Ideas Lab: Brookfield AOF unwinding

This Ideas Lab won’t be of interest to the vast majority of members. Brookfield Australian Opportunities Fund (BAO) is a property fund that owns a portfolio of illiquid and mainly unlisted property trusts. If that doesn’t put you off, consider its tiny market capitalisation of less than $60m and extreme illiquidity, which is about to get even worse.

Still with us? Okay, let’s try another angle: If a proposal currently before unitholders is approved, the stock will delist in October. Unitholders will be left with an investment in an unlisted fund, one that’s next to impossible to sell. Indeed, a provision in the Corporations Act means you won’t be allowed to transfer stock for a year even if you could find someone to buy it.

Wow, you are persistent aren’t you? A final get out: This idea is only suitable for members able to undertake further research, and assess the various risks, on their own. You won’t get any follow up coverage from us. This is an Ideas Lab after all.

An unusual quirk in the fine print of a now worthless investment BAO made years ago (its 100% equity stake in the associated Multiplex Property Income Fund) has meant a ‘dividend stopper’ has been in place since 2008. Yes, BAO cannot pay distributions to its owners until an income security associated with MPIF pays 12-month’s worth of distributions to its holders. It’s a most unusual situation.

Why this quirk eventuated isn’t worth going into. The main effect, unsurprisingly, is that BAO has traded at a steep discount to its underlying net tangible assets (NTA). No dividend, no unit price support.

Canadian property/infrastructure group Brookfield Asset Management, which inherited the whole mess when it acquired Multiplex in 2007, has proposed a few solutions. Each has been knocked back by MPIF income securityholders.

Undeterred, Brookfield—which manages BAO and also owns 61.4% of the outstanding units—has come up with a novel and permanent solution. To satisfy its legal obligations, BAO will pay a year’s worth of income to MPIF income securityholders (approximately $3m) and then use the window created to move all of its assets and liabilities out of the suffocating structure and into a new, unlisted one.

The process isn’t subject to the approval of MPIF owners, only to a vote of BAO owners on 24 September. It should get voted through with little objection.

As at 30 Jun 12, the value of the group’s investments, less debt, came to 13.8 cents per unit. The current unit price is 7.2 cents, a 48% discount. There’s your argument in a nutshell.

Should the resolution pass, the group will move to liquidate its listed assets (about 20% of total assets) and use that cash to pay down most of its debt. It will make a 1.5-cent distribution to all BAO unitholders, make a $3m payment to MPIF owners and then transfer all its unlisted assets and any remaining liabilities to a new unlisted managed investment scheme, distributing units in that fund on a one-for-one basis to existing BAO unitholders.

That unlisted MIS, to be called BAO Trust, won’t make any further investments and will be in a position to pay small distributions that accrue from its underlying investments. It also intends to liquidate individual investments as opportunities to do so arise. Any resulting cash will first be used to extinguish liabilities, with excesses returned to unitholders in the unlisted trust.

If the underlying investments incur no impairment—no sure thing—today’s buyer will outlay 7.2 cents in exchange for 1.5 cents later in the year, and about 11.9 cents (assuming no change from 30 Jun 12 values) of capital invested in an unlisted owner of unlisted property trusts.

Of that 11.9 cents of remaining NTA, Brookfield predicts that 7.6 cents will be liquidated over the next four years with the remaining 4.3 cents to eventually be liquidated but with uncertain timing (see page 22 of Explanatory Memorandum from 22 Aug 12). These assets should also generate small income distributions over their remaining period of ownership.

This looks like the proverbial ‘50 cent dollar’, and will be if all goes well. But there are a number of risks that may prevent that, including: Owning an unlisted trust; the liquidation falling well short of stated NTA; that the liquidation drags on for years; and that a property crash destroys the underlying value in the meantime. Some of the holdings in the underlying unlisted portfolio have weighty debt burdens, too (see 'Further research' pullout box). We also couldn't rule out being skinned by Brookfield Asset Management, but its reputation suggests only a minimal chance of minority unitholders being treated unfairly.

The other major issue is illiquidity. The biggest recent trading day in BAO units was a few hundred thousand dollars. On quiet days, it’s less than $20,000. Stampeding in won’t work here. Indeed, were it not for the possibility of a coming influx of liquidity, we wouldn’t have covered the idea at all.

Table 1 highlights the expected timetable. The delisting won't occur until almost a month after the meeting, specifically to allow existing unitholders unable or unwilling to own an unlisted asset time to sell on-market in the intervening period. That owners of the BAO Trust won’t be able to transfer units for at least a year, due to the Corporations Act (see page 11 of Explanatory Memorandum), is further reason for the trading window.

If you are going to bid, and again we stress the need to do your own research, do so cheaply and patiently. Demand a big margin of safety and don’t chase the price. This situation is only worth pursuing if you can get an entry at a steep discount to NTA. For the patient bidder, though, the stock already looks cheap and may well get a little cheaper before it delists. Good luck.