The Power of OPM (Other Peoples' Money)

Today, I’m digging into Brookfield Business Partners (BBU).

This report is going to be different. I'm not going to focus so much on the company, but rather on why it exists in the first place.

(I'm gonna break from the normal format of these reports, but I will get back to that tomorrow.)

BBU is Brookfield Asset Management’s publicly traded private equity platform that buys and operates large businesses using flexible, permanent capital. They own companies like CDK Global (auto dealer software), Clarios (automotive batteries), BRK Ambiental (Brazilian water and wastewater operator), BrandSafway (scaffolding and access services), and Scientific Games’ lottery business.

Before we dig into the main theme of why I wanted to talk about this company, here are just a few stats to put things into context about the size of the business:

• Market cap: $7.4B

• TTM revenue: $27.8B

• TTM gross margin: ~18.9%

• TTM operating margin: ~14.6%

• Net debt: $39.8B

OPM (Other People's Money)

The bulk of private equity is deployed through time-bound investment vehicles.

Brookfield could have just raised another private equity fund. Instead, they built BBU, a permanent-capital vehicle that lets them use other people’s money to buy/sell businesses no hard expiration date on when the investment period and their fees expire.

Here’s the simple version of how they set it up:

• BBU never has to shut down. A traditional fund has a 7–10 year timer. BBU can hold an asset for 2 years or 20, whatever creates the most value.

• Asset management fees tied to valuation. Most private equity firms charge 1% to 2% of the fund's size as an annual management fee. Brookfield charges 1.25% of the market cap as an annual fee. Based on its current market cap, this fee would equate to $100M a year. Given how hard private assets are to value, I actually like this fee calculating methodology for both parties (without commenting on the level of the fee itself).

• OPM is the core feature. Brookfield uses public capital, asset-level debt, and co-investor capital to scale deals far beyond what a private fund structure allows.

• It gives them freedom. Most private equity funds have mandates and LP committees. It sure appears that BBU gives Brookfield more freedom to do what they please.

They also charge incentive fees based on the level of distributions. This incentive fee is 15% to 25% of a distribution after a certain hurdle rate is achieved. I couldn't find the hurdle rate for BBU, but it's 8% annual return is a typical hurdle rate that you'll see in private equity investments.

The key takeaway when looking at a company like this is that this is a strategy that allows a group of people to take on extreme amounts of leverage without taking on extreme amounts of risk. This is how OPM works.

Why a Perpetual Vehicle?

Let's say you have a group of four or five experienced investors who pool their expertise together to invest in companies. If these are successful young professionals or experienced professionals, they might have $10M to $30M of assets to invest if they were to use their own capital.

They would need to hire some staff to help them invest this capital. And that level of capital just isn't enough.

Now, if this team can raise a few hundred million dollars of capital to invest on behalf of limited partners, they can have a lean team. It manages significant amounts of money. With a lot of potential for moth ongoing management fees as well as incentive fees (carried interest).

The risk with the private equity business model is that you underperform and you are unable to raise any more funds.

This gets to the crux of why Brookfield launched BBU. It's a permanent base of capital that they can use to invest and collect fees on over a much longer time period than a traditional private equity fund.

This combines the power and leverage that comes from OPM without the traditional time constraints of the fund model.

This specific example might not be applicable to your average entrepreneur working on a small business. There are lots of different ways to apply the principles of OPM to growing a business. There's no reason a person shouldn't consider bringing on investment partners to seek attractive opportunities and to get paid for their work along the way.

As you approach your career or business, just keep in mind that you aren't limited to your own capital when looking at opportunities.

With that, I’ll see you tomorrow!

Nick