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Is Annaly's Acquisition of Crexus a Trojan Horse?

John Maxfield
November 13, 2012

If you're an income investor, it's difficult to dislike Annaly Capital Management (NYSE: NLY  ) . A pioneer of the mREIT business model, the industry giant owns a staggering $130 billion worth of domestic mortgages. It's the 800-pound gorilla in the room, outpacing its next largest rival, American Capital Agency (Nasdaq: AGNC  ) , by nearly 50% in terms of mortgage holdings. And perhaps most importantly, it pays a whopping 13.4% dividend yield.

But sometimes, bad news can come in small packages. On Monday, Annaly announced that it submitted a bid to purchase the portion of Crexus Investment (NYSE: CXS  ) , a much smaller REIT that focuses on commercial real estate, that it doesn't own already. Under the terms of the deal, Annaly will pay $12.50 a share for roughly 67 million shares of Crexus. The purchase price represents a 13% premium over the latter's preannouncement market value and a 5% premium over its most recently reported book value.

Examining the deal
The deal itself is relatively inconsequential. While Crexus' $968 million portfolio of commercial real estate assets may appear large, it's hardly even an afterthought compared with Annaly's $141 billion in total assets. Indeed, Annaly could buy Crexus with cold, hard cash and still have well more than $1 billion sitting in its bank account.

But the question is whether the tail -- that is, Crexus -- will eventually wag the dog -- that is, Annaly. Here's what Annaly's new chief executive officer Wellington Denahan had to say in a press release announcing the acquisition (emphasis added):

Since our inception in 1997, Annaly has maintained the capacity to diversify its asset base to include real estate related assets in addition to Agency mortgage-backed securities if we determined that compelling other long-term investment opportunities exist relative to the Agency market. While we remain committed to the Agency market, given the current environment, we believe it is prudent to diversify a portion of our investment portfolio. Therefore, we may allocate up to 25% of our shareholders' equity to real estate assets other than Agency mortgage-backed securities.

For clarity, I want to direct your attention to the italicized portion. It seems relatively clear that Annaly intends to diversify away from its sole focus on agency mortgage-backed securities -- and if t