Earnings Call: Q1 2016

May 13, 2016

Conference operator. Welcome to the Brookfield Asset Management Q1 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 Mr. Andrew Willis, Senior Vice President, Communications. Please go ahead. Thank you, operator, and good morning. Welcome to Brookfield's 1st quarter webcast and conference call. On the call today are Bruce Flatt, our Chief Executive Officer and Brian Lawson, our Chief Financial Officer. Brian will start this morning discussing the highlights of our financial and operating results in Q1. Bruce will then talk about our market outlook and Brookfield's approach to investing. After our formal comments, we will turn the call over to the operator and take your questions. In order to accommodate all those who want to ask questions, we ask 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 in the call as time permits. At this time, I would 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. These statements are subject to known and unknown risks and future results may differ materially. For further information, I would encourage you to review our annual information form and our annual report, both of which are available on our website. Thank you and I'll now turn the call over to Brian. Great. Thanks, Andy. Good morning and thank you for joining us this morning. The year is off to a strong start led by significant growth in our asset management results as well as improvements across a number of our businesses And our success in closing $25,000,000,000 of capital for our most recent series of funds has us extremely well positioned for continued growth. Funds for operations for the quarter totaled $703,000,000 compared to $557,000,000 in the 2015 quarter. Breaking this down, we recorded $491,000,000 of FFO from operating activities, that's up 25% over the prior quarter and $212,000,000 from disposition gains and that's up from $162,000,000 Net income was $636,000,000 or $0.23 per share. Net income benefited from the improved operating results and continued increases in the value of our property portfolios, which gave rise to $352,000,000 of fair value gains. We did however record a higher level of appraisal gains in 2015, which is the principal reason for the higher level of net income, dollars 1,400,000,000 booked in that quarter. So turning to our asset management results, fee bearing capital was $104,000,000,000 at the end of the quarter, up $11,000,000,000 over the last 12 months. And subsequent to quarter end, capital raised in our private funds added an additional $10,000,000,000 of fee bearing capital, bringing the total to $114,000,000,000 and increased our annualized fee revenues and target carry to nearly $2,000,000,000 The increases in fee bearing capital came from a final close on our $9,000,000,000 flagship property fund along with commitments of approximately $12,000,000,000 to our latest infrastructure fund and more than $3,000,000,000 to a private equity fund. All in all, our latest series of funds totaled $25,000,000,000 in capital and that's the largest amount of investable capital that we've raised for 1 series yet. We are targeting an additional $6,000,000,000 of capital in our current marketing efforts, which also include 3 niche funds. In our strategies, we are seeing the vast majority of investors in the last generation of funds coming back as participants in our successor funds. And at the same time, our capabilities to put this capital to work and manage the assets has never been stronger in terms of our global scale and operating capabilities and we're seeing a wide range of attractive opportunities. To that end, we have already invested or committed more than half of the capital in that $9,000,000,000 property fund I mentioned that we just closed. The growth in our fee bearing capital led to a 71% increase in fee related earnings, which totaled $185,000,000 in the quarter. In addition to fee related earnings, we also generated $137,000,000 of carried interest. Over the last 12 months, the total was $304,000,000 and that increases our cumulative carried interest that has yet to be recognized to $795,000,000 We do defer the recognition of this carry in our financial statements until the funds are substantially monetized, which will likely take several years. So I'd like to just take a moment to explain how the increase in fee bearing capital should impact future FFO. The metric that we think best represents this potential is the is that that I mentioned earlier, our annualized fee base and target carry. And again, as I mentioned, that now stands at nearly $2,000,000,000 So the annualized fee base consists primarily of the base management fees that we are contractually entitled to earn based on the fee bearing capital in place at any point in time, along with incentive distributions and other fees and based on the total of $114,000,000,000 of current fee bearing capital, the total fee base amounts to nearly $1,200,000,000 and has more than tripled over the past 5 years. Because most of our capital is in either perpetual or 10 year or longer funds, this is a very reliable source of earnings. The other impact comes from our potential to earn carried interest in our private funds, which represents effectively our share of the investment returns of a fund. As I mentioned a moment ago, we do not record carry as income in our financial statements until the amounts are substantially finalized, which is typically not known until a fund is wound up. Now this differs from a number of managers who accrue carry in the results on an ongoing basis. So given this lack of comparability and the fact that our fund terms are typically 10 years or longer as I mentioned, we use what we call target carry to give a sense of the potential. We currently have $26,300,000,000 of fund capital that is eligible to earn carried interests and we estimate that if we achieve the target returns for each fund, we would accrue nearly $800,000,000 of carry each year on a simple straight line basis. The reality is that the actual returns tend to lag in the first few years of any fund until the capital gets invested and their operating plans get implemented. But we think this metric gives an idea of how we are building out the potential returns in the business. So if you take that $1,200,000,000 of the annualized fee revenues plus that $800,000,000 to target carry, that's the $2,000,000,000 I've been referring to. So moving now to our operating businesses, FFO from our property group was $161,000,000 that's up 33% from the previous year. The increase reflects contributions from new leases on buildings in lower Manhattan and improving results at our shopping mall portfolio in addition to earnings from recent acquisitions. We sold a number of properties in the quarter, very strong valuations, which gave rise to that $212,000,000 of realized Here we benefited from water levels in North America that were above historic averages and the inflows in our South American portfolios were higher than last year as well. We also saw contributions from newly acquired assets such as our hydroelectric facilities in Colombia. These gains however were offset in the quarter by the impact of lower prices, particularly on spot market power sales in the U. S. Northeast which were impacted by the unusually mild weather and low natural gas prices. The infrastructure group contributed FFO of $71,000,000 that's up 25% for the same period last year. The increase reflects contributions from recently acquired assets such as our communications infrastructure network in France and our U. S. Pipeline business and our share of $13,000,000 distribution from our total investment in Asciano and Australian Ports business. But we also had strong growth across the existing businesses, 11% on a constant currency same store basis. In our private equity group, we had FFO of $61,000,000 essentially unchanged from the prior year. A number of our industrial investments in our U. S. Residential business picked up nicely. However, we did see lower results from our residential operations in Alberta and Brazil. Finally, the Board of Directors declared a quarterly dividend of $0.13 per share payable at the end of June, unchanged from the prior quarter Q1 of this year. So that sums up our results for the quarter and I will now turn the call over to Bruce. Thank you, Brian, and good morning, everyone. This morning, I thought I'd cover 4 topics and then Brian or I'd be pleased to take questions. Starting off, I'll briefly highlight our views on the current market environment, then give you a little bit of update on fundraising, picking up on the larger trends from where Brian left off, and also just mention Brookfield Business Partners. As we all know, the Q1 was marked with volatility in the markets. Stock sold off largely on concerns of a slowdown in global growth, but then bounced back as those fears seem to dissipate. It's understandable for to get caught up in short term movements in stock prices, but I guess we continue to emphasize and believe that the way to create long term wealth is to acquire assets at attractive valuations and run them like we're going to own them forever. For all the noise you hear right now about the headwinds for stocks, our view is that the markets are pretty good, not great, but overall conditions are positive for most companies. Rates remain very low. North American banks have never been in better shape. As a result, liquidity is excellent with a few exceptions in specific industry. Corporate balance sheets across North America, again with a few exceptions, are very strong and companies are expanding certain sectors, of course, such as commodities are facing challenges or regions such as Brazil and that's creating opportunities for value investors. Turning to fundraising, as Brian mentioned, against the backdrop of low interest rates and the volatility in stock markets, we believe our real asset strategies have significant appeal, in particular for institutional investors. Property, infrastructure and private equity are excellent places to commit capital for those investors with long liabilities such as pension plans and sovereign wealth funds. We spent the last decade building out our global scale in all of our businesses and it has allowed us to be heading to close $30,000,000,000 of capital for our current round of funds. There has been a great deal of discussion related to capital withdrawals from wealth funds including those in the Middle East and as often the case the story can get obscured by the headline and sovereign fund assets actually increased in the quarter to approximately $6,500,000,000,000 And while the pace was slower than recent years, the funds are so large today and that's really the most important part of that is that they're so large that merely compounding capital annually without regard to inflows or outflows is upwards of $300,000,000,000 a year added to the funds. As a result, while there are some exceptions, we don't see sovereign funds slowing their investments in real assets anytime soon for various factors. At the moment, we continue to see significant support from all of our groups of investors in North America, Europe, the Middle East and in particular in Asia where we've seen increased fundraising over the last year. Turning to investing, investing our capital, we continue to find many great opportunities to put money to work. Each opportunity focuses around 1 or more of our 3 competitive advantages, which to reiterate those 3, our size of our capital, our global scale and our operating capabilities. In addition, we've always found that one of the best ways to avoid mistakes in growing a business is to start slow and grow very methodically. That's what's carried us from owning 1 office building to more than 151 hydro plant to more than 200 power facilities. And the goal of our management teams is to set growth strategies in each of the businesses and then be relentless about growing those businesses, but only when it makes sense to financially do so. In every business we build in every country we enter, we found that the way to make the fewest mistakes is to build incrementally and we try to never use the word transformation. Finally, today, I'll make a couple of comments on Brookfield Business Partners. We expect the shares of these with a symbol BBP to be separated from Brookfield into your hands by the end of the quarter. We believe we have now almost completed all the regulatory requirements to achieve this and should be able to accomplish that timeline. This will be a special dividend to shareholders of Brookfield Asset Management of approximately $500,000,000 just depending on how the shares trade afterwards, which is approximately $0.50 a share. We would recommend you keep your shares as we think we will be able to build this business in the longer term with some great businesses in the company. But if it doesn't fit your profile, you can sell your shares in the market and therefore you can consider it a special cash dividend this year from the company. Post spin off, we will still we, Brookfield, will still own approximately 75% of BBP. Over time, our ownership may be diluted as BBP issues shares to fund its growth. But for a while, like when we had spun off other entities, we expect to provide financial support to ensure that this company has the resources to grow. Starting off, BBP will own a portfolio of industrial and services businesses that are currently part of our private equity group. Most of the businesses are leaders in their sectors such as our construction business, homebuilding, energy and resources. The portfolio is increasing in size and scale and as we continue to grow each of the businesses, we'll also look for add on acquisitions for each and other types of businesses that would be additive to Brookfield Business Partners. The permanent capital base this company will have will broaden the spectrum of investment opportunities that we think we will be able to do in our private equity group and we believe this should present us with opportunities going forward. We believe BBP will be a very attractive investment and it can be a home for some great companies that we have and also that we hope to acquire in the future. Operator, that concludes my remarks and we'd be now I'll turn it over to you to take questions if there are any. Thank you. 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. So you're in the later stages of completing a very successful round of fundraising. And I'm curious if we were to look at So, So I'd say over the years and not I won't to any specific fund, but over the years, our capital originally mostly started in Canada and in the Middle East. And that was because we didn't have track records of funds. Even though we had an investment track record, we didn't have track record of funds. And so I'd say that we now have obviously significant track records in the funds that we have for 10 years. And therefore, a much more significant amount of our capital comes from U. S. Institutional plans than it did in Safe Fund 1. And probably the second biggest change over the years has been that our is that Asian institutional investors have continued to put money into real assets and into funds and into investments outside of Asia. And so those commitments have been growing, probably both because our name is known and our relationships are better, but also because there's more significant amounts of capital coming from those types of groups today. Great. And my second question is, you've already invested over 50% of the commitments to your latest property fund, which is remarkable. So I wonder if you could just comment on some of the larger transactions that have gone into the fund and what that pace of investment implies in terms of when you could start fundraising for a successor fund? So just in general, what we do with the fund is that we start fundraising. And once we have a first close and sometimes before that we'll commit to transactions in a fund. And we just did the final close and by the time we had done all the fundraising, we were about probably 35% or 40% invested and we're now approximately 50% invested. When you're at 75% or 80% invested in a fund, you can then start fundraising for a successor fund. And what it's meant to do is that there's a continuity of investing as opposed to having a period of time when you don't have capital to invest for institutions. So I suspect by mid-twenty 17 we'll have invested the monies in that fund. Specifically, to transactions that are in the second real estate fund. You will have I think you will have seen us do multifamily transaction in the United States, which was a significant transaction that we bought multifamily apartments. We bought a hospitality business in the U. K. Called Centerparks. We bought 7 office buildings in Rio and Sao Paulo and we bought a self storage company in the United States recently, as well as a land lease business for manufactured home communities in the U. S. So it's a pretty diverse portfolio. On top of that, we always have office and retail developments that we're doing along with our business that go into that fund on a more basis. So it's a pretty broad group of investments we've made within the fund. The next question is from Bert Powell of BMO Capital Markets. Please go ahead. Hi. This is Adel Camso on behalf of Burke Powell. My first question, we have seen certain competitors also being active in fundraising to pursue assets that are backbone to the economy. Would you say there are more competitive pressures today on the type of assets that Brookfield is bidding for? Do you see that impacting the yield or return on investment moving forward? For example, CPPIB came for Asciano and now bidding for assets in Peru and other regions. Yes. First, I'd start off by saying there's always lots of competition in the world for everything and we have to be good at what we do and try hard every day to accomplish getting the returns we get. So it's never easy, point number 1. Point number 2 is we try to focus on transactions that we have a competitive advantage with. And I guess we try to focus on 3 things. Number 1 is, and often people have heard us say this, but it's size of capital. We have more money than most people who invest in transactions and that just allows us to do things which it will a lot of others can't do just because of the size of transaction. And we bought the Colombian Hydro Company recently for $5,000,000,000 and there just weren't too many people that could find $5,000,000,000 to do that transaction. So size just helps us eliminate ourselves from the crowd or separate ourselves from the crowd. The second one is we're in 30 countries in the world and we have operating people, investment people in all of them. And that allows us to move our money in the funds which are global to the places where there is a lack of capital and that usually helps us get returns and differentiates us from others. And maybe the most important that we see is our operating capabilities is 3rd and it allows us to do types of transactions which might be perceived as something that others can't do. But we have a lot of people to be able to work on the transactions afterwards or if we make mistakes to work ourselves out of the issues that we have. And so those operating capabilities of 50,000 people we have in the business give us a tremendous advantage. So I'd say those three things are always what we're focused on trying to differentiate ourselves in transaction. Thank you. And my second question, over the past year, Brookfield has been less active in pursuing opportunities in Canada relative to other countries. Given the current economic backdrop in Canada's resource sector, is Brookfield looking to deploy more capital in Canada in the near term? And are you finding an increasing number of opportunities at attractive valuations? And are those opportunities more so in infrastructure, renewable or property? So as most people would know about 10% of our overall business is in investments in Canada. And so we have very large businesses in Canada, but just given the scale of company and investments that we have, there's just not as many opportunities in Canada as there would be, for example, in the United States. Despite that, I'd say that Canada is a great place to invest and we always would look to find investments in Canada, but there's a lot of money in Canada looking for investments and therefore, it's always difficult. On the other hand, now that the markets have are a little bit different for commodity producers, I think there will be more opportunity that will come about and it could be in all of the 3 sectors that we or 4 sectors that we operate in. So I'd say lives favor more investments in the next few years than there have been in the last few in Canada. The next question is from Alex Avery of CIBC. Please go ahead. Thank you. Bruce, on previous calls, you've always talked about Brazil in a pretty favorable light. I have a lot of confidence there. There's, I guess, been a new chapter in that saga yesterday with the suspension of the President. Can you, I guess, give us a sense of whether that's sort of part of your expectations or if anything has changed there? And also a sense of if you've seen a change in recent months in terms of competitions for assets in Brazil? So I'll try to answer your question. I'm not sure where to start. I would say, firstly, that it's been a tough market in Brazil over the last couple of years. The economy is under suits under severe stress. And on top of that, all of the political upheaval has been difficult for business in the country. And so it's been tough and interest rates are high and foreign investment flows to the country have been low. So it's been a tough market. Despite that, I'd say we still believe that it's a great long term country to invest in. It has an enormous resource backing a big middle class population. It has and has proven over the last while to have a judiciary that's separate from the government. And those are all good things that will adhere to the long term value proposition in the country. As a result of that, we've been putting significant amounts of money into Brazil and we'll continue to do so. And you will not see a quick turn in Brazil, but we think it's probably bottomed and is getting better in a number of the businesses, in particular, any business related to exports in the country. And the country's currency came off and the export businesses are doing very well. And we've seen that in a number of numbers in our in the numbers of a number of our businesses in the country. Despite all that, it's not going to turn quickly. But on the other hand, the opportunities to invest capital are very attractive and they either fit in 2 categories. There are opportunities which would have never become available before, but are now available or second at values which you would have never had before or a combination of the both. So we think it's a good market, but we will continue to be prudent with how much capital in relation to how much we deploy putting into the country. Okay. And then just secondly on China, you've been sort of studying that market and investing on a selective basis for a little while. There's a lot of capital coming out of China currently and just wondering how you think about China and do you see a sort of medium term target in terms of percentage of assets that you might want to put into that market? So, we continue to selectively invest into China and we will. And when we find the right opportunities, we'll put money in. We never set targets as to how much money we should have in any area. We're more opportunistic than that. And therefore, we really don't have any goals. I'd say over the next 10 years, odds favor, we'll have more capital invested in China, but I don't we don't have any target as to how much it would be. The one thing that we are seeing is very significant amounts of capital being invested from China to other more developed markets. And again, the story gets confused because most people interpret that, that it's people taking money out of China and wanting to have it out of China and that's possible some of the money is that. But a lot of it is that the institutions in the country have been encouraged to invest outside of the country and they're starting to go from they initially were 0% outside of the country, for example, in the insurance companies and it was 3%, now they're allowed 15% foreign investment. So a lot of this is just them like North American Institutions, which used to have prohibitions on they could only invest in their own country. For example, Canada institutions could only invest in the country. Now there I think are totally unrestricted. They can invest 100% outside the country. China now has gone from 0% to 15%. You may never see it at 100%, but that will continue to increase over time. And the size of the amounts of money is very, very significant in these institutions. So I think we will see that for the next 25 years until the life insurance market starts to pay out as opposed to monies coming in and sovereign wealth funds are needed elsewhere. The next question is from Andrew Kuske of Credit Suisse. You have a pretty unique business model when we compare it to a lot of the other alternative asset managers because you've got the public LPs and then obviously the private capital side of things. And so as your private business continues to gain fundraising momentum, which you've clearly demonstrated more recently, how do you think about the pace of growth of the public LPs when compared to that private business? Yes, I guess I'd just say that we set those entities up to own the assets that we had on the balance sheet at the time and to fund our portion of the growth in the LPs going forward. And we can dial up and down the commitment we make to the private funds based on the capital that they have available and we can also recirculate assets on the balance sheet. So and all of the entities, with the exception of BVP that isn't in existence yet, but the 3 entities that we have are all self sustaining entities. So they can recirculate capital on their own balance sheets to make commitments to anything that we do. And if we need to go from 40% commitment to 25% because that's in their own capital needs or sources, we can do that on the next fund. So we have the flexibility to be able to grow those entities in the fashion we need to with really a goal of their sole objective is to earn a decent return on capital and pay a relatively high FFO payout to their LP investors. So we continue to do that and I think they're well situated to be able to help us with everything we're doing. Okay, that's very helpful. And maybe a bit more nitpicky question as it relates to the relationships between BAM and one of the LPs. Just on the power marketing business that's still held within BAM and obviously it's part of the counterparty relationship with BAM. Is BREP at the size now where that business would really make sense to be at BREP as opposed to sitting on BAM's balance sheet and just being obviously in the current market environment being a bit of a loss maker minor, but still a bit of a loss maker? Yes. I would just say we set it up originally the way it was set up because we wanted to ensure that the rep as an LP had a stable source of income and we believe long term in the power markets. I think given that the power prices have been low on the marginal power that we sell without contracts And therefore, we're taking losses on that right now. It's probably not the time you would ever consider that. But what we probably will do longer term is put a lot of long put the rest of the power into long term contracts. And then it's possible we could just assign those contracts down to the company and get off that trading business. So it's possible we do that in the future. There's no one we don't have any intention of doing anything today. And we have to make sure that all the shareholders of BREP wanted and it was the right thing for them to do. So we're I guess we're open to it in the future, but I want to make sure it's right for everyone. Okay. That's very helpful. Thank The next question is from Mario Saric of Scotiabank. Please go ahead. Thank you and good morning. Bruce, I wanted to just come back to the discussion on Asia, clearly going from 10% of the kind of LP base to 33% over time is pretty material. I think as Alex kind of mentioned earlier on, your committed capital to the region historically hasn't been overly material while it's growing. And then only now are LP investors expanding outside of Asia. So you mentioned brand recognition as being important. Just curious if you can kind of elaborate or go through how you think you've achieved that brand recognition in Asia and where it might go going forward? Yes, I would just say our brand recognition is still has a long way to go in Asia because we don't know that many people. It's a lot more than it was 10 years ago and a lot more than it was 5 years ago. I would the second thing I'd say is we have relationships with most of the large institutional clients in the region. And as we bring the One Fund, we then have brand recognition to keep coming back to them the second, third and fourth time. So that just builds on itself. And it's and I'd say, we're working on a lot of the institutions there. And what's happening is both the pie is widening, meaning there used to be 10 large insurance companies in China and there will eventually be 35 or 50 of them. And therefore, you'll just have more entities to talk to. But secondly, the sums of money that they have to deploy are growing dramatically, both in the sovereign plans in each of the countries. But for example, in the insurance plans, because the insurance plans in Asia, in particular in China, have a very they didn't use to have insurance. So they have a very young population who are starting to put money into insurance plans and they're not paying out yet. So they need money to invest for the next 30 years and start paying out 30 years from now. And so we have a big effort on continuing to build up our resources there. On the investment side, that's a separate item, but in particular, on the fundraising side. Got it. Okay. And then my second question is just with respect to capital deployment risk. We've touched on some of the topics already, but clearly, you've been very successful in ramping up the fundraising business. Your flagship funds are getting twice the amount of capital that the predecessor fund has received. But along with that comes having to deploy $25,000,000,000 as opposed to $12,500,000,000 clearly, you have a competitive advantage in terms of size and global scale. But internally, how do you think about the risk on deploying $25,000,000,000 versus $12,000,000,000 at acceptable returns? Yes, I would just say, I would make the comment and it's always dangerous to say, but I would say that as the company has gotten bigger, we've built out the systems and the risk management within the organization and we think it's easier today to deploy larger amounts of capital than it was before on smaller amounts of capital. And it's just the competition smaller. And when the competition is smaller, you can do things which you otherwise wouldn't be able to do when you're competing in a transaction with 35 people bidding for something. And so I'd say we don't really see any issues in deploying larger amounts of money. In fact, I could probably make the opposite argument to you. Okay. Thank you. This concludes the question and answer session. I would like to turn the conference back over to Andrew Willis for closing remarks. Well, thank you for being part of the Q1 call and we look forward to updating you at our annual meeting in June and after the next quarter. Thank you. This concludes today's conference call. You may now disconnect your lines. Thank you for participating and have a pleasant day.