Brookfield Corporation (BN +1.68%) has been an epic wealth-compounding machine over the decades. The global investment firm has delivered a 19% compound annual return during the past 30 years. At that rate, it would have grown a $10,000 investment into over $1.8 million.
The company is in an excellent position to continue enriching its shareholders in the coming years. One factor driving that promise is the carried interest hidden within its asset management business. CEO Bruce Flatt wrote about this "hidden gem in plain sight" in his fourth-quarter letter to shareholders.
NYSE: BN
Key Data Points
The scoop on carried interest
"Our carried interest is a large asset -- and is not well understood by most investors," Flatt wrote. He noted that the company's asset management business raises a lot of money from investors like pension plans, sovereign wealth funds, and private investors. They expect the company to invest that money into great assets and businesses that generate attractive returns.
Brookfield aligns its interest with those investors in two ways. First, it's a significant investor in its funds. The company also shares in the returns or profits it generates for clients above a certain level. This windfall profit share is called carried interest. Said Flatt:
Put simply, carried interest is our share of the profits realized on an entire fund, subject to that fund exceeding a minimum target return for clients. If we meet fund expectations, we get 20% of the profits. If we earn nothing for our investors, we get nothing.
Flatt then ran through the lifecycle of an investment fund, which has three steps. First, the company raises capital from investors. It then deploys that capital into investment opportunities that can deliver outsize returns. Brookfield has an established record of delivering strong returns for investors, "with almost all our funds meeting or exceeding their target returns," according to Flatt. That's due to the company's deep operating capabilities and its ability to implement its business plans for the assets and companies it acquires.
The final step is monetization. As funds sell assets and businesses, they return capital to investors. "Once all the original invested capital, plus a minimum compound return on drawn capital, has been returned to clients we start to share in the entirety of the profits," wrote Flatt.
The "hidden gem"
Brookfield's carried interest is "of immense value and is our hidden gem sitting in plain sight," wrote Flatt. He continued:
We believe that the value of our carried interest is ±$30 billion, which amounts to $21 per share. This reflects what we would earn in cash today by selling assets in our funds at fair value, plus the value of the carried interest potential valued using a conservative market multiple. Notwithstanding the numbers being very large, the carried interest often remains underappreciated. Nevertheless, it is our hidden gem in plain sight.
That's a significant asset, considering the company's current share price is a little bit above $60 these days. However, most, if not all, of that value comes from the company's other assets, not carried interest. Brookfield has three platforms (asset management, wealth solutions, and operating companies) that currently derive most of its earnings and, therefore, account for most of its value. For example, last year, the company only recognized about $400 million of carried interest into its income. That's a small percentage of its nearly $6.3 billion of distributable earnings.
The company expects to realize $11.5 billion of carried interest, or $7 billion net of costs, over the next five years. Meanwhile, it anticipates receiving about $20 billion in cash from carried interest over the next decade. Flatt noted, "This significant amount of incremental cash flow will allow us to deliver further value for you by either reinvesting back into the business or returning capital via opportunistically repurchasing our shares."
Carried interest is one of the many factors driving Brookfield's view that it can grow its earnings per share at around a 25% annual rate over the next five years. That rapid earnings growth and the market's increased realization of the embedded value of its carried interest supports Brookfield's forecast that it can grow the intrinsic value of the firm to more than $175 per share by 2029.
A hidden cash cow
Brookfield believes the carried interest embedded within its funds is currently worth about $30 billion to investors. It expects to realize this windfall over the next decade as funds mature and return capital to investors. Meanwhile, the overall value of its carried interest should grow as it continues to expand its asset management platform by raising capital for increasingly larger funds. That helps frame the company's view that it can continue to be a wealth-compounding machine in the coming years, which makes it a great growth stock to buy and hold for the long term.
