Will Cetera Be Sold in a Fire Sale?

The news regarding RCS Capital (RCAP), owner of the Cetera Financial Group of independent broker-dealers, is not getting better. The question that many industry watchers have is: How much worse will it get?

It shares trade near $1.15, down sharply from about $4.25 in early August and way off its two-year high of about $39.50. The firm’s market capitalization stands at under $100 million.

While Bloomberg News reported on Monday that RCAP might sell Cetera for as little as $700 million, though, an equity analyst following the company says that figure is simply too low. At least one industry expert, however, disagrees with that view.

“A 10/19 Bloomberg article indicated RCAP was looking to sell Cetera Financial Group for $700 million,” explained William Katz of Citigroup in a note shared with Barron’s. “While we do believe RCAP is likely pursuing various options to deal with tightening liquidity and high debt load, we believe the article is likely misguided on two key dynamics.

“If correct, the $700 million would suggest RCAP’s common equity value is essentially worthless, considering the firm has $850 million in debt and another $300 million in preferred equity,” Katz stated. “Considering RCAP paid $1.15 billion for Cetera, we find it unlikely that the firm would look for such a ‘fire sale’ that would ostensibly ‘zero out’ common equity holders.”

Nonetheless, “RCS Capital needs to raise cash and cannot default on its debt,” said Jon Henschen, a recruiter in the independent broker-dealer space, in an interview. “When it comes to money-making operations, all they’ve got are the IBDs. So, that’s what they would need to sell in order to cover their debt.”

According to Henschen, “The low stock price is forcing the situation.” And the low value put on RCAP shares, he notes, is due to both weak results and the lingering impact of the accounting scandal that rocked the firm and related entities about a year ago.

Past, Present, Future

Speculation about the future of Cetera, which is led by Larry Roth, has been rampant for some time but increased following news in August that RCS Capital’s would sell its troubled wholesale-distribution unit to Apollo Global Management (APO) for $25 million. The two firms said at the time that they were forming AR Global Investments to be owned 60% by Apollo and 40% by RCAP.

These developments followed the debacle of last October, when American Realty Capital Properties (now VEREIT) reported $23 million of accounting errors; at the time, the co-founder of ARCP, AR Capital and RCAP – Nicholas Schorsch – was executive chairman of both ARCP and RCAP.

This October 2014 news, in part, prompted RCAP to renege on its planned purchase of ARCP’s Cole Capital business for $700 million, and ARCP then moved to sue its investment partner. Many broker-dealers temporarily suspended sales of AR Capital-sponsored nontraded REITs.

RCAP’s Cetera Financial Group includes several indie broker-dealers, such as First Allied, and more than 9,000 advisors. In July, it began shuttering the operations of one IBD, JP Turner.

“If RCAP were to sell Cetera for $700 [million], the business would be left with $150 [million] of debt and $300 [million] of preferred equity against Hatteras and about 60% of the I-Bank (with American National Stock Transfer and RCS Advisory Services sold as part of previously announced strategic initiatives), which collectively generated $28 [million] in annualized 2Q15 EBITDA,” according to Katz.

“That said, Hatteras continues to shrink, while it is unlikely the I-Bank would be valued highly, in our view, given sustainability questions post [RCAP’s] recent wholesale-business sale,” he explained.

In the second quarter of 2015, RCS Capital reported a 65% year-over-year drop in its sales of alternative products. It is set to release its next quarterly earnings in November.

“The board of directors of RCS is exploring options to raise significant capital to rationalize the RCS capital structure,” Andrew Backman, managing director at RCS Capital for investor and public relations, said in an email. “These efforts are focused on positioning the business for growth and long-term value creation for all stakeholders supported by Cetera’s market-leading position. The company has engaged Lazard in connection with these efforts.”

Some stakeholders need the value more than others.

“This is a brutal situation for many executives with BDs [acquired in recent years by RCAP], some of whom took up to 80% of their share of the purchase price in stock, said Henschen, who adds that some others took only 20%. “It’s very tough… the name [of the parent company] has been tarnished, and that situation is not going to be resolved in the short term.”