Earnings Call: Q2 2016

Aug 12, 2016

Thank you for standing by. This is the conference operator. Welcome to the Brookfield Asset Management Q2 2016 Conference Call and Webcast. 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 I would now like to turn the conference over to Suzanne Fleming, Senior Vice President of Communications. Please go ahead. Thank you, operator, and good morning. Welcome to Brookfield's Q2 conference call. On the call today are Bruce Flat, 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 talk about our market outlook and Brookfield's approach to investing. After our formal comments, we'll then turn the call over to the operator and take your questions. In order to accommodate all of 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 be happy to respond to additional questions later on 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 do not 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 security regulators in Canada and the U. S. And the information available on our website. Thank you. And now I'll turn the call over to Brian. Thanks, Suzanne, and good morning, everybody. We're quite pleased with the results for the quarter, which highlight the growth in our asset management business and improved operating results across our other businesses. The 2nd quarter marked the completion of several important milestones. In particular, we completed the fundraising for all of our new flagship funds, closing on $27,000,000,000 of capital in aggregate and we launched Brookfield Business Partners which is the 4th of our listed entities. And while our work isn't over yet, these initiatives have set us up very well for continued growth. Our 2nd quarter funds from operations totaled $637,000,000 compared to $520,000,000 in the prior year quarter. So breaking this down, we recorded $514,000,000 of FFO from operating activities and that's up 54% from the prior year. That benefited from a 50% increase in fee related earnings and a 50 6% increase in the contribution from our invested capital. Also includes realized distribution gains of $123,000,000 This came from the sale of core office properties in the UK Energy Distribution business and that compares to $186,000,000 of realized distribution gains and carried interest in the prior quarter. Net income was $584,000,000 or $0.15 per share and that reflects a lower level of valuation gains in our property group relative to the 2015 quarter. Turning to our asset management results, fee bearing capital increased to $108,000,000,000 driven by inflows of $14,000,000,000 in quarter and $23,000,000,000 over the past 12 months. Inflows were primarily the result of fundraising for the new flagship funds and these include Brookfield Infrastructure Partners Fund III, which is a $14,000,000,000 global infrastructure fund, the largest private fund raised by us to date and the largest private infrastructure fund raised in the industry. Brookfield Strategic Real Estate Partners Fund II, which is the second one, a $9,000,000,000 global opportunistic real estate fund and Brookfield Capital Partners Fund IV, a $4,000,000,000 global private equity fund. All three of these funds surpassed their initial fundraising targets and are double or more the size of the predecessor fund. The terms of these funds typically allow us 3 to 4 years to invest the capital, so we have plenty of time to put the work cut to put the capital to work in a disciplined manner. Having said that, we continue to see a number of very attractive opportunities across all of our businesses, so this could happen pretty quickly. As an example, the new real estate fund is already more than 50% invested or committed, putting it on track to be fully invested by 2017 and in a position to launch fundraising for the next one. We continue to raise capital for other niche funds or investments that are complementary to our current product offerings and currently have 4 funds in the market, including an open ended real estate fund and 3 niche funds targeting $3,000,000,000 of investor commitments. The growth in our fee bearing capital led to a 50% increase in fee related earnings as I mentioned. They totaled $191,000,000 in quarter on three $100,000,000 of revenues. And of note, recurring base management and incentive fees on predominantly long dated or perpetual capital accounted for nearly 90% of fee revenue with the difference due to some one time catch up in transaction fees in quarter. Our annualized run rate of total fees and carry is now more than $2,000,000,000 based on current funds under management and that's up from $1,600,000,000 last quarter and $1,400,000,000 in the last year. Strong capital flows increased annual fee revenues by 24 percent to $1,200,000,000 and recent private fund commitments increased carry eligible fee bearing capital to $39,000,000,000 increasing our annualized target carried interest to $830,000,000 So it's that $1,200,000,000 of annualized fee revenues and the $800,000,000 of target carry that make up that 2,000,000,000 dollars of annualized run rate that I referenced at the beginning. In addition to fee related earnings, we also generated $130,000,000 of carried interest and over the last 12 months, a total of $331,000,000 That increases our cumulative carried interest to $925,000,000 However, consistent with prior quarters, we defer recognition of this carry in our financial statements until the funds are substantially monetized, which will take several years. Going forward, we are set up well to capitalize on opportunities and move quickly with $18,000,000,000 of undrawn fund capital on top of our $6,000,000,000 of core balance sheet liquidity. We have found that having large scale capital gives us an advantage in the market to acquire high quality assets at attractive returns, and Bruce will elaborate on this more in his remarks. Moving now to our operating businesses. FFO from our property group was $195,000,000 that's up 36% on the prior year. The increase reflects contributions from investments made in our Opportunity segment as well as good same property growth in core office and retail portfolios and an increased contribution from our multifamily operations. We sold a partial interest in 1 New York Plaza as well as asset sales in our opportunity funds, which gave rise to $80,000,000 of the disposition gains I mentioned earlier. Our Renewable Power Group produced FFO of $37,000,000 compared to 60 $6,000,000 a year ago. After experiencing strong generation in the 1st 3 months of the year, the Q2 saw continued improvement in hydrology in Brazil, but lower inflows across several of our North American watersheds. And we also experienced lower relative power prices year over year in Brazil. New assets helped offset some of this, but we still fell short of expectations. On a year to date basis however, FFO is in line with the prior year. The Infrastructure Group contributed FFO of $68,000,000 that's up 11% from the same period last year. FFO benefited from increased ownership of our gas transmission business, acquisition of the Total Road business in India and an 11% increase in FFO from existing businesses on a constant currency basis. We completed the sale of our UK Gas Distribution business generating $43,000,000 of realized disposition gains. In our private equity group, we had FFO of $97,000,000 up strongly from $22,000,000 in the prior year. Panelboard FFO grew by $29,000,000 as a result of higher pricing and volumes and FFO also increased from the contribution of recent investments, including our Western Australian Energy business and gains on sales of investment securities, which offset a reduced contribution from our Canadian Energy businesses. And our North American homebuilding and land development business benefited from higher volumes in the U. S. And Eastern Canadian operations, although this was offset in part by some lower margins in Alberta. And finally, the Board of Directors declared the quarterly dividend of $0.13 per share payable at the end of September and that's unchanged from the prior quarter. So that sums up the results for the quarter and I'll now turn the call over to Bruce. Thank you. Good morning. As Brian mentioned, I guess notable in the quarter fundraising continues to be very strong and significant amounts of money are flowing into specifically real asset strategies. As Brian also said, we completed the final close for all the flagship funds and significant capital into a number of our other strategies. And total assets today are about $250,000,000,000 I'm going to deal with just three topics today, but Brian or I are prepared to speak on anything else you'd wish at the end. Starting first with the U. K, our view is that the U. K. Will thrive in the long term, but as all of you know, there often are bumps along the way in these type of situations. We also think that many times these situations present opportunities along the way where you can earn significant returns and otherwise in a situation which is smooth during this during the time. The important point though to remember is that it requires a long term view and an ability to withstand bumps along the way. Some of our businesses in the UK will likely not be affected by Brexit and some actually may benefit. For example, we own a short stay resort business that provides vacation accommodation to those who don't own a vacation home. A big part of our competition in this business comes from locals vacationing outside the UK. But with the currency down, we think people more people will be staying local. We're also well diversified across our U. K. Businesses and have, for example, have a local retail mall business, a gas utility business and are building a multifamily residential business, each which will also likely not be affected by the situation. The business we own that will have the most uncertainty for a while is our U. K. Office property business. Essentially, we rent space to large corporations, many of which are global. And uncertainty about the future of the business model in the UK is not helpful to long term planning for these type of companies. The good news is that we have significant time to be able to deal with this since the vast majority of our properties are fully leased on long term leases with very high quality tenants. Even most of our developments which are underway are mostly left to strong tenants. And our issue therefore isn't the next 10 years, it's really the long term business framework for London in the future. In this regard, we think that London will continue to be a very important center of global commerce. It's centrally located. It has a sound rule of law. It has a culture of respective capital. It has a free enterprise system. English is a primary language, a favorable tax regime for foreign companies, individuals and is a city that people like to live in. In fact, there are very few countries in the world that have all those things I just stated. In addition, moving corporate operations is extremely disruptive and expensive. And in addition to that, there's no natural alternative in the EU for corporations to go. It's therefore for all these reasons that London was a global center before the vote and why we believe it will continue to be over the longer term. And while we definitely wouldn't have chosen this outcome, we think there are 3 things that will happen or could happen. Number 1 is that they'll negotiate an acceptable deal with the EU and life will go on. Number 2, the UK will establish itself as a large Singapore sitting next to 1 of the 3 largest trading blocks in the world. Or number 4 or number 3, everyone will get tired of negotiations and leave will fade away and some with some alterations to the current status. And I guess I'd just say that we think that all of these outcomes over the longer term will be are acceptable and we just would hope that certainty would come sooner than later. A final point on this is that UK interest rates recently decreased and while and will likely go lower even more as a result of both the Brexit situation and pressures from EU rates, which are now generally negative across the board. And while most people predict real estate values will go down in London, we believe that once all of this settles out that quality properties with assured income may very well be valued higher than they were prior to Brexit. This we think will be driven by investors' thirst for yield. Turning to interest rates, similarly there are now $10,000,000,000,000 of bonds globally yielding negative returns. Many of those who own these bonds acquired them years ago and have made excellent capital returns by riding them into negative territory and they continue to receive coupons on the bonds until maturity. So they're happy and continuing to hold on to these positions. But over the coming years, most of the as most of these bonds mature, institutions are going to be forced to look for new options for a lot of this $10,000,000,000,000 of cash and rather than invest in new bonds with negative yields on day 1. And in essence, there's only 4 places globally for this money to go. And the first is U. S. Treasuries, the second is corporate and asset backed bonds, the third is equities and the 4th is real assets. In real assets, predominantly real estate and infrastructure, which are specialties are among the safest long duration investments for earning decent returns in this context for the type of institutions that own these securities. As a result, we think we will continue to see substantial capital flows into real assets, which should be very beneficial for our business. Lastly, and because we often get asked this question, I wanted to make a couple of comments on why we are still able to acquire assets for value in a world where interest rates are 0 and the S and P is at $2,200 We often and it really boils down to a couple of simple factors. And in essence, we generally acquire assets in off market means. And this enables us to find transactions that aren't generally available to most others and often allows us to avoid auctions most of the time. When we say off market, it generally means one of three things. First, we have significant capital to deploy in the sectors we operate in. And as a result, when a seller considers who might buy their large asset, we're usually at the top of the list because as transactions get larger, that list usually gets shorter. 2nd, we operate in many markets around the world with a very global footprint and that enables us to ensure that we can move capital when markets are out of favor, we can be there with a bid when others just aren't set up to do the same. And third, we have operating capabilities and reputation that enables us to usually bring more to a transaction than just capital. It allows us to underwrite with speed, certainty and often find additional values that others might not. Our business is based on utilizing these competitive advantages to source transactions followed by working the assets we acquire to to enhance the returns over those that might otherwise result without our resources. In total, these advantages should enable us to continue to earn returns in accordance with those we state and as they compound over time that can meaningfully add value to all of our clients and investors. With that operator, we'll turn the call back to you and we'll take Brian or I will take any questions that anybody has. We will now begin the question and answer session. The first question is from Cherilyn Radbourne of TD Securities. Please go ahead. Thanks very much and good morning. Wanted to start on the asset management franchise, where you've continued to refine both by introducing new products, I noticed an open ended real estate product this quarter, and also by selling off non core businesses. So maybe you can just elaborate a little bit on those two topics, new products and pruning? Thanks for the question. And I'll start with pruning. And I'd just say the following. Our business has always been in it and it is about generally buying assets in large quantums or buying them in off market situations where we have significant amount of work to do to get the asset turned around or turned into a pristine asset. Once either of those things or both of those things are accomplished, usually either they're assets which we're not interested in owning over the longer term, which we then sell or secondly there are we own assets which we can't afford to own at the returns that we can sell them at, in particular, in the low interest rate environment we're in. And therefore, we continuously will be pruning assets over time to be able to both get rid of the assets we don't want to own longer term or secondly to bring other people in with different return characteristics into an asset. And it's not that the in the second category, it's not that the assets are not spectacular assets. In fact, often these are phenomenal assets that you would want to own forever. And what we're doing is we're selling them to clients which or institutions which have a different return risk threshold. They want to own an asset for the longer term and it's a great asset for them if they want to earn that 7% yield in perpetuity. And but it came from a strategy which we needed to earn 14 or 20. And so it's generally how we look at the assets. With respect to new products, I guess we've what our belief is, is that we should be offering our institutional clients a group of products that satisfies that we can operate in, but satisfies their needs for capital across the spectrum. So in all of the areas where we have expertise, being our 4 business areas, we want to be able to offer products both in core, core plus and opportunistic strategies. And we continue to build that out across the spectrum. And the advantage we have therefore with large global institutions and with sovereign institutional investors around the world is that we become more of a one stop shop for them to be able to offer products. And it just it compounds on itself because each fund that you're successful with an institution you get to know them better. And that's helpful if we can offer them another product. So we will continue to do that over the next number of years. And just by way of follow-up on the open ended real estate fund, obviously, some have had some public issues with that type of fund in the wake of Brexit. What kind of protections would you build into the structure to avoid that kind of thing? So the open ended funds in the UK that had the issue were retail funds and they had daily liquidity on them. None of the funds that we would ever operate with long term products in them will ever have daily liquidity. So we don't ever foresee having a product like that within our construct. And then last one for me. I did want to ask sort of a bigger picture question on the power business because we haven't talked about it for a while. But clearly the shale revolution has had a significant impact on the mix of generation in the U. S. And on power prices. BAM's long term thesis has always been that power prices need to rise to incentivize new generation and that clean energy would attract an increasing premium over time. Can you just talk about how your thesis has adapted or how your approach has adapted to the recent changes in the energy market? Yes. So, Sheryl, it's Brian. I'll start off on that one. So there's obviously no doubt that the some of the technological advances on shale have lowered the price on gas, and that's caused a lower power price for markets in which gas technology is a big part. What we've seen less change in though and in fact there's continued to be a number of very favorable initiatives for us in that regard is the continued drive towards having more renewable capacity in a number of key markets for us, particularly in the Northeast. And so that's giving rise to more options for that kind of capacity, forward capacity payments for that kind of technology as well. And so while the and I think as you recall, a lot of our thinking around energy prices, power prices going forward, we look at, I'll say, the almost a corridor you could call it, where the upper band would be the types of incentives and pricing required for new build fully renewable energy, which obviously we qualify for and can pick up a good chunk of that for in place capacity. The lower band which hits you on the margin and when there's lower capacity utilization is when you have the floor set on the gas price, purely on the gas price in those sorts of markets. And we're experiencing more of that today. But as the generation requirements continue to expand as the economy grows, albeit somewhat slowly, we continue to see good long term prospects for the power price. Great. That's all my questions. Thank you. Thanks. The next question is from Mario Saric of Scotiabank. Please go ahead. Hi, good morning. I just wanted to kind of high level come back to the negative interest rate discussion given a big part of the world is currently experiencing them. Now while they may be good for kind of going in yields for real assets, negative interest rates are perhaps there for a reason and may kind of highlight the projected economic growth or lack thereof within those specific regions. So as a long term investor, how do you think about the balance between the two on real assets, which over time, as you mentioned before, a good economy or a strong economy is important to asset appreciation or real asset appreciation. How do you think about the balance between thinking about the economic conditions versus arguably low going in returns because of monetary policy? So firstly, I think I agree with everything you stated. And I'd maybe just answer or add to it by just saying that I think in the world we're in today, you're going to see muted you're going to see moderate growth even in the best countries in the world and there are more moderate growth than you would have expected in past. Despite that, some of the returns versus where interest rates are can be very attractive to real asset portfolios. And I just think if you look at what we can earn on real assets across the spectrum, you're getting paid enormous amounts compared to treasury bill or a U. S. Treasury or something like that. And it's probably we're at historic highs as the differential between what you can earn on a real asset, even on a core asset versus an opportunistic asset to a interest rate treasury. So, I think we're going to be in a more moderate growth world for a long time and a lower interest rate environment for a long time. But I still think that you'll be able to good investors will still be able to make a lot of money. Okay. And I also thought that the commentary on the recycling of capital invested in debt into U. S. Treasuries over time was a pretty interesting one as well. I know over the past couple of years, Brookfield has been selling some U. S. Real asset exposure like in a flattening yield curve environment, does your perception on the U. S. Change and does it become more attractive in a greater beneficiary of incremental capital flow going forward? I would just say we're that's all again, that's all correct. Half of our assets are almost $125,000,000,000 of them are in the United States. We'll always be buying and we'll always be selling. In this environment, there's not as many opportunities. So we'll continue to harvest capital out because we can put it in other places with greater returns for the risk we take. And but that's not to say we won't still be in the United States doing things. And if long rates continue to come down, I think cap rates in the U. S. Will go down. But that's not to say we shouldn't still be doing what we're doing. Okay. Thank you. The next question is from Anne Dye of KBW. Please go ahead. Hi, good morning. Thanks for taking my question. Thanks for the detail on the seating and the new product development that ties in my question. So when we think about how much retained capital you have after the dividend, there's certainly plenty of liquidity to pursue different options for growth. So I guess I'm just wondering how you're weighing the potential of doing the acquisition to very quickly expand the capabilities of your 3rd party management platform versus doing the organic growth and rolling out new strategies as we go? So thanks for the question. So I guess our view has been that and over the past 15 years, other than 2 little tiny acquisitions, we've built the business organically from the start and plan on continuing to do that. We never thought that making any major acquisitions was the right way to build an asset management business. It was much more controllable and disciplined if you did it yourself. And given that we were 15 years into it, I don't think we'll change. On the other hand, there are possibly small areas where we can add expertise and smaller acquisitions could be additive over time because what we have today that we didn't have before is a brand, a name, fundraising capabilities and capital to put behind new strategies. And therefore, it's possible that there are some management teams or strategies that we could add to the portfolio over time, but there'll be small dollars in relation to the overall business. Thanks, Dave. Appreciate it. And my second question was around carry eligible AUM. Percentage of AUM actually generating carry tick up. So I was wondering if you could speak to that and maybe provide some detail around if there is a certain fund that began generating carry across the hurdle, anything around that? Yes. Thanks, Dan. So, look what you're seeing is that and as evidenced by the most recent series of funds is there's a couple of things at play in the stepping up of the amount of carry that we're generating in any particular quarter. So obviously there's the investment performance itself. But also what's happening is that the funds that we had raised, let's say, 3 years ago, it takes you a year or 2 to be raising them. And so the carry doesn't start to kick in until you've actually invested the capital and you can start generating the returns. So there's a bit of a lag from when a fund launches and when it becomes, I'll say, target carry eligible. So that's what one of the things that's happening. So in particular, one of our real estate funds and one of our private equity funds that would be around that vintage would have gotten into that stage where there the capital has been largely deployed and the returns are therefore starting to manifest themselves. And then the second part of it is that the funds are larger with each iteration. Last set was 2 times the previous set, the previous set was 2 times the earlier set. So you get a bit of a compounding effect there or exponential growth factor there as well. So it's really those two things that you're seeing at play there. Does that help? Yes, it does. Thank you. That's it for me. Great. Thanks. The next question is from Andrew Kuske of Credit Suisse. Please go ahead. Thank you. Good morning. I guess the first question is just around some of the supplemental disclosure and it's really on Page 10 as it relates to the underlying groups that you've got across property, infrastructure, power and private equity on their pipelines of development activities? And how do you think about at the BAM level, the balancing act of the growth in the underlying just naturally from their own CapEx activities versus acquisition activities that really tie into your fund business? Yes. So there's okay. So I think what you're the point being, we have the opportunity to invest either in acquisition mode to put capital to deploy that way or we can put it to work through development and CapEx projects. And so the reality is we end up doing both and that gives us the flexibility. It really happens in 2 ways. So one is we have the flexibility of allocating the capital to where we think the best risk adjusted return is whether it's acquisition or internal development. And obviously based on market conditions at any particular time, the risk return profile of 1 versus the other may move. The other point, so it can be a little bit of a not quite either or, but you can shift it from 1 to the other. The other point though is that often in the context of acquisitions that we make, there are development and CapEx opportunities within those acquisitions. And so that capital can get put to work within those opportunities as well. And given the strength of our operating capabilities and that's one of the big areas that where we seek to add value. That is an attractive line of capital allocation for us as well. Okay, that's helpful. And then could you give any color just on the reorganization that's happened with TCEH because you've given disclosures in the past about your involvement as a first lienholder. Is there any color that you can provide given that the reorganization is just underway at this stage? Yes, it's Bruce. Just maybe three things. 1, the reorganization or the continues and we expect the company will come out of bankruptcy before the end of this year. It's longer than planned, but it's on generally on track. 2nd, the as part of the plan, there's always been the sale of the Encore assets or the business called Encore, which is the bid that's on the table today is one from NxThera. And that's always been part of the plan and that or another transaction will happen and as a part of this and that will be sold and that was always part the plan. And 3rd, we've been working on putting a we and other bond holders been working on putting a management team in place so that it can come out of bankruptcy with a management team and be off. And we're quite excited about the opportunity as it comes out. So but it should that should be done this year. The next question is from Alex Avery of CIBC. Bruce, you did a great job of outlining your, I guess, medium and long term views of the U. K. And the London market in particular and did a great job of hedging the currency going into Brexit. But I'm just wondering when you look at it now, it seems like you're probably less concerned about hedging at this point. So I guess a couple of questions. Where does the hedge stand today? And are there any specific events over the next couple of years as this process plays out where you think you would be more likely to ramp up that hedge again? Generally, we put hedges on when we have specific views or if there are specific risks around. Other than that, it's it often doesn't make sense to hedge. There's as many risks in putting a hedge on as there is in not having one. So I think once we're comfortable that the currency is at a point where it's stable and then we probably will scale out of the hedges that we've had. Where that is, I won't predict right now because it often changes based on events, but we have all the hedges on that we had on over the last while. Are there any specific further hurdles with this process that you think there's volatility or risk around? I would just there will be lots of changes that go on. And I think for a while, we'll just be watching the situation and what the economic situation is. And once that bottoms or comes closer to bottom over the next while, then probably you'll see the currency bottom out or at least get more stable. And at that point in time, it probably doesn't make sense for us to have all of our hedges on. But we in some places, it just makes sense to hedge because it doesn't cost a lot to do it. And therefore and most of our funds report their report in U. S. Dollars. So it just in some sometimes for us it's better just to hedge perpetually. Okay, that's great. Thank you. You're welcome. This concludes the time allocated for questions on today's call. I would now like to turn the conference back to Suzanne Fleming for closing remarks. Thank you for participating in our call and we look forward to updating you at our annual Investor Day in September. Thanks. This concludes today's conference call. You may now disconnect your lines. Thank you for participating and have a pleasant day.