February 15, 2023 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Two capital raise transactions with total disclosed proceeds of $11.2M closed this week. The same number of transactions closed as last week, but the volume was down by $30.3M. Five fewer transactions closed than the previous year, and the volume decreased by $124.6M. This week’s average deal size was $5.6M compared to $19.4M last year.
Cannabis capital raises are off to a multi-year low. Only $242.6M has closed through the first six weeks of the year compared to $798.3M last year.
Public companies have raised only 48.5% of total capital YTD, down from 82.6% last year.
Cannabis equities (as measured by the MSOS ETF) were down 3.45% for the week.
Two potentially far-reaching pieces of good news for cannabis this week:
Insurance – Two bills in the legislatures in Arizona and New York would require insurance companies to reimburse for medical cannabis. Making cannabis cost competitive with pharmaceuticals for treating anxiety, pain, and sleep disorders could positively impact medical cannabis penetration.
Advertising – Twitter has announced that it will allow state-legal cannabis companies to post U.S. ads for regulated THC and CBD products, accessories, and services. There are several restrictions to the new policy: ads may not target customers under 21, and advertisers may only target jurisdictions in which they are licensed. Despite these limitations, the policy change could be a massive shot in the arm for the development of cannabis brands, which the lack of national advertising has limited.
The Viridian Chart of the Week explored the critical differences between Illiquidity and Insolvency:
Many otherwise solid companies, like AYR (AYR.A: CSE), suffer from illiquidity. The lack of capital in the market may force them to forgo otherwise attractive investments or sell assets they otherwise would have held. The good news is that illiquidity is a problem amenable to financial engineering.
A more difficult problem is insolvency when the value of the company’s assets is less than its liabilities. Often this happens after a significant period of negative cash flow that depletes balance sheet reserves. Canopy Growth (CGC: Nasdaq) is not yet at this point but is heading in that direction without much sign of an operational turnaround. The company has taken many actions to stem the bleeding, but history has shown that it is difficult to shrink one’s way to profitability.
Both flavors of distress are becoming more apparent in the cannabis landscape, and the situation is sure to worsen before it gets better.
This week’s largest M&A deal, the purchase of Superette out of bankruptcy by SNDL, is a template for what we see as a significant uptick in distressed M&A. However, the lack of bankruptcy protection in the U.S. will continue to inhibit these sales and add uncertainty to the distress resolution process.
The 3-month vs. 10-year treasury spread is still close to the most inverted since 1981, at negative 103bp. 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 and pundits are holding on to the notion that the Fed will pivot to a more accommodative stance, but we feel that is unlikely to happen anytime soon. Powell is quite willing to endure a recession to scrub inflationary expectations from the system.
YTD Returns by Public Company Category
Large Canadian LPs have become the worst performing category in YTD returns, driven by double-digit negative performances across the board last week after the Canopy Growth business restructuring announcement.
Best and Worst Performers of the last week and YTD
Jushi (JUSHF: OTC), Body & Mind (BAMM: CSE), Slang (SLNG: CSE), and StateHouse (STHZ: CSE) are all on the top gainers list this week after appearing on the biggest loser list last week. We are frequently seeing twenty percent swings in two weeks within what is otherwise a relatively flat market.
The Week’s Largest Closed Equity Transaction:
On February 8, 2023, Bloomwell Group (Private), one of Germany’s largest legal private medical cannabis companies, announced closing a “significant multi-million Euro funding round.”
Terms of the round were not disclosed.
Artemis Growth Partners led the round with participation from existing seed investor Measure 8 Venture Partners and a German family office.
The investment fully funds Bloomwell’s business model. It positions the company to continue to gain market share in the medical market and prepares the business for the expected upcoming federal legalization of adult recreational cannabis in Germany.
Public vs. Private Raises:
One of this week’s two capital-raising companies is public and trades on the TSX in Canada and the OTCQX in the U.S.
Equity vs. Debt Cap Raises:
The exact amount of this week’s equity capital raise was not disclosed.
Debt accounted for 35% 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. We expect more companies to need to add equity kickers to their debt deals in the current capital-constrained environment.
The Week’s Largest Debt Raise: “We have almost run out of snarky remarks on this one.”
On February 3, 2034, Entourage Health Corp (ENTG: TSX-V)(ETRGF: OTCQX) close on the second tranche of its amended and upsized credit agreement with an affiliate of the LiUNA Pension Fund of Central and Eastern Canada, providing an additional US$11.2M (C$15M).
The facility has a 15.25% rate with a PIK option and matures on December 31, 2024.
A second lien secures the credit facility on the company’s assets behind Bank of Montreal, the company’s first-priority lender, whose facility matures on June 30, 2024.
LiUNA has now amended and increased the loan to Entourage on five separate occasions:
Proforma for the latest credit extension, LiUNA has lent Entourage approximately $83.6M, which sits behind roughly $20M first-priority debt. We can only make sense of this because LiUNA owns about 20% of Entourage. They are doubtlessly aware of the consequences to that equity if they discontinue providing liquidity. Still, at some point, one has to question whether this is good money after bad.
Entourage has had a remarkable 16 consecutive quarters of negative gross profit. Proforma debt to market cap is approximately 15.8x, which indicates severe distress. Cash flow from operations is running about negative $6-9M per quarter despite not paying interest on the LiUNA facility in cash. Financials do not get much uglier than this.
The Viridian Credit Tracker model ranks Entourage as #18 out of the 20 Canadian Cultivation & Retail companies in our database, with market caps between $5M and $50M. The company’s ranking would drop another notch were it not for the liquidity provided by LiUNA.
The Viridian Value Tracker shows that Entourage’s peer group trades at approximately 1.6x annualized revenue. Applying this metric to the company’s September quarter gives an estimated enterprise value of $49.3M. Adding in estimated cash of $12M and subtracting $20M of first-priority debt gives a recovery value of approximately $41.4M or roughly 50% of the par value. We believe this valuation is generous and would be sellers at those prices. We would love to attend the LiUNA credit committee meeting when the next round of credit extensions is discussed. We think that will be in around four months.
MERGERS & ACQUISITIONS
Two M&A transactions closed this week for total consideration of $5.15M compared to seven transactions for $149.93M in the prior year.
Nineteen transactions totaling $150.1M have closed YTD, compared to thirty transactions for $1,273.9M last year.
The 2023 YTD average transaction size of $7.9M and the 13% 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 570bp to 48.0% on 2/10/23 and continues to signal considerable market doubt about closing this transaction despite both companies continuing to say that they are committed to the deal. An unannualized rate of return of 48% for a less than six-month investment seems too good to be true. Will this transaction fall apart or be recut somehow? What are we missing here?
The valuation gap widened slightly to 1.90 on 2/10/23 but remained close to the lowest measure since we began tracking this measure and 137 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 7, 2023, SNDL Inc. (SNDL: Nasdaq), the fourth largest Canadian LP by market cap, announced the closing of its acquisition of substantially all of the business and assets of Superett.
SNDL entered into a Stalking Horse Agreement to acquire substantially all of the business and assets of Superette on August 29, 2022.
The consideration of $5.2M is made up of a credit bid and set off of $3.6M debt owed to SNDL and $1.5M in DIP financing.
Stalking Horse Agreements and credit bids are common in Chapter 11 cases in the U.S. However, the federal illegality of cannabis has prevented cannabis companies from accessing the Bankruptcy court, adding uncertainty to the workout process.
We expect to see a sharp increase in purchases of cannabis assets out of bankruptcy in Canada in 2023.
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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About Viridian Capital Advisors, LLC
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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