B. Riley Financial Stock: The 9%-Yielding Dividend Still Looks Safe (NASDAQ:RILY)

Thesis: Business Shifting Toward Greater Stability

B. Riley Financial (NASDAQ:RILY) is a diversified financial services company with a number of irons in the fire.

The primary business, which is also perhaps the most volatile, is its investment banking and capital markets segment, which basically provides bookrunning services for small-cap companies. Obviously, when capital markets are effectively frozen by low stock prices and high interest rates, this segment suffers greatly. But when capital markets are hot (high stock prices & low interest rates), this segment thrives.

So, the core business is highly pro-cyclical. But RILY has been diversifying heavily into less cyclical (and even some countercyclical) businesses such as restructuring advising and retail liquidation.

Here’s CEO Bryant Riley from the Q3 conference call:

We recognize our businesses can be difficult for investors to model. We are not a typical broker dealer. The competition and variability of our platform becomes more unique as we continue to diversify to balance the episodic and cyclical parts of our platform.

That complexity is both a blessing and a curse.

On one hand, it keeps some investors away and prevents RILY from becoming as popular as it otherwise might be if the business was more easily understandable. This keeps the stock perpetually “cheap” and high-yielding.

On the other hand, the complexity also makes it very difficult to predict how the company will perform on a fundamental basis. Maybe the cyclical segment will underperform while the countercyclical segment outperforms, or vice versa.

In any case, the shift toward less cyclical businesses shows up clearly in RILY’s results, and this increases the long-term dividend safety, as we’ll see below.

End-Of-Year Update On RILY

In terms of revenue, RILY likely achieved its second-best year in the company’s 25-year history in 2022, behind 2021’s banner year.

I like to think of RILY as one of those Medieval rowing ships that has both rowers and sails. The rowers (less cyclical assets like principal investments, brands, consulting, and wealth management) keep rowing on and pushing the ship forward no matter what, but when the ship enjoys a tailwind, the sails (cyclical segments like capital markets and M&A) power the ship forward far more than the rowers.

Frankly, though, neither revenue alone nor GAAP earnings really do a good job in communicating the real/cash performance of the company, which is why management uses “operating adjusted EBITDA” as one of its primary performance metrics.

Here’s how the company defines “operating adjusted EBITDA”:

Operating Adjusted EBITDA is Adjusted EBITDA (as defined below) excluding trading income (losses) and fair value adjustments on loans and other investment related expenses.

In other words, operating adjusted EBITDA shows something akin to cash EBITDA. It is one of the best non-GAAP measurements for RILY’s complex and multifaceted business.

With that said, here are some metrics to consider regarding O-A-EBITDA:

• Operating adjusted EBITDA came in at $265 million in the first nine months of 2022 (compared to about $96 million in total interest expense and $83 million in dividends during that time).
• Management estimated Q4 operating adjusted EBITDA to be $90-$100 million, compared to $106.2 million in Q3 2022 and $101.1 million in Q3 2021.
• Management issued full year 2022 operating adjusted EBITDA guidance of $355-$365 million, compared to $422 million in 2021, implying a ~15% YoY decline.

While RILY’s overall business is certainly performing worse than it was during the blowout year of 2021, it isn’t performing that much worse.

One big reason it isn’t performing that much worse is because management has made a concerted effort to diversify the business by acquiring less cyclical businesses, such as those in wealth management, telecommunications, and technology accessories (the October 2022 acquisition of Targus).

When it comes to recurring EBITDA, which isn’t affected by the swings of capital markets, Riley made this comment on the Q3 conference call:

So the recurring EBITDA number that I am underwriting to is approximately $322 million. Just as a reminder to kind of get to our dividend, all of our overhead, interest and all those things, it’s about $295 million.

The dividend is about $112 million annually, while interest probably ran about $130 million to $135 million in 2022. Most of the rest of the $295 million mentioned above comes from overhead.

Going forward, with the share count rising a bit recently (even in the face of buybacks) and interest costs likewise increasing, we might push the spending that recurring EBITDA needs to cover up to about $300 million.

Even in that case, assuming no contribution from capital markets activity (the non-recurring EBITDA), recurring EBITDA should still cover everything with some cash left to spare.

That $322 million in recurring EBITDA is comprised of:

• $110 million from interest income on various loans & receivables
• $70 million from telecom assets
• $52 million from Targus (recently acquired tech accessory business)
• $44 million from retail brands like Hurley and Justice
• $23 million from the advisory/appraisal business (GlassRatner)
• $17 million from real estate, capital management, and security lending
• $8 million from wealth management

(I did not hear Riley mention the $8 million from wealth management on the conference call, but the others only add up to $316 million, so I am assuming the missing $8 million comes from this segment.)

Admittedly, though, “recurring” does not mean “guaranteed.” A recession or economic weakness could knock this recurring EBITDA down.

One of the most confusing aspects of RILY is the fact that unrealized gains or losses from its investment portfolio flow through to reported earnings. Hence the huge negative earnings reported in Q2 2022 that I wrote about in “3 Takeaways From B. Riley Financial’s Q2 Negative Earnings Report.”

A little over 1/3rd of the portfolio is invested in small-cap public equities, which naturally rise and fall along with the broader market (although boasts far better returns than the Russell 2000).

At the end of Q3 2022, RILY had total cash and investments of $2.33 billion, including $232 million in cash and cash equivalents.

Meanwhile, total debt at the end of the quarter stood at $2.32 billion, giving RILY net assets of $13.6 million. So, assigning zero value to RILY’s core investment banking / institutional brokerage business, the liquidation value of RILY was theoretically $14 million at the end of Q3.

However, management’s guidance for Q4 does imply a further erosion in the balance sheet, swinging from net assets of $14 million to net debt of $350 million to end the year. In a December update, management estimated that end-of-year cash & investments would be $2.15 billion (down $180 million sequentially), while total debt would be $2.5 billion (up $180 million sequentially).

The Crypto Debacle

In that December update, management also addressed an issue that is undoubtedly on shareholders’ minds: the crypto exposure.

In mid-December, with the price of Bitcoin languishing around $17,000, RILY proposed a debt restructuring plan to help one of its borrowers, Bitcoin miner Core Scientific (OTCPK:CORZQ), to survive. RILY’s outstanding loan principal to CORZ stood at $42 million.

After filing for bankruptcy protection later in December, CORZ recently received a $70 million loan from RILY, which came on top of $500 million in loans from a group of creditors led by BlackRock (BLK) and Apollo Global Management (APO).

Meanwhile, at the end of January, fellow Bitcoin miner Greenridge Generation (GREE) announced the restructuring of $11 million owed to RILY.

Obviously, it’s never good to see borrowers teetering on the brink of bankruptcy. But there is some good news in this situation.

First, these troubled crypto investments make up a relatively small share of RILY’s portfolio, per the December update:

Investments related to digital asset mining and crypto service businesses were valued at approximately $52 million at September 30, 2022, including $49 million in loans receivable and $3 million in equities and senior notes, representing approximately 2% of total cash and investments at quarter-end. Potential fourth quarter 2022 exposure of related investments is estimated to be approximately $39 million, of which $26 million represents a loan to a borrower that has since filed for bankruptcy.

Second, since the worst of the crypto crash in November and December, the price of Bitcoin has recovered a substantial amount of its losses to return to the mid-$20,000s.

Personally, I am not a fan of the loans to Bitcoin miners. Even so, I think the recent pop in Bitcoin’s price, if it holds, should allow RILY’s crypto borrowers to service their debts. And perhaps RILY’s management has learned some lessons about the risks of the crypto space to take away from this situation.

It must be admitted, though, that high yield loans are inherently risky and always come with higher risk of defaults or restructuring.

Bottom Line

With so many risks and such an opaque outlook for this complicated financial services company, why do I own it?

Well, despite the 9%-yielding dividend being on somewhat shaky ground, my own yield-on-cost is around 9.2%, and I believe shareholders are compensated for the risk they take by owning RILY. It is telling that even with severely diminished contribution from the capital markets segment, RILY’s dividend has remained covered this year. And we shareholders are paid handsomely to wait for capital markets to make a comeback.

Another reason to like RILY is that we common shareholders are in it right alongside founder and co-CEO Bryant Riley as well as a number of other insiders, who collectively own around 30% of the company.

And these insiders, most notably Riley, have made some giant open-market purchases at prices not far from where RILY’s stock sits today. That is a comfort. The people who understand RILY’s complex business best believe in its ability to produce strong long-term shareholder value.

I, too, remain confident in RILY’s long-term future, but I am also unsure if there remains more pain to be felt this year before the company mounts a sustained comeback.

As such, RILY remains a “Hold” for now, in my opinion.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.