A Kahn Game: Intrigue and mystery behind the Conn’s-Badcock-FRG deal

You might remember that back in January, we pinboarded the mystery of the all-stock swap that sent Badcock Home Furnishings to Conn’s in exchange for a million shares of preferred Conn’s stock. The question then, as now: Why would Franchise Group dump Badcock just two years after buying it for $580 million?

Now, with the Bloomberg report late Wednesday that Conn’s will likely shut down approximately 100 stores, including 30 Badcock locations, liquidate the inventory of those stores, and file for Chapter 11 protections, the question is all the more mysterious. (Bloomberg did qualify its reporting by stating that the “plans were not final and could change.”

Since the acquisition, FRG has lost its founding CEO, Brian Kahn, while over on the Conn’s side, its market cap has dwindled by 80% to roughly $20 million, and bankruptcy appears to be coming in a few weeks. Just before the Bloomberg report of 100 closures, local media throughout the South had begun reporting indications of Conn’s closures.

This week NOLA.com reported the closure of a Conn’s in Slidell, Louisiana, noting “Store Closing” signs at the 50,000-square-foot North Shore Square Mall location. Meanwhile, The Advocate newspaper in Baton Rouge reported the imminent closing of the Conn’s there, a 57,000-square-foot location on North Mall Drive. A Conn’s store also is in the process of closing in Greensboro, North Carolina, just outside of High Point.

In the middle of the FRG-Conn’s transaction for Badcock was the enabler of so many questionable deals involving Kahn: B. Riley, a “boutique” investment bank. Recall that it was B. Riley’s refusal to buy any more of Badcock’s receivables that precipitated the FRG-Conn’s deal for the retail chain.  

Disclaimers

Now, before we get to the latest litigation, two disclaimers: I own shares in none of these companies. I’m merely trying to make sense of all of this just like a lot of you. Second, I realize that the financial troubles of Conn’s, Badcock, B. Riley, FRG and all of their many subsidiaries and holdings are causing a great deal of pain for a lot of hard-working employees and their families. I’ve heard from a few who have lost their jobs at both Conn’s and Badcock. There’s no joy here. There don’t seem to be any winners, provided you ignore the hefty compensation packages and 18-karat parachutes in the contracts of some of the top executives.

So, to return to the mystery that is at the center of this pinboard, we can add a few more thumb tacks and a bit more red string because of a lawsuit brought against B. Riley Financial and Kahn by “former FRG investors,” including and especially a former Harvard football teammate of Kahn’s, Brian Gale, the lead plaintiff. A Google search found that Gale and Kahn were both on the 1993 Crimson football roster, Gale a defensive lineman and Kahn a defensive back.

Gale and his fellow former FRG shareholders allege in the Court of Chancery of the State of Delaware that they were shortchanged in the $2.6 billion buyout of FRG by a group led by Kahn and financed in part by B. Riley, according to the filing. Blow by blow, the filing details how, at least from the plaintiffs’ point of view, Kahn and his executive group were able to take FRG private at $30 per share, which the plaintiffs argue was below fair market value. They also propose that the take-private move could have been intended to “avoid public company scrutiny of (Kahn’s) fraudulent transactions,” according to page 71 of the filing, alleging that Kahn “illegally covered up $294 million in lost Prophecy funds.”

Kahn stepped down as CEO of FRG in January just after Bloomberg broke the news that he likely is one of the two “co-conspirators” implicated in the Prophecy Asset Management hedge fund collapse. According to the class action filing, Kahn managed 86% of Prophecy’s investments. For his part, Kahn has denied any wrongdoing and any knowledge of wrongdoing. He has also pointed out that no charges have been brought against him by investigators.  

The Prophecy collapse is the focus of a fraud investigation that so far has resulted in a guilty plea by the fund’s co-founder and chief compliance officer, John Hughes. His sentencing is expected sometime next month.

Blood in the water

As we shift our attention on the pinboard from New York to the West Coast and B. Riley, where short sellers are circling like sharks, we wonder how the firm can cover so many loans that each day look more likely never to be paid, at least not in full, especially during a difficult period for furniture retailers. Where is B. Riley parking all this paper? As Dan David of financial research firm Wolfpack Research put it, speaking to the Institutional Investor, “When they indict Kahn, the only thing Kahn’s got to give them is Bryant Riley,” B. Riley’s founder.

David also said B. Riley has sold $2 billion in junk bonds to retail investors in its wealth management division to finance loans to companies that “degenerated into zombies,” according to the Institutional Investor. To his point, one of the takeaways from the class action filing against Kahn is the long history of B. Riley loans to Kahn personally and to Kahn’s Vintage Capital, loans that as of a year ago had a principal balance of $154 million, according to the filing.

It is this two-decades-long “partnership” of B. Riley and Vintage or, perhaps more accurately, Bryant Riley and Brian Kahn that is at the center of the class action suit. The shareholders claim Kahn of using Vintage Capital to execute the FRG buyback by falsely portraying that B. Riley executives came to the company with an unsolicited $30-per-share bid, a portrayal with which claimants accuse B. Riley of supporting.

Kahn then “abandoned the charade of B. Riley being the acquirer of the company and stepped in as the head of the buying consortium,” the claimants assert in the filing.

The lawsuit also states that the six entities controlled by Kahn that represented 86% of Prophecy’s funds lost a total of $294 million, or the same amount that federal investigators identified as “missing” in the fraud scheme to which Hughes pled guilty, according to Bloomberg’s reporting.

“Hughes, Kahn and another co-conspirator concealed the losses from investors and their auditor through bogus transactions and forged documents,” the filing alleges.

The claims of withholding information and presenting a false narrative, as well as many of the same sources and the basic timeline for B. Riley’s and FRG’s collaborations to take FRG private, appear also in a class action suit filed in May in Los Angeles Superior Court. The lawsuit, Ted Donaldson v. B. Riley Financial, et al. claims violations of the Securities Act of 1933.

A shell game?

Now we are tantalizingly close to the mystery’s solving, because, if the filings are materially correct, Kahn/Vintage might have pledged the same $200 million in FRG shares as compensation to Prophecy investors, or “victims,” as the Gale filing puts it, and to B. Riley as collateral for a loan to Vintage.

To connect all of this to Conn’s, recall that B. Riley also loaned the Woodlands, Texas-based chain $108 million in December, as a B. Riley 10Q shows. Appreciate that FRG has all that Conn’s stock on its books, the value of which is difficult to pin down. Conn’s common stock was worth around $3 per share at the time of the acquisition and that as of the closing bell on Monday had dropped to 65 cents per share, or 22% of the value in December. The Badcock sale, however, stipulated preferred stock.

Note that B. Riley’s share price isn’t doing much better – $17.43 per share as of end-of-trading Tuesday, or 29% of its value compared to the 52-week high. In addition, Bloomberg has FRG debt at about 67 cents on the dollar, which has FRG creditors checking with their financial advisers. Finally, Conn’s is mulling bankruptcy while risking de-listing by Nasdaq.

FRG owns a chunk of Conn’s, B. Riley owns a chunk of FRG and holds plenty of paper on both Conn’s and FRG. And caught in the teeth of all of this is the Badcock chain. Can these concerns survive the shipwreck of any one of the others? Or, are the financial woes and fortunes of Conn’s-Badcock-FRG-B. Riley so intertwined that as one goes, so go them all?