B. Riley: High Risk With High Stakes That May Take A While To Play Out (RILYZ)

I’ve been buying B. Riley Financial 2028 5.25% Senior Notes due 08/31/2028 (NASDAQ:RILYZ). The bonds pay a $1.3125 annual coupon and are trading at $13.67 per note, $11.33 below a $25 per note liquidation price. This means a 9.6% yield on cost for what’s an absurdly undervalued 55 cents on the dollar. RILYZ’s yield has never been higher, with the current conundrum driven by an abnormal short interest in bonds that has ramped up volatility and made B. Riley Financial (NASDAQ:RILY) the battleground stock of early 2024. The risks are not immaterial with RILY delaying its Form 10-K annual report filing after its board faced considerable resource constraints during the period following an internal review led by outside counsel at Sullivan & Cromwell LLP that determined the company acted properly with its take-private acquisition of Franchise Group.

RILY has quickly become the battleground stock of 2024 with what would have ordinarily been a sleepy fiscal 2023 fourth-quarter earnings report turned into a high-stakes event for bulls and bears. At the core of RILY’s headwinds is short interest, last updated by NASDAQ at 11,326,601, roughly 37.4% of RILY’s basic weighted average shares outstanding of 30.2 million. RILYZ with a 958,412 short interest is also being shorted. This is 7.6% of the roughly 12.65 million notes outstanding on the back of a quite simply remarkable jump in December short interest. To be clear, RILY’s volatility is abnormal and driven by bearish interest, who now face a 91% borrow rate on the common shares. I remain bullish since I last covered the ticker.

The Conditions For Recovery, The Fed, And Risks

RILY last declared a quarterly cash dividend of $0.50 per share, a 50% sequential reduction, and $2 per share annualized for an 8.6% dividend yield. Cutting the dividend made economic sense, with RILY set to save $75 million annually to repurchase its debt at extremely attractive prices. Critically, this ramps up the safety of the bonds, with RILY recently partially redeeming the more expensive 6.75% Senior Notes due 5/31/2024 (NASDAQ:RILYO). RILYO is actually trading 20 cents above its liquidation price with the next maturing 6.375% Senior Notes due 2/28/2025 (NASDAQ:RILYM) trading $2.68 below liquidation, a 10.7% discount. Hence, bears are essentially engaged in a self-created game of musical chairs trying to guess when exactly RILY experiences a possible credit default event, even with the macro backdrop set to materially improve through 2024. This could be described as a type of Schrödinger’s RILY where the small-firm investment bank is being priced as a going concern while also being priced as a credit default.

The current setup places the 27-year-old firm as witnessing this event sometime just after March 2026 as the 5.50% Senior Notes due 3/31/2026 (NASDAQ:RILYK) trading hands for 77 cents on the dollar. This level does not imply the market is pricing credit risk for these specific notes, with RILYZ seeing more downside over the last 6 months. Do the financials support this bearish game of musical chairs for RILYZ? No, but bulls still face risks here with a further delay of the 10-K filing, an event that would tank the stock and notes. RILY reported fourth-quarter revenue of $347 million, a dip of 9.2% over its year-ago comp. Net loss was $70 million, around $2.32 per share with an operating adjusted EBITDA of $79 million, down from $110 million in the year-ago quarter.

The earnings report was not great, no one wants their investments to be making a loss, but it also did not highlight a company set to experience a credit default. Indeed, the dividend reduction and the launch of a strategic review to sell its Appraisal and Valuation Services, and Retail, Wholesale and Industrial Solutions businesses known as Great American Group have set the backdrop for a possible positive liquidity event later this year.

RILY’s cash and equivalents at the end of the fourth quarter came in at $232 million, with $1.17 billion in securities owned. The dividend cut should help buffer its cash position and address its large total debt balance and upcoming maturities. We also need to pay attention to the Fed, with market expectations pricing in the probability of zero rate cuts at 0.1% to exit 2024. Powell recently came out to state that the process of reducing base interest rates “can and will” begin over the course of 2024. So who is shorting RILYZ? And what are the catalysts that will force an unwound of their short positions? The build of the short position in this singular note series could provide an upside catalyst as we head to a May/June rate cut that could spark a broad fixed-income rally. This is not an investment for everyone, it’s high risk with high stakes that will take a while to play out. Bulls and bears can look forward to the 10-K filing or non-filing as the next source of volatility and RILYO’s full redemption as a possible upward catalyst.