Cannabis Deal Tracker: Investment and M&A Activity in the Cannabis, CBD and Psychedelics Industry March 6th, 2023 - March 10th, 2023
March 15, 2023 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Three capital raise transactions with total disclosed proceeds of $2.5M closed this week. Four fewer transactions closed than last week, and the volume was down by $55.9M. The same number of transactions closed as the previous year, but the volume decreased by $25.8M. This week's average deal size was $0.8M compared to $9.4M last year.
Cannabis capital raises are off to a multi-year low. Only $540.55M closed through the first ten weeks of the year compared to $1,037.34M last year. Debt represents 53.1% of total capital raised. There has only been one week since the beginning of 2021 when less capital was raised than this week.
Public companies have raised only 65.1% of total capital YTD, down from 79.1% last year.
Cannabis equities (as measured by the MSOS ETF) were down 6.78% for the week.
The Silicone Valley Bank Failure seemed to appear in nearly every news story this week. We find it fascinating that with an inflation-pummeled consumer, a steepening downturn in housing, and the approach of what must be the most well-anticipated recession in history, what did in SVB had nothing to do with credit. Although the bank's loan portfolio tilted towards riskier tech credits, by all measures, their loan loss reserves and loss experience were quite good. Indeed one might think they did the right thing by parking so much cash in "riskless" government bonds instead of extending more startup loans. They failed, however, because of factors in the graph below depicting the 3-month vs. 10-year treasury spread. We watch this spread versus the more commonly monitored 2–10 year spread precisely because it better mirrors the economics of bank lending and is a more accurate predictor of recessions.
The inverted curve shows that the primary activity of borrowing short-term and lending long is unprofitable at times like now when the curve is steeply inverted. That might have weakened SVB over time, but it wouldn't have killed it like the forces of a crowd stampede, and make no mistake about it, no bank can't live through a run like SVB experienced.
Why did it happen? Bank risk management was lacking in not having secondary sources of liquidity and locking up so much of its assets in low coupon high duration bonds. There also seems to be some guilt on the part of Peter Thiel, who loudly advised depositors to withdraw funds, apparently after his own Founder's Fund had withdrawn all of its cash. There is blame to be shared by the large number of companies that maintained deposits greatly exceeding the FDIC limit. These companies were responsible for monitoring the health and risks of the institutions where they put cash. The fact that these depositors will be made whole strikes us as bad policy. Fundamentally, we doubt that such a small nonsystematic bank would have caused a cascade of other failures. We do, however, understand that it may be better to be safe than sorry.
A more important question at this point is what this means for Fed policy toward rates and inflation. The curve above is now more inverted than it's been in twenty years, signaling a high recession risk. So does the Fed bail on inflation? We think not. The Fed is after more than just simple inflation. It is trying to correct the all-asset bubble caused by a decade of zero-cost money, and we don't think Jay Powell will back down that quickly. He may not do 50bp, but we think 25 is still in the cards and may not be the last raise. The market believes the Fed will pivot, so look for some ugly price action when it figures out it was wrong.
Luckily, we see no direct impact on cannabis.
Today TerrAscend (TER: CSE) announced that it would seek uplisting from the CSE to the TSX exchange. We had been waiting for a large US MSO to make this move since Canopy's roll-up of its U.S. operations.
It comes down to this: how do MSOs make their stocks more valuable? The SAFE Act doesn't seem likely to happen. Margins continue to be compressed by wholesale price declines and inflationary cost increases. The capital markets are as tight as ever, making expansion funding difficult, if not uneconomic. Many, if not most, companies have laid off people and tightened their expenses. So what's left? Greater stock liquidity! Institutional investors have stayed out of cannabis for many reasons: illegality, reputational risk, a horrendous period of declining prices, etc., but they are still on the sidelines looking. Cannabis stocks are also nearly uninvestable for prominent players due to their illiquidity. Imagine the impact on even the largest MSO if an institutional investor wanted to buy or sell $100M of stock. The TSX has multiples of the CSE's trading volume, which will potentially get more institutions to invest in cannabis.
So why not everyone jump into the pool? It's not so easy!
In 2017, the TSX issued a staff notice that listed issuers "with ongoing business activities that violate U.S. federal law regarding marijuana are not complying" with applicable listing requirements. Furthermore, the notice made it clear that "ongoing business activities" would be broadly interpreted.
There may be ways to restructure the business that gets around these restrictions. One method involves creating a new listing company that only owns non-voting, non-participating shares of the plant-touching business that are exchangeable under certain conditions (like U.S. legalization) for ordinary shares. This avenue is what Canopy is pursuing.
Despite the allure of uplisting, the process seems costly and potentially fraught with unintended consequences. For example, will these arrangements affect the attractiveness of the company's stock as acquisition currency? Will it make the company less attractive as an acquisition target? What accounting or tax implications are there? It's safe to say that only large companies are likely to burn the lawyer's time to attempt this move soon. It will be fascinating to watch. Cynically speaking, maybe this is what it will take to get banking reform back on track.
YTD Returns by Public Company Category
The relative ordering of YTD returns by category is mostly unchanged from last week, except for U.S. Tier 1 MSOS, which have lost two ranking notches since the previous week.
Best and Worst Performers of the last week and YTD
AYR (AYR.A: CSE) led the loser list this week, down 27%. The company beat 4th quarter EBITDA estimates by 12.6% but saw 2023 EBITDA estimates cut by 7.9%. Several cannabis lenders appear on the losers list, including NewLake Capital (NLCP: OTCQX), down 20.1%; SNDL (SNDL: Nasdaq), down 17.9%; and AFC Gamma (AFCG: Nasdaq), down 16.2%. None of these companies are susceptible to SVB-like bank runs, and despite some uptick in their portfolio credit stress, these down moves seem exaggerated.
Gains were more muted: Unrivaled Brands (UNRV: OTC) was up 6.8% on news that it had settled its litigation with Peoples's California.
Lowell Farms (LOWL: CSE) was one of the top gainers this week, up 20.2% after taking the biggest loser spot at down around 38.2% last week. The company remains the worst performer on our list YTD but may be rebounding on the improved California pricing climate. We heard no direct news regarding the company's review of strategic alternatives. Interestingly, StateHouse (STHZ: CSE) repeated on the biggest loser list with a 22% decline this week. The volatilities we are experiencing are remarkable. Multiple companies are up or down more than 15% weekly on low volume and little to no news.
On March 7, 2023, Xebra Brands Ltd (XBRA: CSE)(XBRAF: OTCQB, a British Columbia-based producer of cannabis-infused beverages, closed a $659K private placement of units.
- 15M units were sold at approximately $.04 per unit. Each unit has one common share and one 18-month warrant with a 66% exercise premium.
- The net share price was a 43% discount to the preannouncement share price, consistent with the 38% increase in total shares outstanding before any warrant exercise.
- The issue implied a market cap and enterprise value of $2.32M and $1.44M, respectively. The share price tripled on heavy volume directly after the issue, and current market cap and enterprise values are $8.7M and $8.5M. Valuation metrics are not meaningful given the company's startup status (LTM revenues were approximately $60k).
Public vs. Private Raises:
All three of this week's capital-raising companies are public. Three trade in the U.S. on OTC, one trades on the Australian exchange and two trade in Canada on the CSE.
Equity vs. Debt Cap Raises:
Equity accounted for 33% of the capital raises this week.
Debt accounted for 69% of trailing 4-week capital raises. We expect this ratio to be volatile because of the limited capital raise activity. Debt should average over 50% of capital raised, especially since many companies are trading at or close to their 52-week lows. Since year-end, debt costs have significantly increased because of higher treasury rates and risk spreads. We expect continued increases in equity-linked structures.
The Week's Largest Debt Issues
On March 6, 2023, Creso Pharma ( CPH: A.U.)(COPHF: OTC), a developer of pharma-grade cannabis and hemp-derived neutraceutical products, raised $1.68M in a Secured Convertible Note:
- The note has an 8% coupon and nine-month maturity with an exercise premium of 50%. The effective cost of the issue without fees is approximately 10%. The extra 3% fee on such a short-maturity instrument raises the effective cost to 14.32%.
- Proceeds will support marketing and sales of the company's products in Canada, Europe, and the U.S. and for general working capital.
MERGERS & ACQUISITIONS
Three M&A transactions closed this week for undisclosed value compared to three transactions for $342.46M in the prior year.
Twenty-eight transactions totaling $728.81M have closed YTD, compared to fifty transactions for $2,012.00M last year.
The 2023 YTD average transaction size of $26.03M and the 33% of total consideration accounted for by the U.S. are both the lowest in recent years.
We believe the likelihood of relatively sizeable public/public M&A transactions has increased significantly based on the low trading multiples of tier 2 and 3 MSOs and SSOs, particularly those perceived to be cash flow pressured.
Major Pending Deals Risk Arb
The Cresco/Columbia deal spread widened by 1280bp to 75.6% on 3/10/23, following an announcement of a three-month delay in expected closing. Still, a 75.6% arb spread screams skepticism that the deal will survive as presently structured. An unannualized rate of return of over 75% for a four-month investment seems too good to be true. If you think this deal will close, as does one noted sell-side analyst we respect, then why wouldn't you try to establish the arb position of being long Columbia and short Cresco?
The valuation gap widened to 2.10 on 3/10/23 but remained close to the lowest measure since we began tracking this measure. The valuation gap is the difference between the EV/NTM EBITDA multiple for the largest MSOs and the multiple for the less than $300M market cap group, which are their primary targets.
This measure has been a significant driver of M&A activity since a larger gap creates an opportunity for more accretive transactions. The gap tends to increase in improving markets while declining in retreating markets to the greater trading liquidity of the larger companies. We believe the current gap is understated by the massive illiquidity of cannabis stocks which may not be accurate indicators of the prices at which the entire companies would trade.
The Largest Closed M&A Deal of the Week:
On March 6, 2023, Psykey, a wholly owned subsidiary of CECORS Inc. (CEOS OTC). completed its acquisition of VetComm Corp., a veteran's education and benefits company.
- The transaction value was not disclosed. CECORS enterprise value is approximately $1.7M.
- Psykey recently launched its first retail product offering, Psykey Functional Mushroom Infused Coffee.
- The company recently completed development on a Telemental Health App, Psykey Live, and is beta testing the product.
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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