B. Riley faces investors after deals, profits, stock go sour

Its shares have plunged by more than half since mid-July, driven by the falling value of its investment holdings and weak M&A markets that led to a $75.8M quarterly loss.

B. Riley Financial Inc., the boutique investment bank that specializes in salvaging beaten-down companies, could use some of that expertise for itself lately.

Shares of B. Riley have plunged by more than half since mid-July, driven by the falling value of its investment holdings and weak M&A markets that led to a $75.8 million quarterly loss. It didn’t help when credit raters and investors raised doubts about the financial health and leadership of Franchise Group Inc., which B. Riley helped take private in August.

It’s the latest in a series of setbacks for B. Riley, prompting Chief Executive Bryant Riley, 56, to move up an Investor Day presentation to Wednesday instead of next year to reassure shareholders. It’s also a chance to push back on short sellers who have placed big bets against the Los Angeles-based company that equal about half of the public float.

“We recognize that not every loan or investment has gone as we expected,” B. Riley said in a Dec. 12 statement to Bloomberg. “Nobody on Wall Street has a perfect record, and B. Riley is no exception. However, we manage the downside risk in every situation and believe our overall track record and the results we have delivered for our clients and investors is quite strong.”

B. Riley traces its roots to 1997 as a boutique stock-picking firm focused on smaller companies, a niche that doesn’t always get much attention from mainstream Wall Street. It now offers a birth-to-death business model for small caps that includes stock and bond offerings, market-making and mergers. It’s also prominent in turnarounds, restructurings, bankruptcies and retail liquidations, including big chains such as J.C. Penney, Toys ‘R’ Us and Bed, Bath and Beyond.

The firm’s analysts cover more than 400 companies, and its wealth management business oversees more than $24 billion of client assets, according to an August presentation. About a third of its holdings are in private equity, and B. Riley owns stakes in a collection of companies such as United Online, Targus and Magic Jack.

Some of them have been problematic. B. Riley acquired Targus, a maker of computer accessories, in October 2022 in a deal valued at $250 million, citing its “strong market position.” A year later, B. Riley took a $35.5 million third-quarter writedown on Targus for goodwill and trade name impairment.

A B. Riley spokesperson said Targus will benefit from a recovery in demand for computers as consumers look to replace aging hardware and get the newest technology.

Then there’s Franchise Group, or FRG for short, the owner of brands such as Vitamin Shoppe and Sylvan Learning. Brian Kahn, FRG’s chief executive, led a management buyout in August, and B. Riley invested about $281 million in the deal, which was valued overall at $2.8 billion.

The transaction had its origins in FRG’s November 2021 purchase of W.S. Badcock, a home furnishings company. B. Riley agreed to buy $400 million of Badcock’s receivables, and bought more in 2022. But in early 2023, B. Riley balked because of Badcock’s deteriorating outlook, according to a regulatory filing. The situation was bad enough that FRG said it might have to halt its dividend and could default on its credit agreement.

Kahn and Bryant Riley — who had been an FRG board member from September 2018 to March 2020 — met in person to discuss a potential acquisition, ultimately leading to the buyout this past August, the filing shows.

Bad news soon followed. S&P Global Ratings downgraded FRG’s credit deeper into junk in November, citing weaker-than-expected revenue and operating losses, especially at Badcock.

Meanwhile, the outcome of a securities fraud case involving a hedge fund called Prophecy Asset Management stirred speculation about potential fallout for FRG.

The co-founder of Prophecy, John Hughes, pleaded guilty in November after the fund lost about $294 million and hid it from investors. Hughes said he worked with two co-conspirators — one of whom headed a multibillion-dollar retail franchise company. Prosecutors didn’t identify or publicly charge them, but Bloomberg reported that Kahn was the co-conspirator at the franchise company.

“At no time during my former business relationship with Prophecy did I know that Prophecy or its principals were allegedly defrauding their investors, nor did I conspire in any fraud,” Kahn said in a November statement. “Like many others investors, my relationship with Prophecy was costly, including economically, and I ceased doing business with Prophecy several years ago. In no way, shape or form has this previous relationship impacted Franchise Group.”

GOOD ENOUGH

“That’s good enough for me,” Bryant Riley told shareholders during a November earnings call. “We’re going to make a lot of money for our shareholders on Franchise Group.”

In hindsight, a company spokesperson said this week, the CEO acknowledges his statement was too strong before the completion of an independent investigation by FRG, but he was speaking about his conviction about the underlying assets.

FRG said in a statement to its lenders this week that its probe found no evidence it was complicit in the fraud case or that Kahn’s former relationship with the hedge fund had any impact on FRG’s business or operations. Kahn’s interactions with Prophecy occurred “outside the scope of his role as FRG’s CEO and member of its Board,” it said.

Kahn and Bryant Riley have teamed up on deals before. B. Riley was an investor in Liberty Tax before the company was combined with Buddy’s Home Furnishings in 2019 to form Franchise Group. They also paired up in 2018 during an aborted effort by Kahn’s Vintage Capital Management to buy Rent-a-Center Inc., one of the largest rent-to-own chains in North America.

MISSED DEADLINE

B. Riley acted as an adviser, but according to court papers, Vintage and B. Riley personnel “simply forgot” to send a required notice to extend the deal’s completion date and missed the deadline in December 2018. That triggered Rent-a-Center’s demand for a $126.5 million breakup fee from Vintage.

Vintage and B. Riley lost the court case that followed, and they agreed to settle the matter by paying $92.6 million, but B. Riley said in a filing that it bore none of the cost.

Earnings at B. Riley have been inconsistent, with losses in four of its last eight quarters and a full-year deficit of $168 million in 2022. That’s partly due to the normal, episodic nature of some of B. Riley’s businesses, such as investment banking and retail liquidations, which makes revenue lumpy. In the meantime, steadier units like asset and wealth management and consulting are expected to provide cash flow to help cover much of the operating costs and the dividend. In 2021, B. Riley’s profit topped $437 million and $15 a share.

The pain of the stock’s performance has been partly offset by the $1 quarterly dividend, which yields about 17% — a level that typically reflects doubt among investors that the payout will last. Bryant Riley has an incentive to keep it coming, since he’s the largest holder with about 7.17 million shares – a 23% stake.

SHORT BETS

Short sellers have critiqued B. Riley’s web of relationships, saying the bank sometimes buys companies run by people with whom Bryant Riley already has a business connection such as Kahn and Mikel Williams, Targus’s CEO, who was a member of B. Riley’s board.

“It’s this really incestual relationship with the companies they have ownership in, minority ownership in, the same cast of characters, deals going back for a very long time,” said Dan David, who runs the short seller shop Wolfpack Research. He contends B. Riley is over-levered and can’t afford its dividend.

The relationships are part of B. Riley’s business and how it invests, and the payout is continually evaluated based on performance, B. Riley’s spokesperson said, adding that the short attacks are “a transparent attempt” to drive down the stock.