Brookfield Asset Management: A perfect predator

Brookfield Asset Management isn’t brash. It doesn’t take a lot of wild risks. It waits for the right opportunity, and then it pounces.

 

Brookfield Asset Management CEO Bruce Flatt

Bruce Flatt just dissed Warren Buffett. Realizing his blunder, he practically lunges at the tape recorder and extracts a promise that he won’t be quoted. Flatt greatly admires the investing oracle—he wants that clear—and doesn’t want to seem arrogant.

As a rule, the CEO of Brookfield Asset Management is studiously non-controversial. He rarely appears in public and has little to say to the media. Put-downs? Bravado? “We don’t brag,” he says earnestly. “It always bites you afterwards.”

Instead, Flatt seems to go out of his way to paint Brookfield as boring. “We own 129 office buildings. Some are a little taller, some are a bit shorter,” he says laconically. The strategy? “We’re in the business of buying assets of great quality at less than replacement cost.” The company’s remarkably consistent objective over the years simply has been to earn a 12% to 15% compound annual return per share. “We have no goal to be large or significant,” says Flatt. “If [reaching our objective] meant we should shrink in size, we’d do that.” Even Brookfield’s logo is understated, and its 2009 annual report looks like something thrown together at Kinko’s. Move along, everyone, nothing to see here.

The reality is that this slender 45-year-old executive runs a conglomerate that manages $108-billion worth of real estate, utilities and infrastructure across the planet. In the eight years Flatt has been in charge, Brookfield has emerged as the world’s biggest owner of prime office space—including some of the most prestigious towers on the Manhattan skyline—and its 165 power plants constitute one of the largest hydroelectric portfolios. But what has really impressed observers is how Brookfield weathered the crushing downturn that crippled many of its rivals. Over two years, as its stock plunged by two-thirds along with the markets, the company didn’t panic or go into hype mode. Instead, it quietly added to an already thick cushion of capital. And waited.

This focus on workmanlike deal-making makes Brookfield very much au courant. After two decades of celebrating brash mavericks and gamblers—dot-com dreamers, M&A tacticians, credit-addled empire builders—the zeitgeist, post-meltdown, has shifted toward those who play it safe. And Brookfield, a company run largely by accountants, was dull before dull was cool. Besides, the low profile is intentional, a kind of camouflage. The company’s fundamental strategy—buying expensive properties on the cheap—relies, after all, on others blowing their brains out by taking fliers, so it can come in to clean up the mess and cart off choice pieces from the carnage. Brookfield, in fact, is the quintessential example of what French social scientists Michel Villette and Catherine Vuillermot identified in a 2009 study as a key strategy of iconic companies: eschewing risk and stealthily positioning yourself to spot vulnerability in rivals, then pouncing when the moment is right.

This is one of the best such moments in recent history. The business landscape is littered with companies that gambled with cheap money and got caught with their shares down and their loans called. Brookfield, meanwhile, has amassed a nearly $10-billion war chest of its own and institutional investors’ cash and has gone hunting. After devouring an Australian port and railway giant and a few real estate portfolios, it’s now tracking perhaps its most succulent prey: General Growth Properties, the second-largest mall operator in the U.S., which adopted the spendthrift ways of its customers, stockpiled a glittering array of trophy properties on credit, and when the markets seized, toppled into bankruptcy. Enter Brookfield, offering up its capital and restructuring expertise in exchange for control of the company.

Whether or not Brookfield secures the deal—the outcome may not be known until this fall—it’s an important chapter for the company, says a close long-time observer who requested anonymity. “This could be a huge new platform for them. Or it could be a huge profit.” Some see it as an unusually risky play for careful Brookfield. But they don’t appreciate its predatory ways.

Bruce Flatt’s serene demeanor is not easily ruffled. Appointed CEO of the company—then known as Brascan—at the tender age of 37, he endured years of ribbing about being a nerdy prodigy. His temples now flecked with grey, he’s acquired some gravitas. During the company’s AGM this spring, when a shareholder criticized the company’s drop in earnings, Flatt didn’t get aggressive or condescending. He simply retorted, “I don’t want to sound defensive, but many others got wiped out. We actually earned a net income.”

During his tenure as CEO, Flatt has gradually molded Brookfield in his own image, emphasizing logic, simplicity and discipline. This stands in sharp contrast to the culture fostered by his predecessor, Jack Cockwell, whose complex deal-making and brash business style made him perhaps the most influential corporate leader of Canada’s postwar years. At its peak, the conglomerate that Cockwell forged with Edward and Peter Bronfman’s money represented a third of the Toronto Stock Exchange’s value and owned parts of more than 200 companies—including John Labatt Ltd., MacMillan Bloedel, Royal LePage and Royal Trust—connected in a web of holding companies. One analyst said the organizational chart from that period “looked like someone threw a plate of spaghetti on the floor.”

Flatt, the scion of an Investors Group founding family, grew up professionally at Brascan, but his most formative period—one that also shaped modern-day Brookfield—was the early-1990s recession, when the real estate sector index lost 90% of its value. Weighed down by billions of dollars of debt it couldn’t refinance, the company had to sell its real-estate arm, Trizec Corp. Flatt, who had joined the subsidiary Brookfield Properties in 1994, pushed his skeptical colleagues to immediately jump back in and grab what he saw as unprecedented bargains. Though the recession had wounded it, Brascan was in good enough shape to exploit the woes of others—notably Olympia & York Developments, owner of London’s Canary Wharf and the World Financial Center in New York. Flatt then built on that base by homing in on prime office space, a strategy that enabled his subsidiary to ride the real estate rebound and sent its shares from low single digits in 1995 to $20 at decade’s end.

No one inside was surprised when Cockwell passed the reins to the young Winnipegger. Months after taking over in early 2002, Flatt laid out his new game plan: the giant squid of a holding corporation would focus on operating in just three sectors—real estate, power generation and infrastructure, areas that could deliver consistent revenue, locked in by long-term contracts, and where assets tended to rise in value, making them relatively cheap to finance. With this simplified focus, Flatt invited pension funds to put money into Brookfield-run investment funds, with the resulting management fees serving as a cushion for the company’s own investment returns. Along with a focus on asset management came a more open attitude toward the financial community, in place of the terse, oblique communiques that issued from Brascan under Cockwell. “The management style changed under Bruce to looking to public markets as a partner,” says one analyst. “Under Jack, it was a public company but run more as a private company.”

Despite the dramatic shift in direction, Brookfield’s leadership didn’t change much. Cockwell, now group chairman, can be seen almost daily at the Brookfield Place headquarters in Toronto, and none of the dozen or so senior managing partners left or was heard grumbling. It’s an unusually collegial group, and the most senior people—especially top lieutenants such as Cyrus Madon, Jeff Blidner and Sam Pollock—function almost like knights of a round table, moving around the company’s divisions as need demands. “This is a very flat organization,” says Flatt (who, for the record, dislikes puns on his name). “At the end, there are probably 15 people, and they are a partnership.” Indeed, any of those people could step into Flatt’s shoes. “These are all senior, senior guys, and they all get paid the same salary—a million a year plus a bonus,” says Mark Rothschild, a real estate analyst at Genuity Capital Markets.

When Flatt says that Brookfield is about its people, that hoary platitude is actually a key competitive edge. Brookfield’s extended fraternity comprises some of the best-connected individuals in North American corporate and public life, including board members Jim Pattison, Frank McKenna and Trevor Eyton. This spring, a CIBC World Markets report offered a list of about 100 business and government big wigs (out of 600-plus it identified) that the company’s associates see regularly. “Brookfield’s in the business of acquiring assets upward of $1 billion, and to get a chance at those, you need to strategically position yourself,” says CIBC analyst Alex Avery. That means being privy to intelligence and able to whisper in the right ears. This network is held together partly with the glue of shares. About 40 of the most senior executives and directors own Partners Ltd., a private company that holds almost 20% of Brookfield’s stock. “If you have that kind of holding, often in the tens of millions, even if you weren’t actively involved in the business, you’d be prepared to help,” says Avery. “It’s highly unusual.” And it equips Brookfield with an army of seasoned deal hunters.

Brookfield’s hunts are disciplined and orderly, and the company is perfectly willing to walk away if risk escalates. When others embraced expensive, highly leveraged transactions in the past decade, Brookfield remained highly picky. In 2006, for example, it passed on the privatization of CarrAmerica Realty, a high-profile, $5.6-billion deal. The eventual winner, Blackstone Group, promptly flipped a big portion of that portfolio to a real estate company that soon ran into trouble. Re-enter Brookfield, buying up more than half of the distressed debt and launching foreclosure proceedings—a much cheaper way to get the prize. Thanks to such prudence, the company wasn’t distracted by its own balance sheet troubles when post-crunch opportunities came up.

Brookfield’s biggest deal since the financial crisis was the 2009 acquisition of roughly 40% of Babcock & Brown Infrastructure, an $8-billion global portfolio of ports, railways and utilities. Aside from kicking in $2 billion in cash and sending in an army of financial and sector specialists, Brookfield had to negotiate with 25 banks and other stakeholders outside the relative order of bankruptcy protection. Even for an outfit with a long history of tangled deals, this was a complex transaction, but the acquisition fit Brookfield criteria perfectly: a highly desirable portfolio, bought at a bargain, in a high-growth sector it knows well. “We watch hundreds of companies all the time,” says Flatt. “If one of them gets into trouble, we visit them and see if there’s an opportunity for us to help.”

That’s how Brookfield came to General Growth Properties. A family-controlled giant with more than 200 mainly high-end malls such as Boston’s Faneuil Hall Marketplace and Fashion Show in Las Vegas, GGP is one of only four players in the highly concentrated U.S. shopping mall sector. After an aggressive expansion, the company got sideswiped by the financial crunch, with $27 billion of debt it couldn’t refinance. It was the largest real estate bankruptcy in U.S. history. But GGP wasn’t really insolvent—it was illiquid. “Other than the fact they had too much debt, this portfolio would never have become available for anyone to purchase at a reasonable price,” says Flatt.

Still, investing in American shopping malls at a time when debt-laden consumers have gone into hibernation? When regional malls like GGP’s have 11% vacancies—a two-decade high? When rents have dropped for six quarters in a row? Isn’t that risky for risk-averse Brookfield? Not if you factor in a time frame of not years but decades. And not when the properties are best-in-class. In fact, high-end malls tend to provide very stable returns, notes a veteran real-estate analyst who requested anonymity. GGP’s revenues declined only by mid-single-digit percentages in recent years, and the company remains highly profitable. “The shopping centre industry is greatly misunderstood,” says the analyst. “Retail sales at leading shopping malls have been one of the most stable economic aggregates, close to the GDP.”

And now is an excellent time to buy a mall, says Flatt. He points out that in the early ’90s, office towers got beaten up—so Brookfield loaded up on them. This time around, office space has held up fairly well, especially in Canada; it’s retail that’s been crushed. But it will come back. “Americans have proven that they like to go to the mall,” says Flatt. “We believe that urban centres in America will continue to grow by population. As the cities grow, those retail centres will become more valuable.” Even if shoppers don’t return to their extravagant ways, Flatt says Brookfield would still make a profit. “We’re buying with a margin of safety because we’re buying now.”

Brookfield has made no secret of its interest in American retail. Back in early 2007, the company tried to buy the Mills Corp., a shopping mall operator struggling with accounting issues and troubled developments. Brookfield thought it had a deal, but a month later, Simon Property Group, the largest U.S. mall player, trumped it by offering a 20% premium. That was too rich for Brookfield, and it didn’t put up a fight.

Roughly a year later, when GGP started struggling, Brookfield approached it with an offer to inject capital and help with restructuring. It sent 150 people to examine its properties and got to know the management, but it all came to naught when GGP filed for Chapter 11. So Brookfield began buying up GGP’s debt at a deep discount, ending up with about US$1-billion worth. A year ago, Brookfield, in partnership with two hedge funds, again offered its assistance. Rebuffed, it tried once more nine months ago. In January, GGP finally accepted: US$6.55 billion in fresh funds to finance its exit from bankruptcy in exchange for a roughly two-thirds stake.

But, in a repeat of history, in swooped Simon, offering to buy GGP outright. This time, Brookfield fought back. Over the spring, the two bid consortia— involving four of the world’s biggest hedge funds—upped and refined their bids amid increasingly testy exchanges. Fairholme Capital Management, one of Brookfield’s bid partners, called Simon’s offer “crazy” because of antitrust concerns, while Simon said Brookfield was “unfair” in demanding warrants that would dilute existing shareholders’ equity. But while Simon went from offering $9 per share to, eventually, $20, Brookfield never moved far off its original bid. In May, Brookfield won the first skirmish, being granted “stalking horse” status, which means its bid is the one to beat. As of early July, no other serious offers had materialized.

Whether or not Brookfield wins the prize, it’s approach has been steadfast. “Clearly, Brookfield can pay a lot more than their current offer, but they typically don’t overpay,” says Genuity’s Rothschild. Observers have at times criticized the company for being too strict on that score. “They’ve allowed themselves to miss opportunities,” says one analyst. “You won’t see a portfolio like this trade too often. I would be disappointed if they lost it for a few dollars.”

Several analysts have also noted that the great deals haven’t been as plentiful as expected. “Originally, everyone assumed that those with capital would be able to pick up diamonds on the road,” says Rothschild. “That hasn’t happened, and it’s not going to. The people who were distressed are being saved. Banks are lending again, capital markets have improved. That said,” he adds, “I wouldn’t bet against Bruce Flatt.”

Flatt disputes that analysis. “When people say there aren’t opportunities, we’re confused as to what they mean. Maybe we travel in a different size of transactions,” he says. “There are a lot more people writing cheques for $25 million than those for $100 million or $2 billion or $10 billion.” Flatt points out that while just a few years ago there were numerous rivals able to bankroll multibillion-dollar deals, that field has dwindled sharply.

To Flatt, business isn’t about winning. Let others chase Moby-Dick and drown trying; Brookfield will gladly play the role of shark once blood is in the water. “Enduring and truly successful companies over the long term can be defined by the transactions that they don’t complete,” wrote Avery in his Brookfield report this spring, commending management for consistently showing “discipline, restraint and objectivity” in the heat of bidding. Flatt, ever understated, makes that sound like a no-brainer. “We want to make every share worth more money,” he says. “And to not take too much risk doing it. That’s what every company’s goal should be.”

At the end of the interview, the tape recorder turned off, Flatt visibly relaxes, as if someone just turned off a hot spotlight. Walking out of the conference room, he returns to the topic of Buffett. Berkshire Hathaway is a company centred on Buffett’s grandfatherly persona, he observes. “Companies that are about one person, it’s not a good thing,” he says. “Jack [Cockwell] became a brand in his own right, and it became a problem for him and for the company.”

“We believe keeping a low profile is good for business,” he adds. “It’s best to be under the radar.” All the better to stalk your prey.

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