B. Riley: A ‘Short’ Story to Avoid

On Friday, the shares of B. Riley Financial RILY gave up 5.92% to close the week down 12.9%. This badly underperforming the S&P SmallCap 600 Index, where B. Riley is a member. 

The stock is trading down again in early trading Monday.

What's Gives?

On Sunday evening, Bloomberg News ran a story that the U.S. Securities & Exchange Commission has been investigating, for possibly months, B. Riley Financial's relationship with a certain client identified by Bloomberg as Brian Kahn. Kahn had been, according to the piece written by Donel Griffin and David Voreacos, as an unidentified co-conspirator in a U.S. Department of Justice criminal case that had been "prompted by the demise of the Prophecy Asset Management hedge fund."

The gist of the matter seems to be a buyout last August of a business known as Franchise Group led by Kahn, arranged by B. Riley and partially financed by Nomura Holdings. Both the SEC and Nomura have declined to comment. However, a spokesperson for B. Riley did email a statement that was quoted at Bloomberg. That email states: "We have not received anything from the SEC on this matter and to the extent the SEC makes an inquiry, we would fully cooperate as we have done in the past on all regulatory inquiries."

The email goes further... "We would welcome an investigation into the outrageous tactic the short sellers have pursued to destroy B. Riley, including the coordinated options trading with zero disclosure obligations. The short sellers continue to harass, intimidate, and insult employees and everyone associated with B. Riley, resorting to lies and crude remarks so they can personally profit."

Earnings?

B. Riley is due to report its most recent quarter in about a month. Nobody seems to professionally follow the stock. There are no estimates readily available to take a look at. 

On November 8, for the firm's third quarter ended September 30, B. Riley posted a net loss of $75.838M for a GAAP loss of $2.53 per share, despite growing operating revenue 32.5% to $472.899M. Total operating expenses increased a whopping 86.5% to $441.687M. 

Realized and unrealized losses on investments and interest expenses totaled $120.59M, which is how one gets to such a negative number for net income despite posting fantastic revenue growth.

Balance Sheet

At least as of September 30, B. Riley ran with a cash position of $254.348M and $1.198B in securities and other investments priced at fair value. Including securities borrowed and loans receivable of $549.142, total assets amounted to $6.143B. Goodwill and other intangibles made up $831.029 or 13.5% of that total.

Total liabilities added up to $5.675B including senior notes payable of $1.667B, term loans of $618.301M, a revolving credit facility of $57.246M and notes payable of $21.3M. That's a lot of ways to slice and dice debt-load and it adds up to more than $2.36B.

My Thoughts

My thoughts are to steer clear of this name at least until more news breaks. 

At year's end an incredible 60.59% of RILY's entire float was held in short positions. Yes, there may be a short squeeze at some point. If that provokes the inner gambler in one, then that's what it is, but betting on a short squeeze is just that and there is still plenty of downside risk in this name. It speaks volumes that no one on the sell side is currently extending any kind of professional opinion on the name.

As for shorting the stock, you know my feeling. Once more than 8% of the float is short, I become very wary about piling on for fear of a face-ripping run to the upside. 

It's way too early for any kind of pricing, but if one wished to bet on further downside or even upside movement, one would be wiser to do so through the options market than the equity. This way, at least total losses in a worst-case scenario can be contained from the outset.

At the time of publication, Guilfoyle had no positions in any securities mentioned.