Cannabis Deal Tracker: Investment and M&A Activity in the Cannabis Industry June 27th, 2022 - July 1st, 2022
July 6, 2022 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Transactional Activity: There were two more transactions and a $22.1 million higher volume than last week. One less transaction closed than the previous year, and volume fell by $124.8 million. The average deal size was $9.4 million this week vs. $23.8 million in the same week last year.
Cannabis capital raises are off 64.2% YTD. Equity issuance is off 76.0% y/o/y overall, with a more significant 81.4% decline in Canadian equity financing. Debt, at 54.6% of total capital raised, is at its highest in history for comparable periods. The graph below shows that U.S. activity dominated capital raises for the first twenty-six weeks of 2022, with 77.4% of all capital raised. Public companies accounted for 73.5% of total financing YTD, down from 83.7% in 2021.
The Cultivation & Retail sector has had an even steeper 70.0% drop in capital raises YTD. The chart below shows the 90.0% decline in YTD equity financing. Debt has accounted for 77.4% of total sector capital raises YTD, heavily focused on U.S. companies.
Cannabis stock prices (measured by the MSOS ETF) declined by 8.82%% last week, reaching a new low since the ETF's creation. The ETF is down 59.6% YTD compared to a 19.7% decline in the S&P 500. Cannabis has faced a perfect storm: slow progress on any federal legal reforms, sharp decreases in broader markets (and yes, cannabis IS correlated), a restricted capital market, and the dual margin threats of inflation and recession.
We anticipate an early release of Schumer's broad legalization bill in the next few weeks. The release seems to have little purpose besides political theater since there is almost no support for any more comprehensive legalization framework. The goal appears mainly to make a statement: "we fought the good fight." Releasing the bill early gives extra time for a potential pivot to a more moderate SAFE + Social Equity Lite bill. We expect a muted market response from the bill's introduction since virtually no one believes it has any chance of passage. We also continue to be skeptical about the path of a banking reform bill this year.
We expect cannabis analysts will mark down EBITDA estimates for the later half of 2022. We do not believe they have sufficiently factored in the margin pressures from stagnant to declining wholesale prices mixed with significantly higher energy, fertilizers/nutrients, and other input costs.
We are somewhat less optimistic than most observers about how recession/inflation-resistant cannabis is. The last economic downturn seemed to benefit the cannabis industry. Still, the upcoming one will be different: 1) We see little chance of new COVID-related shutdowns, 2) we think there is virtually zero chance for another round of stimulus, and the last downturn did not include wallet-busting price increases in necessities like food and gas. All of which add to an economic downdraft that could be less favorable for cannabis.
Our Chart of the Week from last week and our previous DCF valuation analysis both pointed to the significant undervaluation of cannabis equities; however, we do not see meaningful upward movement until at least 2023.
The most significant change in our YTD Sector performance was the three-position improvement of Psychedelics. Viridian Capital Equity Research continues to recommend the Tier 2 and Tier 3 companies, despite their superior performance YTD, as we believe these companies are attractive acquisition candidates.
Best and Worst Performers of the Week and YTD
Glass House Brands (GLASF: OTCQX) was the week's best performer with a 39% gain.We attribute GLASF's gains to California's elimination of the cultivation tax. The $161 per pound reduction in cost is a more significant percentage of the total costs of GLASF, given their posture as a low-cost greenhouse grower.
Canopy Growth (WEED: TSX) was the week's worst performer, with a loss of approximately 25%. Canopy announced that it had entered into an exchange agreement with convertible holders, including Constellation Brands (STZ: NYSE), to provide partial relief from the liquidity pressure of the 2023 convertible note maturity.
The Week's Most Interesting Equity Transaction:
On June 30, 2022, Akerna (KERN: NASDAQ), a leading enterprise software company and creator of a technology ecosystem for cannabis companies, priced a $10M Public Unit offering. The two-part offering appears more complicated than the underlying economic reality:
- Part 1 of the transaction included the issuance of 28.39M units at $.23 per unit. Each unit consists of one share and one warrant exercisable for five years at $.23 per share (0% premium).
- Part 2 included issuing 14.1M more units with pre-funded warrants instead of common shares but including 14.1M common share warrants with the same terms as part 1.
- The economic substance of the deal is that the company issued 43.5M units consisting of 1 share and one five-year warrant with a zero premium exercise price.
The five-year warrants with zero premium exercise prices are quite valuable. Black Scholes, using 30% volatility values each warrant at $.074. Subtracting this value from the unit price gives a net share price of $.16, a 32% discount from the unit price. This unit price is, in turn, 57% below the company's closing price before the deal announcement.
The issue increases the company's share count by 118%, assuming no exercise of the common share warrants, and by 236%, assuming the exercise of the at-the-money warrants.
Akerna's share price has responded appropriately to the significant dilution from the offering, closing at $.164 per share on July 5th.
The transaction implies a market cap of $13.16M and an enterprise value of $18.3, representing an EV/2022 Rev of .65x, a discount to the 1.36x average multiple of the four other analyst-covered software companies in the Viridian Value Tracker database.
Akerna likely had little choice but to do this stock deal. Negative cash flow from operations and upcoming debt maturities threatened to produce a liquidity crisis. The $10M proceeds of this issue do not solve the company's long-term cash flow issues, and further dilutive equity issuance or restructuring actions may be necessary.
Public Company Listings:
Six of the seven companies that raised capital this week were public. Five trade in Canada (three on the TSX, two on the CSE), and all six trade in the U.S. (four on OTC, two on NASDAQ).
Equity vs. Debt Cap Raises:
Equity accounted for five of this week's raises and 49.3% of the funds raised.
Debt accounted for 63% of trailing 4-week capital raises.
We expect debt to oscillate around its trendline of around 70% of cannabis capital raises. Large MSOs are opportunistic equity raisers and are currently sitting out the market turmoil.
The Week's Largest Debt Raise:
On June 30, 2002, Ascend Wellness Holdings (AAWH.U: CSE)(AAWH: OTCQX), the 8th largest MSO by market cap, announced that it had closed on $28.M of the remaining additional funding under the accordion feature of its existing term loan facility. AAWH has now raised a total of $275M under the facility.
- The facility bears a 9.5% interest rate and matures on August 27, 2025.
- The facility has a 4% OID and carries 20% warrant coverage with exercise prices of $3.1 per share.
- The 4% OID and 20% warrant coverage produce an effective rate of approximately 11.1%, appropriate pricing given our perception of Ascend's credit quality.
- Below is a table that shows the Viridian Credit Tracker rankings of the credit quality of the Cultivation & Retail sector companies with more than $300M market cap. Note, we rank Ascend as #9 out of the 11 companies. We expect the company's ranking to climb as New Jersey and New York operations begin to produce significant results.
An interesting combination of a debt raise and restructuring.
On June 27, 2022, Entourage Health (ENTRG: CSE) announced that it had raised an additional US$6.9M under its 2nd priority secured credit line with the LIUNA Pension fund.
- The facility bears interest at 15.25% and matures in December 2024. LIUNA owns approximately 20% of Entourage's stock and is considered a related party.
- We have noted before that, in our opinion, 15.25% interest does not adequately compensate for the credit risk of Entourage, a company with 15 consecutive quarters of negative gross profit.
- To its credit, however, the company has secured an extension of the maturity of its senior credit facility from June 2022 to June 2024 and of the 2nd priority facility from August 2022 to December 2024.
- In addition, Entourage received approval from 97% of the holders of its 8.5% convertible notes to accelerate the maturity to June 2022 and to redeem the C$13M notes at maturity for 60% of their principal amount plus 100% of all accrued and unpaid interest.
- These moves should result in Entourage retaining approximately C$1M of the funding from the new advance to support its negative cash flow.
- Despite these steps, Entourage will continue to have a debt to market cap of over 5.75x, a level we find indicative of significant distress. In addition, ENTG's latest quarter shows a negative US$6.4 cash flow from operations. At best, the company will need to tap additional liquidity sources before year-end, and we frankly struggle to see how this ends well.
MERGERS & ACQUISITIONS
Transactional Activity: Two M&A transactions closed this week with a total disclosed transaction value of $55.7M compared to seven transactions for $784.7M in the prior year.
Total YTD M&A volume is down 80.3% from 2021, with $3.80B in consideration and 103 deals closed versus $19.32B in transaction value and 174 closings in 2021. Last year's total included two of the largest M&A transactions ever done in cannabis, the $4.5B Tilray acquisition of Aphria and the $7.2B Jazz Pharma acquisition of GW Pharma. Without the two megadeals mentioned above, the volume in 2022 would trail 2021 by 50.2% YTD.
U.S. volume is down 60.0%, with 36% fewer transactions. The average transaction size of $38.0M is down 35.5% from 2021. Still, it is expected to grow considerably as large public/public transactions like Cresco/Columbia Care and Verano/Goodness Growth close in the 4th quarter.
Major Pending Deals Risk Arb
Cresco/Columbia - a deal with a long time horizon and significant challenges to completion.
- Significant overlaps require asset/license sales.
- Significant integration challenges.
- Relatively low initial premium to market paid.
The Cresco/Columbia deal spread gapped downward by 650 bp to 5.7%% on 7/1/22. We saw no immediate reason for the material narrowing of the spread.
Verano/ Goodness Growth - a transaction we initially believed would close in the 2nd quarter of 2022 is now a 4th quarter event according to Goodness Growth management. The spread on this deal narrowed 710 bp to 5.4% as of 7/1/22. This deal spread may reflect market skepticism about how quickly New York is issuing regulations for the original license holders, including Goodness Growth. Similar to Cresco/Columbia, we saw no immediate reason for the sharp reduction in the arb spread.
The largest M&A Deal of the Week:
On June 30, 2022, Innovative Industrial Properties (IIPR: NYSE), one of the largest providers of sale-leaseback financing to the cannabis industry, funded an additional $55M for Green Thumb's (GTII: CSE)(GTBIF: OTCQX) recently completed development of a 152,000 sq. ft. industrial building in Danville, Pennsylvania.
- IIPR's total investment in the property is now $94.6M.
- IIPR's total investment in properties operated by Green Thumb is approximately $177M, and Green Thumb is IIPR's fourth-largest tenant
VIEW DEAL TRACKERS
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.
Launched in January 2015, and having analyzed more than $60B in deals, the Viridian Cannabis Deal Tracker is a proprietary data service that monitors and analyzes capital raise and M&A activity in the legal cannabis and CBD industries. Each week the Deal Tracker provides proprietary data and market intelligence on transactions, including:
- Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors - from Cultivation to Brands to Software)
- Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A)
- Principals to the Transaction (Issuer/Investor/Lender/Acquirer)
- Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)
- Deals by Location of Issuer/Buyer/Seller ( To Track the Flow of Capital and M&A Deals by State and Country)
- Credit Ratings (Leverage and Liquidity Ratios)
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Viridian Capital Advisors (www.viridianca.com) is a financial and strategic advisory firm dedicated to the cannabis market. We are a data- and market intelligence-driven firm that provides investment, M&Amp;Amp;A, corporate development, and investor relations services to emerging growth companies and qualified investors in the cannabis sector. Our banking practice, through broker-dealer Bradley Woods & Co. Ltd. (Member FINRA/SIPC), provides capital and M&Amp;Amp;A services to fund the growth of our clients, while our advisory practice helps to position and build their businesses. Our team's decades of high level operating and transactional experience on Wall Street in a variety of emerging sectors, allows Viridian to provide comprehensive strategic and financial solutions that assist cannabis enterprises in realizing their full potential.
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