The first part of this analysis can be found at, Orchid Island Capital: A Deep Look Part I.
In this article Orchid Island Capital, Inc. (NYSE:ORC) will be referred to as Orchid or Orchid Island. Part II is split into three parts. These parts will answer the following questions:
- What impact does the management agreement have on Orchid Island?
- What is the 2012 Equity Plan?
- What does the recent public offerings mean for Orchid Island shareholders
- Is Orchid Island overvalued?
Term and Termination
If Orchid chooses not to renew the Management Agreement, the company will:
- Pay three times the average annual management fee (calculated by 2 year period preceding the recently completed quarter prior to the effective termination date).
- Pay the Manager all compensation accruing to date of termination.
If Orchid decides not to renew the Management Agreement because they deem the management fee is unfair, the Manager may agree to reduce its fees and the Management Agreement will not terminate. However, the Manager may give Orchid notice that it wishes to renegotiate the fees. If they cannot agree on a revised fee structure after 30 days, the Management Agreement will terminate and Orchid must pay the termination fees listed above.
- 1.50% of the first $250,000,000 of Orchid stockholders' equity.
- 1.25% of Orchid's equity that is greater than $250,000,000 and less than or equal to $500,000,000.
- 1.00% of Orchid's equity that is greater than $500,000,000.
Reimbursement of Expenses
The following costs and expenses shall not become reimbursable until the first calendar quarter after the calendar quarter in which Orchid's ending balance of stockholders' equity equals $100.0 million or more for the first time. Until such date, the Manager will pay all such overhead expenses; however, Orchid will continue to be responsible for all other expenses.
- ((i)) The design and maintenance of Orchid's web site or sites and (ii) Orchid's pro rata share, based on Orchid's percentage of the aggregate amount of the Manager's assets under management and the Company's assets (measured as of the first day of each month), of any computer software, hardware or information technology services that is used by Orchid and the Company;
- Market information systems and publications, research publications and materials, and settlement, clearing and custodial fees and expenses; provided, however, that Orchid shall only be responsible for its pro rata share of such expenses, based on Orchid's percentage of the aggregate amount of the Manager's assets under management and the Company's assets (measured as of the first day of each month), where such expenses were not incurred solely for the benefit of Orchid;
- Rent (including disaster recovery facilities costs and expenses), telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Manager and its affiliates required for Orchid's operations; provided , however , that Orchid shall only be responsible for its pro rata share of such expenses, based on Orchid's percentage of the aggregate amount of the Manager's assets under management and the Company's assets (measured as of the first day of each month), where such expenses were not incurred solely for the benefit of Orchid; and
- Orchid's allocable share of the compensation of its Chief Financial Officer, including, without limitation, annual base salary, bonus, any related withholding taxes and employee benefits, based on the percentage of time spent on Orchid's affairs.
This part of the reimbursement of expenses leads into the first quarter results of Orchid Island. The Management Agreement can be found in the Form 8-K filed by Bimini.
First Quarter Results
As seen in the balance sheet below, the total stockholders' equity is now above $100 million for the first time. As per the Management Agreement, the company will now have to reimburse the Manager for the expenses listed above. This is confirmed in Note 12. Related Party Transactions of Form 10-Q. It states that the reimbursement for expenses will commence with the quarter beginning July 1, 2014.
What is more interesting is how the company got to $100 million in stockholders' equity. In the first quarter of 2014, Orchid completed two secondary offerings. The net proceeds were approximately $68.2 million. It is important to note the Book Value of Orchid was $13.40 and $12.47 per share as of December 31, 2013 and March 31, 2014 respectively.
It is clear to me that the first offering was dilutive to shareholders, being only 16 days after the fourth quarter. However, the second offering is much harder to tell. The main question I have is why did the company needed to raise capital after losing 10% of its book value after less than a year of operations?
I tried to get answers as to what goes into the determination that the company should raise capital, as well as, if the two common stock offerings were done with the goal of achieving a shareholders' equity of greater than $100 million, but I received no response from Orchid or Bimini.
What is most concerning to me is the stock incentive plan found in Note 7. Stock Incentive Plan. The 2012 stock incentive plan was put into effect BEFORE the company went public. This reminds me of the "2003 Plan" Mr. Zimmer and Mr. Cauley implemented at Bimini before they went public in 2004, which you can find in Note. 7 Stock Incentive Plan.
Current Valuation (Industry AVG is made up by AGNC, ANH, ARR, CMO, CYS, HTS, and NLY)
As seen in the chart ORC has outperformed the industry average in economic returns since going public (starting March 31, 2013), but clearly fell behind last quarter. This was mainly due to the significant drop in book value in the first quarter, which could be attributed to the two secondary offerings. Currently, Orchid is trading at a premium to Book Value when most companies in the industry are trading at a discount. The premium to Book Value coupled with an expected increase in expenses later in the year is a strong argument that Orchid Island is currently overvalued.
Part I Summary
- Orchid Island is a REIT managed by the co-founder of Bimini who has also been CEO since 2008. The CIO/CFO of Orchid has been the CIO/CFO of Bimini since 2008.
- Orchid Island was a wholly owned subsidiary of Bimini, and went public in 2013.
- Bimini is a REIT founded in 2003, listed on the NYSE in 2004, and now trades OCTBB.
- If you would have invested in Bimini's IPO (with reinvested dividends) you would currently have losses of 99%.
- Bimini (OTCQB:BMNM) has been mixed up in litigation dating back to 2007, and still has a case ongoing, which could impact Orchid Island's performance.
Part II Summary
- The management agreement is typical of externally managed mREITs.
- The 2012 Equity plan is a compensation plan put in place before the company went public.
- The recent public offerings put the company above $100 million in stockholders' equity, increasing expenses per the management agreement.
- Higher equity also means higher management fees.
- Orchid Island is currently overvalued trading at a premium to book with an expected increase in expenses later in the year.
Investors looking for an income producing investment with capital preservation might want to reconsider investing in Orchid Island. There are significant red flags around the company's management team, as well as external manager (who are the same people). This coupled with the company trading at a premium to Book Value when many of their peers are trading at a discount should make an investor shop elsewhere for better returns.
As I said in Part I, I contacted both Orchid and Bimini on May 12th, and I received no response.
Disclosure: I am long CYS, CMO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Information in this article is my opinion only and shouldn't be construed as advice to buy or sell securities. Recommendations don't take into account individual readers' investment risk or return objectives and constraints. The article is for information purposes and you are encouraged to do your own research before making any investment decisions. All information here in this article is accurate to my knowledge.