Earnings Call: Q2 2015

Aug 7, 2015

Welcome to the Brookfield Asset Management 2015 Second Quarter Results 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 questions. At this time, I would like to turn the conference over to Andrew Willis, Senior Vice President, Communications for Brookfield Asset Management. Please go ahead. Thank you, operator, and good morning. Welcome to Brookfield's Q2 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. Bruce will then discuss our views on the market environment and our investment strategy. At the end of our formal comments, we will turn the call over to the operator and open the call up for 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 will 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 our new initiatives and our financial and operating performance, we may look we may make forward looking statements. These statements are subject to known and unknown risks and future results may differ materially. For further information for investors, 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. Thanks, Andy, and good morning. We had a solid quarter highlighted by strong growth in our asset management business. Our clients continue to commit capital to our private and public funds and we had net capital inflows of $9,000,000,000 in the quarter. And that brings fee bearing capital to nearly $100,000,000,000 representing an 18% increase over the past year and gave rise to a 44% increase in fee related earnings. We deployed $4,000,000,000 of capital into new initiatives and advanced a number of key development projects, which Bruce will speak to in his remarks. Our funds from operations or FFO in the 2nd quarter were $520,000,000 In addition to the pickup in fee related earnings, we also had improved operating results at most of our businesses, including increased volumes, operational improvements and the contribution from recently completed acquisitions and development projects. On the other hand, we experienced below average generation in our renewable energy business due to weak hydrology and a lower contribution from our residential property business. Net income in the quarter was $1,200,000,000 and this compares to 1 point $6,000,000,000 of net income a year ago. So as I mentioned, our fee bearing assets are now at the $100,000,000,000 mark and increased by $15,000,000,000 over the last 12 months. There are several components of this growth. And if I just break down the expansion of the 3 major elements within this business to illustrate our ability to access different forms of the capital. So first of all, we added more than $7,000,000,000 to our private funds over the past 12 months are currently raising an additional $5,000,000,000 and expect to be in a position to launch an additional $10,000,000,000 to $15,000,000,000 of fundraising later this year. We now have a well established base of 3 20 investors globally and are well positioned for continued growth. The second component of our growth in fee bearing assets was a 6 $1,000,000,000 increase in the capitalization of our flagship listed partnerships over the past year. These entities are listed on the New York Stock Exchange and the Toronto Stock Exchange and have aggregate market capitalization of $45,000,000,000 Finally, we increased the assets in our public market securities business by $2,000,000,000 bringing total equity and debt securities managed in this part of our business to $18,000,000,000 We think this is a very good demonstration of how our strategy of offering a combination of listed securities and private funds gives us diversification in our fee bearing assets and the ability to raise capital in a variety of markets. Now turning to our results. We had $142,000,000 in fee related earnings for the quarter compared to $88,000,000 a year ago. The annualized fee base and target carried interest is now running at $1,400,000,000 and that's up by 28% year over year, reflecting growth in fee bearing capital. In our property business, we recorded FFO of $324,000,000 and that compares to $271,000,000 in the same quarter a year ago. Disposition gains totaled $181,000,000 as we've proceeded and completed the sale of mature assets including office buildings in Boston and Washington. Last year, we had $128,000,000 of such gains. In the office portfolio, we're signing new leases at 36% above expiring rents. And in our retail business, new leases are being done at 10% above expiring rents. So we've got good growth there as well. The Renewable Energy business generated FFO of $66,000,000 and this was down from the same period a year ago and as I mentioned reflects lower than normal water levels in Brazil and some of our North American hydro facilities. Overall, generation levels were about 11% below long term averages. At the end of the quarter though, North American reservoir levels were back at the long term average, which means we are well positioned to capture premium summer power pricing. At our infrastructure business, FFO was $61,000,000 This is up over the last year and part of that increase comes from FFO generated by newly acquired businesses such as our telecom business, operations in France and transportation business in Brazil. But importantly, we also had 11% year over year growth in same store FFO, meaning the operations that we held both in the period last year and in this year, if you hold currencies constant. In our private equity business, we generated FFO of $12,000,000 This was below what we reported in the prior period for a few factors. First of all, we experienced lower prices and some of them are more cyclical investments. And also we did not receive FFO from businesses that we sold last year, which also gave rise to some disposition gains in the prior year. And finally, in our residential housing business, which is now part of the private equity business, we are seeing strength in U. S. Markets where we're selling more homes. However, in Brazil, economic growth, as I think you all know, has slowed and consumer demand is down. As a result, we delivered fewer projects, which impacted our results there. And lastly, our Board declared a quarterly dividend of $0.12 per common share payable on September 30, 2015. So thank you. And with that, I will now turn the call over to Bruce. Thanks, Brian, and good morning, everyone. I'd like to take a few minutes to speak about 4 items. First, the overall market environment second, interest rates third, some of our investment activity and 4th a few comments on our listed entities. First on the economic environment, I guess our view is that none of the business events in the first half have given us any pause about the continued recovery of the U. S. Economy. We see no indication in our businesses of a retracement. Despite this, though, we have been net sellers of assets in the U. S. Merely given the robust amounts of capital available to investors. Oil and commodity prices have hurt economies like Australia and Canada, although we're still seeing very good employment levels across those regions. We continue to pursue value investments in and around these markets. Brazil is undergoing extreme pressure, but the country has a strong democracy with an emerging middle class. As a result, we are investing large sums capital there and believe we are acquiring some incredible assets that will be great value investments over the longer term. In India, government reform continues and we're pleased with the investments we've made over the last few years. Capital is starting to migrate back to the country, but India and India is still recovering in many sectors. We hope to selectively put more money to work in opportunities in property, power and possibly infrastructure. With Eurozone interest rates near 0 and looking to stay that way versus the United States, our investments are focused on operating businesses where we can achieve some growing cash flows, but while locking in extremely attractive borrowing costs. Our telecom tower business in France is a good example of that. 2nd, we often get asked about interest rates. Our view continues to be the same. We've been running our business with the expectation and belief that interest rates will increase particularly in the United States. We actually welcome this as interest rates only rise when the economy is improving and that is positive for business. Our business is positioned to do well in a higher interest rate environment and there's four simple reasons for that. The first is that and most important reason is that we own real return assets that increase their cash flow generating capacity over time either through one of 3 methods. The first is contractual rights. The second is our ability to operate them more efficiently or better. And the third is an expansion of the operation where we can invest small amounts of capital and enhance the cash flow significantly. These enhancements should far outpace any extra interest costs in particular in a more inflationary environment. 2nd reason is we generally earn total returns on equity of 10% or 20% and this is much greater than treasury yields and therefore a 1% or 2% increase in interest rates does not really impact the long term returns of the assets that we purchase. 3rd, we finance approximately 50% of our investments with debt and moving interest rates up by 1% impacts our returns by 1% or 2%, which is not that meaningful to returns. And 4th, most prudent property infrastructure investors have fixed rate debt. We have a lot of it. And therefore cash flows until maturity of that debt actually won't change at all over the period until that debt matures. Turning to our investments. We continue to see many great value investments across our platform capitalizing on our advantages, which are as most of you know, but are worth repeating number 1, size number 2, operating strengths number 3, our global platform and number 4, our ability to work on large corporate transactions. During the quarter, we committed as Brian said to $4,000,000,000 of new investments which brings our total over the last 12 months to $16,000,000,000 and we continue to invest capital the capital raised in our private and our listed funds. We've also been busy harvesting capital. We've generated significant proceeds across the franchise including $3,000,000,000 from sales of mature assets across a number of our businesses. In our Property Group, we committed to $2,500,000,000 of capital per property acquisitions during the quarter including with clients including the acquisition of the $3,500,000,000 resort operator called Centreparks in the U. K, the Bloomberg headquarters building in London and a portfolio of office properties in Sao Paulo and Rio. In power, we agreed to acquire over 1,000 Megawatt Early Stage portfolio of wind development projects in Scotland adding these to our European development pipeline. We also continue to pursue numerous opportunities in Europe where the renewable build out has caused significant disruption in the markets. In infrastructure, we've done a number of tuck in acquisitions and have a number of significant acquisitions on the go. We recently added a further natural gas storage business to our operation, which now includes facilities in California, Texas, Oklahoma and Alberta. We also continue to add district energy systems in a number of cities in the United States and have started pursuing opportunities in both the U. K. And Australia. In private equity, we continue to expand by both scale and geography. As you know, that's been one of our priorities. During the quarter, we closed on just over a $2,000,000,000 acquisition with a partner of a mid tier oil and gas company in Australia. We tendered to acquire a $900,000,000 graphite electrode producer, which manufactures components that are used in steel mini mills, acquired an infrastructure products manufacturer and purchased a palladium line. So it was a pretty active quarter. I'll end with one note and that relates to our listed affiliates, which are Brookfield Property Partners, Infrastructure Partners and Renewable Energy Partners that all trade on the NYSE and the TSX Stock Exchanges. These entities are very important to our overall long term franchise. And to ensure the long term success of these companies, we have will and will continue to use our own resources to support them where required. That's one of the reasons, we maintain substantial liquidity at Brookfield Asset Management as we always want to be in a position to enable our companies and funds to achieve transactions and build their businesses in a way that create value for all unitholders and clients. Two examples at Brookfield Property Partners since spin off, we've been supporting their plans with lending to ensure that while they were reorganizing their company to have optimal ownership structure, they could also continue to grow the business and keep complete the major developments that they have in the pipeline. BPY is well into achieving their goals in this regard and also coming close to completing a number of asset sales to repay bridge loans taken on to complete their office acquisition integration. In addition, given that private markets have very robust pricing for assets and the public markets have sold off with the interest rate items in the market, there is a great arbitrage for BPY to continue to sell interest and assets and repurchase its own units. Furthermore, as the major leasing and development projects start to contribute to bottom line FFO over the next 2 years, the growth in FFO will be between 15% 20% annually for the next few years. Together, this should contribute to substantial value creation for all BPY unitholders and part of it was due to the contributions of us assisting BPY. At Brookfield Infrastructure, we recently were required for regulatory purposes to announce that we're in negotiations to acquire a channel, a major rail and port operator in Australia. This transaction requires significant capital to complete. And since the disclosure the unit price of BIP has traded off from where it was prior to announcement. Given our positive outlook for BIP and its strong results, we believe the dip in unit price relates to concerns regarding the issuance of units to complete the transaction. I'll be very specific. We don't know at this stage if the transaction will proceed. But if it does, we are confident that this will be a solid long term investment for BIP. In addition, fortunately due to the scale of capital available on BIP's balance sheet today, client capital that we have and our own financial resources off our balance sheet, we have the flexibility to negotiate and structure a transaction of this scale to maximize value for all BIP unitholders. We believe that as a manager of these entities that one of our roles is to enable these companies and our other funds to be in a position to complete transactions that they might not otherwise be able to do on their own. We believe that this is key to our success as an asset manager and we intend to continue using this advantage to support our companies. Operator, I'll now turn the call over to you. Those are my comments and we welcome any questions from people on the line. Thank you. We will now begin the question and answer The first question is from Cherilyn Radbourne of TD Securities. Please go ahead. Thanks very much and good morning. So fundraising was clearly a highlight of the quarter. So I thought I'd ask a couple of questions around that side of the business. And the first one is your sheer number of clients has expanded quite a bit and the average commitment is now $80,000,000 versus $1,000,000 a couple of years ago, which would say to me that you're starting to penetrate smaller and midsized institutions. So I wondered if you could talk a little bit about the evolution of your client base. Sure. No, that's it's Brian, Cherilyn. Thanks. And that is exact your observation is bang on. And that's been an objective of ours. It's been really important for us to have strong relationships with all the very large global institutional investors and we feel good that we have those. They're valuable in a lot of ways. But it's also really important for us to broaden out that investor base into the smaller and mid sized pension funds. They're great solid clients with a strong tendency towards continuing in future funds and the economics and margins are good as well. So it's a key part of our strategy. And then just as it relates to Cary, you've rebuilt the unrealized Cary nicely since the big realization on general growth. I was just wondering if you could offer some thoughts on how long it will be before carry starts to become a more regular contributor to your quarterly results? Yes. So that it's a hard one to predict exactly. Having said that, that 600,000,000 dollars relates to funds that will be harvested are targeted to be harvested over the next 3 years. So you should see that coming along along with any additional carry that gets generated in those funds over the next few years, which is really as they come to maturity, which is the typical pattern. All right. That's my 2. Thank you. Great. Thanks, Sheldon. The next question is from Mario Saric of Scotiabank. Please go ahead. Hi. Thank you and good morning. Maybe sticking to the theme of the evolution of your asset management business. I've also noted that the percentage of investors that invest in multiple funds has really gone up in the last 12 months. And even in the past quarter, it's up about 6% to 40%. As that extra $10,000,000,000,000 of incremental capital becomes available for the sector that you highlighted in your letter to shareholders, is there a specific target that we can think about in terms of how high you can go in terms of the participation in the multiple funds by your clients? Yes. I'd start off maybe just a more broad comment on that. And I think what the factor that's at work you're seeing and maybe we'll try to come up with a specific figure for you. But the factor at work is really that as you know for investment managers, it's hard work to vet people that allocate money. It's hard work to vet managers. And if you have both a strong number of funds that you can offer institutions and you have a global franchise to be able to put behind it. It's a lot easier for managers to allocators of capital to vet a manager and then continue to A, invest in follow on funds, but B, it's even better if they can broaden out and do other things with those institutions. So what we've seen is something that what's happening is that more money as opposed to if somebody walks in with one fund and it's just a specific fund in a specific country, they may or may not receive money from an institution, a large institution. But it's a lot harder than if you have very broad relationships with institutions and you can offer them multiple products. And it's kind of just human nature that if you trust somebody and if they can do the work for you, you're going to go with that party. So we continue to see that at work. And I think you will increasingly see that at work over the next decade as the industry consolidates and the number of allocations in accounts continues to come down. Okay. Yes. So I guess specifically to your to the actual quantum, I think if you look around the industry with some of the larger managers they're up at north of 75% in terms of clients within multiple funds. And obviously there's no reason why we shouldn't be in the same category. Okay. That's great. And then maybe an associated question. It's probably not a coincidence that you're also seeing some pretty strong margin expansion within the business both quarter over quarter and year over year and it's gravitating towards kind of some of the target margins that you've talked about in the past. Was there anything specific within the quarter that led to the roughly 300 basis point increase quarter over quarter? Or should we use 55% as a pretty decent base going forward? Yes. I think we've definitely built the margin up nicely. Part of it is, as you know, we put a lot into building out this business, I'll say, in anticipation of the growth in the fee bearing capital and therefore the revenues. And there will always be a little bit of evolution on that front, but meaning that it's not always going to track completely in line. Having said that, I think that's a big part of it is that. And then the other part is on the incentive distributions as well because that's a good margin for us as well on that front. Okay. Thank you. The next question is from Brendan Maurena of Wells Fargo. Please go ahead. Thanks. Brian, if I could just ask a quick follow-up related to that question about the margins. On your incentive or the carried interest, it looks like the generated versus fees, so it's about $100,000,000 generated $103,000,000 of generated in the quarter and associated fees was $34,000,000 It's about the same relationship for the last 12 months. Is kind of 65% margin on carried interest a fair target over the longer term? Overall, yes. Okay. Great. And then just a question for Bruce. So I completely get everything you're saying about institutions moving towards real assets and you guys have highlighted that for a number of years and certainly you've been proven correct in terms of where fund allocation is going. Do you feel like there's any risk that either valuations that are being paid today not necessarily by Brookfield, but maybe by other asset managers that are in the field make the risk that returns that have been delivered in the past or maybe that are promised in the future may not be realized for real assets overall? And is that a risk that institutions could sour on real assets if returns don't come out as expected? Maybe I'll try 2 comments. First, I'd say the returns are so far in excess of their fixed income allocations that they'd be taking this from that it's unless people make large mistakes, it's tough to come near 2% returns. So I think if they thought they were going to get 15% returns and they only get 9% That's possible that that occurs. But when they look back and say, well compared to our we were going to be in fixed income, maybe it wasn't a bad decision, if that's what occurs. So I think it's possible that there's some assets there's some likelihood of that occurring with some assets being purchased. Secondly, I'd say that there really are 2 types of real estate and infrastructure and we try to purchase or acquire assets in the first category. And the first category is transactions which are acquired where it takes it's corporate in nature. It often has an operating angle to it. And it's large and therefore we have competitive advantages to earn higher returns out of it. On the offset side, if you buy 100% let office building for the next 30 years or a fully let transmission system on a fixed coupon for the next 20 years. Those are assets which are closer to fixed income instruments than what we generally buy and those could get harmed with increases in interest rates. And therefore some of the returns out of infrastructure may not be as good as what people thought. That's not to say, I think that that will ever disrupt the marketplace for real estate net infrastructure investing. I think that our view is that the trend continues and it will continue other than in one circumstance, which is if you think interest rates are going to 8% in the United States on the back on the long end treasury then probably that's going to disrupt a number of things including real asset investing. Okay, great. Thanks. The next question is from Andrew Kuske of Credit Suisse. Please go ahead. Thank you. Good morning. Bruce, I appreciate the comments on supporting the underlying LPs. But could you give us some perspective on just ownership levels and how you think about that over a period of time? Is right now you've got 29% ownership of BIP and this is aside from the GP interest just on an LP basis and then you're in the 60s on BIP and BPY. So how do you think about a stabilized level? And what's the appropriate range around ownership for really a duration? How low would you go and how high would you go? On the low side, I'd say we probably we've always thought that we wanted to own 20% of these entities at the lowest level, because it enabled us to earn to feel like we were a true owner of the business along with everybody that's there. And I'm not sure that we're going to go below 20% other than in some extreme circumstance, but that isn't in our plans. On the high side, I would just say that our we don't really have an expectation or what we should own in these companies. The companies are set up to grow and build their asset portfolio and we'll be as supportive as we can to let them complete transactions which grow their business if it makes sense for all of the unitholders and add the value to the company. And if that means if there's transactions that means that we should support them, our percentage will increase. And if there's transactions which require them to issue Really we'll just work with Really we'll just work with the management teams to support the companies and it's not really dependent on how much like the percentage of ours isn't that important. It's just about creating value for the unitholders. Okay. That's helpful. And then I guess a somewhat related question because a lot of the deals that the underlying LPs do is really in conjunction with your private funds business. So there was some discussion earlier on about effectively tapping into a broader variety of funds and really the middle market clients. But what's the ability to really tap the really large checks from some of the larger clients around the world? Because you've clearly had long term relationships with very big funds around the world the sovereign wealth funds. But has that ability been effectively enhanced for the $500,000,000 commitments and above? Yes. The number goes down. The size maybe I'll say it is that the size of check on average goes down, but that actually doesn't mean that the large investors are less than the investors are less in the funds. What's happening is our funds are getting larger and therefore we still have very large commitments from big funds. But in addition, we're bringing in a lot of other institutions at smaller numbers. Therefore, the average goes down. Maybe more important than that, those institutions that are good clients of ours that are in our funds also are there because of what we can bring them as investments beside the funds that we have. So when we complete transactions and when we're doing large transactions, we have very significant amounts of capital that we can choose to bring in an amount and sometimes it's X and it could be X times 3. And so we have those and many of them are interested in putting significant amounts of capital into transactions. So we have that available to us when we're working on large transactions. Okay. That's very helpful. Thank you. This concludes the question and answer session. I'll hand the call back over to Mr. Willis for any closing remarks. Thank you, operator. Please feel free to follow-up with us directly and we look forward to updating you in next quarter. This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.