If you're a shareholder of Annaly Capital Management (NYSE:NLY), then I can assure you that there are many things about the company that you're likely missing. I don't mean that as an insult by any stretch of the imagination. It's rather the natural consequence of owning shares in a company that, in my opinion, intentionally obscures important facts to the detriment of its investors.
The list of things that Annaly has done in this regard is long. It includes paying seven-figure salaries to relatives of Annaly's executives and board members to run a publicly traded portfolio company that subsequently became embroiled in an ongoing accounting scandal. It includes obfuscating the egregious manner in which its executives are compensated. It includes contradicting shareholder votes on the election of directors and the frequency of executive say-on-pay votes. And I could go on.
However, even I was surprised when Annaly proposed externalizing its management structure to a private company owned entirely by Annaly's executives. Even more dismaying was the fact that shareholders approved the action. This alone is strong evidence that few investors truly grasped the significance of the now-consummated reorganization.
For those who haven't followed this story, the externalization proposal was marketed as a way for Annaly to save money. "If we had paid [the proposed] fee in 2010, 2011, and 2012 instead of paying compensation to our employees, we would have saved $83.5 million, $104.4 million, and $48.0 million, respectively," reads Annaly's 2013 proxy statement.
The filing went on to note, "We estimate that when comparing the management fee to our annual compensation expenses for 2012, implementing the Management Externalization Proposal would result in savings over the next five years with an estimated net present value at April 1, 2013 of approximately $210.9 million."
Pitched like this, you'd be excused for concluding that the move was an entirely altruistic one by Annaly's executives -- that they're taking one for the team, if you will. But this is a complete mischaracterization of reality.
In truth, the deal creates an exceptionally valuable asset that has been given -- without consideration, mind you -- to Annaly's now-former group of executives. Under the terms of the new agreement, the private management company earns an annual fee equal to 1.05% of Annaly's stockholders' equity. At present, that equates to slightly more than $100 million a year.
Suffice it to say, it doesn't take a theoretical physicist to deduce how valuable and marketable that asset is. If the private company were to, say, sell itself to a larger asset manager such as BlackRock, PIMCO, or any number of other potential suitors, it wouldn't be unreasonable to think that Annaly's now-former executives could clear upwards of $500 million.
Remember, that value used to reside in Annaly itself. Just six months ago, it belonged to Annaly's shareholders. But now it's migrated with the mere stroke of a pen to the personal balance sheets of Annaly's executives.
On one hand, I can't help but commend Annaly's former executive cabal for such a feat. Those managers created enormous personal wealth that will likely sustain their respective families for generations. At the same time, however, I can't help but feel outraged for Annaly's unwitting shareholders who found themselves on the wrong end of a horrible deal.