Thursday, December 20, 2007


Well the deal is back on and its structured in such a way that it doesn't need any additional approvals -- that way it can be wrapped up before the end of the year.

So the price is better -- $180 mill vs. $290 before. The number of shares is greater, which is a reflection of the price drop in DFR. Sellers note so we don't have to worry about some covenant from a bank or bond deal causing troubles.

3 Keys to why this deal is cool:

1. Internally managed REITs get higher valuations because there are less conflicts of interest and presummably the management team has more incentive to do well.

2. Income stream is now more diversified -- asset management fees are pretty steady and simple to model -- just a precentage of the assets. Incentive fees are harder but at least one analyst has already stripped them from his model for 2008. People will use conservative assumptions on incentive fees in this environment.

3. The management side gives them a path to growth -- not too many ways to grow a bond portfolio other than getting more capital. DFR had a plan to expand ROE by going into alternative assets from RMBS and that would have a one time boost to the income from the REIT (one time but spread over a couple of years of implementation) but once that is done how do you grow?

By growing assets under management, DFR now has an easy way to continue to grow after they have shifted their asset mix in the REIT portfolio. Big yield and growth story is a potent combination.

The deal is dilutive to 2008 and if you read carefully, you should have noticed that the company said that pool of 2007 earnings that had not been distributed yet would get paid out in either the December dividend or the next one. That suggests they might keep the dividend at 42 cents but the earnings will be less than that due to the dilution (hopefully, because otherwise that means they are earning less too.)

The spread they are earning in their RMBS portfolio has widened, which should help support their earnings so to me any decline in earnings power is dilution driven.

So let's say 1.50 in dividends going forward -- that's a high teens yield and they should be able to grow that over time thanks to the management side, which showed 4% asset growth since July -- quite impressive given the turmoil in the fixed income markets.

I think the stock would be closer to fair value in the low teens.

No comments: