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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Thank you for standing by. This is the conference operator. Welcome to the Brookfield Asset Management 2017 Year-end Conference Call and Webcast. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference call over to Suzanne Fleming, Managing Partner, Branding and Communications. Please go ahead, Ms. Fleming.
Thank you, operator, and good morning. Welcome to Brookfield's 2017 Year-end Conference Call. On the call today are Bruce Flatt, our Chief Executive Officer; and Brian Lawson, our Chief Financial Officer. Brian will start off by discussing the highlights of our financial and operating results for the quarter and the year, and Bruce will then give a business update. After our formal comments, we'll turn the call over to the operator and take your questions. [Operator Instructions] I'd like to remind you that in responding to questions and in talking about new initiatives in our financial and operating performance, we may make forward-looking statements, including forward-looking statements within the meaning of applicable Canadian and U.S. securities law. These statements reflect predictions of future events and trends and do not relate to historic events. They are subject to known and unknown risks, and future events may differ materially from such statements. For further information on these risks and other potential impacts on our company, please see our filings with the securities regulators in Canada and the U.S. and the information available on our website. Thank you. And I'll now turn the call over to Brian.
Thank you, Suzanne, and good morning to all of you on the call. Let me start off by saying that we are pleased with the results for 2017. In particular, it highlights a successful year of growth for our asset management franchise and a further step-change increase in our earnings base. Bruce will expand on this in his remarks, but in summary, we continue to expand our fee-bearing capital, generate carried interest and deploy capital across multiple asset classes and geographies. Funds from operations, or FFO, totaled $3.8 billion for the year, that's a record for us. This represents $3.74 per share and an 18% increase over last year. Net income was $4.6 billion for the year or $1.34 per share attributable to shareholders. Both FFO and net income benefited from the significant increase in fee-related earnings as well as growth in our existing businesses and contributions from new investments, and they also benefited from an increase in the level of realized disposition gains and fair value gains, respectively. I will now cover some of the highlights within FFO. First, focusing on our asset management results. Fee-related earnings increased by 26% to $896 million and that's due to growth in fee-bearing capital, which now stands at $126 billion. This growth is driven by both capital committed to new private funds and growth in the capitalization of our listed issuers. We also earned our first performance fees from BBU as a result of a significant growth in its unit price following several notable acquisitions. Moving over to carried interest, which is becoming increasingly relevant to our financial results. As our earlier vintage funds mature, they are starting to generate meaningful levels of unrealized carried interest. As we've noted it in the past, carry doesn't typically arise in a fund until the capital has been invested and we begin creating value, so there is a natural lag. In 2017, we generated $1.3 billion of unrealized carried interest or $928 million net of costs. Total accrued carried interest is now over $2 billion, more than double that of the prior year. And while nothing is guaranteed, this provides a good indication of how we are tracking against the carried interest targets that we expect to realize over the coming years and puts us ahead of plan. The growth in fee-bearing capital led to a 22% growth -- increase in annualized fees and target carried over last year, which now stand together at $2.5 billion. Within that, annualized fees stand at $1.5 billion and that adds significantly to our current earning potential of the asset management franchise, while the annualized target carried interest increased to $1 billion, representing significant future earning potential. Turning to the invested capital side. FFO increased to $1.5 billion, which reflects improved results across our businesses. We benefited from strong pricing and volumes, including higher generation within our renewable power operations, increases in tariffs across our transportation businesses and higher pricing in some of our industrial businesses. We benefited from the contribution from completed development projects, which provide us with opportunities to put capital to work within our existing businesses. And we also deployed capital into a number of significant acquisitions, including $3 billion within our private equity operations and the acquisition of a $5 billion Brazilian regulated transmission business, which enabled a step change in that business as well. The strong growth in FFO per unit in Brookfield Infrastructure Partners, Renewable Energy Partners and Property Partners supported distribution increases in each of those businesses within their 5% to 9% target ranges. Disposition gains in FFO contributed $1.3 billion, as we completed several significant sales in 2017, including the sale of our European logistics company and several core office buildings. Before I turn it over to Bruce, I wanted to provide a brief update on fundraising. As you're aware, we are through 80% invested or committed on both of our flagship real estate and private equity funds. And so we are currently fundraising in these sectors. Our infrastructure fund is 50% deployed, which is right on track given its vintage. And in 2017, while we didn't hold final closes for any of our larger flagship funds, we made very good progress in building out our other strategies such as our credit business. We raised our first infrastructure credit fund, which exceeded the target size, and held a first close on an open-ended real estate credit fund. With interest rates still expected to be very low compared to the returns we can generate, we continue to see demand into the foreseeable future for products which are alternatives to fixed income investments. We are pleased with our initial progress in the high net worth space where we are raising over -- where we've raised over $400 million since the beginning of 2017 through multiple channels, including private banks and registered investment advisers. Going forward, we plan to offer more of our products to clients in this channel and expect it to be a good area of growth for us. Finally, I'm pleased to confirm that our Board of Directors has declared a $0.15 quarterly dividend payable at the end of February, and this represents a 7% increase over the prior year. And with that, I will hand the call over to Bruce. Thank you.
Thank you all for joining the call. As Brian mentioned, asset management -- assets under management continue to grow, and our investments performed well last year. We continue to find opportunities to invest the capital that we've been raising despite a competitive environment, and we put that down to 3 of our core advantages, which are size our global presence and our operating platforms. These advantages allow us not only to identify a wide range of investment opportunities globally, but also to acquire assets for value, and then use our operating businesses to create upside. With strong markets, as Brian mentioned, we sold a number of assets more than usual and we'll continue to do so into 2018. Our strategy has been twofold. First, to sell mature, stabilized assets and redeploy the proceeds into higher-yielding assets. Or secondly, into -- returning capital to investors, particularly when this allows us to substantially compete -- complete a defined investment strategy. Fundraising for real assets in both the public and the private markets for the assets that we manage remained strong, with institutional funds continuing to allocate greater amounts of capital to these sectors. With interest rates expected to remain in a low range compared to the returns that we can generate, I'll return to that in a second, this should -- this growth should continue for the foreseeable future. Turning to the general markets. We see no signs of underlying economic issues despite the U.S. economy being 9 years into an expansion. While this economic cycle shows no signs of ending, it is clearly in the mid-to-later stages of a elongated expansion, so we are being cautious. To that end, we continue to focus on our liquidity and our funding profile to ensure we're in excellent financial shape and position to react to substantial growth opportunities in the next down-market, as we have done in past. Outside the U.S., economies are continuing to recover, and in general, offer more value than available in the United States. Looking at a few of those markets, in the U.K., Brexit stress is offering select opportunities. Broader Europe is looking slightly stronger than it has been for a long time. Brazil is recovering, remarkably interest rates have dropped from over 13% to 6.75% now on the short-term rate. Australia has been very resilient. China continues on its path to becoming the largest economy in the world. And in India, where we've done a number of transactions, they're dealing with an overleveraged corporate sector and that's presenting opportunities. Across the developed markets, the main place where this cycle's excess liquidity has been -- had been and has been building up, we've been monetizing mature assets at values that align with our investment strategies or where we can put it to work more productively. This has also enabled us to add liquidity to the balance sheets and invest more capital in the emerging markets and out-of-favor businesses where multiples have not seen the same expansion. We currently have over $25 billion of core liquidity and dry powder in our private funds. And in this environment, we believe that real assets do continue to offer excellent long-term value. I'd also point out that most competitive capital targeted at this sector did not have the breadth or the advantages of size, global reach and operating capabilities that we have. Over the past year, for example, these specific points enabled us to complete purchases even in the United States where values were higher. We bought 2 SunEdison subsidiaries out of bankruptcy. As well, we recently announced an agreement to acquire Westinghouse Electric Company out of a bankruptcy. We also added a number of quality businesses from sellers in need of capital in Brazil and India, which totaled around $10 billion. Lastly, I wanted to make a few comments on the business -- our business of managing real assets for private investors across real estate, infrastructure, renewable power and other related businesses. This business continues to mature and is now firmly established as a component of investment portfolios of most pension and sovereign plans. With these plans expected to double upward -- to upwards of $80 trillion and with the allocation of real assets and alternatives to also expected to double, there could be a further $20 trillion of capital available over the next 10 years for investment into the type of assets that we invest in. This will continue to fuel significant growth in the industry. We believe this is a long-term trend and it is important to reflect on absolute returns when looking at our investments. In the context of low interest rates and highly correlated equity returns as well as growing liabilities and longevity risk, our investors are seeking alternatives to generate sufficient returns, diversify their portfolios and reduce volatility. Our products address these needs. And to make that point, on our more opportunistic strategies, we generally earn 20% plus or minus and our lower strategies earn in the range of 7%. Today, these returns compare very favorably to a 10-year treasury in the U.S. even at its increased rate of 2.9%, Europe at 0.7% and Japan at essentially 0. In our opinion, the only thing that can stop this trend of continued funding going towards these type of products is the significant increase in global inflation that pushes the long-term interest rates into a territory in which -- and this is the important point, in which returns are not sufficiently superior to the yields that we can earn. Despite interest rates increasing from unduly low levels they were at, something we have expected for a very long time, we do not expect that this will affect our business and believe that it will be a long time before a high-rate paradigm returns. So with that, operator, that completes my remarks. I will turn it over to you, and Brian or I will take any questions, if there are any.
[Operator Instructions] Your first question comes from Cherilyn Radbourne with TD Securities.
Wanted to start by asking about the private fund client base, which is up nicely to 500 clients. Can you talk about how the high net worth channel gets counted within that number? And give us some color on how your private fund capital has continued to evolve by size and type of client, and also the distribution by geography?
Sure. So I'll start off on the private clients. This is Brian, Cherilyn, and thanks for that. So much of that happens in through what I would call an aggregated basis. So we would not include if there is, I'll say, 1 channel that we go through that represents 50 high net worth clients, we would just count that as 1. So that does -- so that's how that plays it. The -- but -- so of the increase in the number of clients, which I think there were about 40 new clients that we introduced across the funds over the past year, which was in a wide variety of geographies that's very well diversified, the -- there was a very -- only -- a very minimal amount of that was actually, from a numbers perspective, private clients.
And so just in terms of some of the areas that you've been focused on, can you just comment on progress relative to small and midsized institutions in the U.S. and then also Europe where you've been a little bit underrepresented, arguably?
So...
Yes, Cherilyn, I might just comment that I would say across the board, our brand keeps getting better known, and we keep growing in all areas. So I'd say we're pushing -- we're adding more U.S. small clients, we're adding a number of European clients to our list when we continue to add clients, but really, across-the-board in all jurisdictions.
Great. My second question relates to something you've referred to in the letter, which is the idea that as a value investor, you have to be increasingly aware of the potential impact of technological change. So I wonder if you could just talk about how you've adapted your underwriting process or your regular business reviews to incorporate considerations of that type of risk?
Look, I would say there's nothing that scientific about it other than we're extremely aware in some businesses. In fact, in all businesses, technology is affecting them, some more than others. And the businesses where it is getting -- where there is direct effects, we need to understand that and try to better incorporate it into our underwritings. So although I would -- what I would say is our -- generally, it's more technological change. Usually, people overestimate what it's going to do to most businesses. And very seldom is it is -- is it's dramatic or as quick as what most people expect. So often getting -- people getting overexuberant about it means that there is opportunities for us to invest in the interim stages where people are just wrong on predicting the time or the impact on businesses. So that's probably the biggest focus for us, is more from a value perspective versus looking at it from where we can grow businesses from scratch, which most growth investors would be focused on.
Your next question comes from Yian Dai with KBW.
So first one's on tax reform. I guess, I'm -- I was just wondering if you guys could talk about the impact of tax reform on some of your underlying businesses and investments. Just given the size of the investments you have in the U.S. and the nature of real asset investing, so maybe -- what are some areas where you might see investments start to look fundamentally less attractive due to limitations on deductibility? And then conversely, are there areas where changes to roles around capital investment and deductibility around that might make other opportunities look more attractive in the near term?
Sure. It's -- thanks, Yian. It's Brian. So in general, our take of this is that it is overall positive for us, and some of that's going to play out over time. The -- you mentioned a couple of things in there, and yes, there will absolutely be some benefits from accelerated write-off or deductibility of capital expenditures in a number of our businesses that will be helpful. The interest expense is probably overall not a big issue for us, in part, because we run an investment-grade model fundamentally and so we keep our leverage in the interest -- according to the interest cost is on the lower side in that regard. On -- also, I would observe that several of the industries that we operate in are exempt from a number of these changes, whether it's utilities or it's in real estate. So those would be some of the -- of ongoing impact. And then, of course, having the tax rate go from 35% down to 21% is obviously a benefit. So overall, I'd say it's generally positive for us. And then, of course, a lot of that is just what is -- how does that kick into the economic environment overall, which if it has a positive impact, then that's good for us.
Bruce, I also wanted to address something from the shareholder letter. So there's a line in there talking about you guys thinking about the next phase of Brookfield post 2025. So I understand that's a long time away and may be not a conversation for today. But I guess, I'm just kind of curious what some of those gross considerations are? And at that point, what might some of the concerns be that you'd want to talk through? And then what's the motivation for taking those discussions off today?
Yes. I would say the line in the letter is really -- it was meant to indicate 2 things to shareholders. The first one is the next 7, 8 years by virtue of the business we have and the maturing of the business we have and the continued growth we think that can happen just with the business we have. For 7 -- for 6, 7, 8 years, this business grows at a very fast clip and we don't have to do anything else, and we'll do -- we can meet, we think, the returns that we've set out for the company. Once the business matures, if we haven't done anything else, 10 years from now, the growth rate will slow. Of course, we're going to do other things. And what we need to do is between now and 10 years from now is figure out how do we widen out the franchise and use what we have from -- for the brand and our fundraising capabilities and our investment capabilities to add other products for our clients, and we don't think that will be an issue. But -- so the reason for the comment was really twofold. One to say that the growth rate is -- we'll not have to do anything for the next 7, 8 years. Post that, we need to figure out, but we have a long time to figure that out. Most companies can't give you that predictability on the growth of the business from that perspective.
Your next question comes from Mario Saric with Scotiabank.
I just wanted to piggyback off of the last question with respect to this post 2025. One thing that you've talked about in the past is just trying to identify perhaps what the optimal balance sheet for Brookfield Asset Management looks like over time. And I was just wondering how that may play into any potential restructuring, if you will, as you go through that next phase of your evolution?
Yes, thanks for the question. I would just say that our -- we are always open to doing things with the company that maximize the value for all the shareholders in the business in the longer term. So if that means 10 years from now that we should distribute capital out to shareholders, then, of course, we'll do that. And at some point, that might make sense. I think if you would've looked back 20 years ago or even 10 years ago and looked at where we are with the business today, we might have said we were overcapitalized and we should distribute capital out. The thing -- the differentiation is this business keeps get -- getting bigger, and we can use the capital we have to keep building a bigger franchise. And we think that'll continue for a while. At the point when the franchise doesn't get built and we can't put the money productively to work, then we will look at what we do with that capital, whether we increase dividend to give back to shareholders or buy back shares or distribute it out in some other form. So look, we're open to all suggestions and we look at it all the time. Right now, I'd say we think that it's an enormous competitive advantage to have the capital we have, and that gives us a lot of ways to grow the business that others don't have.
Okay. And then my second question, just again referencing the letter to shareholders and specifically the market environment. You've been noting more of a cautious stance in the last several quarters, just kind of referencing the elongated expansion. And then, I guess, in this letter, also referencing a couple of specific items that may raise kind of question marks with respect to valuation in the broader markets making you a bit more cautious. How do you -- outside of pace of capital deployment, how does that shift the deployment mix in terms of capital allocation for you? And how has the cycle change develop in the last 3 to 6 months for the shift in the mix in terms of how you deploy capital's changing?
I would just say that we always are investing and we're always putting money to work. We try to move our capital to where value is. So where -- everywhere in the world today, there is not overvalued and every industry isn't overvalued. There are many businesses, I referenced 2 of them being the SunEdison subsidiaries and Westinghouse, that these are 2 bankruptcies that happened in the United States. So this is the most liquid, highly valued market in the world over the past 12 months. And we -- those are over $10 billion of assets we purchased because of 2 specific situations. So we're always putting money to work. I would just say on balance though, we try to have themes of should we be more cautious or more aggressive. And in 2009, while we were worried like everybody else, we viewed that the best thing we could possibly do was, as much as prudently possible, we were trying to put money to work at that point in time. That wouldn't be the -- what we are added to today, as we should be cautious. We should keep investing because we have strategies to invest and we have to keep growing our businesses. But on balance with excess capital we have on our own balance sheet and with funds, we're just a little more cautious today in some of the more highly valued markets. But that doesn't mean we're into other places and that's really the value we have in a broad -- the breadth of the franchise because there are places still in the world that are undervalued today.
[Operator Instructions] Your next question comes from Andrew Kuske with Crédit Suisse.
Question is probably for Brian and it just relates to the ENI comparative and I appreciate that being in the results this time around. But maybe beyond the really obvious -- but you might want to also address the really obvious is why did you include the ENI in your supplemental today?
So thanks, Andrew. The -- what we're really trying to do is get out some comparable metrics relative to the other alternative asset managers and try and facilitate that. And if you do think about -- and as you know, how we think about the business, there really are -- the easiest way to think about is with the 2 components. One is the economics of the asset management business itself, and then the other is the tangible value of our balance sheet. And so by putting out the ENI, it gives folks insight into the fee-related earnings as well as the carry that we book, but more -- as importantly or more importantly, the amount of carry that is generating and building up in the system. And we think now the business has evolved to the stage where that is more representative. There's still a lag, but it's more representative of what's actually going on, whereas 5 years to go, I'm not sure, would have been as good a metric for valuation purposes.
And then maybe just a follow-up on that. When you think about your ENI calculation and how it compares to some of the U.S. alts, how do you think about the quality of your ENI number versus the U.S. alts' that tend to be very reliant upon IPO markets for cycling assets?
Yes. So I think really what that's getting at is on the carry side of it. And so we would maintain that -- the IPO markets obviously are relevant as an exit for certain types of investments. We feel fortunate in that because of the breadth of the business that we're in, and in particular, the nature of some of the businesses that they're in that they lend to a much wider variety of exit opportunities. And so we think that our ability to crystallize carry should be more robust as a result and that we -- because we have more options on how we can monetize an investment.
There are no further questions queued up at this time. I'll turn the call back over to Suzanne Fleming for closing remarks.
Thank you, operator. And with that, we'll end today's call. Thank you, everybody, for participating.
This concludes today's conference call. You may now disconnect.