Saturday, February 24, 2007

Brookfield Asset Management Inc. Profile

  
Barron's, Michael Santoli, 24 February 2007

Pension funds are desperate for long-term investment income amid low bond yields. Companies and governments are selling off their infrastructure assets to raise capital. And emerging-market economies are becoming resource consumers as well as producers.

Brookfield Asset Management, a low-profile but high-performance Toronto-based investment firm, stands astride these powerful and durable trends, having transformed itself in 15 years from a jumbled conglomerate of commodity and financial businesses into a focused manager of alternative assets, from real estate and hydro-power plants to timber lands and power grids. Its deal-making expertise, value-investing discipline and long-term perspective have generated superior returns on capital and extraordinary profits for shareholders.

Operating cash flow per share -- the preferred metric, because it adds back depreciation on assets that don't depreciate -- grew 35% last year, to $4.43, after rising 45% in 2005.

Brookfield's shares have more than doubled in two years, to a recent price of $55.

With its formidable head start in the burgeoning field of infrastructure management, Brookfield looks well-positioned to continue pleasing investors. Given foreseeable cash-flow trends, the stock easily could approach 70 in the next couple of years.

Although not well known in the U.S. -- except for its ownership of premium office buildings through 50%-owned Brookfield Properties -- the company has attained a $20 billion market value and manages $70 billion of assets.

Known as Brascan until November 2005, Brookfield was founded in 1895 to invest North American capital in Latin America. It largely exited Brazil in the 1970s, becoming a holding company with interests in mining, timber and real estate. The last of its mining assets, Falconbridge, was sold last year.

Bruce Flatt is president and chief executive of Brookfield, but he runs the company as first among near-equals, also sharing the title of managing partner with four other executives. This underscores Brookfield's collegial culture of capital stewardship.

Only 41 years old, Flatt has been with the company since 1990, and has been instrumental in re-imagining it as an opportunistic asset manager of tangible, long-lived, cash-generating properties.

Flatt and his colleagues began building Brookfield's office-building business in the real-estate recession of the early 1990s, taking on a large slug of the properties owned by then-bankrupt Olympia & York. (This portfolio includes New York's World Financial Center, home to Barron's.) Brookfield's value acumen was richly rewarded as commercial real-estate values soared in urban markets.

In the past decade, Brookfield has bought two-thirds of all the hydropower-generating stations that have come on the market, a sustainably profitable collection of assets in North and South America now worth more than $5 billion. In addition, the company acquired a large power-transmission system in Chile, which can serve as a platform for additional power-grid purchases. Brookfield also owns more than two million acres of timber lands, a position that will grow with the planned purchase of Canada's Longview Fibre.

As Flatt, who is based in Toronto, described the situation in an interview in his New York office, the company saw its holdings had benefited dramatically from declining interest rates. With rates unlikely to go much lower, "we decided five years ago that we had to earn an extra return," he says.

Around this time, Brookfield began to manage institutional money for outsiders, in addition to shareholder funds. Today, some $30 billion, or 43% of its managed assets are provided by unaffiliated institutions.

Brookfield has moved some holdings off its balance sheet and into discrete funds along with client money, a familiar model in asset management. It has launched a new fund to invest in Brazilian shopping centers, and a finance fund to invest in debt instruments and distressed securities, a specialty.

While Brookfield's asset mix might look haphazard, its target markets share several important similarities. They feature very long-duration assets requiring only modest ongoing capital investment, with steady and growing cash flows. Brookfield studies every investment sector in depth, maintains a value discipline in purchasing new assets and applies a sensible amount of leverage to attain its stringent return-on-capital goals. It is now looking at ports, pipelines, railroads and other large physical installations.

Brookfield's value standards were on display this month, when it was outbid by Simon Property Group for mall-operator Mills Corp. After doing intense due diligence on the company, Brookfield bid $21 a share and provided financing. But when Simon offered $24 a share, Brookfield stood down, collecting a $40 million breakup fee and a $25 million expense reimbursement. It had hoped to use Mills as a platform to build a larger retail real-estate portfolio, but is unlikely to buy other assets in the sector because prices are too high.

Flatt's insistence on buying high-quality assets at a decent price rather than subpar assets on the cheap is reminiscent of Warren Buffett's approach. Brookfield also shares Buffett's investment horizon: "forever."

And, like Buffett, Flatt's letters to shareholders clearly set out financial objectives and principles. Brookfield verges on under-promising; when it over-delivers, it cautions investors to keep stock-return expectations grounded. Brookfield seeks 12% annualized growth in operating cash flow.

Charles Kantor, a portfolio manager at Neuberger Berman, a longtime Brookfield shareholder, says, ""Management follows a very disciplined and patient long-term approach to capital allocation, that focuses on generating stable and growing long-term cash flow at attractive risk-adjusted returns. The team enjoys a unique ability to take advantage of stock- market dislocations to create wealth."

Infrastructure investing is fast becoming the next new thing on Wall Street. Goldman Sachs has entered the fray with a $5 billion new fund. Three big financial institutions bought London City Airport last year, and Barron's has chronicled the moves by Australia's Macquarie to pay up for U.S. toll roads.

Flatt acknowledges the growing popularity of infrastructure, and concedes it could make new investments at good prices harder to find. "More money [in this sector] is bad for the short-term investment horizon," he says. "Longer term, we'll have all these funds creating a new industry."

Flatt estimates global companies are 50% to 60% done with divesting infrastructure assets, while governments barely have started.

Brookfield enjoys several advantages over rivals. It is bigger than many, and can raise debt rapidly. It has experience with nontraditional assets, and perhaps most important, has built the operating structure around targeted industries, such as hydropower and Brazilian real estate.

It takes small positions in targets to learn the business and build relationships, and strives to keep existing management at acquired companies. Notably, Brookfield doesn't usually take management fees from the uninvested portions of client funds. Its own returns are its clients' returns, an arrangement that, like much else, should please both shareholders and clients for years to come.

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