Thursday, June 13, 2024

Brookfield has a vision for the future – and it’s building it

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When we met Sam Pollock, chief executive of Brookfield’s infrastructure business, at the sprawling Brookfield Place in Toronto, it was days after wildfires in Québec had wreaked havoc, spreading smoke across Canada and into the US, making Toronto and New York among the most polluted cities in the world with the worst air quality, and cancelling thousands of flights in the process.

It was a timely reminder that Brookfield Asset Management, with last year’s $15 billion closing of its Brookfield Global Transition Fund I, manages the world’s largest vehicle focusing on the energy transition.

It was also a reminder that, with no airports in its portfolio, Brookfield is no ordinary infrastructure manager, despite it now boasting the world’s largest closed-end infrastructure fund, having revealed to the market in August it had raised $27 billion for Brookfield Infrastructure Fund V, with a planned close later this year after further commitments.

“I think we’re now in a 10- to 20-year period where countries will reshore or realign critical manufacturing and critical energy infrastructure”

Sam Pollock

Brookfield’s unconventional infrastructure approach means it has taken significant bets in South America (c$20 billion AUM), a much larger presence in the region than many other global infrastructure managers. It led it to start investing in data centres in June 2018, when few of its peers had done so. And it is reflected in the unusually high 25 percent GP commitment it makes to each of its infrastructure funds, through listed entities Brookfield Infrastructure Partners and Brookfield Renewable Partners.

When it is put to Pollock that Brookfield has built a $161 billion AUM infrastructure business by being a contrarian at times, the man responsible for driving that since it began in 2008 delivers a rather more traditional infrastructure response.

“When we think about when we make a long-term investment, sometimes being contrarian, the first part of it is taking a long-term perspective, to try to make sure that we don’t get caught up in the negative sentiment of the day,” he says. “The second thing that we focus on is the capital flows. You have to step back and assess: where is all the capital needed for the next 10-30 years? And get in front of that tailwind. Getting in front of digitalisation and decarbonisation now obviously seems like a no-brainer, but not everyone could see that eight years ago and how important it was going to be.”

Betting on the energy transition

Brookfield’s much-vaunted BGTF I is a good example of the manager’s ability to glimpse the future and then marshal the resources to go after it.

“Probably around 2015, we began to see two things changing within our opportunity set,” recalls Connor Teskey, president of Brookfield Asset Management and CEO of its renewable power and transition unit. “One was, with the growth in renewable power around the world, the ability to do a lot more development at very attractive risk-adjusted returns. And the second was that, increasingly, more and more of our equity deployment went towards working with a counterparty – almost always a corporate – to help them reach their decarbonisation or energy transition goals.

“As those two things – development and, let’s say, becoming more of a solutions provider – became more and more a part of our business, that was really the impetus to launch BGTF I. And our LPs were looking for that. The market opportunity was huge, and we thought we could be a leader.”

Core: the $30bn dream

In between the closing of the $14bn Brookfield Infrastructure Fund III and the launch of its successor, the manager added another string to its bow

Brookfield may not have known it at the time, but the mid-2018 launch of the open-end vehicle Brookfield Super-Core Infrastructure Partners was to be the start of a renewed interest in core infrastructure from some of the asset class’s major players.

“What we found is there’s many assets out there that our clients would love to own as an alternative to fixed income but don’t meet the thresholds of returns that we get in our more opportunistic funds,” chief executive Bruce Flatt explained at the time. There was, though, another motivating factor, as a longing Brookfield gazed at the market during 2017.

Natalie Hadad, managing partner and co-head of the fund, says: “In the US, there were a series of utility transactions that, at that time, if we would have had the super-core fund, we would have pursued. Similarly, there were utilities in Europe that came to market that we didn’t have the right vehicle for.”

The initial reception took time, Hadad admits, although by the end of 2020 it had reached $4.1 billion and now stands at over $9 billion. And while BSIP eventually got its hands on those US and European utilities it coveted, similar assets have also been acquired in Australia and the Middle East, with around $17 billion deployed overall in about 15 transactions, including co-investment. Crucially, they all must fit within the 8 percent net return target and have overwhelmingly fixed-rate financing structures.

“[The pillars are] long-term contracted or regulated revenues, conservative, prudent financing structures, inflation protection, and a significant portion of the total return coming from current yield,” says Hadad. “When we see the other products in the market, we don’t see those same characteristics.”

That will get tested in today’s macroeconomic conditions, but Hadad is unconcerned about the impact of rising interest rates on the product.

“It’s very simple. Our super-core fund is a perpetual vehicle, and as such, we underwrite investments on a permanent hold basis, and we look for long-dated cashflows. Second of all, every single one of the investments that we have in our portfolio has inflation protection and we expect new investments to follow that profile.”

With that in mind and five years into BSIP, Hadad has a bold prediction for the next five years. “There’s no reason why this strategy can’t go to $25 billion-$30 billion in the next five years. There’s certainly the pipeline of opportunities in the market and there’s the investor appetite for the strategy.”

Scale is a big part of the energy transition. But even if Teskey admits BGTF I closed “right at the high end” of Brookfield’s expectations for it, the point is not “to be big for the sake of being big”. “What we have found is that having those large-scale dollars allows us to execute on not only the most impactful but also the largest and most attractive decarbonisation investments”.

Offering a big fund also allowed Brookfield to capture the growing LP appetite for the energy transition, he says. “Increasingly, we are seeing large institutional investors have direct allocations – whether those are hard or soft allocations – to sustainability or transition or decarbonisation.

“And it’s not solely because every LP around the world recognises the need to decarbonise. It’s important to recognise that many are increasing allocations towards this space simply because they think it can offer very attractive, risk-adjusted returns.”

That brings us to an important point regarding Brookfield’s transition strategy.

“We are adamant that there is no return discount because our Transition fund focuses on decarbonisation,” Teskey stresses. “We want the decarbonisation angle and the value-creation angle to be completely aligned. That creates a very actionable investment thesis. It creates an environment where you can rally stakeholders, because if decarbonisation and value creation are aligned, you completely avoid that potential conflict. It really is an opportunity to do well by doing good.”

Connor Teskey

“We are adamant that there is no return discount because our Transition fund focuses on decarbonisation”

Connor Teskey

Business transformation, which focuses on transitioning individual businesses, is probably the Transition strategy’s highest-profile investment theme. The prototypical deal is the acquisition – together with EIG’s LNG platform MidOcean Energy – of Australian energy generator and retailer Origin Energy. It is large-scale – it has an A$18.7 billion ($12.5 billion; €11.6 billion) price tag attached – and ambitious in scope, with Brookfield aiming to spend a further A$20 billion over the next decade to build 14GW of new renewable generation and storage facilities, to help decarbonise Origin’s generation fleet.

“By building that replacement capacity to shut down coal, we will hopefully drive emissions down by more than 70 percent over the next decade,” Teskey explains. “To put that into perspective, a 70 percent emissions reduction at Origin is equivalent to an 8 percent reduction of emissions across all of Australia – that’s not an insignificant decarbonisation story.”

The other two investment themes for the strategy are sustainable solutions – “where we invest in the production of a good or service, like biofuels, that helps decarbonise a large number of businesses” – and clean energy – “that’s renewables development, pretty straight down the fairway”, says Teskey.

Clean energy includes nuclear, which Brookfield wholeheartedly endorses. In an indication that nuclear is perhaps not as straight down the fairway as other types of clean energy, the Transition strategy’s first deal in the sector came through the $8 billion purchase of services provider Westinghouse, in partnership with uranium provider Cameco. “Nothing would stop us from investing in nuclear power at the generation level, but it’s always about, ‘Are we getting an attractive entry point and an attractive risk-adjusted return?’” Teskey says.

Westinghouse, which has its technology embedded in 50 percent of the world’s nuclear power plants, offered an appealing infrastructure-like cashflow and risk profile. “This business does not take construction risk, does not take commodity risk, and does not take nuclear liability risk,” Teskey explains. It also has plenty of upside potential, whether it’s life extensions of existing facilities or new plants, such as the contracts it recently won for Poland’s new nuclear programme.

Another technology that is also key to the future is hydrogen. “A large number of people get very excited because hydrogen burns clean, and that’s great. The other thing that is very interesting about hydrogen is it also represents a long-term storage solution, so that excites us.”

Mostly, though, Teskey is enthusiastic about how many decarbonisation solutions are seeing their cost curve drop dramatically. Given that the energy transition will need a mix of solutions and different technologies, “the more of these that pop up that become commercial, cost effective and have the right impact, that’s fantastic because they all represent investment opportunities for ourselves”, he says.

Latching on to deglobalisation

If decarbonisation and digitalisation – two of the three themes driving Brookfield’s infrastructure strategy – are also heartily embraced by its peers, the third – deglobalisation – is arguably where the manager really strays from the pack.

Brookfield first started publicly talking about this theme in early 2022, observing the onshoring of critical supply chains and industries, with a lens focused on the energy, data and transport sectors. Pollock, however, tracks these conversations back a little earlier.

“The trend towards deglobalisation probably accelerated during the previous US administration, when we saw protectionism starting to build up a bit more, and governments focused even more on where they sourced their goods. That really precipitated with the tensions with the two major economies – the US and China. I think we’re now in a 10- to 20-year period where countries will reshore or realign critical manufacturing and critical energy infrastructure.”

He adds that Brookfield has “a number of LNG businesses where we’re now looking to expand our footprint significantly and so that will require billions of dollars”, while also predicting a new wave of ports investment.  “As manufacturing diversifies away from China to other parts of the world, everyone has a China-plus-one or China-plus-two strategy.

“For instance, we are witnessing manufacturing moving to India, where we’re now seeing a lot more components of iPhones being built. Vietnam is another big area where you’ll see a lot of manufacturing move to. All those countries are going to need new ports to deal with the additional capacity and it will change the flow of goods and where they enter countries. In the US, there may be more investments into expanding the capacity in ports on the East Coast as well as Canada, where historically it’s primarily been on the West coast.”

Helping move goods along is Triton International, the world’s largest owner of intermodal shipping containers and the subject of a take-private offer in April from Brookfield, valuing it at $13.3 billion. First and foremost, Pollock hails the cashflow of the business, but he also has other ideas for Triton.

“Because they are interacting with all the major shipping companies, they have a great database of where the boxes are going. As a result, it gives us unique intelligence to make decisions on where we should be supporting infrastructure around the world, as well as where the future trends are leading towards. I think it has that dual impact: good cash returns and that informational benefit. It’s going to be huge for our transportation business.”

Expanding with credit

While chief executive Bruce Flatt may have pointed in 2018 towards super-core as an alternative for fixed-income investors, Brookfield had already created such a product within its infrastructure suite

Brookfield closed its Infrastructure Debt Fund I on $885 million in December 2017, having launched the product with a $700 million target in June 2016. The third of the series, which targets net returns of between 6-7 percent for its mezzanine strategy, has exceeded its $4 billion target.

“We found that we do pull from the fixed-income bucket and the alternatives bucket, but the fixed-income bucket is interesting because from that segment it is hard to get exposure to infrastructure,” Hadley Peer Marshall, managing partner and co-head of the business, tells us. “That diversification becomes quite interesting when you’re looking at the portfolio construction, and pulling from there is quite advantageous.”

The strategy, investing across transport, renewables, utilities, data and midstream spaces is certainly flexible, with Peer Marshall stating that the fund can offer loans from $50 million to $500 million. In the case of Altitude Infrastructure, a fibre provider in France, it loaned an initial $245 million in 2020, before adding a further $350 million the following year.

Peer Marshall shrugs off any concerns of future deployment in a dislocated debt market. “We are seeing an opportunity set that is really looking to find capital in a scarcer environment than there was before, so we are viewed as more valuable now than ever. And then of course, you’ve got the overall debt capital markets and more disruption, so both of those added together have allowed us to see an opportunity set that has been expanded further and where we are viewed as more valuable.”

The opportunity set aside, nothing has changed for the infrastructure debt team from launch in 2015 to 2023, Peer Marshall insists. “We have always had covenants so that we have early warning signals, and for that nothing has changed. A tighter credit market doesn’t necessarily mean we all of a sudden are getting more restrictive, because we were always consistent in how we saw credit and what we thought was appropriate from a structuring perspective.”

Ports and LNG aside, which Brookfield had already been leaning into from its early days and prior to the Russian invasion of Ukraine, investing in deglobalisation is in full swing, marked most notably by the August 2022 announcement of up to $15 billion in funding for Intel to build a $30 billion semiconductor manufacturing facility in Arizona.

It was an unprecedented infrastructure transaction, which raised eyebrows among some of its own LPs and fellow GPs, per a variety of people we spoke to. But Pollock says Brookfield was Intel’s “natural partner” to onshore manufacturing of one of the most critical components of the modern world. Crucially, 60 percent of the world’s semiconductors are manufactured in Taiwan and would therefore be at the centre of any conflict between Taiwan and China.

“We looked at [Intel] and this structure [as] not dissimilar to how we looked at the data sector a number of years ago, where hyperscale companies were looking to have people build and finance data centres,” says Pollock, who reveals the deal took about a year from origination to agreement. “Construction, production and commercialisation risk stays with Intel. That was their choice – to retain certain risks to bring down the cost of capital.”

Speaking of critical components, Pollock says the CHIPS and Science Act, which authorised $280 billion in funding to bolster US manufacturing and passed into law two weeks before the deal was announced, was “a critical component of making the project itself financeable and economic for
Intel”.

Powering future homes

A few months before the Intel deal last year, Brookfield went a little closer to home than the onshoring of semiconductors with the £4.1 billion ($5.3 billion; €4.8 billion) take-private of Homeserve. Another route that few infrastructure GPs have taken, Homeserve is a UK-based home repair company, with significant operations also in the US, Canada, Spain and France.

A new subsector for the ever-widening infrastructure landscape, then? Not for Pollock, who says Homeserve is actually a “tuck-in” acquisition to a deal Brookfield secured in 2018 to buy Enercare, a residential energy leasing business. And it’s all under the decarbonisation banner, he says.

Natalie Hadad

“There’s no reason why this [super core] strategy can’t go to $25 billion-$30 billion in the next five years”

Natalie Hadad

“We call it a demand-side decarbonisation business where we effectively finance various utilities and appliances inside a home,” he says. “There’s a huge secular trend towards more energy-efficient appliances and equipment inside the house, but also, because of their high upfront cost, consumers need innovative ways to get financing. So providing a rental or financing product for them allows us to effectively create a long-term cashflow stream that’s highly secure, that’s essential for the home and that’s where Homeserve fits in.”

There are the infrastructure buzzwords again, but Pollock admits that LPs needed questions answered. “Effectively, think of our long-term cashflow stream as a regulated asset base that we’re building. Once we explain exactly what we’re trying to do to investors and what the cashflow profile looks like, they understand why these demand-side decarbonisation businesses are attracting infrastructure companies.”

The cautious pioneer

For all its less conventional bets, one might be surprised to find that Brookfield’s returns are neither outsized nor abnormal. All of its four closed infrastructure funds are generating net IRRs of 11-14 percent, as of the end of Q2 2023, with a 10 percent net return targeted by the series.

Pollock is unapologetic about this and points out a key reason: “I think where others might have some outperformance can often be attributed to a shorter investment time frame where they sell things quickly. Shorter time frames can enhance your IRRs, but reduce your multiple of capital.

Hadley Peer Marshall

“A tighter credit market doesn’t necessarily mean we all of a sudden are getting more restrictive, because we were always consistent in how we saw credit”

Hadley Peer Marshall

“We tend to hold on to our investments longer than some others, and so that will naturally bring down your IRRs over time because you’re not taking advantage of those quick wins, but we benefit from a much-improved multiple of capital. I think our performance has been excellent.”

Having widened the strategy to credit, core and energy transition infrastructure, Pollock does not rule out further segmentation.

“The things that we will evaluate will be whether or not we have regional funds for certain areas that have outsized deployment opportunities,” he says.

“Sector-wise, the data sector today is a possibility. We have outsized opportunities relative to what we put into our fund, but we’ll have to monitor that to see if it levels off or if it continues to go up.”

To end on a contrarian note, Brookfield is, as ever, the cautious pioneer.

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