It’s not hard to understand why so many chief executives suffer sleepless nights.
Earnings calls have become a litany of laments over the pogo stick stock market, penny-pinching lenders, persistent inflation, pulverizing interest rates, and prospective recession. The market caps of big tech companies like Meta and Amazon are in meltdown. Value firms offer no refuge to investors. Even Warren Buffett’s Berkshire Hathaway lost billions in the third quarter of 2022 — its latest reported earnings.
Which is why the jarring optimism voiced by Bruce Flatt, CEO of Brookfield Corp., makes one wonder if the huge Canadian alternative-asset manager inhabits the same planet and time frame.
“I sleep well at night,” insists Flatt. “This cycle has actually been pretty good for us. We’re still investing, growing our businesses, providing money to firms. And we can still borrow from banks.”
A sputtering economy is supposed to stifle the urge to merge and acquire. Yet the past year and a half witnessed a trio of multibillion-dollar infrastructure deals by Brookfield that would be eye-popping even in the recently ended era of near-zero interest rates and inflation.
Late in 2021, Brookfield Infrastructure Partners — the firm’s main infrastructure vehicle — swatted aside an undersize rival posing as a white knight and gobbled up Inter Pipeline, a leading Canadian transporter of natural gas and producer of petrochemicals.
In October 2022, Brookfield’s private equity arm made a huge profit on the sale of Westinghouse Electric Corp., the world’s top provider of services to nuclear power plants. The buyer was a joint venture between yet another Brookfield subsidiary and a major uranium producer.
And in a pathbreaking, blockbuster deal last August, Brookfield agreed to invest up to $15 billion in Intel Corp. to finance a new factory for advanced semiconductor chips. Brookfield will claim its returns from the factory’s revenues.
In periods of inflation and recession, infrastructure investments gain favor over stocks and bonds because building contracts are linked to price rises and projects will hopefully reach completion just as the economy revives. For investors needing further incentive, the U.S. government has earmarked more than a trillion dollars for infrastructure spending.
According to Brookfield Infrastructure Partners CEO Sam Pollock, up to 90 percent of Brookfield infrastructure contracts are linked to inflation rises. The impact on BIP’s bottom line has been dramatic: Though the company’s organic growth usually hovers near 6 percent per annum, last year’s high inflation pushed that figure above 10 percent.
Yet not even a firm as large and cash-rich as Brookfield is able to eliminate risk from its infrastructure investments. The company also does itself no favors with a complicated structure of interwoven subsidiaries that can make dealings between them look awkward. And vagueness about projected returns from some of its infrastructure transactions sometimes requires shareholders to simply trust Brookfield’s strong track record.
Still, neither adverse macro trends nor the carping of critics can curb Brookfield’s appetite for infrastructure deals.
Brookfield’s growing clout underscores the fact that infrastructure is out of reach for all but a handful of private equity heavyweights. Besides Brookfield, that short list includes KKR & Co., Apollo Global Management, Carlyle Group, latecomer Blackstone, and possibly a few others.
“The size of projects and their financing needs are so much greater than a decade ago,” says Greg McGahan, PwC partner for U.S. infrastructure deals. His advice to smaller investment firms: Become niche players or seek out less costly infrastructure opportunities in lower- and middle-income countries.
Scale and deep pockets aren’t the only things that set the brawniest infrastructure investors apart from the rest. An alternative-asset manager must have in place a smooth capital replacement process that enables it to sell older assets in time to help finance the purchase of new ones. Debt maturities must extend over years in order not to strain an asset manager’s balance sheet.
Large asset managers are also better able to cope with the sudden shifts in infrastructure that are shaking the pillars of this once-staid, reliable asset class.
Consider the example of energy — traditionally the biggest magnet for infrastructure investments. Less than a year ago, asset managers faced a clear choice between long-term commitments to fossil fuels and allocations to cleaner renewables. But crippling shortages and soaring energy bills linked to the Russia-Ukraine war moved climate concerns to the back burner. That means asset managers — and the banks that provide financing — now have to calibrate the balance between carbon and noncarbon investments to satisfy rival camps of shareholders.
Transportation is another classic draw for infrastructure investments. But Covid-19 disruptions snarled supply chains, setting off a scramble among firms to gain priority access to ships, cargo flights, railways, trucks, and pipelines.
There is also the fear of over-reliance on foreign factories for high-tech products. This has led Washington to embrace an industrial policy that encourages domestic production — most notably in semiconductors. But again, the prime beneficiaries are asset managers able to invest billions in onshoring infrastructure projects.
Add to these new factors the record fundraising that is outpacing the availability of attractive infrastructure projects, bloating their price tags and squeezing projected profits.
“Today there are relatively few assets that promise the steady returns that infrastructure investors became accustomed to in recent decades, leading investors to lower their expectations for future returns,” concludes a recent report by McKinsey & Co.
But Brookfield is well equipped to navigate these challenges.
“Infrastructure is where we started,” notes Flatt. “We’ve been in the business a long, long time.”
Founded in 1899 to build tram and electricity lines in Brazil, the firm was initially known as Brascan — an allusion to its Brazilian operations and Canadian headquarters.
Under Flatt, who at 57 has been chief executive for 20 years, the firm spread beyond infrastructure into real estate, energy, private equity, and insurance and was renamed Brookfield Asset Management in 2005. It ended last year under yet another name — Brookfield Corp. — after spinning off BAM as a separately listed subsidiary, with the parent holding a 75 percent stake.
Among alternative-asset managers, Brookfield is by far the largest investor in infrastructure. Alone among its peers, it maintains an enormous operational staff — 150,000 strong worldwide — that enables the firm to take over an underperforming utility and restore it to profitability, or build one from scratch. The alt manager has a whopping $110 billion in dry powder to back up this army.
In the rivalry for the top spot in alternative-asset management, Brookfield (with $750 billion in assets under management) appears better positioned defensively than Blackstone ($950 billion AUM) for the current economic environment. More than a quarter of Brookfield’s AUM is in already contracted, inflation-linked infrastructure and energy assets. By contrast, Blackstone has only $30 billion in such assets, or about 3 percent of AUM.
As tech stocks began their swoon in late 2021, Flatt repeatedly asserted the sector was becoming attractive enough to draw new investment. Wall Street assumed that meant Brookfield would acquire one or more tech companies.
Instead choosing an innovative strategy, Brookfield announced it would invest up to $15 billion in a new Intel semiconductor chip plant in Arizona. The deal leaves management and operations to Intel, which has a 51 percent share in the joint venture. Brookfield will be repaid in revenues for its 49 percent stake in the plant.
For Brookfield, Intel was an opportunity waiting to happen. After decades atop the semiconductor industry, Intel fell far behind Taiwan Semiconductor Manufacturing Co. as a result of a fateful 2005 decision not to make advanced chips for Apple’s iPhone and to focus instead on the personal computer market. Today, TSMC serves a market that is ten times as large as Intel’s and far outstrips the U.S. company in leading-edge chips.
Intel’s problems stand out even in a U.S. semiconductor industry thatshed $1 trillion in market value in 2022. Intel’s$110 billion market cap is no larger than it was a dozen years ago. Its $1 billion in net income in the third quarter last year was down 85 percent from the same period in 2021.
Intel faces the almost impossible task of raising more capital for soaring R&D expenses while cutting back on operational costs. “It’s just hard to see any points of good news on the horizon,” Intel CEO Pat Gelsinger conceded on an earnings call with analysts last October.
So what enticed Brookfield? Long-term prospects for semiconductors look promising. Chips are needed in every industry, with demand swelling especially for electric-powered vehicles, military weaponry, and consumer electronics.
Geopolitics has become a prime stimulus. Today all advanced chip manufacture takes place abroad, mainly in Taiwan and South Korea. Incredibly, the U.S. does not produce any of the chips needed for artificial intelligence, the military, or satellites.
The sense of urgency was great enough for the CHIPS Act to gain bipartisan congressional support. Passed last August, it provides $52 billion in subsidies for semiconductor manufacturing in the U.S. — including the Intel-Brookfield plant in Arizona.
According to Flatt, it was Intel that first approached his firm. In negotiations with Brookfield, Intel emphasized it wasn’t looking for an equity investment. Brookfield offered as an alternative a large capital injection into a new Intel factory, allowing the company to forgo debt financing that would have strained its already overburdened balance sheet. Furthermore, Brookfield agreed to stick to the brick-and-mortar side of the Arizona plant, leaving all decisions on the production and commercialization of chips to Intel.
Brookfield will collect the returns on its megabillion-dollar investment from revenue generated by the facility. But missing from the deal’s announcement are key details — like when construction of the plant will be completed, how soon production will begin, and what size chips will be manufactured. Gelsinger has said that Intel will hold off on the purchase of costly chip-making equipment until demand picks up.
According to BIP chief Pollock, Brookfield has safety nets and other credit protections that “don’t leave us exposed” to delays in the factory’s output or other potential setbacks. Still, it’s hard to imagine that a smaller, less experienced asset manager would have agreed to invest in a deal with so many uncertainties.
Brookfield’s mega-investment in Intel faces other risks and possible shortfalls. Catching up to Taiwan’s TSMC will be a herculean task. TSMC followed the Intel-Brookfield deal with an even bigger blockbuster move — a $40 billion outlay for its own Arizona factory, one of the largest foreign investments ever in the U.S.
Nor is there anything vague about the TSMC facility’s schedule and output. The building is timed for completion in 2024. And it will produce three-nanometer chips, helping TSMC maintain its lead in the most advanced, tiniest, and fastest transistors.
But the strongest headwinds of all for the Intel-Brookfield deal are the export controls that Washington has imposed on chip sales to China. The Chinese market takes a quarter of Intel’s chip production.
“The CHIPS Act subsidies will not make up for the loss of sales to China,” says Mark Lipacis, a semiconductor industry analyst for investment bank Jefferies Financial Group.
Despite these hurdles, Brookfield sees its Intel investment as a harbinger of similar deals. “We have the operating skills, capital, and broadly diversified global businesses,” says Flatt. “And we’re always looking for new, innovative ways to finance firms.”
The acquisition of Inter Pipeline — a leading Canadian midstream company engaged in the transportation and processing of energy products — fits the more classic mold of Brookfield infrastructure deals.
In energy, Brookfield has always favored the steady, predictable returns from midstream assets over investments in volatile oil-and-gas extraction and refining. “Midstream assets provide very bondlike returns,” notes Pollock.
Building new natural gas pipelines — the quintessential midstream asset — is almost impossible because of a maze of government regulations and the objections of private landowners. This guarantees that existing pipelines will be fully used and under perpetual contract. But finding a prized asset like Inter Pipeline at an affordable price is a rare event.
“The market told us Inter Pipeline had problems,” says Pollock. During 2020, its share price plummeted by 75 percent. The company had huge cost overruns on a major capital project — the Heartland Petrochemical Complex — and was so leveraged that it was about to lose its investment grade.
Early in 2021, Brookfield Infrastructure Partners made a hostile bid for Inter Pipeline aimed at taking the company private. Inter Pipeline urged its shareholders to accept instead a friendly bid by Canadian midstream company Pembina Pipeline.
But after a bruising five-month battle, Brookfield countered with a 21 percent higher bid, forcing Inter Pipeline’s management to recommend that its shareholders accept the $6.7 billion offer in cash and equities.
The deal is a prime example of Brookfield’s capital replacement policy. Before buying a new asset, the firm sells a mature, less productive asset. A few months before acquiring Inter Pipeline, Brookfield sold Enwave District Energy, which provides heating, cooling, and power to 13 North American cities, for $4.1 billion. Enwave was generating only 5 percent in funds from operations (the cash flow from ongoing business activities), whereas Inter Pipeline will generate more than twice that.
Brookfield had more than enough capital to quickly complete Inter Pipeline’s stalled Heartland Petrochemical Complex. By the end of 2022, Heartland was fully operational and had signed clients to long-term, inflation-linked contracts.
A moat provides an essential competitive advantage, and in nuclear energy nobody has built a wider one than Brookfield. Yet rivals turned a blind eye while the firm was girding its nuclear fortress.
Brookfield’s acquisition of Westinghouse in 2018 was greeted by the investment community as a head-scratching contrarian bet. Once an iconic American brand, Westinghouse had been purchased a dozen years earlier by Japan’s Toshiba Corp., which had plans to expand its involvement in nuclear energy.
Then came the 2011 tsunami in northern Japan that destroyed a nuclear plant, spewing radioactive waste into ocean, farmland, and urban communities. Never had the nuclear business seemed more toxic to investors. New-plant construction in the U.S. came to a standstill. In Europe, Sweden and Germany began to phase out existing reactors.
Toshiba declared Westinghouse bankrupt and put it up for sale. Backed by private equity investors, Brookfield was the only serious bidder and acquired Westinghouse for $4.6 billion.
“Westinghouse was a complicated story to understand, and most people just didn’t get it,” recalls Flatt.
But Brookfield reasoned that even if the world stopped building nuclear plants, Westinghouse had lifetime, inflation-linked contracts to service about two-thirds of existing reactors around the globe.
“Customers never leave Westinghouse — it has a 99 percent retention rate,” notes Connor Teskey, CEO of Brookfield Renewable Partners, the asset manager’s renewable energy subsidiary.
Moreover, a rising chorus of environmental experts asserts that nuclear energy must play a key role in the reduction of global carbon emissions. And in the wake of the Ukraine war, Western countries have sought to increase domestic sources of energy, including nuclear power.
“Sovereignty over energy sources has become very important,” says Flatt. So besides just servicing nuclear plants, Westinghouse quietly developed new, presumably safer reactors.
When Brookfield’s private equity company sold Westinghouse last October — to a joint venture of Brookfield’s renewable energy business and Cameco Corp., a leading uranium miner — the transaction valued Westinghouse at $8 billion. That’s three-quarters more than what Brookfield paid for it just four years before.
The deal — giving Brookfield a 51 percent stake and Cameco the remaining 49 percent — raised eyebrows because no open auction was held for other potential bidders. Critics wondered how two Brookfield entities sitting on opposite sides of the table could negotiate a fair market price for Westinghouse.
Flatt felt obliged to defend the transaction in a letter to shareholders last November, citing two main reasons for keeping the deal in-house. First, Westinghouse’s low-cost, long-term debt was too valuable to surrender to an outside party. Second, because Westinghouse was considered a strategic asset for the U.S., non-American bidders might have been vetoed by Washington. (Never mind that Brookfield is a Canadian firm.)
Flatt went on to inform Brookfield shareholders of a third compelling reason for holding on to Westinghouse: “The long-term plan is to build a vertically integrated nuclear operator for the Western world,” he explained.
Cameco will mine and refine uranium for the joint venture. And Westinghouse will continue to service existing nuclear plants while building new ones from models it has developed. These include the AP1000 reactor, with passive safety measures intended to automatically prevent a meltdown of the reactor core and containment; and a micro reactor called the e-Vinci, which will be factory-built, fueled, and assembled before it is shipped by truck and deployed onsite.
Last October, Poland announced it had contracted for three AP1000 reactors and was planning to purchase three more. At the same time, Westinghouse announced it would install two AP1000 reactors at a Chinese nuclear plant.
Public anxiety over nuclear disasters remains a concern. Brookfield’s new technology is designed to avert the kind of accident that occurred in Japan.
Then again, the Japanese nuclear plant was supposed to have had safeguards in place to prevent a repeat of the 1986 Chernobyl disaster in Ukraine — which in turn was supposed to have corrected the mistakes that precipitated the 1979 Three Mile Island accident in the U.S.
Nor is there any solution in sight for the other troublesome nuclear issue: the disposal of nuclear waste. Attempts to bury it deep underground bring outpourings of local opposition.
But Brookfield is prepared for even the worst outcomes. The asset manager is confident that Westinghouse has structured its contracts with suppliers and clients so that it isn’t legally responsible for nuclear plant liability or nuclear waste risks.
The backlash against the Westinghouse deal echoed apersistent criticismleveled at Brookfield by financial advisers and analysts: The relationship between the parent company and its listed subsidiaries is too complex.
Flatt justifies the organizational structure as an efficient way to allow executives running a subsidiary to manage its affairs more independently. The arrangement is also meant to encourage shareholders to focus on their specific investment interests. Thus somebody wishing to invest in hydroelectric, wind, solar, and nuclear energy assets would funnel money into Brookfield Renewable Partners, whereas another investor might favor Brookfield Infrastructure Partners for public utilities, midstream, transport, and data operations.
To be sure, the subsidiaries have performed well. Brookfield Infrastructure racked up a 23 percent increase in funds from operations during the first nine months of 2022 compared with the same period the year before.
The parent company, Brookfield Corp., benefits hugely because it holds stakes of 30 to 75 percent in its listed subsidiaries. Its latest spin-off is Brookfield Asset Management, the former name of the parent, which only adds to investor bewilderment. But Flatt insists it was a necessary move to create an attractive, pure-play asset management subsidiary.
“We think that after some months, people will forget about the confusion,” says Flatt.
If Brookfield continues to deliver healthy returns even as the economy slows, perhaps their minds will clear even sooner.