November 4, 2008

Value idea: Preferred Shares

The dislocation in the market has presented several opportunities not only in equities but more so in debt instruments. Here is one example the preferred shares of Brookfield Asset Management (BAM).

Brookfield Asset Management Inc. (Brookfield) is a global asset management company. The Company operate and manage assets in property, renewable power, infrastructure, specialty investment funds, and fixed income and real estate securities. The subsidiaries of the Company are Brookfield Homes Corporation, Brookfield Properties Corporation, BPO Properties Limited, Multiplex, Brookfield Power Inc., Great Lakes Hydro Income Fund, Brascan Brasil, S.A., Brascan Residential Properties, S.A. and Brookfield Investments Corporation.

Upside potential of the shares:
  • The preferreds trade at Junk level valuation. Pref issues M and N trade on a perpetual basis at 11-12% discount rate. However, BAM is an investment grade rated firm; its rating was recently affirmed by DBRS.
  • The preferred shares have a current yield of 9% for the two issues, at that yield you can double your money in about 10 years.
  • Strong management team that have strong acquisition and valuation discipline
  • Long term quality assets in place from power, infrastructure and property.

Downside risk for the preferred in particular:

  • Interest rate risk: typically preferred shares go up when interest rates go down. This relationship have been broken lately due to negative sentiment and investors liquidating out of fear. The relationship will return to normal levels in due time. However the prospect of central banks raising rates in hurry after the credit crises subsides can hurt the preferred.
  • Liquidity risk that can lead to withholding dividend payments.
  • Leverage risk / adequate debt service provisions.
  • Redemption risk as the company can redeem the issues at its option however the risk comes with a nice upside as it will be redeemed at par.
  • Conversion risk to common by the company. Here the company can convert the issues to common but with a premium to the trading price of the common shares.
  • Black swan: any event leading to company bankruptcy: book value of the company is $3.2 Billion ( total assets less intangibles less liabilities). If we assume a bankruptcy recovery rate between 55%-65%, reasonable rate as based junk bond historical recovery rates, we can see up to $2.5 billion to recover for equity and preferred shares. Off course preferred shares rank higher than common equity and should see full recovery of their book value; book value of all outstanding preferred is $870 million. And because we are buying those issues at deep discount we have almost 45% margin of safety.

Which issue to choose?
It depends on several things. you premium on liquidity as many issues have limited liquidity than others. Some issues have floating rate dividends while other have fixed rates. This requires more research on your part.

I am going to zero on issues B, M and N for selection.


Anonymous said...

How does an investor look for information on a company’s preferred shares?

Sami said...

same as you look up information about common stock. The company's investor relations have tons of info about them.

Also a good source of info and analysis on Preferreds can be found at

did i answer your question?

Anonymous said...

What form should I look for in Edgar and Sedar that describes the preferred shares? Is it in the annual report or proxy statement?

Do you recommend any books or other resource that would help provide more information on how to search and gather information on these investments?

Thank you

Sami said...

generally preferreds are issued like any capital issue. the issue will be detailed in registration statement those will be S-1 or S-3, depending on circumstances. so preferreds will not have a unique identifiable registration statement.

In the US preferred are typically issued by banks and reits. so do not expect to have a lot of variety due to tax code and policies.

Start here:

and follow some of their links. It should give you good background. Also the site I gave earlier although for canadian investors you will learn a lot from it.

Unfortunately preferred investing is not prevalent to have books or other resources devoted for it. This is can be an advantage as those who can analyze it carefully can find good values.