.00%↑ and Carlyle Group CSL 0.00%↑ , which also have diversified portfolios and strong track records in the alternative asset management space.

A quick comparison to some competitors

Long Term Fundamentals

A high-level examination of the balance sheet reveals steady growth without incurring excessive debt. However, some assets, particularly in certain real estate segments, may be overvalued.

An analysis of distributable earnings and revenue from different segments indicates promising long-term growth.

Our objective remains to achieve a 12%-15% per annum return on our capital on a long-term basis. - Bruce Flatt, 2018 shareholder letter

Brookfield Segment Revenues

Fund from OPS breakdown

Alignment With a Long Term Partner

Bruce Flatt is the CEO of Brookfield. Under his leadership, Brookfield has grown into a global force in real estate, infrastructure, renewable power, and private equity. Flatt's values and strategies have propelled Brookfield to the forefront of the industry, and his actions and incentive structure align with shareholders' interests.

Integrity

Bruce Flatt has made integrity a cornerstone of his leadership style. In his 2018 shareholder letter, he emphasized the importance of trust:

We believe trust is earned through consistent, honest behavior and transparency in our actions.

Flatt's commitment to transparency and honesty has helped Brookfield gain the confidence of both retail and institutional investors, paving the way for the company's growth. This relationship with large clients has taken monumental effort and long term commitment and is not something that is easy to replicate. When it comes to a moat, there is likely a source of one here.

Aligned Incentives

Flatt's alignment with shareholders is evident in Brookfield's unique incentive structure. He and the management team have significant "skin in the game," with substantial personal investments in the company. Flatt and a group of senior leaders and executives own approximately 8.4% of outstanding and issued shares of the business. This ensures that their interests align with those of shareholders, as stated in his 2020 shareholder letter:

We continue to be focused on long-term value creation, aligning our interests with our shareholders and partners.

Vision and Outlook

The leader’s long-term vision has guided Brookfield's growth and expansion. In his 2016 shareholder letter, Flatt highlighted the importance of a long-term perspective. This focus has helped the company navigate the rapidly changing business landscape and capitalize on emerging opportunities.

Our approach is to focus on the long term, constantly seeking to build our business, and thereby deliver value to shareholders over time.

From the comments on the Q4 2022 earnings call, while the company remains positive about the global macro environment, it recognizes the ongoing uncertainty and volatility driven by elevated levels of inflation and interest rate increases, as well as structural dynamics such as deglobalization and a tight supply of skilled labor. Brookfield's business is aligned with the dominant global secular trends of digitization, deglobalization, and decarbonization, with a focus on infrastructure renewables and transition strategies. The company's underlying businesses generate stable and growing cash flows and are largely inflation-protected, with high margins. Brookfield's credit platform is also seen as a key asset in the current economic climate. However, the company acknowledges the risks posed by cyclical exposure and market volatility.

Wisdom

Flatt's wisdom, grounded in decades of experience in the industry, has played a significant role in Brookfield's success. He has demonstrated a keen understanding of the global economy, recognizing the potential of renewable energy and infrastructure investments. In his 2019 shareholder letter, Flatt emphasized the need for adaptability:

We are always learning, adapting and evolving to the changing world. We must never forget that complacency is the enemy of progress.

One of Flatt's most notable insights has been his recognition of the potential of investing in alternative assets. This forward-thinking approach has allowed Brookfield to diversify its holdings and remain ahead of the curve. He wrote in the 2017 shareholder letter:

We continue to see significant growth opportunities in alternative investments, as more investors around the world appreciate the value of real assets in their portfolios.

In an industry often characterized by short-term thinking and self-interest, Bruce Flatt stands out as a leader committed to integrity, vision, and wisdom. His focus on long-term value creation, alignment with shareholders, and adaptability to changing markets has cemented Brookfield's position as a powerhouse in the world of asset management. As an investor, I can take comfort in knowing that his steadfast commitment to these principles will continue to guide Brookfield towards a prosperous future.

Valuation

I suggest we examine the cost associated with distributable earnings, while assuming a modest growth rate of below 10%. This is lower than both historical figures and the company's anticipated long-term returns on investment, which stand at 15%.

Presently, the business is valued at 10 times distributable earnings. In the event of an enduring correction within the real estate sector, earnings are likely to undergo a certain level of adjustment. However, over an extended period, it is challenging to envision a scenario where one would not attain an upper single-digit or lower double-digit annual return. Taking into account the exceptional caliber of the business itself and, more specifically, the management team, I find the current price to be sufficient. This is not to say that there is a large immediate or near term upside to be had here.

Some Closing Thoughts

As I reflect on my recent exploration of the world of finance and asset management, one concept that has truly resonated with me is the importance of partnering with people who share a long-term, high-integrity mindset. Interestingly, Chuck Akre of Akre Capital Management initiated a position in Brookfield in Q4 2022. He has held other asset managers for long periods and knows the space well. He is an investor who has a long term view and has held onto several of his holdings for decades.

In the words of Naval Ravikant, we should "play long-term games with long-term people." This idea is beautifully exemplified by the leadership of Bruce Flatt at Brookfield, whose focus on integrity, vision, and wisdom has left a lasting impression on me.

In a world that often seems dominated by short-term gains and instant gratification, I find solace in knowing that there are still leaders like Flatt who prioritize long-term value creation and nurturing trust with their partners and shareholders.

As I continue to navigate my own investing path, I am inspired to seek out partnerships with those who share this long-term, high-integrity mindset.

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