The management team of Brookfield Asset Management has been held up as a gold standard for many years now and rightfully so. Bruce Flatt and his crew have assembled an impressive array of real estate, infrastructure, private equity and renewable power assets. The company recently added some glamour by signing up former Bank of Canada and Bank of England Governor, Mark Carney, as its Vice-Chairman of environmental, social and governance (ESG). Investors have rewarded Brookfield for its acumen sending Brookfield Asset Management’s (TSX:BAM.A;NYSE:BAM) U.S-listed shares higher by nearly 125 per cent over a five year span up until February 21 of this year. That outstripped peers KKR & Co. (NYSE:KKR) and Blackstone Group (NYSE:BX), which had respectable returns of 76 per cent and 83 per cent, respectively, over that time. (Apologies for the chunky paragraph. WordPress is being stubborn today).

 

Flatt and his team are still well-regarded but questions are now swirling about the value of Brookfield’s commercial real estate holdings.

Brookfield and its real estate subsidiaries, Brookfield Property Partners (TSX:BPY.U;NASDAQ:BPY) and Brookfield Property REIT (BPYU), the second-largest mall operators in the U.S., have shown to be especially exposed during the pandemic.

In early July, the parent company, BAM, offered an “equity commitment” to Brookfield Property Partners of up to $1 billion so that BPY could fund an $890 million unit buyback that allowed unit holders the opportunity to get their money out at a more than 17 per cent premium to where the NASDAQ-listed units were trading at the time.

The arrangement could bring BAM’s stake in BPY to 63 per cent from 55 per cent.

Nonetheless, Veritas Investment Research put out an “accounting alert flash” in mid-August questioning how BPY reported its second-quarter results.

Veritas wondered how it was that if BPY’s net operating income declined 7.7 per cent year over year, following a 3.4 per cent drop in the first quarter that “net operating income (NOI) did not decline more given that BPY collected just 34 per cent of its rents during the quarter?”

You’ll recall from our interview with Veritas CEO Anthony Scilipoti that his firm relies on forensic, accounting-based research and notices these kinds of things.

Another research group that follows the Brookfield real estate entities closely is Dalrymple Finance, which released a 12-page report detailing why it thinks that Brookfield Property Partners is essentially insolvent.

BPY has a market capitalization of about $14.2 billion, as of this writing, and its units trade at $15.08 (Canadian).

Here is an abbreviated version of a longer report by Dalrymple Finance that outlines its thesis on Brookfield Property Partners and Brookfield Property REIT:

A Note on Structure:

Brookfield Property Partners is ~64% owned and externally managed by Brookfield Asset Management. Brookfield Property REIT is ~95% owned by Brookfield Property Partners and is externally managed by Brookfield Asset Management.

 

Brookfield Property Partners and its publicly traded subsidiary Brookfield Property REIT, and the second largest mall operator in the U.S, are not self-sustaining enterprises.

In addition to retail, BPY owns office, hospitality, student housing, multifamily and logistics assets.

Embedded incentives in the structure facilitate overleverage and cash extraction through fees and overpayment of distributions by the external manager, Brookfield Asset Management.

Historical cash deficits at BPY have been filled largely by adding leverage to the properties. The strategy has become unstable in the current environment. We believe BPY and BPYU will cut their distributions.

Issues include:

 

  • Overpayment of distributions – We estimate that BPY had annual cash flow deficits after distributions of approximately ($1 billion) before Covid that will grow in 2020.

 

  • Cash cow no more – BPYU was the largest source of cash for BPY. In 2019, we estimate that $790 million of cash upstreamed from BPYU amounted to 67% of BPY’s distributions paid. BPYU’s cash distributions to BPY declined to $0 in the first half of 2020.

 

  • Overstated NOI and operating metrics – BPYU’s steady revenue and soaring accounts receivable in the face of collapsing cash flows suggests reported NOI and earnings before interest, taxes, depreciation and amortization (EBITDA) are overstated. We use reported figures, but adjusted operating metrics are likely 20 per cent lower at BPYU and 10-15 per cent lower at BPY.

 

  • Insurmountable debt – BPY and BPYU both have extremely high levels of debt. Debt/EBITDA of 15.4x and 14.3x, respectively, are twice the peer group average of 7.4x. Interest expense is 61 per cent and 182 cent of adjusted cash flow for BPY and BPYU, respectively, compared to 30 per cent for high-quality peers.

 

  • Debt defaults and consequences – BPYU is in default on $1.2 billion of mortgage debt across 12 properties and has approximately $4.9 billion coming due by the end of 2021. We believe continued debt defaults may lead to a collapsing of the corporate holding structure, putting assets across BPY at risk.

 

  • Distribution cuts are coming – All mall REITs (except BPYU) and 36 per cent of all REITs have cut or suspended dividends. BPY’s excessive leverage, high exposure to retail, poor cash generation and costly external management make distributions unsustainable. The distribution will have to be scaled down.

 

  • Bailouts for now – BAM has engineered bailout programs through various strategies for the organizations, including funding tenants, direct cash infusions and stock buy-backs, using both corporate cash and private equity funds, in what we view as deeply conflicted transactions. BAM committed nearly $2.4 billion to the entities in the fiesta half of 2020.

 

  • Watchful investors and lenders – Will BAM’s private equity clients watch while their cash is used to bailout BAM’s failing public entities? Will lenders accept ring-fenced, asset specific, defaults where partial and/or implied guarantees exist while the parent, BPY, continues to upstream ~$800 million annually in fees and distributions to BAM?

 

  • The units are worthless – Using EV/EBITDA metrics from the peer group indicates that BPY’s units have negative equity.

 

The Endgame: Insolvency is Here

  • Historical substandard cash flows exacerbated by Covid-19.
  • BPY’s largest source of cash disintegrates.
  • Revenue recognition policy appears to overstate operating metrics.
  • Excessive leverage and debt defaults.

Brookfield Property Partners is not a viable entity as it does not generate enough cash to sustain the enterprise. Further, it has negative real equity after years of asset stripping through a conflict-ridden incentive system by BAM.

Bankruptcy could be imminent given the defaults of $1.2 billion of property debt.

Cash flow deficits have plagued BPY since its inception. We are now at the point in the cycle where declining cash flows and asset values are bringing financial mismanagement to the fore.

In our analysis, BPY is teetering on the edge of insolvency.

And now the bull case for Brookfield Property Partners courtesy of The Motley Fool contributor Amy Legate-Wolfe who doesn’t own BPY but says investors have the potential to get rich off over time, especially when the juicy distribution yield of nearly 12 per cent is thrown in.

 

One High-Yield Dividend Stock is All You Need to Get Rich.

 

Related stories: Brookfield: Inside the $500 Billion Secretive Investment Firm (Financial Times subscription)

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Disclaimer
Dalrymple Finance makes both long and short investments. Readers should assume we have positions in entities mentioned in this piece.
All opinions expressed within are done in good faith and the result of what we believe is a deep and rigorous research process. All data cited in the report is taken from public sources. Although we believe the information in this report is accurate, we make no representation, express or implied, that it is so.
This report is not an offer to buy or sell any security. Nor should it be construed in any way as investment advice. Anyone who access this opinion piece should not rely on it for investment purposes.
Individuals interested in investing should conduct their own due diligence. Additionally, numerous sell-side analysts at investment banks cover entities discussed in this opinion piece. They offer investment advice and specific recommendations on securities discussed here.