RILYZ - The Bullish Case For B. Riley Financial Stock And Baby Bonds

2023-11-22 15:48:27 ET

Summary

• B. Riley Financial, Inc. stock has lost almost 60% of its value since its peak in July 2023.
• The company has strong balance sheet liquidity and easily manageable near-term debt maturities.
• Business conditions are improving, and recent insider buying suggests confidence in the stock.

B. Riley Financial, Inc. ( RILY ) has become a battleground stock. At a recent price of $23.88, RILY stock has lost almost 60% of its value since it peaked at $59.13 on 7/26/2023. About 25% of the float is now shorted . RILY acquired a $281 million equity stake in Franchise Group on 8/21/2023 as it was taken private in a deal that valued the Franchise Group enterprise value at $2.6 billion. RILY shares dropped after S&P Global downgraded Franchise Group on 11/11/2023 following a weak Q3 earnings report. There has also been concern about RILY's 27.8 million share investment for Babcock & Wilcox Enterprises ( BW ). BW stock has lost 71% of its value over the last 6 months.

On the positive side, RILY had operating adjusted EBIDTA of $107.5 million in Q3 . 2024 operating earnings should be about $400 million. This article makes the positive case that RILY is significantly undervalued even after accounting for any reasonable losses on Franchise Group and BW. I've also taken a quick look at balance sheet leverage from a debt perspective.

The RILY baby bonds are on sale. The B. Riley Financial, Inc. CAL NT 28 ( RILYZ ) is trading at just 59 cents on the dollar at a recent price of $14.85. Some of the major risks are also highlighted.

Excellent balance sheet liquidity

Balance sheet liquidity is always an important consideration for investors. This is especially true of battleground stocks such as RILY. As noted in the Q3 earnings release :

"Strong balance sheet with total cash and investments ⁽⁶⁾ of $2.05 billion at September 30; over $250 million in cash and cash equivalents and undrawn revolver of approximately $100 million."

Easily manageable near term debt maturities

RILY is fortunate to have sold several fixed interest rate baby bond issues and preferred stock issues when interest rates were very low. Coupons and debt maturities are shown below (See page 39 of the 10Q report ). The balance sheet cash alone of $250 million nearly covers the total bond maturities of $286 million through 2025. RILY also has a secured $600 million bank credit line with about $100 million available. Note that there was $199 million of RILYO outstanding on 12/31/2022. RILY has already begun buying back buying back this near term maturity issue on the open market.

RILYO 6.75% notes due 5/31/2024: $140 million

RILYM 6.375% notes due 2/28/2025: $146 million

RILYK 5.5% notes due 3/31/2026: $217 million

RILYN 6.5% notes due 9/30/2026: $181 million

RILYG 5.0% notes due 12/31/2026: $325 million

RILYT 6.0% notes due 1/31/2028: $266 million

RILYZ 5.25% notes due 8/31/2028: $405 million

RILYL & RILYP Perpetual preferred stock: $114 million

Business conditions are improving

The Russell 2000 Index (RTY) tracks smaller companies that are comparable in size to typical RILY client companies. iShares Russell 2000 ETF ( IWM ) has been rallying since it bottomed at $164.52 on 10/31/2023. The market now expects that interest rates will drop significantly in 2024. Lower interest rates ahead and the rally in IWM suggest that business conditions are improving for RILY.

Recent insider buying

There have been eight insider buys filed since RILY reported Q3 earnings. Chairman and Co-CEO Bryant Riley bought 30k shares on 11/17/2023. There was also one forced insider sale by Andrew Moore due to a margin call. As explained in the filing footnote that sale does not indicate management sentiment:

"The sales reported in this Form 4 were made by a broker, without instruction by the Reporting Person, to satisfy a margin call. As a Section 16 filer, the Reporting Person has not otherwise sold shares of the Issuer's common stock and the Reporting Person intends to continue increasing his investment in the Issuer over time."

Is the Franchise Group investment impaired?

RILY's stake in Franchise Group was valued at $281 million on 9/30/2023 (see page 15 of the Q3 10Q report ). Note that the $281 million includes new money invested of $217 million as well as RILY's prior investment in Franchise Group that was rolled into the buyout. On the Q3 conference call Bryant Riley strongly defended the valuation and purchase of Franchise Group:

"We would have bought all of Franchise Group. We are a huge fan of that business."

However let's be conservative and assume that RILY's Franchise Group investment has lost $140 million in value (about half its initial value) due to their weak Q3 earnings report and the subsequent credit downgrade by S & P.

RILY also bought receivables from the Badcock Home Furniture & More unit of Franchise Group. However, those receivables were rapidly collected or sold. RILY owned only $34 million of secured Badcock receivables as of the Q3 earnings report (see page #14 of the 10Q filing ).

Estimated BW investment impairment

As of 9/29/2023 (last trading day of Q3), BW was trading at $4.21. Therefore the 27.8 million shares of BW owned by RILY had a Q3 fair market value of about $117 million. BW sold off and traded recently at $1.65 which would value RILY's stake at about $46 million. The fair value of the BW stake has declined by $71 million since Q3.

RILY history of regulatory compliance

As a public investment bank, RILY is subject to intense regulation and scrutiny. There are Directors, internal auditors, an external auditor, reviews by credit agencies and bank lenders. As a broker / dealer, RILY is also closely regulated by FINRA. Given some of the allegations by shorts regarding Franchise Group and RILY, I thought it would be appropriate to check the actual detailed FINRA regulatory records of Bryant Riley (CRD#: 1702453) and B. Riley Securities Inc. (CRD#: 25027) using FINRA's Broker Check tool . Bryant Riley's report shows that he has been licensed for 34 years and passed 10 FINRA exams. During that time he had 1 regulatory incident back in 1998 which was settled with a $12,000 fine and AWC (Acceptance Waiver & Consent). The report for B. Riley Financial, Inc. shows 13 regulatory incidents since the firm was licensed in 1989, but no incidents since 2011. Some minor regulatory incidents are common and expected for any major broker / dealer. It's impressive that Mr. Riley has not had an incident in the last 25 years and RILY has not had a single incident in the past 11 years. Clearly RILY has a strict culture and focus on regulatory compliance.

Investment banking peers trade at 9X - 13X earnings

In order to estimate a fair valuation for RILY, we should look at other medium sized independent investment banks and then adjust for RILY's unusual business model and somewhat distressed recent state. Stifel Financial Corp ( SF ) is trading at 9.8X 2024 earnings estimates . Piper Sandler Companies ( PIPR ) is trading at 13.3X 2024 earnings estimates . Jefferies Financial Group ( JEF ) is trading at 9.3X 2024 earnings estimates . Evercore Inc. ( EVR ) trades at 13.4X 2024 earnings estimates .

RILY has a hybrid business model. There are some traditional investment banking businesses such as wealth management, market making, underwriting, trading and financial consulting. RILY also has businesses such as telecom, retail brands and retail inventory liquidation that are not typical of an investment bank. Traditional investment banking peers trade at about 9X - 13X 2024 earnings. Since RILY has some recent distress and a hybrid business model, I'm going to apply a much lower 6X multiple to 2024 operating earnings.

What is RILY stock worth?

As noted in the Q3 earnings report , RILY had:

"Operating adjusted EBITDA ⁽³⁾ of $107.5 million in Q3, up 34% sequentially; and $267.8 million for the first nine months of 2023"

These operating earnings were achieved even though important RILY businesses such as Wealth Management, market making, trading and underwriting have been in a depressed operating environment. The recent rebound in IWM and improving 2024 interest rate expectations suggest RILY 2024 operating results are likely to be higher in 2024. Given strong Q3 results, a $400 million 2024 operating earnings estimate for 2024 seems very reasonable. RILY has $114 million par value of preferred stock which I'll treat as debt. I'll assume that the total unrealized impairment on Franchise Group is $140 million and $71 million for BW group. As noted by Chief Financial Officer Phillip Ann on the Q3 earnings conference call :

"Total debt net of cash and investments was $311 million at quarter end."

Therefore, RILY stock should have a value in millions of dollars of about:

(400 X 6) -(425 net debt & preferred) - (211 FRG + BW impairments) = 1,764

RILY has 30.6 million shares outstanding, so the $1.764 billion fair value of the equity works out to $57.65 per share. Note that RILY raised $115 million on 7/28/2023 selling shares at $55 per share. This is very consistent with my calculated fair value estimate of $57.65 per share. As per the 7/28/2023 press release:

"Certain of the Company's officers, directors, and employees participated in this Offering and have purchased, in the aggregate, approximately $7 million of shares of common stock at the public offering price."

Is the RILY dividend covered?

The $1 quarterly RILY dividend on 30.6 million shares amounts to $122 million per year. Therefore $400 million of 2024 operating earnings would cover the dividend about 3.3X. This suggests that RILY should be able to cover the dividend in 2024 while simultaneously reducing debt. RILY insiders own about 34% of the shares (see page #4 of Q2 investor presentation ) and must enjoy receiving that generous dividend.

There are some incentives for RILY to reduce the dividend in favor of share buybacks or debt reduction. At a recent price of $14.85 the par $25 RILYZ baby bonds are trading at just 59 cents on the dollar. Buying back baby bonds on the open market would reduce debt and be very profitable. RILY has a $50 million share buyback program. Buying back some shares at current prices would also be an attractive option. On the Q3 conference call , there was a question about the possibility of reducing the dividend from Sean Hayden of Charles Lane Capital. Bryant Riley answered the question and defended the dividend:

"...the dividends are very important to us, and it's important for us to return a portion of our EBITDA to shareholders."

Excellent baby bond coverage

Net RILY debt was $311 million as of Q3 2023. Let's adjust that for $211 million of expected impairments from Franchise Group and BW. Therefore we have:

(adjusted net debt) / (2024 operating earnings) = $522 million / $400 million = 1.3X

RILY's current debt level is really quite modest given the expected earnings for 2024. A highly leveraged company would have a multiple of about 5X.

What are the major risks

See pages 9 - 46 of the 10K annual report for an extensive discussion of risks related to RILY. I've briefly highlighted a few of the major risks here. A smear campaign by shorts can cause stock volatility even if many of the allegations turn out to be false. RILY has some investments including a portfolio of retail brands and Franchise Group that would be vulnerable in a recession. Some other RILY businesses such as retail inventory liquidation are counter-cyclical and would benefit from a recession. RILY debt such as RILYZ is currently trading at very high yields and would be difficult to refinance in the near term. Fortunately, RILY has very light near term debt maturities, substantial cash and operating earnings to repay debt as it comes due.

Conclusion

B. Riley Financial, Inc. stock appears quite undervalued even after adjusting for potential losses on their Franchise Group and BW investments. The estimated fair value of RILY stock is about $57.65 per share using a 6X multiple for estimated 2024 operating earnings of $400 million. RILY traded above that price earlier this year and could easily more than double once the panic selloff has ended.

The RILYZ baby bonds are also a bargain, trading at just 59 cents on the dollar. RILY debt trades as if RILY was a highly leveraged company. However, (adjusted net debt) / (2024 operating earnings) is only 1.3X.

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