Bryant Riley's favorite small-cap stocks

Jennifer Schonberger | Jul 28, 2008 9:11am EDT | Comment

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Bryant R. Riley is founder and managing member of Riley Investment Management, an investment advisor which provides investment management services. He also is founder and Chairman of B. Riley & Co., a Southern California-based brokerage firm providing research and trading ideas primarily to institutional investors.

Riley serves on the board of directors of Aldila, Inc., Alliance Semiconductor Corp., DDi Corp. and Silicon Storage Technology Inc. He has served as advisor on a variety of M&A engagements, including the sale of Mossimo Inc. to Iconix Brand Group. In February 2007, Riley and a group of investors acquired Oregon-based Country Coach, Inc. from Perris-based National RV Holdings.

Prior to 1997, Riley held a variety of positions in the brokerage industry, primarily as an institutional salesman and trader, including co-head of equity at Los Angeles-based brokerage firm Dabney-Resnick and was a co-founder of Huberman-Riley, a Texas-based brokerage firm. Mr. Riley graduated from Lehigh University in 1989 with a B.S. in finance.

Riley is our tech expert on our small cap round table. He launched his third version of the Cash Rich Tech Stock Index (CRTS) in January. Year-to-date the index is down 2.44%, while the tech laden Nasdaq is down 12.89% and the Russell 2000 is down 7.27%. The first index was launched after the implosion of the tech bubble in 2002 and returned a jaw dropping 326% in just 19 months. It was closed down after that as stocks within the index reached fair value. The second was launched in May 2005 and returned 18.6% in a little under a year. Naturally, to gain some insight into investing in the tech and for some of his favorite names we turned to the mastermind himself, Bryant Riley.

What qualities do you look for specifically in a small-cap stock? What criterion do you employ?

“We look for strong balance sheets, a product differential, recurring revenue stream or solidly installed base.”

Broadly speaking, what’s your formula for picking winners for these tech stock indices?

“We focus on things that everybody else hates and that people are selling because that’s how you get your best values. You take that and the segment, and find companies that have the best fundamentals. You’ve got to think contrarian and find the right company.

“The reason we did our index is because the last time [we had saw these market conditions], we put the index together and it was up some 300% in a year. So we put this index together because there are like-sized opportunities. Does that mean everything is undervalued? No, I can’t speak to anything that we haven’t specifically researched, but in our environment, we think it’s hugely miss-priced companies.”

Could you name your top three small-cap technology stocks under $1 billion for the year and give your rationale behind why you think each will excel?

"Silicon Storage Technology (Nasdaq:SSTI) is very cheap. It’s got $240 million in cash and investments, so you’re paying $60 million for the business and for that $60 million you’re getting a licensing stream of revenue with high margins of roughly $40 million, therefore the revenue stream is big. Then Silicon Storage invested $200 million in new products. You’re getting a generally cash-flow positive business that spent a lot of money to invest in new products with licensing and a recurring stream of revenue that enables them to do that.

“United Online (Nasdaq:UNTD) has a very strong balance sheet, over $200 million in cash and completed an acquisition of FTD Group (NYSE:FTD), the flower specialty retailer. Adjusted for that acquisition, we think it trades at about three and a half times EBITDA. It’s very well-managed, and, again, strong cash flow and strong balance sheet.

“Extreme Networks (Nasdaq:EXTR) has a market cap that’s 75% cash. The company has a good set of networking products and has good recurring revenue. They’re generating cash and are very strategic. The company could fetch a much higher value in a transaction. Many of these companies have buybacks. United doesn’t, but Extreme and Silicon Storage do, and both have a lot of insider ownership.”

What’s your typical investment horizon when you’re generally investing?

“We don’t have one. We just try and focus on what the ultimate value is, and once that’s realized we’re pretty disciplined about selling, so we came in with the first index. Did we think that it was going to be up so much in a year? We didn’t. We had certain views on the valuations, and when we hit those targets and moved on. [Basically] we’ve been in some stocks for three months and we’ve be in some for five years.”