Here’s a Model for Solving a Huge Cannabis Industry Problem

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Since September, we have been detailing the challenges the sector faces with respect to raising capital, a situation set in motion by the vaping crisis and then exponentially magnified by the pandemic. Many operators, both public and private, are burdened with debt and facing an existential threat. Investors in public companies have shied away from both Canadian and U.S. operators with near-term debt maturities that are challenging to address, leaving the equity price under selling pressure.

Companies facing debt maturities have several options:

  • Sell stock to repay existing debt holders
  • Convince the debt holders to take equity
  • Raise additional debt capital
  • Sell assets
  • File for creditor protection

While Aphria wasn’t facing any near-term liquidity issue, the company was extremely proactive addressing a weakness in its balance sheet. Recall that the company issued debt last April, selling US$350 million 5.25% convertible debt in a private placement, with a maturity of 2024. The bonds were convertible at US$9.38, then a 20% premium to the price but, more recently, more than 2X where the stock was trading.

On Friday, the company announced what we think is an extremely smart deal to repurchase 26% of the debt at a big discount. Specifically, it paid US$2.1 million to cover accrued and unpaid interest and issued 18.7 million shares to retire $90.8 million of the bonds, effectively US$4.84 per share, a 31% premium to its recent closing price. To be clear, the debt holders received stock valued at about $69 million, a discount of 24%.

In hindsight, the company would have been better off a year ago selling stock rather than issuing convertible debt, but this transaction reduces debt, improves net cash and lowers interest expense. Shareholders didn’t appreciate these benefits initially, as the stock sold off and ended the day down almost 7%. The best explanations of why the stock declined are that the increased share count is seen as dilution (the 18.7 million shares boosted shares outstanding by 7%) and, perhaps more importantly, that most likely a portion of the stock issued hit the market.

We were a bit surprised that the debt holders agreed to do the deal, so we reached out to the company to gain a better understanding.

The bonds had apparently been trading at about sixty-one cents on the dollar, so this transaction enabled the shareholders to exit the bonds at a higher price, effectively. As the bonds are privately traded, pricing data isn’t readily available to the public. For the debt holders to lose, the stock would have to decline to US$2.96.

So, why is this such a big deal?

We see a path to debt reduction through similar negotiated transactions across the sector. There are several Canadian LPs and U.S. operators with out-of-the-money convertible debt that need to address the maturity over the next 12 to 24 months, depending upon the issuer. Debt holders for some publicly traded convertible notes and presumably private placement convertible notes as well are willing to sell for very low prices, and companies, rather than trying to figure out how to repay them in full, should access capital to buy back the discounted debt or negotiate equity settlement, as Aphria did. Just chipping away over time could help the equity improve as the debt appears to become more manageable, decreasing the risk of a default at maturity, as relying upon other solutions becomes more tractable.

We are encouraged to see Aphria and some of its debt holders create a win-win scenario through the transaction announced Friday, and we are hopeful that holders of debt in other companies will take back reduced principal, effectively, a move that may save many companies that are otherwise executing operationally.

With the recent change in its laws, Colorado is now open to publicly-traded company ownership. A first-mover is Medicine Man Technologies, now doing business as Schwazze, which has closed its first acquisition and is in the process of closing several others to create a very large roll-up in the state. Led by management that played a big role in the turnaround of Albertsons, it is focused on being the nation’s largest vertically integrated cannabis holding companies.

Get up to speed by visiting the Schwazze Investor Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.

New Cannabis Ventures publishes curated articles as well as exclusive news. Here is some of the most interesting business content from this week:

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Alan & Joel

Exclusive article by Alan Brochstein, CFA
Alan Brochstein, CFA
Based in Houston, Alan leverages his experience as founder of online community 420 Investor, the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures, he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha, where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter | Facebook | LinkedIn | Email

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