Idea Brunch with Nate Koppikar of Orso Partners

Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Nate Koppikar!

Nate is currently the portfolio manager of Orso Partners, a San Francisco-based short-focused fund he launched in 2019. Before launching Orso, Nate worked in traditional long/short funds and private equity.  He got his undergraduate degree from the University of Pennsylvania, Wharton School, and MBA from Stanford. Nate has been profiled in various media outlets and is respected for deep short-biased research.

Nate, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Orso Partners (“Orso”)?

I got my start at Goldman in a PE secondaries fund right as the Great Financial Crisis began to unfold.  It was an interesting time; I saw the ugly side of capital call/distribution mismatches right out of the gate.  After that, I joined TPG in the immediate post-crisis years.  The LBO market was essentially dead then – I was mostly looking at restructurings in the portfolio and credit investments.  Starting my career right into the crisis years and seeing distress front and center shaped my thinking and investing outlook.  I went on to get an MBA at Stanford and moved over to long/short investing.  And rather quickly, I came to find the long side dull.  Short selling, on the other hand, I came to love.  I got to know the community of short sellers in the SF Bay Area, and I had found my investing home.

Philosophically, most investors look upon management teams with admiration and awe.  I look at management in an adversarial light.  Consider the world we live in.  Since the early 2000s, regulations have consistently loosened, corporate lobbyists have become exponentially more powerful and literally write political platforms, the DOJ (across both political parties) has severely slashed the number white collar prosecutions of executives to historic lows, and universities, management consultants, and shareholder advisory firms have actively encouraged enormous stock-based-compensation schemes that allow management to get rich while having no skin in the game.  All of this is a recipe for encouraging fraud.

The result of these shifts is that the pay-off to public company fraud is now enormous, and the cost of committing fraud is miniscule.  When the risk/reward for fraud is skewed so positively, committing fraud and maximizing shareholder value become synonymous.  Shareholders don’t seem to care, because they understand the risk/reward as well – and executives that push the envelope are cherished as thought leaders.  From my own experience, long-only managers prefer to ignore fraud, because their best career move is to blame a subsequent stock blowup on exogenous circumstances (e.g. recession, circumstances outside of management control). 

That is why I launched Orso with Scott Matagrano in 2019.  Scott spent time at Kingsford, Third Point, and launched Sophos which was one of the largest short funds ever.  I love investing on the short side and so does he.  Public company fraud is a market with a growing TAM and strong secular tailwinds.  Yet there is a gap in the market because fewer analysts want to go after these types of companies.  “Winning” against companies engaged in malfeasance has become infinitely more difficult for all the reasons cited above which has discouraged even the most talented short sellers from pursuing their craft, and the market has made things even more difficult as never-ending flows to US equities has created a steady stream of shareholders who will excuse even the most reprehensible of behavior from public companies.

Each year there are fewer and fewer people doing this work because short selling is hard.  Large swaths of the professional and retail market now engage in coordinated strategies to blow up short positions.  Orso’s competitive advantage is that my partner Scott and I have the staying power to go after malfeasance, this is all we focus on and we have been doing it for years, we love this work, and we are not looking to be something else.

You’ve been a vocal skeptic of B. Riley Financial (RILY), which has fallen ~85% since your first public criticism. Can you tell readers what got you interested in B. Riley and what went so wrong?

Back in 2022, one of the sharpest investors I know called me and described an investment bank idea to me – he said it had negative tangible book value and was trading at a $2 billion market cap.  As someone who spends a lot of time in financials, the description had me hooked immediately.  Anything with negative tangible book value is worth a closer look.  When he then told me that the bank in question was B. Riley, I was very excited.

For the past several years, B. Riley has been a source of idea flow for us.  Despite “strong Chinese Walls”, their research analysts often publish pieces that resemble stock promotions that are strategically timed right in front of capital raises involving B. Riley.  In some ways, B. Riley was no different than any of the other small-cap brokers that publish research and provide banking services to questionable small-cap issuers.  However, what got us interested in B. Riley is that they had raised a bunch of money through their wealth management channel via so-called “baby bonds” (preferred equity securities).  B. Riley funneled a lot of client money into banking deals — stepping up and offering to buy large chunks of its own banking offerings to differentiate itself from the competition that never put money into deals.  Bryant the Chairman/CEO would apparently brag about how his firm (and he personally) puts money into his banking deals.  Apparently, Bryant Riley did not believe in the saying “never get high on your own supply.”

When Bryant Riley announced he was facilitating the buyout of Franchise Group in early 2023, he fully knew that he had a loan – a bad loan that had gone unpaid for years – out to Brian Kahn, the CEO of Franchise Group.  He had never publicly disclosed the loan, which was very obviously material.  Even in November 2023, after the deal had closed and when Brian Kahn was publicly named as a co-conspirator in the Prophecy fraud, Bryant Riley continued to keep the $200 million loan a secret. 

Wealth Management clients of B. Riley purchased around $250 million of the Franchise Group LBO equity (around 27% of the total).  Would they have still bought the deal if they had known B. Riley – the deal organizer – had a secret $200 million underwater loan with Brian Kahn?  I know people who participated in the deal who have told me they unequivocally would not have bought into the deal had Bryant told them about the margin loan to Brian Kahn.  These people bought into the deal thinking Brian Kahn was “fully aligned” as the Chairman/CEO of Franchise Group, but the reality was he had pledged almost all his Franchise Group stock to B. Riley and Prophecy victims.  Kahn even secretly sold FRG shares to B. Riley at the last minute before the August 2023 deal close – how is that alignment? It’s absolutely madness this was not disclosed, but this from our research this is par for the course in how B. Riley treats Wealth Management clients. 

So, in November 2023 after the Prophecy scandal broke, we found the loan, we published evidence of the loan, and I believe that is when Bryant Riley’s problems blew up.  He had an opportunity to walk from the Franchise Group deal before August 2023 – or to not even do it in the first place.  But he had this margin loan he had been hiding from the public for years.  If he pulled out after signing the deal, he would have had to pay a break fee of around $57 million.  He decided he did not want to pay the break fee.  But given Franchise Group was rapidly deteriorating fundamentally, he may have been better off paying the break fee of $57 million.  Yes, Franchise Group stock would have cratered, and it would have resulted in a huge loss on the $200 margin loan (perhaps all of it).  He would have been out as much as $257 million.  Instead, Franchise Group is now on its way to zero, he is going to be out closer to $500 million, which blows a titanic-sized hole in B. Riley’s already weak balance sheet.  So, the margin loan cover-up ended up being a colossal mistake.  He would have been better off walking from the deal.  I think covering up the loan was the beginning of the end for B. Riley and the Board of Directors is one of the worst I have ever seen – how has no one in that C-Suite lost a job yet?

In any scandal, it’s natural to want accountability. From the conduct you’ve seen at B. Riley and elsewhere, who generally deserves blame when financial institutions fail? Are regulators doing their job?

Management deserves the blame when financial institutions fail, full stop.  The U.S. regulatory environment is loose for a good reason – to encourage risk-taking.  I often see people on Twitter hoping for a halt or a regulatory raid – draconian outcomes.  Be careful what you wish for on that front.  People who expect regulators to storm the offices of a public company and put a halt to a company’s activities are living in a dream world and effectively asking for the government to interfere with the capitalist process.  Yes, it occasionally happens in banks every decade or so, but that’s just because of the unique nature of bank runs which has no parallels in any other operating company.

On B. Riley, there is another potential villain outside of management – the audit firm Marcum.  I hope the shareholders of B. Riley file a lawsuit against Marcum as they have clear grounds and clear damages.  Marcum is a terrible audit firm with a terrible regulatory history.  The firm has been hit by the SEC and PCAOB repeatedly.  Despite getting in a lot of trouble a year ago and getting an SEC monitor in place, they botched the B. Riley audit while short sellers were providing them with clear evidence of accounting malfeasance at B. Riley.  There is no excuse this time.  Marcum signed off on the B. Riley 10-K that marked up the value of Franchise Group while the 1^st lien debt for Franchise Group was trading in the deeply distressed range and after a double downgrade by Standard & Poor’s.   This mark-up took place on April 24, 2024.  Flash forward just over three months and B. Riley is slashing the Franchise Group value to near zero and admitting it is materially impaired.  How could B. Riley hold Franchise Group above cost on April 24, 2024 filing and then come out on August 12, 2024 and mark it down 75%?  Give me a break.  Marcum did not do its job in the 10-K filing and hiding behind “weak internal controls” is not going to be enough given that there was clear evidence provided to Marcum that B. Riley management was engaged in a fraudulent cover up of its relationship with Brian Kahn.  I think Marcum signed off on the 10-K because they were afraid they’d get sued if they didn’t.  All they ended up doing was delaying the inevitable lawsuits, and now it looks even worse because their work was so obviously shoddy.

In a different era, the regulators put Arthur Andersen out of business and Arthur Andersen was a lot more significant than Marcum. 

Despite having a background in private equity, you’ve reportedly been shorting the big publicly traded private equity asset managers. What problems do you see in the private equity world? In your view, is there a particularly egregious actor, or are the issues with everyone?

The PE short has proven to be incredibly difficult in the past few years – which is not surprising for an industry with incredible political connections, robust access to capital, and with the ability to materially manipulate fair marks without getting pushback from investors.  Surprisingly, the strength in PE stocks has been despite distributions being terrible relative to history.  I surmise that the public stocks are looking forward to rate cuts, but they seemed to have completely looked past some of the worst net capital flow years for these entities in their history.  Investors in these funds should be asking questions about why so few PE LBOs have hit the market in recent months despite a huge increase in valuations.  Just how ugly will the 2020-22 vintages be?  We will start to learn more soon but we are getting previews of some of the ugliness hiding in the COVID vintages in deals such as Pluralsight (Vista Equity Partners) which recently went bust.

One issue in PE that I think is interesting is what is happening with RealPage.  The DOJ recently filed a lawsuit against RealPage for colluding with landlords to price-fix rents.  This was a very high-profile charge – AG Merrick Garland himself held a press conference to chastise RealPage for having a hand in pushing rents higher.  This case is interesting because the documents on their face are highly damaging for RealPage – they present a company – using its employees’ own words – teaching landlords how to raise prices as aggressively as possible.  At the same time, I saw the press conference and thought to myself “Is this really news?”.

Private equity is involved in collusion, price fixing, and violating antitrust laws?  You don’t say.  I’m pretty sure euphemisms for those terms and descriptions are used in every single investment committee memo a PE firm has ever compiled, but I guess it’s newsworthy now because inflation is topical this election season and rent inflation hits home with a lot of voters. 

There was a time when private equity would buy underperforming segments out of public companies, or private companies that were undermanaged.  They’d layer on debt, lay off workers, and improve margins.  But thanks to shareholder activist funds and improved corporate governance standards, these types of transactions are few and far between.  In recent years, most of the LBO-style deals you see, especially in the middle-market, are roll-ups.  Middle market sponsors build “platforms”, and those “platforms” are eventually sold to larger “platforms” owned by large market funds.  The purpose of every one of these roll-ups is to accumulate power (think, buying up imaging clinics, contracts with doctors, daycare centers, HVAC outfits), and with that accumulation of power, flex pricing muscle.  So, I do think the fact they charged this company and made loud noise about it is a signal that the regulators think things have gone too far.

There is possibly some cycle read here that I want to call out.

In very late 2006, the PE mega funds were investigated by the DOJ for bid rigging in club deals.  In that case, it was alleged they were price fixing in LBOs (i.e. KKR would agree to not bid on Public Company A that Blackstone was bidding on).  It appears the government was concerned about the massive growth in private equity, and the dynamic of public companies being taken out of the mix and brought into private hands using high leverage that left the companies more vulnerable.  The investigation went on for years and resulted in no charges but was high profile.  The commencement of the investigation was also a clear sign of a local top for private equity – the reality is that they overpaid for many of the deals they did in that era, many went bankrupt, returns were quite poor in that vintage, and the government was late to the party in bringing an investigation.  Are they late to the party yet again?

RealPage is an April 2021 LBO by arguably the hottest firm in private equity Thoma Bravo.  Generally, when sector specialist firms get as hot as Thoma Bravo has gotten and take in the type of AUM that they have taken in, there is some cycle read.  The fund is now too big to do what they had historically done.  Thoma Bravo has made a lot of phenomenal investments – the most notable of which involved dumping two portfolio companies onto public company buyers with empire-building-oriented CEOs facing slowing growth (the two exchange deals).  But they have also paid out the nose for software companies in the past few years.  And missed obvious fraud in FTX, a deal that had the appearance of style drift given it was not the traditional cash flowing SaaS company they buy.  Vista Equity, another firm that exhibited insane growth in the past decade, is also showing signs of deal problems.

Watch private software deals closely.  In the COVID vintage – the vintage that looks like it will be comparable to the 2005-07 vintage of LBOs, software became the dominant share of deals done.  We think 30-35% of LBOs in that vintage were in tech and largely software.  Sponsors paid nosebleed prices, private credit funds financed the deals (and are now stuffed to the gills with software), and instead of seeing exits, we are seeing early failures play out publicly.

Recently, the SEC and Department of Justice charged Andrew Left with fraud and market manipulation. Do you have any thoughts on the charges and the effect it could have on the activist short field?

The Left case is interesting because he is described as an “activist short seller” in the DOJ Office of Public Affairs press release: “Activist Short Seller Charged for $16M Stock Market Manipulation Scheme”.  On the other hand, the Central District of CA DOJ press release only refers to Left as an “Analyst”.  Interestingly, the actual indictment has little to do with activist short selling, charging Left for a relatively even balance of both long and short ideas that he provided public commentary about.  The government’s allegations focus largely on the timing and truthfulness of Left’s trading claims and activities relative to “price targets” he publicly proclaimed rather than on falsity with respect to any specific activist short report. 

Given the government alleges in the complaint that he has no fund (the government in fact alleges that he lied about having a fund), it is odd that they did not refer to him as a “retail investor” because that is what he appears to be.  He is, per the government indictment, someone who largely trades his own capital in retail brokerage accounts such as E-Trade and Interactive Brokers.  Even “analyst” seems to be a stretch as a title because then you’d assume he was employed at a fund or associated with a sell side firm which, according to the government, he was not.  He appears to be best described as a retail investor.

But then reimagine the case with the headline of “Retail investor IHateGabePlotkinGMEtoMoon69 arrested for trading counter to publicly stated opinions on Reddit”.  Hard to imagine that case would warrant government resources.  There are a lot of cranks on the internet.  If someone is offering opinions on the internet for free, would any reasonable investor ever really take them seriously?  In a 2024 civil case from the 9^th Circuit Court of Appeals (the circuit in which Left was charged), the Court stated in the context of Left’s own reports that reasonable investors consider reports like his “with a healthy grain of salt.” 

Therefore, given the indictment had nothing to do with falsity as it relates to activist short selling reports, the fact the government made a point to identify him as an “activist short seller” should certainly concern people who hold themselves out as “activist short sellers.”  But if you’re reading it closely, it should also have an impact on long touts who spend their time on CNBC as well.  It likely has a chilling effect on speech, and that is what makes this a difficult case but perhaps that is the outcome the government wanted – the social media era has led to a proliferation of voices expressing opinions about various matters online including stocks, and this case will test the limits of online opinions in the influencer age.  It will test what duties and responsibilities (if any) an influencer has to an audience that voluntarily and freely decides to listen to his/her opinions.  It may even have implications for influencers outside of finance who provide hypocritical opinions free of charge online (for example, can vaccine skeptics who secretly vaccinate their own children be held accountable criminally if their followers don’t vaccinate their children and these children then subsequently contract measles?). 

We aren’t “activist short sellers” at Orso.  We at Orso take a long-term view on our shorts and generally remain short the stocks we discuss.  There are some stocks we are short today that we collectively were short for literally years – tracing back to prior firms.  Once we determine a management team is not on the “up and up” we tend to stay with these securities for a long time as it always takes longer than we expect for a fraud to unravel.

With B. Riley, I got hassled and harassed by company employees and touts (whether paid or not) who expressed that they would have preferred that I was more like a short activist who moved on after one report and was never heard from again.  I think if companies are going to be the subject of a short seller report, they’d prefer it to be the typical short activist that puts out a short report one time, covers on the report, and is never heard from again to a short seller who stays the course and keeps digging up new information.  And there really are few short sellers who stay with their stocks these days because some of the best talent on the short side has moved towards the short activist approach.

My understanding is that most short activists are in the trade for the very short haul and the “money machine” aspect of these strategies is attractive to allocators who want to monetize short research but do not want to take on the volatility of being short stocks for periods of time.  I do think the market understands that dynamic, and I think that model is challenging outside of even the recent regulatory pressures.  Short activists appear to rely on a “brand” that they build.  They spend time cultivating the brand – often requiring some “hit” report to become a breakout star.  Then they must maintain the brand without oversaturating.  On the other hand, some authors go dormant long enough that they can become forgotten.  The short activist business was already tough due to the fleeting nature of fame, and now you have an added unresolved regulatory overhang.

What is an interesting idea on your radar now?