Most readers interested in investing in asset managers are at least somewhat familiar with Brookfield Asset Management (BAM). Over the last three weeks, its stock has jumped by about 30%. That makes it somewhat less of a bargain, but still rather attractive since even conservative valuations lead to intrinsic value of at least $45 per share (compared to the present $40 share price). This article aims to remind the readers that there are indirect ways of owning BAM shares that could prove a lot more profitable.
The crucial entity in this respect is Partners Value Investments LP (OTC:PVVLF, TSXV:PVF.UN) which I will refer to as PVI. This Canadian limited partnership was created in 2016 as a vehicle primarily targeting passive ownership of BAM shares. It holds a ~9% stake in BAM and its owners are mostly former and current Brookfield partners. I wrote some articles on PVI before, so I won’t repeat the background information here. (Note: the currency used in this article is $ for USD and C$ for CAD; be careful not to confuse the two when analyzing the financial reports of PVI.)
The most important assets of PVI are Partners Value Investments Inc. and Partners Value Split Corp. through which PVI holds its BAM shares and several other equity investments (mostly BAM spinoffs BIP, BPY, BBU, TSU). For simplicity, we will only focus on the BAM shares since all the rest is rather negligible. This is the balance sheet of PVI at the end of 2Q 2020.
(source: latest quarterly report)
PVI does not pay any dividends. As you can see from the statement of operations, the dividends from BAM and income from other investments are used to cover operating expenses and dividends on preferred shares with an ample margin of safety.
(source: latest quarterly report)
The preferred shares provide a modest amount of leverage. They are issued on several levels (directly by PVI, traded under the ticker PVF.PR.U on TSXV, or by certain subsidiaries) and I don’t find them particularly interesting, but sometimes they trade with a decent discount (C$18 vs. C$25 of par value) and can be used at par when one is exercising the warrants mentioned below, so perhaps you would want to keep an eye on those, too.
Now, we come to the key point: while BAM jumped recently by ~30%, the price of PVF.UN, which tends to be a very good proxy for BAM share price, barely moved up 10%. (You can compare the charts on the TMX website; use a 1-year horizon.)
Net book value per unit was $42.60 at the end of 2Q 2020, when BAM was priced at $32.90 (the net book value fully accounts for the dilution caused by exercising all outstanding warrants, see the section on warrants below). At today’s ~$40, the net book value is about $53, or almost C$70. The current price of PVI is just C$44.50. Thus, we have a 35% discount. If we put BAM’s intrinsic value at $50 per share (which I find reasonable), PVI can be bought for half of its worth.
The following chart shows the historical values of the discount to net book value (I used historical prices from the TMX website and data from PVI financial reports in its preparation). Apparently, one should not hope it will close anytime soon, but if the discount narrowed down to just 15% (a much more likely scenario), it implies a nice 25% return. In addition to this, BAM’s share price seems pretty sensitive to positive vaccine news, so it is quite likely to significantly climb upwards over the following months.
Warning: PVI comes pretty close to what I imagine a PFIC to be, so a U.S. owner could stumble into nasty tax consequences by owning it (about which I don’t know anything).
A topic also discussed in the previous articles is the existence of warrants on PVI expiring in June 2026. Currently, there are 73,470,631 units of PVI outstanding, and 14,708,666 more units would be issued if all the warrants were exercised: one unit for each 5 warrants; the exercise price is C$32.45. The current price of C$44.50 per PVI unit implies that the warrants are in the money, and if they traded for ~C$2.40, one would need exactly C$44.50 to acquire a unit by buying 5 warrants and exercising them. The value of C$70 per unit implies that warrants should cost C$7.50. Since they trade for about C$4.80, the upside is 50-60%. Unfortunately, the warrants trade very thinly, sometimes not at all even for weeks.
The following table (calculated by myself) captures the relationship of warrant value vs. BAM share price, assuming that the discount on PVI units stays the same. For calculations of the present values, 10% discount rate over 5.5 years has been used. If the highest BAM share price was achieved sooner, the returns would be greater.
If the discount closed completely, it would basically double the value of the warrants.
I find it realistic that the price of BAM shares reaches $80 over the next 5 years. That would put the present value of the warrants somewhere between C$7 and C$12, and by buying the warrants at C$5, you can expect a 2x to 4x return.
The risk is, however, considerable: you are relying on market prices over a rather short term of less than 6 years. I don’t like being in such a position, so I am keeping my warrant position rather small.
On the other hand, $80 per BAM share implies a fair value of C$145 for a PVI unit, and so you would triple or double your money (if the discount closed completely or not at all, respectively), and you can perhaps sleep better.
I find the recent widening of discount on PVI LP units somewhat surprising (I see no reason why the discount should increase so suddenly) and am tempted to replace some of the warrants with LP units if I can sell them for a reasonable price, say, C$5-6. I already managed to replace a portion of my BAM stake with PVF.UN.
Disclosure: I am/we are long BAM, PVF.UN, PVF.WT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.