When Bruce Flatt, the chief executive officer of Brookfield Asset Management Inc. BAM-A-T, said in his recent letter to shareholders that he was mulling the idea of spinning off the company’s asset management business, investors faced a question of their own.
Should you bet on a stock that trades at a significant discount to the value of its parts?
Initially, the answer appeared to be a resounding yes, as the share price rallied nearly 10 per cent on Mr. Flatt’s proposal.
But with the price down about 14 per cent over the past seven trading days, early enthusiasm is fading – giving curious investors another chance to examine the opportunity.
Companies with relatively unrelated operations have struggled with a so-called conglomerate discount in recent decades, as investors ascribe less value to a complex holding company than pure-play firms that specialize in a particular area.
If diversification can weigh on a stock, then surely a company that streamlines its operations can give its stock a lift, which explains why the number of conglomerates is fading in much of the developed world.
The golden era of conglomeration in the United States arrived in the 1960s. The trend faded in the 1980s, when shareholders grew concerned about lagging stock valuations and pushed many companies to streamline their operations.
Brookfield Asset Management considers spinoff of asset-management business
Though Apple Inc. AAPL-Q and other mega-sized technology companies look like modern, successful conglomerates, many others are making efforts to simplify and drive valuations higher.
General Electric Co. GE-N is planning to carve itself into three public companies over the next couple of years. AT&T Inc. T-N is divesting WarnerMedia division. And Power Corp. of Canada POW-T recently eliminated an ownership layer that had weighed on the stock’s valuation.
Where does this leave Brookfield?
Brookfield operates an asset management business, which invests on behalf of pension funds, sovereign wealth funds and endowments, along with its own money. It’s massive, with US$364-billion in capital at the end of 2021, generating enormous fees from investments in real estate, global infrastructure and other assets.
Here’s where things get interesting for investors.
Mr. Flatt estimates that the value of a separated asset management business could range between US$70-billion and US$100-billion, or US$45 to US$60 a share. The remaining parent company, composed of US$50-billion in net assets, would be valued at about US$30 a share.
Brookfield’s total value then, according to Mr. Flatt’s estimates, comes to US$75 to US$90 a share, compared with a current share price of US$55 – implying that the shares trade at a discount of at least 27 per cent.
That’s hard to ignore.
The unlocked value is based on the idea that pure-play asset managers – such as Blackstone Inc. BX-N, which has significantly less invested capital – enjoy valuations that are considerably higher than Brookfield, whose share price has lagged many of its peers over the past two years.
“Pure-play managers have been more in vogue across global markets because they are easier to value and have attracted higher multiples,” Mr. Flatt said in his letter.
Spin out the asset manager, the thinking goes, and watch that multiple expand as investors reward a higher valuation to the separated division that could trade alongside other public subsidiaries: Brookfield Infrastructure Partners, Brookfield Renewable Partners and Brookfield Business Partners.
Brookfield Asset Management, the parent company, would maintain a significant ownership stake in all these entities, including the spun-off asset manager and its substantial real estate holdings.
A number of observers have greeted the idea enthusiastically, if not fully embracing the high-end of Mr. Flatt’s estimates.
“We don’t think the spinoff changes the intrinsic value of Brookfield Asset Management but the intent is to reduce the trading discount to said intrinsic value, which we think is substantial,” Mario Saric, an analyst at Bank of Nova Scotia, said in a research note.
Mr. Saric believes that Brookfield’s share price should trade above US$70, if not higher, rewarding investors who buy into Mr. Flatt’s proposal.
There are, admittedly, a lot of moving parts here. There’s no guarantee that Brookfield will pursue a spinoff of its asset management arm, since the CEO said that doing nothing is an option.
As well, a bullish case rests on the spinoff attracting a higher valuation simply because it would be a pure play among other asset managers. That’s not a sure thing. Also, investors should note that Brookfield’s share price can be vulnerable to market downturns.
Still, if Brookfield already offers investors exceptional management capabilities and compelling exposure to operating businesses within areas such as renewable energy, real estate and infrastructure, a little structural tweaking looks like an attractive bonus.
Full disclosure: The author owns shares in General Electric Co. and Brookfield Infrastructure Partners.
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