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Is It Fair to Attack Brookfield
Posted by: Gordon Pape (IP Logged)
Date: March 16, 2013 06:40PM

The shares of Brookfield Asset Management (BAM) and related companies took a hit last week following the publication of an analysis by the Southern Investigative Reporting Foundation (SIRF) which questioned the company's corporate structure and financial reporting practices. SIRF says it is an independent, non-profit investigative reporting organization that focuses on "in-depth financial investigative reporting for the common good". It says it is funded entirely by reader contributions.

The Brookfield analysis, published on March 11, was written by Roderick Boyd, a SIRF director and a former staffer for Fortune and the New York Post. He is also the author of Fatal Risk, a book about the near-collapse of insurance giant AIG in 2008.

In his report, Mr. Boyd raises questions about Brookfield's "pyramidal control structure" that he says enables a small group of shareholders to run the business without putting a proportionate amount of capital at risk. He also expresses concern about the financial reporting of the company and its spin-offs such as Brookfield Infrastructure Limited Partnership (TSX:BIP.UN)(BIP) and Brookfield Renewable Energy Partners (TSX:BEP.UN)(BRPFF), both of which are recommendations of our companion Income Investor newsletter.

Mr. Boyd does not accuse the company of illegal activity but he raises questions about their accounting methods. For example, he notes that in 2010 Brookfield Infrastructure began reporting its financials in accordance with International Financial Reporting Standards (IFRS) instead of U.S. Generally Accepted Accounting Principles (GAAP) "after Canadian law mandated the switch". As a result, he said, the LP's 2009 assets skyrocketed in value from US$1.074 billion to US$6.046 billion.

"Nothing save the accounting system had changed; it was the same company through and through, except one with a much larger balance sheet," he writes.

He also says Brookfield Asset Management paid out more in $272 million more in dividends than it received in cash flow from operations from the start of 2010 to the third quarter of 2012, relying on new financing to make up the difference. He also criticizes the number of non-arm's length transactions on the company's books.

The report can be read in its entirety at http://sirf-online.org/2013/03/11/paper-world-of-brookfield-asset-management/.

I asked contributing editor Tom Slee to read the report and offer his thoughts. Tom does not follow Brookfield closely but his accounting background enables him to assess the validity of the claims from a professional perspective. Here are his views:

"Looking at some of the criticisms, there is no doubt that tightly controlled voting power is always a problem. Brookfield is structured as a pyramid so that the directors exercise total discretion through Brookfield Partners but that may be the only way to run an international empire. There are bound to be conflicts. However, there is nothing illegal about controlled voting stock and we have lived with that at Magna and Canadian Tire. SIRF seems to think that it's ominous but that is not necessarily so.

"The comments about booking profit through mark to market property value adjustments and non-arm's length transactions are far more serious. We ran into this sort of thing at Enron. There is also the on-going problem of marking to market when properties with no real market quotes are involved.

"My feeling is that we have to depend on company auditor Deloitte & Touche, presumably chastened after what happened at Enron, and the SEC (Brookfield is listed in New York) to make sure that the values are reasonable. Hopefully we can also rely to some extent on the directors' integrity.

"It's interesting to note that SIRF is concerned about Brookfield Partners yet negotiations are underway with the SEC to have this company listed. The necessary audits will certainly shine a searchlight on dealings with hedge funds and other transactions. It would suggest that the directors are comfortable with their dealings.

"One more thing. I had a quick look at Brookfield's coverage and none of the analysts have serious reservations. In fact they are bullish. On the other hand, this is a very difficult company to dissect."

Mr. Boyd says that he tried to get reaction from the company and that a Brookfield spokesman answered some questions but then refused to participate further and referred the matter to legal counsel. He added that the law firm subsequently informed SIRF that Brookfield was considering legal action.

It's important to remember that Brookfield and its predecessor company, Brascan, have been accused of opaque accounting and reporting practices for many years so in that sense this is not new. However, I have not seen this level of detail in an analysis before.

Although it was not widely reported in the mainstream media, the analysis was posted on some Wall Street websites and clearly triggered enough concern among investors to prompt a mild sell-off in the shares of Brookfield and the partnerships. Whether this will accelerate will depend on how much traction the report receives and whether it prompts any action by regulators.

This is clearly not another Sino-Forest situation. Brookfield's assets are real but one of the key issues raised by Mr. Boyd is how they are valued. The report may cause some investors to think twice before buying or to take profits on their holdings. The stock closed on Friday at C$37.89, US$37.20. It was down 4.4% on the week in Canadian dollar terms.

We are changing are guidance to Hold and I will monitor the situation.



Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: tonyg34 (IP Logged)
Date: March 17, 2013 08:04AM

I read this article when it first came out and think it is a bit much to assume the article caused a pull back in BAM b/c it coincided with a secondary offering by BIP at below market price.

I also find that the accounting practices at BAM are obtuse. They basically offer two sets of numbers, one of which is based on what they think (wish) the "true" value of their assets should be.

While this is annoying and somewhat concerning, three people whom I respect greatly and are far more sophisticated investors than I shall ever be have (I assume) already done due diligence on this stock and deemed it worthy of investment. Those three are the Third Avenue Value team, Bruce Berkowitz, and Lou Simpson. If all three of those guys looked at the company and thought it was safe, I have to defer to them. That's no reason to buy, just saying that BAM gets the benefit of the doubt via peer review.

If you are one of the many who will not invest in something you don't understand, odds are this one isn't for you.


Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: AlbertaSunwapta (IP Logged)
Date: March 17, 2013 11:31AM

Excellent article! It's also great that asset valuation treatment is being reassessed. Unfortunately it's being done by vested interests like SIRF.

Tonyg34, a very intelligent response. The 'wished for' asset values are comparable to mark-to-maturity valuation, or for that matter, some of the risks are comparable to the basic flaws in YTM on non-coupon, strip, residual bond pricing. You need something to give you a sense of intrinsic value.

In my view, the huge shift to PE investments over the past decade has greyed the whole treatment and resulting assessment of overall portfolio valuation and one should always be suspicious of how the valuations and commensurate returns are being arrived at. (So the same applies to conglomerates or any business for that matter where a good portion of the assets have no market comparables and people look to book value and acquired good will for insight.) In other words, " just because something can be measured, that doesn't mean it should be measured." Or more importantly, given much weight. BAM has to provide some form of "fair" valuation because of the nature of its business. Investors are lucky if the are provided two despite it seemingly creating an obtuse result.

By analogy, in 2008 the disappearance of a market for many derivatives (or more accurately the realization that there never really was a market for most of the crap) caused their prices to be marked down dramatically (I'd say over-conservatively) despite the rules of the day addressing unobservable events and the lack of a market. This treatment spread like wildfire throughout the business and I believe greatly exacerbated the credit crisis.

Back then I had broker-dealers refusing to provide, essentially required pricing of very large fully subordinated derivative positions! Shortly after that, even highly placed people started the baloney of 'mark-to-maturity' to do an end run around what they perceived the ruling to require and the damage it was doing. It was either Whitman or Van Den Berg or both that raised to the public issues about the misguided interpretation and application of the fairly new derrivatives guidance.

The following is worthy of a read because a lot of thought and experience is reflected in these words. Other asset classes and their treatment should be viewed with considerable introspection.

FASB157
"As a basis for considering market participant assumptions in fair value measurements, this Statement establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The notion of unobservable inputs is intended to allow for situations in which there is little, if any, market activity for the asset or liability at the measurement date. In those situations, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity must not ignore information about market participant assumptions that is reasonably available without undue cost and effort. "

I have no position in BAM.


Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: vgm (IP Logged)
Date: March 17, 2013 12:20PM

"Although it was not widely reported in the mainstream media, the analysis was posted on some Wall Street websites and clearly triggered enough concern among investors to prompt a mild sell-off in the shares of Brookfield and the partnerships."

BAM was down less than 4% over the week in New York. A sell-off? I think not.

The present article seems to me to be trying too hard to find some dirt to stick to BAM by mentioning the likes of Enron and Sino-Forest in the same breath, and getting 'experts' (I use the word loosely) to comment.

BAM is an outstanding operation, led by Bruce Flatt who is held in very high regard by some of our top ranking value investors (Marty Whitman, Lou Simpson, et al). See also the comment of Tonyg34 above.


Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re: Re Is It Fair to Attack Brookfield
Posted by: AlbertaSunwapta (IP Logged)
Date: March 17, 2013 05:02PM

^ what? ...it is just fine to mention Sino-Forest and Enron (both of which were held in high regards by many experts prior to their collapses). Getting held in high regard while playing loose with the books are what many of the best frauds have been all about.


Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: vgm (IP Logged)
Date: March 18, 2013 06:24AM

"...it is just fine to mention Sino-Forest and Enron (both of which were held in high regards by many experts prior to their collapses)."

Alberta -- not all "experts" are created alike. Far from it. The people who wrote this and the original article, as well as those quoted, are not my idea of "experts". This is low level, opportunistic journalism - at best.

Let's watch how it turns out. When I see Jim Chanos busy around BAM I'll worry. He IS an expert.

No position in BAM or related stocks.


Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: stevenramsey (IP Logged)
Date: March 18, 2013 09:39AM

I might also toss in that Buffett partnered with Brookfield this year in a joint-venture. I don't think he'd get near a pyramid scheme with any of his money.

His mistakes are normally not accounting mistakes. And he doesn't make many mistakes.



Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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Re Is It Fair to Attack Brookfield
Posted by: buynhold (IP Logged)
Date: March 18, 2013 10:04AM

From the SIRF article:

Quote:
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.


For some businesses, yes, but not all. You need to look beyond the income statement.

Quote:
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.)


As a value investor, I look at the total return on my investment at any point in time - both asset appreciation and income. Same goes for an entity like Brookfield, Cheung Kong, Henderson Land, or for that matter, any investment property that one owns.

It's ok for SIRF to question the value of an asset on the balance sheet if it wants to and has reason to (because it is open to manipulation), but to indicate that asset appreciation should not be used to gauge intrinsic value is hogwash.

Brookfield management has majority control through a separate class of shares, so don't invest if you don't trust their integrity and capital allocation skills.

Disclosure: I have owned BAM since the spring of 2009, and have no plans of selling in the foreseeable future.



Stocks Discussed: BAM, BIP, TSX:BIP.UN, TSX:BEP.UN,
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