|Shares Out. (in M):||13||P/E||0||0|
|Market Cap (in $M):||30||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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Before explaining why we believe that Bimini Capital Management is an intriguing investment with multi-bagger potential over the next few years, we would like to share the following caveats:
(1) We are not experts on how to manage a levered mortgage portfolio
(2) We do not pretend to know where the curve is going over the next few months or years.
(3) We would appreciate any feedback from the VIC community who might have greater insight into (esp. point number (1) because this opportunity is massive if the company can avoid being the proverbial 6-foot tall man who drowns in 4-foot tall water on average.
In summary, we find Bimini Capital Management (BCM) intriguing because it is a tiny company ($30M market cap) with effective control over a much larger and growing entity (Orchid Island Capital) which it earns a relatively sizeable and growing management fee on. Assuming normalize historical spreads and leverage over time, we think BCM currently trades at a 15%+ after tax free cash flow yield which can CAGR at nearly a 20% rate over the coming decade. To our surprise, by making normalized assumptions, Bimini Capital Management might utilize most (if not all) of its $270M+ NOL. Management, which owns 40% of BCM, seem to appreciate the importance of not being cavalier in their portfolio management responsibilities and are playing the “long game” to utilize the NOL as markets permit. Applying a range of assumptions, we think that the probabilistic fair value of the shares are worth $10+ per share today (v. $2.30 share price) even after factoring in a 33% chance of this company drowning in shoulder high water.
What is Bimini Capital Management?
Bimini Capital Management (BCM) is a holding company with two principal operating subsidiaries: Bimini Advisors and Royal Palm Capital. Bimini Advisors manages a residential mortgage-backed securities (MBS) portfolio for a mortgage REIT named Orchid Island Capital (OIC) and receives fees for providing these services. Royal Palm Capital maintains a MBS portfolio for the benefit of BCM. Both OIC and BMC leverage their equity with borrowed funds to invest in portfolios of predominantly federally insured Agency MBS. The portfolios seem quite “plain vanilla” for the space. Although BCM is legally structured as a corporation and Orchid Island Capital is a mREIT, the underlying businesses are quite similar and they are effectively controlled by the same management teams based in the same office. A key point of distinction is BCM, unlike OIC, is not an mREIT. They have no requirement to distribute management fees and interest accrued. Intuitively, this should afford BCM management greater ability to weather difficult conditions as well as flexibility to increase leverage.
Why is BCM a compelling investment opportunity?
ü BCM is not only an asset manager of its own internal pool of capital, but also serves as an outside asset manager. It has two sources of value creation. This differentiates it from many traditional mREITs.
ü Due to OIC’s growth (via share issuance) in 2017, the advisory fees earned by BCM have increased materially. This should continue to translate into material growth in normalized earnings power for BCM.
ü This normalized earnings power was “hidden” in the past few quarters due to changes in the tax code in Q417 and a significant flattening of the yield curve so far in 2018.
ü Due to historic mistakes stemming back from the acquisition of an Asset Backed Lender in late 2005, BCM has a massive (NOL) carryforward of roughly $270 million. Most of these NOLs expire by 2029, but some go into the 2030s. Our understanding is that BCM will be shielded from taxes into the early 2030s assuming they don’t utilize the existing NOLs before then.
ü Playing around with key modeling variables including (a) spread (b) leverage (c) issuance at Orchid and (d) growth in SG&A leaves a wide range of outcomes but, assuming normalized spread and leverage and arguably conservative estimates in issuance, we come to a discounted fair value of roughly $15.50. More aggressive issuance at Orchid (or even some at BCM when share price justifies it) can result in a share price that is more than double this fair estimate of value.
ü The management team which controls both BCM and OIC is incentivized to ‘shift profitability’ to BCM since they own roughly 40% of BCM’s shares and this entity has a “tax shield” that will ultimately expire. At a minimum, they are incentivized to protect BCM because a $15 share price is worth roughly $75 million dollars in value to them.
History of Bimini Capital Management
Origins of Company: Founded in December 2003, BCM had raised roughly $140 million through private placements by early 2004. In September of 2004, it completed its IPO in which it raised another roughly $75 million in net proceeds. Another capital raise of $67 million occurred at the end of 2004. As a business which leverages its balance sheet to invest primarily in residential mortgage related securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, the company was structured to earn the difference between the interest income on its assets and its costs, including the interest expense on the funds it borrows. This is effectively its business model today as well. BCM was designed to leverage its equity capital between 6x to 12x to enhance its return to shareholders. Due to its material issuances and leverage profile, BCM ended 2004 with roughly $280 million in shareholder’s equity and a portfolio of mortgage related securities and cash of $3.1 billion.
Opteum Financial Services Merger: After earning roughly $20M-$25M in pre-tax earnings in 2004 and 2005, Bimini attempted to grow and “diversify its revenue stream” by merging with a privately held home mortgage lender in a deal costing roughly $60M in late 2005. The enthusiasm for this (prospectively accretive) transaction must have been meaningful since they renamed the entire company Opteum, Inc in 2006.
Nevertheless, the Opteum merger could not have been more poorly timed considering the impending decline in the broader housing and financial markets. Not only did the core historic Bimini business struggle, but the acquired business imploded. Operations in the private home mortgage lending business were discontinued and, by 2007, the company was renamed Bimini Capital Management. Although the core mREIT business did lose $113M (EBIT) between 2006 and 2008, it lost roughly $20M if you include the years prior and year after this period. Considering they entered this period with a $3B portfolio, the portfolio managers arguably managed this difficult period reasonably well. In contrast, the historic Opteum business reported over $240M in losses (“Earnings of Discontinued Operations”) from 2006 through 2008. Bimini Capital Management was delisted by the New York Stock Exchange in 2007.
Summary: Although the promise of early BCM was destroyed by both a material decline in the underlying US housing market and associated financing coupled with an ill-timed merger, the company survived. After years of deleveraging and restructuring, the same management is again focused on building a sustainable and meaningful financial firm.
Origins and Growth of Orchid Island Capital
Origins of Orchid Island Capital (OIC): Formed by Bimini Capital Management in August of 2010, the specialty finance company invests in Agency residential mortgage backed securities via traditional pass-through Agency RMBS and structured Agency RMBS (e.g. CMOs, IOs, IIOs, and POs). In early 2013, Bimini listed Orchid on the New York Stock Exchange and, through its wholly-owned subsidiary Bimini Advisors, manages its investment portfolio. Both companies maintain similar business models, identical senior management, and office headquarters. This agency issue to OIC shareholders is actually beneficial to BCM.
Growth of Orchid Island Capital: Since Orchid’s public listing, their management team has managed to issue nearly $600 million of stock at premiums to book value. We believe that management intentionally kept dividend distributions at higher than sustainable levels to capture a higher price-to-book value multiple than its peers due to capital that was attracted to such high yields. When the shares traded at a premium to book value, management was quick to issue shares resulting in material growth in shareholder’s equity. To management’s credit, although they have issued roughly $140 million in net stock per year from 2014-2017, they did repurchase roughly $20 million in shares (and didn’t issue any) in 2015 when the shares traded at a material discount to book value. Similarly, management repurchased $8M in shares and hasn’t issued any shares since they have tended to trade at a discount to book value.
Impact on and Opportunity for Bimini Capital Management
As the external manager of OIC’s investment portfolio, BCM receives a monthly management fee and a pro rata portion of certain overhead costs (as well as certain direct expenses reimbursed). This monthly management fee is (one-twelfth of) 1.5% of the first $250M of OIC’s equity, 1.25% of OIC’s equity that is greater than $250M and less than or equal to $500M, and 1% of OIC’s equity that exceeds $500M. Consequently, the growth of equity at OIC results in higher Advisory Services revenue for BCM. Furthermore, as the owner of roughly 1.5 million shares of OIC, BCM also receives OIC’s dividend. The shares are worth roughly $10 million at today’s price and may distribute roughly $1.4M in dividends over the next 12 months. Finally, as BCM covers its (relatively fixed) operating expenses with increased Advisory Service Revenues, BCM accrues profits which grow its own equity that can be reinvested in the core MBS strategy for greater profits by its Royal Palm subsidiary. Finally, this arrangement is protected not only through the alignment of management between OIC and BCM, but also a “poison pill” where OIC will be required to pay BCM a termination fee equal to 3x the trailing management fee should OIC terminate the management agreement without cause. BCM’s agreement with OIC is protected by management team overlap with potentially aligned loyalty to BCM as well as “poison pill” in place.
What assumptions are necessary for the $15 per share DCF valuation and how do we get there?
Orchid Related Compensation
First we look at the impact of OIC on BCM’s revenue. We assume that Orchid raises no capital in 2018 but raises $140M per year after that. We assume $140M because that was the average of the amounts raised in 2014 ($171M), 2015 ($72M), 2016 ($118M), and 2017 ($198M). We don’t expect a straight line in equity raises but for approximation purposes this might even be low since the company should be working off of higher equity balances from which to issue over time. For example, from 2015 through 2018, they averaged equity raises of 36% of the prior year’s ending book value. We excluded 2014 to avoid distorting this average higher. Our model effectively assumes a 34% equity raise in 2019 over 2018 ending book value and gradually scaling down to 5% over time. Assuming the existing management fee terms (perhaps a bit under market) remain in place, this would imply that OID’s management fee to Bimini would rise from roughly $6M in 2018 to over $30M in 2036. In addition, we assume that Orchid’s share of overhead continues to increase at a 6% rate. Total Orchid compensation (seen on the bottom chart) grows from $7.8M in 2018 to $35.3M in 2036. Total Orchid related compensation grows by 8.8%.
Growth of Royal Palm Subsidiary
Since BCM has achieved enough scale to achieve profitability, increased equity should go into Royal Palm. We anticipate that Royal Palm will end 2018 with $25M in equity. This figure will be aided by $2M from the recent sale of a historic asset which had been written off to zero (see below). Assuming an average leverage on Royal Palm assets of 7.5x and a gross yield spread income on the Royal Palm portfolio of 1.75%, Royal Palm’s internally generate cash flow (coupled with cash flow coming from the Orchid relationship) results in a nearly 18% CAGR on Royal Palm equity. Remember, they are not paying out a distribution and they have very little taxes for the next decade (plus).
Assuming OIC pays a $.90/annum dividend (currently at a $.96 rate), this should result in roughly another 1.4M per year in revenue for BCM.
Based on these assumptions, assets and revenue should compound at roughly 11%-12% per year.
We estimate that SG&A grows at 6% per year. While SG&A growth at 50%-60% might be a bit below a a normalized estimate of costs growing at 60% of assets, we assume that BCM/Orchid has $2M in (unrepeatable) overhead costs. Off of this lower base, we would be assuming 7.6% in overhead cost growth. This is roughly 65% of asset growth (at OIC and BCM combined). We thought this seemed reasonable.
Based on the assumptions above, EBIT grows at nearly a 16% rate over time with higher rates of growth (closer to 20%) over the next decade due to the tax protection of the NOL.
The company has sub notes that are 3 month Libor + 350bp. They paid $700k in interest expense over the first 6 months of 2018. We don’t have a view as to where rates go, but we do generally look at them as great capital vehicle for a company with BCM’s description. Of note, associated with this Note issuance are some assets which BCM had written off to zero. They just announced a sale of some of them for $2M.
Although the company has a buyback which was recently put in place, we don’t anticipate any net dilution or net share buybacks over time.
According to the 2017 10k, BCM had federal NOLs of $19.1M and Florida NOLs of $18.5M which will begin to expire in 2028 but (according to management) go into the 2030s. At the Royal Palm subsidiary, they have a federal NOL carryforwards of $254M and Florida NOLs of $26M. These NOLs begin to expire in 2025 and generally expire by 2029. Our model doesn’t take into account state taxes in Florida but we don’t think that this will be highly meaningful. We do begin to assume some taxes by 2030 and a full, all-in tax rate of 25% in 2031.
Although we don’t apply any terminal multiple, we are adding in discounted (at 8%) cash flow accrued at BCM for a long time. We did this to illustrate the value of the flywheel of internal capital growth, the outside management agreement, and tax protections of the NOL.
We obviously understand that the model below is likely to be quite inaccurate for any specific period due to the cyclicality of this industry. Nevertheless, we would suggest building your own models and looking at potential upside should larger issuances at OIC be implemented or even some modest (non-382 impacting) issuances at BCM when it is more appropriately valued. The upside, while far from our base case, is not unreasonable and results in much higher valuations than we have laid out below.