As we gradually emerge from the shutdowns, quarantines and mourning, we will need to deal as quickly as possible with a financial system that will not be capable of delivering the income streams it has promised or, in its present form, efficiently allocating capital across the global economy. The public shock will turn to anger at failed promises of wealth, or even functionality.
The restructurings that are coming will have to cut away wasteful and self-serving corporate forms, pointless “activity” and opaque “disclosure”. Among the financial structures we do not need any more are highly leveraged holding companies that depend on continuous capital markets access to shuffle debt and interests in operating companies.
The most questionable groups are those which have explicitly or implicitly promised public investors steady streams of dividends from “operating” earnings that appear to come from the revaluation and releveraging of their asset base. The holding companies of these groups collect very high management fees for this asset shuffling.
In recent weeks the public has numbly accepted state and central bank support for banks and corporate finance. There is a revulsion, though, at allowing the bailed-out groups to pay dividends, high executive compensation or management bonuses. This is a mortal threat to the existence of asset shuffling leveraged holding companies.
For several years I have examined the Brookfield group, in particular Brookfield Infrastructure Partners (BIP) and its parent Brookfield Asset Management (BAM).
BIP had more than $56bn in assets at the end of 2019 and, according to chief executive Sam Pollock, “$20bn of capital”. On March 31, BIP’s management changed its corporate form from a Bermuda partnership to a Canadian corporation. BIP says these forms will be “economically” equivalent. BIP, now BIPC, does not have any employees of its own, depending on BAM to be its “service provider”. In the past, Brookfield compared BIP to US Master Limited Partnerships, which pass through dividend income from energy-related assets such as pipelines and gas processing plants.
MLPs have gone out of favour as a group, since under the Trump tax reforms there are fewer advantages to investors from the pass through structure. Also, the perceived value of energy assets has declined with oil and gas prices.
But MLPs and Reits, their pass-through cousins in the property and data centre trades, pay dividends to investors that are less than the cash flows they receive from operations. For example, Magellan Midstream, an energy MLP, last year paid out only about 71 per cent of its cash flows as dividends. Digital Realty, a data centre Reit, paid out about 73 per cent of its cash flow in dividends.
BIP, in contrast, appears to be paying out more in management fees to BAM, dividends to its unit holders, and “incentive distributions” to BAM and its senior management, than it receives as dollars paid in to BIP’s holding company as dividends from its operating subsidiaries.
The difference between cash dividends from operating subsidiaries coming in and fees, incentive payments, and dividends going out appears to be covered by capital markets activity at the holding company level, ie. BIP’s net issuance of equity, debt and preferred shares. A person close to Brookfield stated this analysis was untrue. I refer readers to the “Consolidated Statement Of Cash Flows” in Brookfield’s 2019 annual report, page F-13, if they would like to draw their own conclusions.
In the near future it may be even more difficult to raise or maintain the flow of cash dividends from BIP subsidiaries, such as rail and pipelines in the US or toll roads in Brazil to the BIP holding company, BAM and their outside partners. BIP’s holdings are not reported by country, but Brazilian assets seem to comprise more than a quarter and as much as a third of its total. Since May the Brazilian real has declined by about a third against the US dollar in which BIP reports. There would be similar currency value and forex transfer issues with BIP’s substantial assets in India.
What foresight do BIP shareholders receive for the hundreds of millions of management fees and incentive distributions? Well, on February 10, Mr Pollock said on an investor call that “from a BIP perspective, we do not anticipate any material financial impact from the coronavirus situation and remain optimistic regarding the business outlook for the regions we operate in”.
That comment can be “recycled”.
