The following segment was excerpted from this fund letter.
Brookfield Asset Management (NYSE:BAM) – The Counterfactual
In our letter last quarter, we talked in detail about our investment in Brookfield Asset Management and a potential value-unlock transaction.
BAM also operates a large holding company trading at a substantial discount. However, management has a better track record in unlocking value.
In our letter we wrote:
During the quarter, management announced that they’re considering splitting their ‘asset heavy’ investments and the ‘asset light’ asset management business. Nothing has been crystalised, but this could be an additional value unlock.
In May, BAM confirmed that they are indeed going through with a transaction to spin off a portion of their ‘asset light’ asset management business by the end of the year.
With all the market turmoil, market participants have surprisingly ignored the potential value unlock. We think this business could end up on a 5-6% dividend yield and create a favourable return for us.
BAM has undertaken many of these spin-offs in the past with great success. Their modus operandi is to seed new businesses utilising holding company capital and then spin them off into new discrete businesses whilst preserving shareholder value. Young up-and-coming managers get to prove their worth running these emerging businesses. Importantly, they need to interface with capital markets (which can sometimes be brutal).
Public investors can directly access their renewables, infrastructure, or private equity funds on the public markets.
But as we have shown, BAM management has undertaken these spin-offs several times without the initial diminution of value. This perhaps is indicative of how adroit BAM management is.
The Brookfield Reinsurance Example
In our letter last quarter, we spoke about BAM’s new insurance business. This business is still subscale and is naturally making losses. Management expects that this business in five years could hold $200bn-$300bn of assets (currently $40bn). Despite the nascent stage of the business, management decided to spin off the business to shareholders last year. But guess what, the indiscriminate selling never happened.
In a masterstroke of corporate finance ‘wizardry’, management embedded two elements in the spun-off entity that preserved share value to allow the business time and space to scale:
- Firstly, it made the economic distributions match BAMs. This means that dividend cash flows are the same as BAM.
- Secondly, they created an exchangeability right embedded in the insurance business.
The exchangeability right allows an insurance business shareholder to simply exchange a discounted insurance share for a fully valued BAM share at any time. The implication is that if the share was trading at a 50% discount to BAM, a shareholder could simply exchange the discounted share for a full value one.
The result is that since the spin-off, the insurance share has traded very closely with the BAM share. This has left the management of the insurance business to continue scaling without the overhang of a discounted share price. Shareholders have won too.
Where We See Value
Despite the share price discounts, we believe that the intrinsic value of the business will continue to compound at high rates over the coming years. Of course, buying at substantial discounts simply enhances our overall return.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.