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(Bloomberg) — Bryant Riley, who built an underdog investment firm into a multibillion-dollar financial empire that bears his name, was defending his close friend and business partner, Brian Kahn.
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It was November 2023, and Kahn had been implicated in a federal investigation of a failed hedge fund that lost hundreds of millions of dollars. Kahn had insisted he hadn’t done anything wrong.
“That’s good enough for me,” Riley said during the quarterly earnings call for B. Riley Financial Inc., which was one of Kahn’s biggest financial backers. “We’re going to make a lot of money for our shareholders.”
It wasn’t good enough for US authorities, who’ve now widened their investigation of Kahn, his dealings with Bryant Riley and the firm Riley co-founded more than 25 years ago. It didn’t work out well for shareholders, either. The stock collapsed on Aug. 12 on word that Riley and his firm received subpoenas from the US Securities and Exchange Commission, and that the company was headed for its worst-ever quarterly loss, largely because of its investment in Kahn’s business.
Riley tried to stop the bleeding last week with an informal offer to take B. Riley private – he’s the biggest stakeholder at about 24%, he wrote. But his letter to the board lacked specifics on who would give him the money to do it, and B. Riley’s market value remained mired at a fraction of the $1.77 billion it commanded little more than a year ago.
For now, it’s validation — and probably a massive profit — for short sellers who’ve attacked B. Riley’s deal-making, accounting and overlapping personal connections with Kahn for more than a year. What happens next matters to both Wall Street and Main Street.
B. Riley isn’t a blue-chip firm, but the Los Angeles-based company occupies an important niche selling stock, raising debt and providing analyst coverage and investment conferences for hundreds of middle-market companies that might otherwise be overlooked by big investment banks. The brokerage makes a market in over 1,500 securities and counts 1,000 money managers as customers. The wealth-management unit runs about $25 billion for institutions and retail clients, some of whom bought high-risk debt issued by the firm.
With a total staff of about 2,400, B. Riley also makes direct investments in struggling companies, aiming to sell them later when the investments mature. One of those bets was Kahn’s management-led buyout of Franchise Group, a deal that now threatens to unravel much of what Bryant Riley has built.
“It was a good operating company — I don’t know how they got so far off track,” said John Lekas, chief executive and senior portfolio manager at Leader Capital Corp., which invested in B. Riley securities. “If you’re serious to make an offer, get your lawyers involved and get the SEC to sign off. If there was ever a time to have a sense of urgency, it’s now.”
Riley, 57, his company and a Franchise Group official didn’t respond to requests for comment. A lawyer for Kahn, 50, declined to comment.
Riley’s Startup
Building the firm was a “labor of love,” Riley said in last week’s letter to the board. He learned the trade after graduating from Lehigh University in 1990 at several small brokerages, and launched B. Riley in 1997 with his wife as well as classmate Tom Kelleher, the firm’s co-chief executive.
It was a rocky start. The following year, the National Association of Securities Dealers sought to expel Bryant Riley from the finance industry, according to his BrokerCheck record, which alleged violations on trade reporting and lax supervisory procedures. The watchdog settled for a $12,000 fine and censure of Riley and his firm, with no admission of wrongdoing.
Riley’s company stayed small, employing fewer than 100 people by mid-2014, but business grew at a steady clip as it broadened its M&A advisory, restructuring and investment banking arms. His firm made some good hires, with several analysts ranked among the best in prestigious Wall Street surveys.
The biggest leap came in 2017 with the takeover of FBR Capital Markets, a venerable brokerage with a business model that fit neatly with B. Riley, and profits soared in the following years.
Company Culture
It’s been a lucrative ride for Riley. The company said in a filing that Riley was paid $4.9 million last year, and he was holding almost 7 million shares, which paid a $1 quarterly dividend before it was cut and then eliminated. Records show a six-bedroom home in his name valued at about $11 million in the Pacific Palisades neighborhood of Los Angeles and another six-bedroom home in Montana valued at more than $21 million.
There are touches of glamour, with Riley counting as a friend Sugar Ray Leonard, the legendary boxer, and attending star-studded fundraisers for Leonard’s foundation that supports childhood diabetes research.
Riley is known internally as a charismatic and savvy executive who trusts his own judgment and those close to him, according to a dozen current and former employees and managers contacted by Bloomberg News. He prefers to dress casual, going tieless even on special occasions like ringing the Nasdaq opening bell in 2015.
For junior bankers, the culture can be challenging, with long hours, modest base pay and heavy competition for deals and bonuses, said the people, who asked not to be identified to preserve their relationships with the firm. Riley frequently travels to the New York office, jumping on a red-eye flight with little notice if a pitch seems important.
Michael Biener, B. Riley’s deputy chief information officer, described the firm as “a family.”
“We want this to be a place where people come to work and enjoy it,” Biener said in an interview. “That came from the top.”
One person familiar with the firm’s model said B. Riley layered on more debt than FBR’s previous management. The result resembled a leveraged investment portfolio alongside a broker-dealer, similar to the way big Wall Street firms like Lehman Brothers were structured before the financial crisis, the person said.
Echoing a concern that B. Riley has acknowledged in its annual reports, some of the people said internal controls were weak. One employee said they pitched about 30 deals during two-and-a-half years there and none of the details got questioned. B. Riley has a conduct and ethics policy that applies to everyone, and a policy for clawing back incentive pay in the event of a restatement.
Riley himself has flagged some of the risks that come with the firm’s mix of “recurring and episodic” businesses, which can make earnings volatile.
“To our shareholders, we know we’re a somewhat difficult story, and we have some ups and downs,” he said in February 2023 after posting an annual loss. “But overall, I think we performed.”
‘Accidental Franchisee’
That story included helping Kahn build his own business. He was a Harvard graduate, listed as a 5-foot-10 senior defensive back from Boca Raton on the school’s 1995 football team. Three years later he set up what became Vintage Capital Management, described as a value-oriented firm with public and private stakes in various industries.
Kahn has described himself as “an accidental franchisee,” after acquiring two chains of rent-to-own businesses out of receivership in Arizona in the early 2000s. He ended up selling them to Aaron’s Co. under pressure and becoming a franchisee. Kahn said he “learned a ton” about that kind of business and “certainly learned that I’d rather be a franchisor.”
Along the way, Kahn became one of Bryant Riley’s clients for research reports, Riley said in 2020 testimony.
“Our career tracks were somewhat similar,” Riley said. “We each did bigger deals. And we didn’t do a lot together until more recently, the last few years.”
Typically, Kahn would buy a stake in a business, and Riley and his firm often would provide financing and invest directly alongside him. In some cases they’d both serve on the board.
Some deals worked well. One failed spectacularly.
Among the transactions that laid the foundation for Kahn’s empire was the purchase of Liberty Tax Inc. John Hewitt, a pioneer of the US tax-services industry, was in a tight spot when he first crossed paths with Kahn around late 2017.
Directors had ousted Hewitt as chief executive of the business he’d founded, after an internal review found that he’d had sex in his office and hired relatives of female employees with whom he’d had romantic relationships, according to court filings. Hewitt denied all of that, and he remained chairman and a major shareholder. The result was months of boardroom conflict, he said in a recent interview.
An acquaintance put Hewitt in touch with Kahn. Over dinner at Morton’s steakhouse in Orlando, Kahn outlined a deal to buy out Hewitt’s shares; B. Riley would support the deal and Bryant Riley would join the board.
“He negotiated the whole deal,” Hewitt said, referring to Kahn. “The only thing that I was happy about was that I was out of the civil war.”
With Liberty in hand, Kahn sought to buy Rent-A-Center Inc., a rent-to-own retailer of furniture and electronics, for $1.4 billion in 2018. B. Riley agreed to underwrite the purchase in what Riley later described as the largest deal his firm had ever arranged.
Breakup Fee
The merger was headed for completion until disaster struck in December 2018. A US antitrust review had dragged on and a deadline neared for Kahn’s firm to send Rent-A-Center an extension notice. As a Delaware judge later wrote after the matter wound up in court, someone on the buyout team — it wasn’t clear who — “simply forgot.”
The next day, Rent-A-Center stunned Kahn and Riley by canceling the deal and demanding a $126.5 million breakup fee, later cut to $92 million by the court.
“It makes you angry, but you feel stupid and then you’re humiliated,” Kahn testified. “I mean, it’s just – it’s a disaster. It’s an absolute disaster.”
That didn’t halt his efforts to build his business or his relationship with Riley.
Kahn used Liberty to acquire Buddy’s Home Furnishings, changed the name to Franchise Group, and bought the Sears Outlet chain and Vitamin Shoppe. More deals followed: American Freight home furnishings, Pet Supplies Plus and Sylvan Learning. Riley was on FRG’s board for some of its deals.
Kahn even made a bid in June 2022 for retailer Kohl’s Corp. valued at $8 billion with Riley’s assistance. While that deal wasn’t consummated, it showed the scale of their ambitions.
Watching from the sidelines, Hewitt became disillusioned by “know-it-alls” who were assembling what he called “a mismatch of non-quality companies.” By 2021, Liberty Tax was gone from FRG’s roster, sold to NextPoint Acquisition Corp. for $249 million.
Furniture Slump
The seeds of FRG’s current troubles were planted when Kahn bought still another furniture chain in November 2021, W.S. Badcock, with B. Riley buying two batches of Badcock’s customer receivables.
But by then, the consumer buying spree fed by Covid stimulus checks was petering out along with the pandemic. Revenue slid at FRG’s furniture chains, and by early 2023, the company was in trouble. B. Riley didn’t want any more of Badcock’s receivables, leaving FRG facing a potential loan default, according to a regulatory filing.
Riley met with Kahn in March and initially offered to buy his friend’s entire company, and let him keep running it, according to the filing, but B. Riley soon re-thought the idea — it didn’t want to consolidate FRG onto its own balance sheet.
The result was a $2.8 billion management-led buyout last August, with B. Riley getting a 31% minority stake. Nomura Holdings Inc. arranged a loan of $600 million to fund it, and B. Riley loaned about $200 million to Kahn, with his stake in FRG used as collateral.
“We would have bought all of the Franchise Group — we are a huge fan of that business and it’s a really simple analysis,” Riley said during last November’s call when he was standing up for Kahn. “That was our opportunity, and we would buy that over and over again.”
Prophecy’s Collapse
Kahn was under pressure on another front. He’d been accused in civil litigation of cheating investors in Prophecy, a hedge fund whose 2020 collapse led to the guilty plea of a top executive on fraud charges last November. Prosecutors tagged Kahn as an unindicted co-conspirator, Bloomberg reported, but Kahn has said he never knew Prophecy was cheating investors and didn’t conspire in any fraud.
Short sellers latched on, noting that the lawsuit accused Kahn of diverting money from Prophecy to finance what became FRG. If that’s true, short sellers argue, then Kahn didn’t have the right to transfer FRG shares to B. Riley or pledge them to Nomura, potentially tainting the finances of both firms.
Or so goes the theory. None of that has been proven in public. B. Riley says its borrowing was sound, and the lawsuit was settled confidentially — with Kahn agreeing to pay more than $200 million, Bloomberg reported. Riley has said his company had nothing to do with Kahn’s role at Prophecy and that regulators will conclude the same thing.
FRG Writedown
In the end, the Prophecy episode may be beside the point for investors. FRG has been so weak lately that B. Riley has written off the bulk of its investment, and the rest could be wiped out, too.
Late last year, FRG persuaded Conn’s Inc., another furniture chain that offered subprime financing to its cash-strapped customers, to buy Badcock. For payment, FRG agreed to take shares of Conn’s, which collapsed within months into liquidation.
S&P Global Ratings warned in July that this made FRG’s capital structure unsustainable and that a default could wipe out junior creditors. In this kind of scenario, equity holders typically wind up with nothing. B. Riley has money at risk, too — a $93 million balance on a loan made to help Conn’s do the deal with FRG. B. Riley has said it still expects to be repaid.
Pressure was forming elsewhere as other B. Riley investments began to sour. A minority stake in Babcock & Wilcox Enterprises Inc., a producer of power generators, has lost most of its value over the past year. Targus, a maker of computer accessories, was acquired in October 2022 and valued at $250 million. Writedowns since then have topped $63 million.
Information Gaps
Questions have swirled for months around whether B. Riley is accurately valuing its assets, fed by criticism from its own auditors about the company’s financial controls. The concern was amplified on Aug. 12 when Riley announced a writedown of up to $370 million on FRG and its loan to Kahn, and it missed a deadline for its quarterly regulatory filing, citing asset valuations.
“If B. Riley is forced to raise cash, they also will be forced sellers of their better positions, leaving problem deals on their balance sheet,” said James Ward, former head of European high-yield at Axa Investment Managers and now a finance professor at the American University of Paris. “A death spiral in that situation is what management is trying to avoid.”
Unofficially, some staffers of the former FBR have been asking whether it’s feasible to buy out their old employer, said people familiar with the discussions, adding that the financing and legal liabilities would be difficult to surmount.
For now, Bryant Riley’s team is left laboring to catch up on the overdue filings, fend off the US investigators and figure out a way to handle more than $2 billion of debts due by 2027.
Said Lekas at Leader Capital: “They should have stuck to their knitting.”
–With assistance from John Gittelsohn, Jill R. Shah and Diana Li.
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