March 1, 2023 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Five capital raise transactions with total disclosed proceeds of $163.9M closed this week. Two fewer transactions closed than last week, but the volume was up by $94.2M. One more transaction closed than the previous year, and the volume increased by $160.5M. This week’s average deal size was $32.8M compared to $0.8M last year.
Cannabis capital raises are off to a multi-year low. Only $475.96M has closed through the first eight weeks of the year compared to $894.46M last year.
Public companies have raised only 72.4% of total capital YTD, down from 79.4% last year.
Cannabis equities (as measured by the MSOS ETF) were down 7.27% for the week. The Canopy Growth convertible notes issue dominated capital raise activity.
This week’s Canopy Growth (CGC: Nasdaq), convertible debenture issue, and recent transactions by Tilt Holdings and MariMed make it clear that the cost of debt is rising. Treasury rates and cannabis risk premia are up significantly, and companies are hard-pressed to pay the required returns in cash. One result is a reversal in the trend toward straight non-equity-linked debt. In 2019, approximately 80% of all cannabis debt issues were equity-linked, but this had fallen to around 5% by 2022. We also see other mechanisms for cranking up the IRR of debt deals like OIDs, mandated premiums at maturity, and various fees. Viridian attempts to explicitly value these options and features to arrive at an actual effective cost of debt.
The 3-month vs. 10-year treasury spread inversion narrowed about six basis points to negative 96bp, but it is still the most pronounced inversion since 1981. We like to watch this spread as opposed to the more commonly monitored 2yr-10yr spread for two reasons: 1) it is the measure that the Fed focuses more attention on, and 2) this measure does a better job of mirroring bank lending economics. This inversion has successfully predicted the previous five recessions, and we don’t think it will miss this time either. Investors have slowly realized that the Fed is not about to pivot anytime soon since it considers inflation quite ingrained and sticky. The chart below makes it clear that in virtually every case, the yield curve will begin to steepen before the onset of the recession.
Arguably, cannabis is already in a recession, at least in many developed markets where profitability has been sapped by commodification-driven wholesale price declines exacerbated by inflation-driven cost increases. We continue to hear pundits bemoan the “race to the bottom” of pricing as though competitors in an agricultural commodity-based business have many choices. Unfortunately, we believe this is not a temporary condition but a sign of things to come. Retailers continue to tell us that their customers are primarily concerned with price and THC content, which spells commodity. It’s another reason why we consider federal legalization and the eventual interstate commerce it will bring to be the industry’s most significant long-term risk factor.
This week BDSA predicted that the size of the legal cannabis market would increase from $32B in 2022 to nearly $60B by 2027, which seems like a bold prediction given the sharp contractions we have seen recently in the mature state markets like California, Colorado, Oregon, and Nevada. The forecast depends on converting illegal to legal sales primarily in newly developed markets like New Jersey, New York, Missouri, and states yet to turn on the adult use spigot. Luckily there are still enough new markets to be opened to maintain cannabis’ status as one of the world’s fastest-growing industries for at least the next five years. Commodity price pressures, however, are not going away. The battle for increased legal usage against likely continued price compression will determine how much growth is realized.
YTD Returns by Public Company Category
Large Canadian LPs are still the worst-performing category in YTD returns, registering high single-digit weekly losses led by an 8.7% decline for Cronos Group (CRON: Nasdaq). Cronos dropped an additional 4% today after reporting lackluster earnings. The company’s market cap is now below its cash level. Four of our eleven public company categories are trading at negative YTD returns.
Best and Worst Performers of the last week and YTD
Slang Worldwide (SLNG: CSE) was the top gainer this week, up 15.4% after taking the biggest loser spot at down around 25% last week. Other gainers include TPCO (GRAM.USD: otc), after revealing its merger of equals with Gold Flora, and Tilt (TILT: NEO) on continued strength from its series of refinancing transactions announced last week. Lowell Farms (LOWL: CSE) was the big loser for the week, down 38.2%. We saw no news to account for the decline.
On February 23, 2023, Green Check Verified (Private), a financial services firm that provides compliance services to help banks work with cannabis companies, closed a $6M Series A funding round.
Mendon Venture Partners led the round.
Green Check announced in September that it was acquiring PayQwick, a business providing payment services and lending to cannabis companies.
The combined firms will provide compliance services and real-time transactions, including lending and other banking solutions.
Public vs. Private Raises:
Four of this week’s five capital-raising companies are public. Three trade in Canada (two on the CSE and one on the TSX), three in the U.S. (two on OTC and one on Nasdaq), and one on the Paris exchange.
Equity vs. Debt Cap Raises:
Equity accounted for 4.9% of capital raised this week.
Debt accounted for 62% 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. Accordingly, more companies are using equity-linked structures like this week’s Canopy Growth convert and the recent MariMed and Tilt Holdings transactions.
The Week’s Largest Debt Issues
On February 21, 2023, Canopy Growth (WEED: TSX)(CGC: Nasdaq, the 2nd largest Canadian LP by market cap, cultivation, manufacturing, processing, brand development, and retail, agreed to sell $150M of senior unsecured convertible debentures to an institutional investor. The first $100M was received at closing, with the remaining $50M subject to the satisfaction of certain conditions.
The notes carry a 5% coupon which will be paid in common shares, as will any principal outstanding at the maturity date of 2/28/2028. In this regard, the notes resemble a forward equity sale since all principal and interest payments will be paid in additional stock shares.
The debentures are convertible at 92.5% of the three-day VWOL price of the shares ending on the trading day of conversion.
The 5-year discount conversion option is quite valuable. We value it at approximately 40 points of bond value. Treating this as an OID gives us an effective cost of roughly 17.18%. This transaction is dangerous for shareholders as it resembles an equity line with corresponding downward pressure on the stock price.
The effective cost is consistent with our view that Canopy is a stressed credit. The Table below shows the rankings of the seven Canadian Cultivation & Retail companies with over $100M market cap. Canopy ranks as the fifth strongest of the seven based on having the worst ranking for liquidity (proforma for this transaction), the worst profitability ranking, and the second worst leverage ranking.
The graph below shows consensus analyst estimates for the Next Twelve Month EBITDA from February 2019 through February 2023. Canopy missed analysts’ estimates for 9 of the last 16 quarters, including the four most recent.
MERGERS & ACQUISITIONS
One M&A transaction closed this week for non-disclosed value compared to five transactions for $15.91M in the prior year.
Twenty-two transactions totaling $195.1M have closed YTD, compared to thirty-nine transactions for $1,358.3M last year.
The 2023 YTD average transaction size of $8.87M 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 narrowed by 800bp to 60% on 2/24/23, as the companies announced a three-month delay in the deal closing. The market breathed a collective sigh of relief as a three-month delay beats the other potentially bad news possibilities. Still, a 60% arb spread screams skepticism that the deal will survive as presently structured. An unannualized rate of return of 60% 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? Granted, the short side is difficult and expensive to maintain, but we don’t project 60% returns over the next four months anywhere else. What are we missing?
The valuation gap narrowed to 1.81 on 2/24/23 but remained close to the lowest measure since we began tracking this measure and 136 bps lower than its 52-week average. 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.
The Largest Closed M&A Deal of the Week:
On February 21, 2023, Irwin Naturals (IWIN: CSE)(IWINF: OTC), a premier nutraceutical formulator that recently entered the psychedelic market through its acquisition of Braxia Scientific, announced the closing of its acquisition of Serenety Health, LLC, one of the leading ketamine clinics in Louisville, Kentucky.
The total consideration and terms of the transaction were not disclosed except that it would include upfront, deferred, and contingent consideration.
The transaction brings the number of clinics under the Irwin Naturals Emergence umbrella to 22 pro forma.
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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