CA - Brookfield Reinsurance: Getting $33 Billion Of Real Estate Basically For Free

2023-03-27 17:40:42 ET

Summary

• BN and BNRE are trading below the estimated net asset value for Brookfield Corporation, even when ignoring the value of Brookfield Property Group.
• While the office and retail property assets are facing headwinds, there are reasons to believe they still hold enormous value.
• The extreme undervaluation as well as the optionality offered by the creation of potential new businesses means shares are very attractive right now.

Sometimes the market has the right idea but takes it too far. We believe that is what has happened with Brookfield Corporation ( BN ) and Brookfield Reinsurance ( BNRE ), where the negativity around office and retail properties is somewhat warranted, but the discount has now become absurd.

Today, we are focusing on Brookfield Reinsurance, and we will touch on the Insurance Solutions business, but the analysis is equally relevant for Brookfield Corporation. Brookfield Reinsurance shares are exchangeable for BN shares and are therefore expected to trade at a similar price, and their fundamentals are intertwined.

SOTP Valuation

Below, we share a sum of the parts valuation for Brookfield Corporation, which is based on the most recent supplemental shared by the company. We just updated the value of the public businesses with the most recent share prices, and we estimated the NAV per share using the total diluted share count, including and excluding the value for the Brookfield Property Group. As can be seen, NAV per share is much higher compared to where shares are currently trading, in fact, the current share price is below the NAV per share even after excluding the value for the Brookfield Property Group. This reflects an extreme undervaluation, in our opinion.

With respect to the public entities in which Brookfield holds an interest, we currently believe most of them are either fairly valued or undervalued. These include Brookfield Asset Management ( BAM ), Brookfield Renewable Partners ( BEP ), Brookfield Infrastructure Partners ( BIP ), and Brookfield Business Partners ( BBU ). Most of the value resides in BAM, which is a terrific business growing rapidly, and which we recently covered in another article . The biggest uncertainty resides in the valuation of the private businesses, for which the value estimated by management is used. For Insurance Solutions, a value of ~$7.9 billion appears reasonable, given the enormous promise this new business holds, and the fact that the company is estimating this business can generate $650 million in annualized cash flow. This puts the price/cash flow multiple at ~12x, and this is a business that the company is rapidly scaling. The business which is likely to generate more controversy with respect to its valuation is Brookfield Property Group, as many investors are very pessimistic with respect to office and retail real estate assets. Still, this is a business generating ~$2.3 billion in annualized cash flow, which puts the price/cash flow multiple at 14.2x. In any case, at current prices, we believe investors are getting this business basically for free.

Is the Real Estate Worthless?

Given that investors are getting the property business basically for free, it is worth asking if maybe there isn't that much value there in reality. We do believe that some of the properties are now worth less as a result of the work-from-home trend in the case of office real estate, and increasing e-commerce penetration affecting the value of the retail assets. Still, many of these properties are trophy assets that continue to hold significant value. In the latest shareholder later, CEO Bruce Flatt shared some very interesting statistics and arguments as to why the real estate Brookfield Corporation holds continues to have enormous value (emphasis added):

The reason we focus on the highest-quality, best-located real estate assets is because we have found that these outperform over very long periods of time and through economic cycles. When office leasing demand slows, these prime buildings tend to remain full, as tenants take the opportunity to upgrade their premises. For example, with overall vacancy as high as 20% in some markets currently, our U.S. office portfolio remains 95% occupied , and our like-for-like NOI is forecast to grow 10% this year.

Similarly, our shopping centers benefit when retailers make decisions to consolidate their premises into the highest-productivity centers. Our top 20 shopping centers comprise more than 50% of the value of our retail portfolio. They are highly productive, with average tenant sales currently exceeding $1,100 per square foot, 20% above their sales prior to the pandemic. Occupancy in these malls has rebounded to 97% , roughly where it was before the pandemic, and we are renewing leases with rents at an 8 to 10% premium to the expiring terms.

These statistics reassure us that the top real estate assets that the company holds continue to be very valuable. That said, with high-quality office REITs such as Boston Properties ( BXP ) and Kilroy Realty ( KRC ) seeing significant operational and share price pressures, it is reasonable to apply a margin of safety to the valuation of these assets. Same thing with the shopping center assets, even REITs focused mostly on Class A malls like Macerich ( MAC ) and Simon Property Group ( SPG ) are seeing significant pressure on their valuations.

New Business Optionality

In addition to the valuable assets described above, investing in Brookfield Corporation offers optionality on new businesses the company might create, or small investments the company has made that might become significant in the future. In the shareholder letter, Bruce Flatt shares as an example the company's investment in Shein, which is a rapidly growing fast fashion retailer which is increasingly challenging the likes of Zara ( IDEXY ) and H & M ( HNNMY ). Perhaps the best recent example of a new business is Insurance Solutions, which the company has grown from almost nothing into a very valuable part of the corporation in a short period of time. It was also extremely smart in acquiring "insurance float" during a period of extremely low interest rates and patiently waited in cash and short-term investments for better opportunities to invest this money. Now that interest rates have significantly increased, the company is deploying these resources into very attractive credit opportunities, which should result in significantly higher cash flow and distributable earnings for Brookfield Corporation shareholders.

Risks

We see several risks to take into consideration with Brookfield Corporation, including the significant use of debt. Most of the debt is non-recourse and at the asset/project level, which significantly reduces risks. The debt risk is further mitigated by a strong balance sheet at the corporate level that is rated A- or equivalent on its unsecured senior debt by S&P, Fitch, Moody's, and DBRS. Perhaps the biggest risk would be a potential scandal that would tarnish Brookfield's excellent reputation. As an asset manager, its reputation is critical for investors to trust the company with their capital.

In the short term, we believe there is some volatility risk from the company being classified as a "financial" stock. Financial and banking shares have been under significant pressure as can be seen by the share price declines of ETFs such as the SPDR S&P Regional Banking ETF ( KRE ) and the Financial Select Sector SPDR ETF ( XLF ). Unless the banking crisis gets much worse, we believe the impact on Brookfield Corporation will be relatively modest. Still, it would appear that the company's share price is nonetheless being affected by the turbulence in the financial world.

Conclusion

At current prices, investors in Brookfield Reinsurance (and Brookfield Corporation) are basically getting an investment in Brookfield Property Group for free. This is despite BPG owning some extremely high-quality trophy real estate assets, which probably still hold significant value despite the work-from-home and e-commerce headwinds. There is also significant optionality from potential new business the company might create, as well as enormous potential from growing the Insurance Solutions business. We, therefore, believe the undervaluation in the shares of BN and BNRE to have reached extreme levels.

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