Earnings Call: Q2 2017

Aug 10, 2017

Welcome to the Brookfield Asset Management Second Quarter 2017 Conference Call. As a reminder, all participants are in listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Suzanne Fleming, Managing Partner, Branding and Communications. Please go ahead, Ms. Fleming. Thank you, operator, and good morning. Welcome to Brookfield's Q2 conference call. On the call today are Bruce Flatt, our Chief Executive Officer and Brian Lawson, our Chief Financial Officer. Brian will start off by discussing the highlights of our financial and operating results for the quarter and Bruce will then give an overview of our market outlook and Brookfield's investment approach. After our formal comments, we'll turn the call over to the operator and take your questions. In order to accommodate all those who want to ask questions, we ask that you refrain from asking multiple questions at one time in order to provide an opportunity for others in the queue. We'll then be happy to respond to additional questions later in the call as time permits. I'd like to remind you that in responding to questions and in talking about new initiatives and our financial and operating performance, we may make forward looking statements, including forward looking statements within the meaning of applicable Canadian and U. S. Securities laws. These statements reflect predictions of future events and trends and don't relate to historic events. They are subject to known and unknown risks and future events may differ materially from such statements. For further information on these risks and their potential impacts on our company, please see our filings with the securities regulators in Canada and the U. S. And the information available on our website. Thank you. And I'll now turn the call over to Brian. Great. Thank you, Suzanne, and good morning. We reported $1,000,000,000 of funds from operations or FFO for the Q2 and that compares to $637,000,000 for the 2016 quarter. Net income was $958,000,000 just shy of 1,000,000,000 dollars up from $584,000,000 in the same quarter last year. Breaking the FFO down into its key components, fee related earnings increased by 22%, that's due to a higher level of fee bearing capital and growth in unitholder distributions. FFO from invested capital increased by 2%. We had good growth from operational improvements at existing operations, although some of this was offset by the impact of lower currency exchange rates on our non U. S. Operations. And realized disposition gains totaled $64,000,000 compared to $123,000,000 in the 20 16 quarter. Net income benefited from a higher level of fair value gains than 2016. So turning to our asset management operations, fee bearing capital increased to $117,000,000,000 We had net inflows of $15,000,000,000 over the last 12 months and that drove a $32,000,000 quarter quarter over quarter increase in fee revenues. Incentive distributions were higher as a result of increases in distributions to unitholders of our listed funds, we recorded $25,000,000 of performance income from Brookfield Business Partners, representing our share as manager of the increase in BBU's unit price. Increases in transaction and advisory fees were largely offset by a lower level of catch up fees compared to 2016. So all in all, quarterly fee revenues increased by 21 percent to $353,000,000 that's $1,200,000,000 over the last 12 months. And fee related earnings totaled $732,000,000 over the last 12 months and that's up from by 15% from the amounts this time last year. Fee revenues are now tracking at an annualized rate of $1,200,000,000 each year. And in terms of carried interest, we generated $477,000,000 over the past 12 months based on investment performance in our funds and that brings total unrealized carry to $1,200,000,000 at June 30. As a reminder, this is the amount of carry we would expect to be paid if we wound up all our funds at that date. As a point of reference, on a simple straight line basis, what we refer to as target carry, we would expect the existing funds to accumulate carry at roughly $860,000,000 each year based on their target rates of return. The actual increase at this stage of the game tends to lag somewhat while the funds are being invested. And as we have noted before, we don't book carry in our FFO until the funds are largely wound up, which will take some time as our larger funds were raised fairly recently. And to highlight the point, as at June 30, roughly half of our carry eligible private fund capital is still in the process of being invested, it's dry powder or it was invested fairly recently. Turning to FFO from our invested capital, we experienced significantly higher water volumes in our renewable power operations, which led to a significant increase in generation and FFO. This was partly offset by the impact of continued low prices in North America. Infrastructure results benefited from operational improvements and the contribution from new operations. Our property operations experienced similar increases in FFO, although this was somewhat offset by the impact of recent sales of core office properties, which reduced net income net operating income from these assets as we no longer own them. Within our private equity operations, we experienced improved commodity prices, which gave rise to better results from these operations. However, this was offset by lower FFO within our construction business and our residential business in Brazil, as well as a lower interest in these operations following the spin off of a portion of our interest in Brookfield Business Partners last year. Realized disposition gains in both quarters related primarily to our ongoing strategy of selling interest in core office properties in mature markets at favorable values and redeploying the capital through our opportunity funds into properties and other asset classes and geographies with higher return potential. And lastly, before handing the call over to Bruce, I will confirm that the Board of Directors declared the latest quarterly common share dividend, dollars 0.14 per share payable at the end of September and unchanged from the June dividend. So with that, I will hand the call over to Bruce. Thank you, Brian, and good morning, everyone. As Brian noted, the Q2 'seventeen was a strong quarter. Our asset management fees continue to grow at a rapid pace and most of the operations we have achieved plan. Most importantly, the selling the market for selling mature property infrastructure assets continues to be very positive and we've been using the environment to monetize assets and recycle capital where it makes sense. At the same time though, we continue to put significant amounts of capital to work, largely targeted at markets that are out of favor or in businesses that require our operating a road fuel distribution company, a water distribution business, a road fuel distribution company, a water distribution business and various real estate properties globally. At this stage in the business cycle, we are also very focused on enhancing and de risking cash flows in all of our businesses through operational improvements. Turning to the global investment market for alternative assets, As this market grows and matures, we continue to adapt our investment products to meet client needs. We primarily offer 2 types of products. First is opportunistic return ones and the second are core products. The former is an alternative for traditional equity investments, the latter for fixed income investments. In each of our business sectors, we continue to grow our funds and expect to have large scale opportunistic funds of $10,000,000,000 to $20,000,000,000 for each of our business sectors. Our clients consider these substitutes for equities in their portfolios and the returns we earn for them are welcome respite from low return or more volatile liquid investments. Increasingly, institutional investors are also looking for alternatives to supplement the return on their fixed income portfolios. Since with a 2.25% to 3.5% long U. S. Treasury rate, they also need to earn higher returns with this capital while taking more moderate risk. In response, we have been growing our credit businesses and have also started to focus on private perpetual long term entities to enable our clients to own these type of assets. In particular, we recently established a private core plus fund focused in real estate in the U. S. And given the size and scale of operations, we believe that over time our core real estate products could exceed up to exceed $50,000,000,000 We've also been considering this product for long duration renewable energy and infrastructure assets, which we think are ideal for also for our clients wishing to match liabilities. Infrastructure renewable power are also particularly suited for Petrol Capital Investors. Longer term, each of these businesses should also be able to grow to the scale that I just mentioned on real estate and be highly complementary to our operations. For taking questions, we thought you might be interested in what we are seeing in the United Kingdom, which has continued to capture the news of the day with the political negotiations of Brexit. Despite the headlines, virtually all of our businesses are doing well. We have a number of office buildings under construction in the City of London and leasing continues to be strong. Since Brexit, we signed a major law firm to over 200,000 square feet at our 100 Bishopscape project and we are progressing construction of a number of major residential rental projects and other office projects which are substantially fully leased. Our electricity, gas and fiber connections business in the UK is robust, sales volumes are up 16% over last year as housing sales across the UK continue to be strong. Our Centre Park Hospitality business is effectively 100% occupied and cash flows continue to grow. Our port on the East Coast is seeing solid volumes, our industrial warehouse property business is very strong with Internet deliveries driving growth and valuations on industrial properties are at all time high. Specifically on real estate prices in City of London for major high quality office properties there at least 30% higher than pre Brexit. Lastly, while the full impact of Brexit on the UK is still unknown, our view continues to be that the effect will be moderate and that London will remain one of the great global centers of commerce for a long while. We have not seen any major distress opportunities as a result of Brexit and we do not know if we will, but if business weakness appears over the next few years, we will use it as an opportunity to continue our to expand our operations as we have in past at these moments. Operator, that completes my remarks and I'll turn it over to you and Brian or I would be pleased to answer any questions if there are any. Thank you. We'll now begin the question and answer Our first question is from Cherilyn Radbourne of TD Securities. Please go ahead. Wanted to touch on a couple of things that are mentioned in the letter to shareholders. I guess firstly, you talked about having large scale opportunistic funds of $10,000,000,000 to $20,000,000,000 across each of your major business sectors. And effectively, you're already there in real estate and infrastructure, and it's private equity where you have a good investment track record, but not the same scale. So I just wonder if you could speak a little bit more about how you plan to scale up your private equity business? So I guess 2 things. Thanks for the question. First of all, I'd just say that we continue to build out the business. We launched business, our Brookfield business partners last year to be able to assist in that. So far that's gone well. The size of transactions that we're doing because of that and because of our balance sheet is much larger than what the fund we have would normally do. And therefore, we think this next fund will be substantially larger than the fund we have. I would note maybe secondly that the number that $10,000,000,000 to $20,000,000,000 didn't have a indicated time period on it. But our goal is to have that in all the businesses that we operate to give us a scale. And then secondly, with respect to perpetual private funds, which does seem to be an industry trend and why you've already tapped in real estate. Can you talk about what you see as the major pluses and minuses of closed end fixed life funds versus perpetual funds? Well, the perpetual fund and I'll try to answer your question. If I don't get it right, please ask me again. But I would say, for opportunistic investments, generally what people are buying into is that you're investing the money for them and you'll return it within a 10 to 12 year period. Generally, it's a 7 year average life of investment, call it. With a more core product, what people want is to it's a form of investment to otherwise own a direct interest in real estate or power or infrastructure, but we own it for them and we have it through a fund and it's mixed with and it's owned for a very long period of time. So the fees and the incentives of the managers are set up to have very long duration capital invested and therefore the investors get the benefits of owning a piece of infrastructure real estate. They don't have to sell it and they can stay invested and the incentives are all aligned that way, but their returns are lower and that's why I guess we indicated that it really is benchmarked off of fixed income alternatives versus others. And large, large investors may do it themselves, but most investors don't have the scale and diversification capabilities to do it other than these type of products that we're creating. That's all my questions. The next question is from Anne Dye of KBW. Please go ahead. Hi, good morning and thanks for taking my question. My first question is around the capital commitments with your private fund business. So I guess I'm wondering does the fact that each listed partnership have commitments to invest in these next gen private funds that are getting successfully larger create any situations where the partnerships can become limited in their ability to invest in other opportunities that they're seeing? And so is the cash flow from prior funds sufficient at this point to fill those commitments? And if not, what are the levers that you can pull, whether it's taking down the proportion of their commitment or having BAM provide liquidity in some way, just maybe talk a little bit about that flexibility? Sure, Ann. It's Brian. And that I'd say falls into the overall approach of how we approach bringing capital these type of opportunities and what we think is actually one of the great advantages of having the listed funds and the private funds and having BAM with a strong balance sheet as well. So I think what you're getting at and just to clarify for other folks on the call is that the our listed partnerships, our listed funds like the BIPs and the Brookfield Infrastructure Partners, Brookfield Renewable Energy are what we described as cornerstone investors in our flagship private funds. And so they would have a 20% to 30% ownership interest partnership interest in those funds. So when we approach, so when the funds are calling for capital, then just to fund a new investment, then the listed issuer would put up its share. And we the funds are organized such that we have multiple sources of capital. So if it's a large transaction within a private fund that may be larger than its mandate, it also has the ability to go out and seek co investors with our institutional partners. So that's one alternative avenue of capital. 2nd, the listed partnership can act as a co investor and has the ability to put in additional funds and what they and they organize their affairs as investment grade issuers with diverse access to capital whether through bond market equity issue, sale of mature assets and you've seen us doing that as well. So there are multiple sources of capital for those entities. And then finally, we do have Brookfield Asset Management and our balance sheet at the parent level to be able to act as a co investor or backstop commitments in respect of a larger transaction. So we do think we have multiple access or access to multiple sources of capital that enable us to proceed with some of these larger transactions, many of them at the same time with full flexibility. The other question I had was around the energy marketing business. So, wondering if you could remind us what the weighted average life is on those purchase agreements with counterparts and whether there are any meaningful expirations coming up? And then also what's the remaining life on the contract term with that? Sure. So most of the contracts that we have from Bene facing the market, what we would describe, they really fall into 2 camps. There are ones that are very short dated and those really fall into just how we deal with the power that is not sold under the long term contracts, which I think are really the contracts that you're asking about. Those have a very long life. There's a couple of smaller ones that are coming due over the next 5 years, but most of them are very long life and have renewable options. So we're talking about an average lifespan of more than 10 years. Okay, great. Thanks. The next question is from William Katz of Citigroup. Please go ahead. Okay. Thank you very much. I'd also like to go back to your letter as well this morning. All of that's very helpful. So thank you for all that perspective. You mentioned a couple of things in there, I'd like maybe expand a little bit on. One is you had mentioned the wealth management business. I think you said you started a feeder fund. I wonder if you could talk a little bit about strategically how you sort of think about the opportunity set there? And then on the renewable infrastructure side, I think you also said that you expect that to be a pretty sizable fund as well. How you think about pacing to sort of get to that kind of level of AUM? So with respect to the feeder funds and maybe just to explain what they are is for smaller investors that don't have the size to invest into our actual private funds And for people that aren't buying in the common market buying our partnerships, we have private products now that are a combination of a number of our different funds. So we offer that as a product and we've just started it and we think it will be a successful product, but it's early days in building a product to an investor's needs in the private market. With respect to renewables, I do think a very large business, long scale. It's on the right side of the carbon equation. It's green and the world is going there over the next 50 years. And therefore we think that the renewable funds we have will be able to scale up and probably in the future we will have separate renewable funds from infrastructure, and we think that can be a very large business either within both renewable and infrastructure together, but also some portions of both box to be separate. Okay. And just one follow-up, and thanks for taking the questions. Within you put a fair amount of money to work in the Q2. I'm assuming all that sort of sell relative to your metrics in June. But as you think about where you are prospectively with the private equity book, any way to sort of think through how quickly you might hit the threshold where you could actually get out there start marketing the successor fund on the private equity side? Yes. Hi, it's Brian. So as it really depends on the rate at which we invest the funds. Once we get up to that 70% to 80% of current investment, then we are in a position to go out and raise and market a successor fund. So we can't be definitive in terms of when we will do that, but I think that's the of timing and as you see we've got a pretty good pace of investment going there. So we would hope to be out there in a decent amount of time. The next question is from Andrew Kuske of Credit Suisse. I guess the first question is just along the lines of the product category that you're seeing the most success in selling or turning around the other way, the most inbounds from clients on just from a product category standpoint? What's the most interesting to people? So I think if I understand the question just with respect to all our products, what are people most interested in? Would that be fair to characterize it? Yes. So I would say that there is no real there is an enormous amount of institutional investors that like investing into real estate. Infrastructure only started 10 years ago, but today there is a big thrust into it. Probably the biggest increase on allocations to any sector between infrastructure of real assets being private equity infrastructure, real estate is infrastructure, but merely because it started at the lowest level. So the increases and the new clients coming into it are greater every day, but that's merely because the base is lower. And therefore, the allocations, there aren't as many managers, it's not as established and it continues to grow. But I would say there's large amounts of money going into private equity funds, large in infrastructure and large in the real estate. They're all quite significant. And then maybe just a follow-up, is there any inherent contradiction in just the demand that you're having in certain funds and just your fundamental reality of your contrarian investors? Does that create an inherent conflict or an inherent contradiction that you have tremendous inflows in one category, but you like to contrary invest? So as you know, the reason and we've tried to articulate this before and I'll try to simplify The reason that we set up the business we have, which is in a number of businesses and it's very global is because countries don't generally come into favor and out of favor at the same time. Sometimes, once there is a general economic trend across the world that's positive or negative, but even within that environment, there are situations where it gets much worse. And so I would just say that and the reason why most of our funds are very global in nature is because we want to be able to capitalize on the situation where we can move the capital and the resources we have to the countries where which require capital and that we can then capitalize on the opportunities with our local people. And so to date, I would just say that we haven't really had a we haven't had a problem putting money to work in the things that we do on a value basis, because we haven't been able to move from country to country, but we'll have to see longer term as the business continues to scale up. Okay, that's great. Thank you. The next question is from Neal Downey of RBC Capital Markets. Please go ahead. Thank you. Good morning. On the subject of perpetual core private funds, if we take real estate as an example, how should we think about one of these funds relative to let say a private REIT in terms of structure, risk, expected return, etcetera? So the way we think of it is really 3 buckets of we have 3 buckets of capital and then I'll come to your private REIT concept, but just to maybe lay the terms that we think of opportunistic money, we think of our partnership money and then core, core plus money. And the return thresholds go down. Opportunistic money that we're investing is 20% or around there, above or below. Core, our partnerships is our 12% to 15% long term IRRs and our corporate plus are 8% to 10% to 11% depending on jurisdiction. So it's in there is the threshold of the the market for in the United States where people are marketing private products to smaller investors under the private REIT format, and I would say our products are largely institutional. It it's possible in the future we look at it. But it's possible in the future we look at it. But there so I'd say they're similar in nature to the core, core plus returns. Okay, thank you. And the follow-up question maybe for Bruce, maybe better for Brian. I suspect you saw a Wall Street Journal article earlier this week that was entitled Brookfield's Toll Road to Riches. And in that article, the journalist focused on a couple of infrastructure investments, our tariffs, and I believe Natural Gas Pipeline Company of America. And in the article, it referred to how your valuations were at odds with some others on the same asset. And I think it also went on to discuss the implications or the author's view of the implications of these valuations on your asset management fees, whether it be for the listed issuers or the private funds. Could you maybe just comment on some of the content of that article? Sure, Neal. It's Brian. Thanks. So that's a rehash of a story that you may have noticed ran a while back in Barron's and it does contain a number of fundamental inaccuracies. And in particular, we felt it was misleading as you noted. There is a suggestion that our use of fair value accounting can lead to some questionable increases in book values and that in turn can result in higher management fees payable to Brookfield. And that's simply not the case. As you can imagine, this is something we take very seriously. So I would say a couple of things. Most of you on the call will know this already, but this is important. So first of all, the management fees that Brookfield earns are based on the stock market capitalization of our listed affiliates and not based on the IFRS valuations or book values. In fact, if you look at the company that mentioned that owns those assets that you referred to, Brookfield Infrastructure Partners, most of the assets owned by BIP are not actually mark to market at all because they are concessions. And so the IFRS value is only a fraction of what the value of the company is. And this is further evidenced by the fact that BIP has sold many businesses over the past number of years proceeds significantly above IFRS values. We've observed that when investors look at a company like BIP, they're really looking at the increases steadily over time. Again, none of this is influenced by the IFRS valuations. And again, the other point we'd like to make and this comes to your comment on the questions raised about the values of our tariffs, which is our Brazilian toll road operations in particular. And this suggesting that we had widely differing values that we apply to it, assigned to it. And again, that's just not true. We don't we did not revalue this asset over that time period. In fact, this isn't even we don't even use fair value accounting for our tariffs. Just to clarify the confusion around that one, The increase in the value of our tariffs was due to 2 factors and 2 factors only. First, we invested another $700,000,000 of cash in the business to fund capital projects and purchase interest. And second, the exchange rate for the Brazil currency went up by 20% during the period. So this had nothing to do with our change in our valuation of the business. So I hope that helps clarify your question. The next question is from Mario Saric of Scotiabank. Please go ahead. Thank you and good morning. I just wanted to come back to the perpetual fund discussion. So we're sitting here and it seems like a fairly sizable opportunity and to me it's akin to perhaps the opportunity that surfaced post global financial crisis in 'nine, 2010 when you launched many of your global opportunistic funds. So when we sit here today, how do you think about the opportunity going forward in relation to how you thought about the opportunity with respect to launching the opportunistic funds post the global financial crisis? And is there a catalyst that you can see that can drive that type of fee bearing third party capital growth under the perpetual funds similar to what you saw for the opportunistic fund late in a decade? So I would just it's Bruce. I would just say that firstly, we think there's an opportunity. If interest rates stay relatively low, then there's this opportunity is going to stay for a long period of time. These things never happen overnight. They take a lot of hard work and a lot of getting the franchise to work together and it's for us it should be easier than for most because it's just strapping this business on to the what we have and we do a lot of this in other areas and therefore we should be able to do it. And I would say that over the next 5 to 7 to 10 years, as long as we're in a low interest rate environment, this business is going to expand exponentially, because it's going to really replace a portion or a significant portion of fixed income, traditional fixed income investments in pension and other sovereign plans. So I think we think the opportunity is very big and it'll just success will be how we execute over the next 10 years. Okay. And then just maybe on your comment on the fixed income investors kind of driving demand for that product offering. Is there is the offering complementary to your existing offering in terms of your opportunistic funds and so far as the expectation isn't that your ability to raise these $10,000,000,000 to $20,000,000,000 opportunistic funds in the foreseeable future is anyway in any way compromised by raising substantial perpetual funds? No, I'd actually make the opposite argument and what we've continued to find is we broaden out and we continue to bring other products to our clients, it enhances our relationship with them and therefore enables us to have a better long term business. And so we don't think this is there are different category. That's why we tried to make the emphasis. One is an equity alternative, one is a fixed income alternative. These are different buckets within a pension plan. But the overall relationship we have is enhanced by the greater number of products that we can offer them in a responsible basis. And so we think longer term, this is all additive to the franchise. And one last clarification question for me and I appreciate it's a longer term comment, but the $50,000,000,000 opportunity that you see in each of real estate infrastructure and renewable power in the perpetual side, would that be an equity figure or an asset value figure? Let's go with asset values for now. How about that? Okay, that's great. Thank you. The next question is from William Katz with Citigroup. Please go ahead. Okay. Thank you for taking the follow-up question. Just sort of coming back to capital management for a moment, circling through over the next year or so, it looks like you had a nice pivot point in terms of fee bearing AUM rising. How are you thinking about maybe buyback versus reinvestment back into the business and or dividend policy? Thank you. So I'll maybe start and Brian can add to it. I'd just say, firstly, we've had a general policy to have a relatively modest dividend relative to what we could pay in the business, but to increase it over time with increases in cash flow in the business and we don't really plan on changing that. Point number 2, we do generate very significant amounts of excess cash flow and have a highly under leveraged balance sheet. And the only thing I would say is, we always want to have very significant amounts of capital, A, to support all of our funds and all our affiliates if we need it and B, be prepared for an opportunity should it come along. Therefore, I guess the point I would say is at this point in the business cycle where the stock markets are more robust certainly than they were in 2,009. We're probably more apt to continue to put money into our businesses and liquefy our balance sheet and continue to put cash and financial assets on the book, to be prepared to do things either within the business or buying back stock at a different point in time. It's Brian. The only thing I'd add to that Bill is the ability to just to incubate new fund strategies on our balance sheet directly, just to clarify Bruce's comments. This concludes the question and answer session. I would now like to turn the conference back over to Suzanne Fleming for closing remarks. And with that, we'll end the call. Thank you everyone for participating.