AAIC - Ellington Financial: Impending Acquisitions A Potential Turning Point

2023-07-06 03:54:53 ET

Summary

• Ellington Financial Inc., a real estate investment trust, is leveraging mergers and acquisitions for long-term growth, despite a 10.74% loss in shares over the past year.
• The company has announced merger agreements with Great Ajax Corp. and Arlington, which are expected to increase liquidity, operational efficiency, and diversify its portfolio.
• Ellington Financial has consistently distributed quarterly dividends since 2010, with a relative dividend yield of 13.3% as of July 5, 2023, higher than the industry median.

Investment Thesis

Ellington Financial Inc. ( EFC ) is a real estate investment trust [REIT]. The company acquires and manages mortgage-related, consumer-related, corporate-related, and other financial assets. The company’s shares have lost 10.74% over the last year, slightly higher than the industry average loss of 4.06%. This consistent drop in performance in the financial industry is associated with the harsh macroeconomic conditions that have persisted. It has even contributed to some major banks’ collapse, which shows the matter’s severity.

Despite the economic downturn, the corporation appears to be positioning itself for long-term growth and success through mergers and acquisitions. I have optimism regarding the company’s long-term viability because, in my opinion, mergers and acquisitions are among the most significant sources of competitive advantage.

Acquisitions: A Solid Foundation For Future Growth

The typical motivation behind an acquisition is to leverage the acquired company’s capabilities and reap the associated synergies. In the mREITs industry, acquisitions and mergers are key competitive tools. For this reason, I believe EFC is pursuing mergers and acquisitions to bolster its capacity for long-term growth. Here are its recent mergers and acquisitions.

1. Great Ajax Corp. Merger Agreement

Ellington Financial ( EFC ) and Great Ajax Corp. ( AJX ) have announced that they have entered into a definitive merger agreement whereby Ellington Financial will acquire Great Ajax. Both companies are REITs that invest in a wide variety of financial assets, including residential and commercial mortgage loans. By the end of 2023, the deal should be finalized.

In accordance with the provisions of the merger agreement, each share of common stock in Great Ajax will be exchanged for 0.5308 shares of common stock in Ellington Financial, for a total of around 12.5 million shares of Ellington Financial common stock.

The implied offer price of $7.33 per share of Great Ajax common stock based on Ellington Financial’s NYSE closing price on June 30, 2023, represents a premium of approximately 19% over Great Ajax’s NYSE closing price on June 30, 2023. Shares in the combined firm are projected to be owned roughly 84% by Ellington Financial investors and 16% by Great Ajax stockholders following the deal’s closure. In addition, EFC will take on the senior unsecured notes and senior convertible notes currently held by Great Ajax.

Shareholders of both companies have a lot to gain from this merger. The main advantages that will result from this deal are outlined below.

• Business Line Synergy: With over $1 billion in first-lien residential re-performing loans (“RPLs”) and non-performing loans (“NPLs”) in Great Ajax’s investment portfolio, Ellington Financial would be able to expand its current RPL/NPL strategy significantly. These loans are primarily financed through term, non-mark-to-market, non-recourse securitizations. Great Ajax’s whole loan asset management resolution skills and Ellington Financial’s hedging, trading, and structuring capabilities should come together to establish a powerful platform that optimizes Great Ajax’s portfolio and provides superior returns to shareholders.
• Strategically Enticing: It is anticipated that the equity investment made by Great Ajax in Gregory Funding LLC, its affiliated servicer, will allow Ellington Financial to realize a number of synergies and operational benefits throughout its investment portfolio.
• Scaling Up: With a pro forma market cap of more than $1 billion , Ellington Financial and Great Ajax investors could benefit from increased liquidity. Efficiency gains in operational costs are expected due to distributing fixed costs across a broader equity base.
• Diversified Portfolio: Great Ajax’s NPL investment portfolio would make Ellington Financial’s portfolio more diverse by adding assets that fit with EFC’s current investment strategy and match its expertise.

These benefits and the premium stock prices will benefit the existing clients when the transaction closes.

2. Arlington Acquisition

EFC has signed a final deal to acquire Arlington Asset Investment Corp . ( AAIC ) in a stock-and-cash transaction. The deal will likely close in the fourth quarter of 2023 as long as AAIC’s shareholders agree and other standard conditions are met. Both companies’ boards of directors have all agreed on the deal. Arlington is a REIT that invests mostly in mortgage-related and other assets. The merging transaction is projected to bring an improved scale of operations and enhanced access to financial markets.

Under the terms of the merger deal , each share of Arlington common stock will be turned into 0.3619 shares of Ellington Financial common stock, or about 11.7 million shares of Ellington Financial common stock in total. The external manager of Ellington Financial will also give the common investors of Arlington $3 million in cash, which comes out to $0.09 per share. Ellington Financial and Arlington’s stock prices at the end of trading on May 26, 2023, suggest an offer price of $4.77 per Arlington share. This is a 73% increase over Arlington’s share price on May 26, 2023, and a 15% decrease from the adjusted tangible book value per share as of March 31, 2023. When the deal is finalized, Ellington Financial stockholders will own about 85% of the combined company’s stock, while Arlington stockholders will own about 15%. Ellington Financial will also take over the outstanding preferred stock, senior unsecured notes, and trust preferred securities of Arlington.

The following benefits are expected to materialize once the deal is finalized.

• Increased Market Capitalization and Liquidity: With a pro forma market cap of roughly $1 billion (based on the closing price of EFC common stock on May 26, 2023), the liquidity of EFC common stock is expected to increase, allowing for easier access to capital markets.
• Ideal Capital Structure: Arlington has an enticing mix of unsecured debt and preferred stock in its capital structure.
• Increased Operational Efficiency: Fixed expenses dispersed over a bigger equity base should improve operating expense efficiency.

Looking at the terms of these acquisitions, it is clear that in addition to the advantages enjoyed by individual shareholders, EFC stands to gain from a more stable capital structure and improved efficiency in operation. In my opinion, these synergies will steer the company’s long-term growth, which should draw investors to this company.

Dividend

Since December 15, 2010, Ellington Financial Inc. has distributed quarterly dividends to its stockholders. As of July 5, 2023, EFC’s relative dividend yield was 13.3%, which was higher than the median of 6.5% for the REITs - Specialized business. Last year, its payout yield was 10.8%. Since December 15, 2010, Ellington Financial Inc. has given out quarterly payments that range from $0.40 to $1.31 per share. The average dividend return over the past five years has been 10.7% yearly.

The company has paid dividends without missing a payment for 11 years, which is longer than the 10-year industry average. It also has a dividend growth history that aligns with the industry average of two years.

A negative payout ratio means the company used existing cash to pay dividends, which I believe isn’t a good sign. It has also been very volatile, making it not a reliable income stock. However, given the company’s acquisition which is yet to materialize, I anticipate it to stabilize its dividend in the future.

Conclusion

For the past year, EFC has lagged behind its competitors due to the poor state of the economy. The corporation has launched prospective mergers and acquisitions that could spark long-term growth to turn things around. Considering its dividend policy, it is clear that the company’s income is volatile; nevertheless, I anticipate that this will change once its recent acquisitions begin to yield positive results. The opportunity here, I believe, is for present investors to hold this company until the acquisitions is fully accomplished in order to reap the gains emanating from the mergers, especially in light of the fact that the macroeconomic backdrop currently remains unclear.

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