Enter the name of Toronto-based public company Brookfield Asset Management into a search engine and it delivers more than 1 million results. The global conglomerate, whose annual sales exceed $18 billion, controls ports in England, owns Manhattan’s prestigious World Financial Center and sells Chicago a fair measure of its electricity. Yet the massive enterprise is better known for what it owns than how it operates.
The Southern Investigative Reporting Foundation began a full-time investigation into Brookfield’s far-flung operations in late fall. This reporting and research uncovered a series of earnings quality problems, the presence of a mostly hidden ownership group that effectively controls Brookfield’s governance and corporate structure, and a business model that involves heavy reliance on related-party transactions with its subsidiaries.
Few companies bear a structure as complex as Brookfield’s: Analyzing the company’s organizational tree and its web of entities, stakes, partnerships and operating companies is to behold the work of gifted accountants and lawyers. Similarly, Brookfield’s financial filings are mind-boggling in their complexity.
A brief glance at a stock chart, which shows that Brookfield’s share price has been on a fairly steady climb from a low of $11 in 2009 to almost $40 in recent months, might give credence to the argument that the labyrinthine structure works.
No one doubts that Brookfield’s share price performance has pleased investors, but how it is achieved should matter.
Control without risk
Brookfield bears a pyramidal control structure, a design that U.S. regulators have frowned on since the 1930s. Simply stated, this type of structure lets a small group of shareholders exercise control of a business without putting a proportionate amount of capital at risk.
(This kind of corporate structure is often depicted by a pyramid; hence the name. It is legal and to varying degrees common in Europe, Asia and Canada. But it should not be confused with a pyramid scheme.)
As has been deeply parsed in academic literature, pyramidal control structures are either tremendously efficient or very worrisome, depending on one’s vantage point. Indeed, legendary investor Benjamin Graham devoted an entire chapter of his still influential 1934 book “Security Analysis” to their risks.
Those in the founding group can leverage their capital to effectively control a broad network of assets or investments; often members of this group do so by creating a holding company with the right to appoint half or more of the board of directors of the parent company.
In turn, these directors can oversee a series of acquisitions using the company’s capital, most of which belongs to other people.
For the shareholders outside of the control group — even if their capital is doing most of the buying — their influence upon the board of directors is perpetually limited, no matter how much they have invested.
Here’s how Brookfield’s pyramidal control structure works: Partners Limited, a private holding company with 45 equity holders (a mix of current and former Brookfield officers, with just eight publicly named) owns slightly more than 20 percent of Brookfield’s Class A shares via a combination of trusts and direct holdings valued at more than $4.7 billion. Partners Limited also owns 100 percent of Brookfield’s 85,120 Class B shares, allowing it to elect 50 percent of Brookfield’s board of directors. Owning just 20 percent of the Class A shares but electing half of Brookfield’s board, those who run the almost invisible Partners Limited end up with effective control over all Brookfield’s operations and governance, and anyone else who happens to be a Brookfield shareholder with a gripe cannot do much but grin and bear it.
Should an enterprising Brookfield shareholder summon the nerve to put forth a measure for a vote, its adoption requires approval from two-thirds of both the Class A and Class B shareholders alike. In other words, if the 45 Partners Limited shareholders who own Class B stakes believe a measure goes against their interests, the motion is dead even if 80 percent of the Class A holders approve it. Ultimately this creates a public-private hybrid: a corporation that has ready access to public capital but whose governance can be a private matter.
The use of A and B classes of shares is almost universally panned by governance advocates for its allegedly unfair treatment of minority shareholders. But Brookfield is hardly the only company with what is known as a dual-class share structure. The roster of companies with such a structure includes Google, Berkshire Hathaway and The New York Times Co. Whatever their merits, dual-class share structures are designed to keep the company’s operating assets in the hands of founders. When Berkshire Hathaway’s Warren Buffett likes another company, he does not use his publicly traded corporation as a springboard to build a string of downstream corporate investments via minority stakes; he generally buys all of it.
Want to know more about Partners Limited, its history and how it goes about business? Apart from mentions in Brookfield’s management information circular (equivalent to a U.S. corporate proxy statement), the entity is rarely mentioned in the filings of Brookfield and its subsidiaries. Examining public filings, the Southern Investigative Reporting Foundation came up with a list of 40 of the 45 current and former Partners Limited equity holders; a sizable number of them were instrumental to the rise and fall of Brookfield Asset Management’s high-profile predecessor, the Edper Group.
[module align=”left” width=”half” type=”aside”] See the Southern Investigative Reporting Foundation’s exclusive list identifying 40 Partners Limited equity holders — those who really call the shots at Brookfield Asset Management.[/module]
In response to a U.S. Securities and Enforcement Commission comment, Brookfield recently came close to acknowledging that it has a pyramidal control structure in the “Risk Factors” section of a prelaunch filing for its Brookfield Property Partners unit: “The company at the top of the chain may control the company at the bottom of the chain even if its effective equity position in the bottom company is less than such controlling interest,” the document states.
(With its shares traded on the Toronto and New York exchanges, Canada-based Brookfield submits filings to the SEC but does so as a foreign issuer, which allows it to legally bypass some U.S. laws.)
No matter how little Brookfield Asset Management controls economically of Brookfield Property Partners, Brookfield Asset Management will retain control of Brookfield Property Partners’ board.
All this fine print has paid off handsomely for Partners Limited.
Consider just this one, commercial real estate branch of the Brookfield Asset Management ownership tree: Partners Limited, with a stake worth $4.7 billion, is able to control Brookfield Asset Management, whose market capitalization is $23.8 billion. One of Brookfield Asset Management’s investments is its 50 percent stake in Brookfield Office Properties, a commercial real estate developer with $8.5 billion in market capitalization, that in turn owns 73 percent of Australian real estate investment trust Brookfield Prime Property Fund. With what ultimately amounts to a 7.3 percent blended equity stake in these three entities, the 45 people in Partners Limited exert managerial control over many billions of dollars’ worth of commercial real estate around the world.
Asked about the role Partners Limited plays in Brookfield Asset Management, Andy Willis, a company spokesman replied, in part, with the following:
“We believe [Partners Limited] creates a significant alignment of interests with our shareholders that sets us apart from other companies and is valued by shareholders and our clients alike. We believe that Partners’ participation in the ownership of Brookfield will result in greater long‐term value creation for all shareholders.”
The U.S. regulatory distaste for pyramidal control structures can be traced to the presidency of Franklin Delano Roosevelt. Then Federal Trade Commission analysts fervently argued that a series of collapses in the 1930s by pyramidal control structure companies (primarily utilities) had deepened the Great Depression. The FTC analysts seized on three things: real and potential abuses by “minority” shareholders (resulting in investors who did not exert control over corporate affairs), the prospects for one-sided related-party transactions — and most important — weak accounting controls that led to the inflation of asset values.
What the numbers really say
Investors in Brookfield have remained loyal to the corporation despite such governance issues perhaps because it has grown assets and earned billions of dollars annually. With Brookfield’s shares widely held in Canada and finding increasing favor among American money managers over the past few years, members of Partners Limited and the rest of Brookfield’s senior management likely are optimistic about prospects.
But a sunny outlook might not be what comes to mind after close scrutiny of Brookfield’s financial filings and an analysis of how the company interacts with several of its subsidiaries.
Despite its profits, Brookfield is not doing as well as investors might suppose.
Brookfield is a creature of the capital markets, relying on financing to fuel its growth and meet its commitments to investors, as the chart below shows. From the start of 2010 to the third quarter of 2012, Brookfield’s distributions — its dividend payments to investors — were $272 million greater than its cash flow from operations, according to filings. Fortunately for Brookfield, its investors are a truly generous bunch; they helped the company eliminate this deficit and raise almost $1.75 billion more than it paid back out, ensuring that its increasing dividend obligations were met — with cash to spare.
But relying on a constant stream of investor capital has proved a substantial risk for many corporations — the 2008 credit crisis serves as an object lesson — since companies whose business models center on a constant stream of capital market funding hit trouble when the markets seize.
And U.S. tax policy toward dividends is a major stumbling block for companies with pyramidal control structures. The primary method a pyramidal control structure company has to sustain itself — using preferred stock dividends to shuttle cash from the subsidiaries through the structure to the publicly traded holding company — becomes impractical when both the dividend payer and recipient are being taxed.
Generations of businesspeople have assessed the success of enterprises based on a set of simple criteria: Are they profitable? Do they sell enough goods or services in a given period so that after fixed and variable costs are subtracted and taxes paid, something is left to reinvest, retain for future use or even return to shareholders?
Using net income as a barometer of financial achievement is not without its flaws; any business that requires a substantial investment or a longer time frame for its assets to generate a return is likely to eke out a meager income in the short term. But net income is a rational and understandable measurement of where a business stands.
Brookfield sees things very differently and suggests investors judge its success by relying, as the company does, on a measure called “total return” to accurately capture the growth in asset value and cash flow generation in its units. The company describes this view in its annual report as follows: “We define Total Return to include funds from operations plus the increase or decrease in the value of our assets over a period of time.” (“Funds from operations” consist of the cash flow from its businesses.)
Accordingly, Brookfield’s management says it is not the biggest fan of using net income to define profit because only “fair value” adjustments from its real estate and timber segments can be included but not any from its renewable power and energy businesses. (A company can make fair value adjustments if it decides that the market value of its assets has significantly changed from their book value.)
Whatever the merits of “total return” as a measurement, Brookfield’s investors would need to determine net income to gauge the return on their invested capital in comparison to other investment possibilities.
Management’s linguistic preferences are not the sum total of the drama surrounding Brookfield’s accounting, however. Its income statement has several line items that suggest flaws in the company’s earnings quality.
A frequently debated subject in the accounting community, earnings quality is usually defined to include, in part, how closely a company’s reported net income tracks its so-called true income (or what it can easily convert to cash).
Those willing to put on the green eyeshade and examine Brookfield Asset Management’s 2011 Consolidated Statement of Operations can find $3.67 billion in net income. It’s an eye-opening number. More interesting, however, is discovering just how much of that figure is generated from accounting entries and not from profits related to business activity.
The problem starts a few rows above the line for net income where one can view the various streams that comprise it. In 2011, almost $1.29 billion, or 35 percent, of Brookfield’s profits came from fair value gains. (This figure, however, is listed as $968 million in the 2012 earnings release; it is not clear why there is a difference between the two filings.) For 2012, according to Brookfield’s most recent earnings release, more than 43 percent — or $1.19 billion — of its net income of $2.74 billion came in fair value changes.
Accounting standards allow for including fair value changes in net income. But any gimlet-eyed investor knows that they are nothing more than paper entries, and in Brookfield’s case, they represent its own assessment of its timber, commercial real estate and agricultural asset values; they have nothing to do with the cash typically associated with profits. Even though company executives may legally term a fair value change as profit, this sum cannot be used to pay dividends, build new plants or be readily tapped for a rainy day. All it represents is that the company thinks an asset has increased in value. As a key driver of the much larger net income figure, however, it certainly appears to have added some heft to Brookfield’s share price in recent times.
Consider a complex line item titled “equity accounted income” in the 2011 annual report’s Consolidated Statement of Operations, representing Brookfield’s share of income from its far-flung investments in entities it controls. Pegged at slightly more than $2.2 billion, this amounts to 60 percent of its total net income of $3.67 billion. Similar to fair value adjustments, equity accounted income is (mostly) noncash. For 2012, it totaled $1.24 billion and equaled more than 45 percent of earnings. (Brookfield released its 2012 earnings in mid-February but not its entire annual report, so details about the components of 2012 earnings are not yet available.)
The primary driver of the “equity accounted income” entry in 2011 was Brookfield’s high-profile 22 percent investment in General Growth Properties, a New York-based commercial real estate developer and manager. (Funds managed by Brookfield own another 18 percent of the stock.) Buried in the back of the annual report, this notation is easy enough to miss, but the carrying value — the value Brookfield assigns to the General Growth Properties position — was $1.17 billion more than its market value: Brookfield valued the highly liquid, New York Stock Exchange-traded shares of General Growth Properties at about 40 percent above the market’s valuation at the end of 2011. All told, about $1.4 billion from this one investment eventually wound up in equity accounted income, but it added only $204 million in cash to the till, according to the annual report. (In 2010, Brookfield reported equity accounted income of $765 million but its only source of actual cash from that input was $374 million in dividend payments from companies it had invested in.)
Thus, accounting entries are making Brookfield look really good. Without including fair value changes and equity accounted income, Brookfield’s earnings sharply decrease.
What does this situation look like numerically speaking? As shown in the chart below of Brookfield’s net income in the last couple of years, after adjusting for fair value changes and equity accounted income, the sum that might be called the “true profits” — the earnings from all the investments and assets Brookfield has the world over — is relatively low.
Investors may accept Brookfield’s desire to be analyzed this way but the SEC has publicly questioned how Brookfield used specific investment terms and its valuation methodology. In one instance in July 2011, the SEC noted its concern that Brookfield’s use of the phrase “cash flow from operations” was outside the standard definition. Despite the unambiguously skeptical tone in the SEC’s correspondence about the phrase, Brookfield held its line for more than five months. The company repeatedly parried the SEC’s concerns in a dispute that played out in a cat-and-mouse series of filings before Brookfield finally consented to change its wording in November. [module align=”right” width=”half” type=”aside”]Find out more about a host of concerns the SEC had in 2009 about another Brookfield subsidiary, Brookfield Homes.[/module]
The real number for Brookfield’s earnings is anyone’s guess. The sheer complexity of its income statement and management’s insistence on nontraditional measurements seem to work in Brookfield’s favor, as virtually no analysts or investors have raised public concerns in this regard.
As Brookfield’s auditor, the accounting giant Deloitte & Touche, notes in an article it wrote in 2002, the prevalence of noncash earnings is an important criteria in assessing earnings quality.
In 2011 Brookfield paid Deloitte $38.7 million for audit work for Brookfield and its subsidiaries. Below, view a chart showing how much Brookfield and other large Canadian corporations compensated their auditing firms.
The curious case of an infrastructure player
As is the case for some icebergs, much of Brookfield Asset Management’s activity is happening below the surface, at the level of its operating subsidiaries and limited partnerships.
Brookfield Asset Management’s approach to navigating the myriad disclosure, accounting and valuation challenges of its pyramidal control structure is perhaps most clearly seen in the filings of Brookfield Infrastructure Partners L.P., a publicly traded affiliate spun off from Brookfield Asset Management in early 2008.
Holding Brookfield Asset Management’s infrastructure investments in commodities like utilities, timber, toll roads and seaports, Brookfield Infrastructure Partners is structured as a publicly traded limited partnership. Though Brookfield Infrastructure Partners is legally autonomous from Brookfield Asset Management and sports brand-name investors like Morgan Stanley Investment Management and Fidelity Investments, there is no apparent practical distinction between the two. Brookfield Asset Management and Partners Limited currently owns about 29 percent of Brookfield Infrastructure Partners’ units (down from 60 percent in 2008) and acts as its general partner, earning a 1.25 percent management fee and incentive fees, which amounted to $53 million in 2011, according to the annual report.
(Using an unusual approach, Brookfield Asset Management calculates its management fee from enterprise value, meaning that the larger Brookfield Infrastructure Partners’ capitalization gets, the bigger the fee. Brookfield Asset Management also receives 25 percent of surplus cash each year from Brookfield Infrastructure Partners if Brookfield Asset Management’s quarterly distribution is more than $.305 per unit; it was $.370 per unit for the most recent quarter. Other limited partnerships have a similar clause for paying out additional dividends with surplus cash but have very strict guidelines about when it applies; in Brookfield Infrastructure Partners’ case, these extra distributions are at the “sole discretion” of the general partner, according to the 2011 annual report.)
For all practical purposes, Brookfield Infrastructure Partners exists solely on paper and has no employees or assets. What Brookfield Infrastructure Partners does have is a series of remote and indirect ownership claims on about 15 assets managed by Brookfield Asset Management employees and held in private-equity partnerships domiciled in Bermuda and controlled by Brookfield Asset Management.
Tracking Brookfield Infrastructure Partners’ cash flow is a fool’s errand: Its filings don’t indicate the cash flow from all its investments. Until recently Brookfield Infrastructure Partners (like Brookfield Asset Management) has had some rough times; it failed to generate enough cash from its operations to cover its distributions to unit holders in 2010 and 2011. This turned around sharply during the first nine months of 2012, when Brookfield Infrastructure Partners booked a surplus of $171 million. But look at the difference between the finances raised and what was invested: Brookfield Infrastructure Partners regularly raised more capital than it needed to finance asset purchases and had some left over.
Like its parent, Brookfield Infrastructure Partners has an earnings quality problem. As the consolidated statement of operations shows, the partnership reported $106 million in net income for 2012 but fair value changes amounted to $200 million of that. In 2011, the $187 million in net income for the partnership was dwarfed by $356 million in fair value changes.
In 2010, Brookfield Infrastructure Partners made a pair of accounting changes (described in Note 7 of its 2010 annual report as a $239 million “remeasurement gain” and a $194 million “bargain purchase gain”); these were related to the purchase of a remaining 60 percent stake in Prime Infrastructure Fund that it didn’t already own. (The fund was founded by Babcock & Brown, an Australian infrastructure finance investment firm that began liquidation in 2009.) The $433 million noncash gain was the majority of the year’s $467 million in net income for Brookfield Infrastruture Partners. In a 15-page response to the SEC’s questions about this gain and other accounting and valuation issues, the partnership offered a host of reasons why the book value of its new assets were markedly above the purchase price; the cited reasons included the appreciation of the Australian stock market from 2009 to 2010, as well as Brookfield Infrastructure Partners’ own unit price.
The conclusion is stark: Noncash accounting entries are saving Brookfield Infrastructure Partners and the market value of its units from some hard times and harder choices.
The charms of consolidation
The balance sheet gets even more convoluted. In 2010, Brookfield Infrastructure Partners began reporting its financials in accordance with International Financial Reporting Standards — as opposed to U.S. Generally Accepted Accounting Principles — after Canadian law mandated the switch. In an attempt to harmonize accounting treatments around the world, IFRS does away with GAAP’s strict definitions, granting financial managers wider latitude to determine the fair value of assets. The end result for Brookfield Infrastructure Partners has been remarkable.
In 2010, Brookfield Infrastructure Partners reported its 2009 balance sheets using both GAAP and IFRS. Under GAAP, Brookfield Infrastructure Partners reported $1.07 billion in assets. Under IFRS, Brookfield Infrastructure Partners’ assets ballooned to slightly more than $6 billion.
Recall that nothing save the accounting system had changed; it was the same company through and through, except one with a much larger balance sheet. And indeed from the spring of 2010 onward, the price of Brookfield Infrastructure Partners’ units have found much more favor in the market.
Brookfield Infrastructure Partners has been able to do this because as it switched to IFRS, it also changed its policy about an accounting concept called consolidation. At its core, consolidation is an easy concept to grasp; it occurs when Company A takes Company B’s financial statements onto its books and presents the combined results to investors. (This usually happens when Company A owns a majority of Company B’s equity, giving it effective control over Company B’s governance and operations.)
Under U.S. GAAP, consolidation can take place when a company owns 80 percent of another; but with IFRS, a corporation has plenty of freedom to define consolidation.
So Brookfield Infrastructure Partners consolidated the financials of five companies it had invested in even though its stake was less than 80 percent. It seems this move amounted to a deft legal maneuver, whereby Brookfield Asset Management — which managed these investments — ceded to Brookfield Infrastructure Partners the voting rights for these companies, giving the latter the right to select board members and direct corporate actions.
A fair question to ask is, What changed after the voting rights transfer? The answer is apparently not very much. The Brookfield Asset Management executives in charge of Brookfield Infrastructure Partners before this ceding of voting rights were the same executives, in the same roles and with the same incentives, as the ones afterward.
What wasn’t immaterial was Brookfield Infrastructure Partners’ ability to add about $2.4 billion of assets to its 2010 balance sheet from two investments, Longview Timber and Island Timber L.P., even though it had less than a 40 percent equity stakes in each.
The SEC’s Division of Corporate Finance raised specific questions in its previously mentioned Jan. 31, 2012, letter about Brookfield Infrastructure Partners’ consolidation practices.
Consolidation of investments in which Brookfield Infrastructure Partners has a minority stake has not been a one-off occurrence. In 2012 Brookfield Asset Management purchased minority stakes in Warwick Gas Storage and Columbian Regulated Distribution (22 percent and 17 percent, respectively) and then transferred the utilities’ voting rights to Brookfield Infrastructure Partners, which consolidated the companies on its balance sheet.
But finding consistency in Brookfield Infrastructure Partners’ approach to consolidation is difficult, as it has made investments in seven companies (with the equity stake ranging from 10 percent to 50 percent) that did not lead to a consolidation, according to its documents.
The most important aspect of Brookfield Infrastructure Partners’ consolidation policy is the part we know the least about: cash flow. While consolidating select minority stakes certainly improves the appearance of Brookfield Infrastructure Partners’ income statement and balance sheet, this also skews any attempt to figure out just how much cash is flowing into the partnership from these investments.
When it comes to discussing the merits of consolidating its minority stakes, Brookfield says this is done for shareholders and analysts, so they can get a “much clearer depiction of [Brookfield Infrastructure Partners’] underlying investments by showing on a consolidated basis the company’s assets, liabilities and financial performance.”
Asked by email how consolidation makes these metrics clearer, Brookfield’s spokesman refused further comment.
A question of independence
Using the standard interpretation of good corporate governance, an autonomous board of directors is supposed to serve as the investors’ advocate and ensure that senior management is effective in building shareholder value.
Brookfield Infrastructure Partners’ eight-member board of directors includes seven individuals classified as independent. Research shows, however, that five of the eight have clear professional, economic or board ties to Brookfield Asset Management and its subsidiaries.
When pressed on the matter, Brookfield Asset Management disputed the notion that Brookfield Infrastructure Partners’ board of directors lacks autonomy. Responding to questions from the Southern Investigative Reporting Foundation, Brookfield Asset Management stated, “The BIP board has eight directors of which seven are independent. The BIP board approves all significant matters involving BIP. BIP also has fully independent audit, compensation and governance committees which are required to approve the matters within their purview.”
[module align=”left” width=”half” type=”aside”]Read about a former Edper executive’s affidavit stating he and his colleagues set up private investment companies that issued preferred shares to investment vehicles controlled by Edper senior managers.[/module]
What exactly constitutes an independent corporate board is certainly the subject of much debate. Following the letter of the law, Brookfield Asset Management can term Trevor Eyton an independent member of its board as long as he has not drawn a paycheck from Brookfield within the prior three years and has no family members working for the company. Yet this ignores the fact that from 1979 to 1997, Eyton (a longtime shareholder in Partners Limited and its predecessors) served variously as chief executive and chairman of Brascan, a key Brookfield subsidiary, and also had been for an extended period one of the most public executives of Brookfield’s predecessor, Edper.
The terrific value of related parties
One area where little doubt remains about Brookfield’s intent is its frequent use of related-party transactions; they happen so often — across so many subsidiaries — that they are clearly part of an overall corporate strategy. The risks inherent with doing a lot of related-party business are apparent: Non-arm’s-length transactions can disproportionately benefit one party’s investors at the expense of the other’s. Such a practice also raises concerns about whether certain deals can be replicated outside of the pyramidal control structure.
One related party transaction stands apart from all others: Buried deep in the rear of Brookfield Renewable Energy’s 2011 annual report are the details surrounding two adjustments to a pair of power purchase agreements with Brookfield Asset Management-controlled parties. Brookfield Renewable Energy, an electricity-generating partnership that’s 68 percent owned by Brookfield Asset Management and that sold 55 percent of its output in 2011 to Brookfield Asset Management-related parties, was able to amend two power purchase agreements with its wholly owned subsidiaries Mississagi Power Trust and Great Lakes Power Limited on remarkably favorable terms.
How favorable? In one instance, the new contract was repriced 50 percent higher; another time it was 20 percent. As far as the Southern Investigative Reporting Foundation can discern, this appears to be an unusual event within the renewable power industry. (Power purchase agreements, typically struck for 10- or 20-year durations, are indeed repriced annually, but only to account for an agreed-upon change in an inflation measure, such as the consumer price index. The delivery price, however, is almost never touched and if it is, it certainly is not augmented 50 percent.)
[module align=”right” width=”half” type=”aside”]Take a closer look at another Brookfield related-party transaction that involved a rights offering with Rouse Properties. [/module]
The results from the changed contracts were indeed significant, amounting to $140 million in additional revenue, 17 percent of Brookfield Renewable Energy’s 2011 earnings before interest, taxes, depreciation and taxes (EBITDA) and 33 percent of its funds from operations. More important to Brookfield Renewable Energy, its annual report discloses that these power purchase agreement revisions were pure profit, contributing an additional $140 million in Ebitda and funds from operations.
Brookfield Asset Management, for its role in the upward revision of the two power purchase agreements, was paid $292.3 million Canadian dollars. The payments kicked off a complex chain of transactions, according to a publicly filed merger document from 2011, resulting in Brookfield Asset Management’s receiving an additional $292.3 million in Brookfield Renewable Energy units.
Getting paid to revise power purchase agreements upward was not always so complex. In 2009, a pair of such revisions netted Brookfield Asset Management a $349 million cash payment, according to Brookfield Renewable Energy’s annual report.
For providing management and “energy marketing services” to Brookfield Renewable Energy, according to its annual report, Brookfield Asset Management was paid a total of $40 million in 2011.
The Southern Investigative Reporting Foundation does its reporting based on publicly available documents and seeks to fully engage with the subjects of its reporting.
So it was when it came to the foundation’s reporting about Brookfield Asset Management.
After the Southern Investigative Reporting Foundation conducted preliminary reporting for many weeks, it submitted detailed questions via email to Brookfield on Feb. 8 and Feb. 11. On Feb. 15 the Southern Investigative Reporting Foundation had a phone conversation with Willis, Brookfield’s media relations chief and a former business journalist. Among other issues, the foundation’s disclosure and trading policies were discussed, and it was reiterated that no one at the foundation has any economic interest in Brookfield’s shares, long or short, and no one outside the reporting foundation sees its work prior to release. Plans were discussed about setting up interviews of some Brookfield executives.
Prior to the call, Brookfield’s Willis also provided the Southern Investigative Reporting Foundation a letter of introduction and the company’s replies to the first two sets of questions.
On Feb. 17 the foundation submitted a third round of questions.
Brookfield’s Willis said on Feb. 19 that the company refused to answer further questions and had referred the matter to its U.S. legal counsel, Kasowitz, Benson, Torres & Friedman LLP; the firm informed the Southern Investigative Reporting Foundation that its client was considering legal action.
While engaged in other reporting assignments, members of the board of the Southern Investigative Reporting Foundation have previously experienced contentious exchanges with Kasowitz, Benson, Torres & Friedman as well as with Michael Sitrick, who is now serving as an outside public relations adviser to Brookfield. (Sitrick has provided media representation to Kasowitz, Benson clients who have unsuccessfully sued short-sellers and analysts, allegedly for conspiring to damage their share prices.)
6 thoughts on “The Paper World of Brookfield Asset Management”
Your writing and research on BAM’s accounting approach is first-rate, with a studied skepticism seldom found in business journalism now. The between your piece and a profile of a BAM executive I read a year or so back in the NYT Sunday business section is striking.
Another way to decipher Brookfield is acquisitions.
Brookfield is a small, if crude, sovereign wealth fund capitalized by Canadian pensions, the loony bank syndicate and natural resource wealth extracted from maples, tar sands and gold.
The investments BAM makes are consistently rich, poorly timed and devoid of an exit strategy.
Why else did BAM/BIM/BRE recently agree to pay over $2 million a megawatt when it purchased NextEra Energy’s hydro operations in Maine?
NextEra Energy (NEE) narrowly averted a default on the debt for its Maine portfolio (White Pine Hydro Investments LLC) of 351 megawatts when BRE agreed to purchased it in Dec. 2012 – for a premium. Assuming $700 in debt and paying $60 million in cash, BRE acquired NEE’s loss leader. NEE climbed out of the water to take off, eh, and soar with the wind, bake in the sun all the while passing gas – at a fraction that a megawatt of hydro costs. No amount of cost efficiencies or regulatory overhaul will beat natural gas in the electricity space.
In March 2013, BRE assumed control of a watery brew of depreciating dams that generate declining revenue and suffer from millions in unfunded capital outlays for maintenance and repair. Courtesy of sweetheart bridge loan.
BRR’s bridge, pegged at $350 million US, was financed by the Canadian banking oligarchy – Scotia, TD, RBC and CIBC – via the distribution of limited partnership shares placed at the mothership, BAM. Due diligence of the foam emitted by this dam deal?
And the Canadian bubble – courtesy of the commodity cycle – shows no sign of popping. But BAM demonstrates that energy finance has finally reached a peak.
[…] of earnings, a matter discussed in detail in the Southern Investigative Reporting Foundation’s March 11 story on the company. Paper gains on an income statement contribute nothing to the growth of […]
A large portion of this article seems to be missing the point. While I do not know the ins and outs of the entire Brookfield empire, I have been a unitholder of BIP for close to 5 years, so I am quite familiar with BIP specific issues.
First, the low-hanging fruit. The statement: “Under U.S. GAAP, consolidation can take place when a company owns 80 percent of another” is either inaccurate or extremely misleading. The author seems to have confused US GAAP rules with IRS rules relating to double taxation of dividends (i.e. in context of two corporations, it goes away when an entity’s ownership in another entity passes the 80% threshold).
The US GAAP rules, and perhaps most importantly, the spirit of the rules governing consolidation, are very complicated. Pre-Enron, the US GAAP rules were pretty straightforward in most cases. The ethos there was that when one entity controlled another an entity, the second entity should be consolidated into the first’s financials. In a simple Corp setting without a General Partner and only one class of shares, this meant >50% of common stock. In that world, if the ownership was approx. 20 % – 50%, then the equity method would be used; less than 20%, and the cost method would generally be used. Broadly speaking, the spirit of this is correct and the rules were simple. Then Enron went under and two (or more) batteries of reforms occurred over the last decade or so, to address Enron’s SPVs of which it nominally had little ownership in, and also partly to address abuses by banks with SIVs and the like. The rules are very complicated now, and whether they are better or not is debatable. But what is the spirit of the reforms? Generally if one controls something it should still be consolidated, and if it doesn’t per se control an entity, we should be careful to make sure that the owner can’t use the entity unfairly to hide things (typically indebtedness).
Consolidating the financials of Longview Timber and Island Timber LP into Brookfield Infrastructure LP (“BILP”) and then in turn consolidating BILP’s financials into BIP’s both occurred during 2010. In each case the subsidiary was not consolidated into the entity (indirectly or directly) above it on the legal chart. And what about control?
Ask: is there really any difference a scenario where:
1) marionette X owns say 50% of marionette Y but doesn’t control it – an entity called BAM controls both X and Y.
2. marionette X owns say 50% of marionette Y and controls it. An entity called BAM controls X.
In reality, the answer is there is no substantial economic difference. In both cases X and Y are ultimately having their strings pulled by BAM. This means the consolidation or non-consolidation argument is ultimately pendantic when one only looks at control in the case of BAM’s partnerships. The real question is what is the spirit here: which case makes things easier for debt and equity holders to evaluate BIP’s performance?
Consolidating BILP into BIP clearly simplifies BIPs financials without distorting economic substance. Consolidation makes the most sense here.
As for consolidating the timber funds? This is harder to say, and there is no real consensus. By consolidating them in capital allocators have a better view on total assets and debt under BIP as opposed to BIP just accounting for much of its business under the equity method (which obscures the investments underlying business to the footnotes and tends to keep debt off balance sheet). Generally consolidation, because it includes indebtedness of subs allows for an easier ROIC analysis, though BIP’s use of mark-to-market accounting neutralizes this unfortunately. If BIP did not consolidate… its financials might be more like those of TC Pipelines (TCP, fka TCLP), a PTP controlled by Transcanada. Either side is debatable here.
The reality is that the accounting for diverse holding investment companies, or for entities that sit on top of a web of interlocking publicly traded partnerships is inherently complicated. This is the nature of the industry, and the accounting is always a challenge.
This makes is hard for markets to follow but it is not inherently abusive. Put differently the analysis should be contextualized with the outside world practices, much in the way that all analyses should be made in the context of base rate information.
For instance, one of the best performing infrastructure businesses over the past couple of decades was a company called Enterprise Products. Readers should be aware that companies like this have at times had extremely complicated ownership structures (pyramids if you prefer). A link to Enterprises structure at its most complex, is :
Enterprise radically simplified its legal structure subsequent to 2008, but the point is that in the case of Publicly Traded Partnerships, interlocking pyramids with hard to decipher accounting require extra careful, prudent analysis.
Similarly, pointing out that BAM earns a 1.25% annual fee on BIP enterprise value (mkt cap plus net recourse debt), is interesting, but seems to be missing two things. One: between the 2010 20-F, and the 2011 20-F, BIP changed its management fee to go from being paid off of equity value only, to equity value plus recourse debt net of cash. Two: BIP’s incentive distribution rights (IDRs) only go up to 25%, as opposed to 50% in many PTPs (which are predominantly MLPs). A full discussion of IDRs is extremely complicated and probably goes beyond the scope here, but again the point is that the PTP world tends to be very complicated in many different ways.
The bigger issue here is probably Brookfield’s use of fair value accounting for extremely illiquid assets, something that can allow a company to engage in mark to model practices that degenerate into ‘mark to myth’ practices– as Buffett once quiped. Why does Brookfield do it? And what are peer practices? With respect to other PTPs involved in infrastructure, particularly oil & gas infrastructure, it is not a common practice (though there may be issues between IFRS and GAAP here).
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