Brookfield Asset Management (BAM) offered to buy the publicly held units of Brookfield Property Partners (BPY) for $16.50/unit (LINK)
I organized my thoughts to assess how much upside might remain to a definitive agreement.
The price is low by most metrics:
- 38% discount to IFRS Net Asset Value per share of $26.80. BAM’s own quarterly financial supplement says: “we reflect BPY at its IFRS value as we believe that this best reflects the fair value of the underlying properties”
- 13.5 times the average analyst forecast of 2021 FFO
- 20.4 times the average analyst forecast of 2021 AFFO
- 8.2% dividend yield
- 15.1% discount to the average closing price over the past five years.
A Deal is Highly Likely
- BPY has failed as an investment vehicle. Investor interest is limited by the complex scope of its business, above average risk, and high compensation payable to BAM.
- BAM’s controlling interest in BPY gives it a veto over alternative transactions.
- BPY has traded at a persistent and growing discount to NAV. BPY has made its case for years that it owns “the world’s largest, highest quality real estate portfolio”. The company has paid high dividends and aggressively repurchased units, but the valuation remains depressed, similar to other diversified Canadian REITs (Morguard, Artis, H&R, Cominar). A 20% diversification discount would mean BPY would be fully valued at $20.44 (detail below).
- In 2014 BAM privatized Brookfield Office Properties and Brookfield Residential. In both cases the final merger agreement was signed at a price 5% higher than the initial offer. The same premium would result in a $17.33 price for BPY.
- BPY’s book value does not reflect the off balance sheet liability of the management agreement with BAM. BAM’s estimate of its own Net Asset Value incorporates this agreement as part of “annualized fee-related earnings” at a 25X multiple. If this agreement is an “asset” for BAM then it’s a “liability” for BPY. The average “base management fee” from 2017-2019 was $98mm and the average “equity enhancement distribution” was $18mm for a combined average of $116mm/year. At a 54% margin, BAM generates “fee-related earnings” from BPY of $63mm. At a 20X multiple the management contract would be a $1,260mm asset for BAM and liability for BPY. This would reduce BPY’s NAV by $1.25/unit to $25.55.
- BPY unitholders have the option of taking payment of 0.4 shares of BAM. BAM estimates that its own fair value (including its stake in BPY) is $59.65, but I believe $51.43/share is more realistic (detail below).
Impact of the Merger on BAM
- Immediate accretion from purchase of BPY assets at a discount to the fair value, but the benefit cannot yet be calculated because it will be divided between BAM and “institutional partners“
- Deployment of dry powder at a time when a lot of money is available for deals, but transaction volumes are relatively light
- Removal of capital constraints imposed by BPY’s high leverage and dividend obligations. BAM will have more flexibility in restructuring and redeveloping BPY’s assets
- Increased complexity could mean that BAM suffers from the diversification discount that investors previously applied to BPY.
BAM Fair Value at 9/30/20
BAM provides a suggested sum-of-the-parts estimate of its own value in its quarterly financial supplement (see page 5). I make several adjustments to arrive at a more conservative valuation of $51.34/BAM.
BAM has an excellent long-term record, but this seems to be already reflected in the high market valuations of Brookfield Renewable and Brookfield Infrastructure and the modest consolidated discount for being a diversified holding company.
Fair Value for a Buyout = $20.44 cash or 0.5 BAM Shares
BPY investors could participate in the economic benefits realizable from the transaction through a fairly calculated share exchange ratio.
At a fair exchange ratio BPY investors would exchange their discounted units of BPY for shares of BAM at an equivalent discount.
I believe a merger would be beneficial to BAM at a price up to $20.44 or 0.5 BAM/BPY, but it will try to complete a deal as cheaply as possible. Precedent suggests that it will offer $17.33.
BAM’s offer is a signal of the strong demand from private investors for quality real estate and suggests there may be opportunities in other discounted REITs as I described in a prior article (Canny Insiders Buying Canadian REITs During Tax Loss Season).
DISCLOSURES & NOTES
At the time of publication the author held no position in any Brookfield securities. The author does not make any recommendation regarding any investment in any company mentioned in this article. The author’s position could change at any time without any further public disclosure. Investors are encouraged to check all of the key facts cited here from SEDAR filings and other sources prior to making any investment decisions.