August 17, 2022 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Three capital raise transactions totaling $30.7M closed this week, three fewer transactions, and a $46.0 million lower volume than last week. Three fewer transactions closed than the previous year, and volume decreased by $218.9 million. The average deal size was $10.2 million this week vs. $31.2 million in the same week last year. Last year’s figures were skewed by the $200M Cresco Labs (CL: CSE) Senior Secured Term Loan.
Cannabis capital raises are off 63.1% YTD.
Total Equity issuance is off 74.1% y/o/y, and total debt issuance is down 37.1%. U.S. debt is down only 16.9%, while Canadian debt is down a more significant 72.4%. At 54.8% of total capital raised, debt remains the highest in history for comparable periods. The graph below shows that U.S. activity dominated capital raises for the first thirty-two weeks of 2022, with 76.6% of all capital raised. Public companies accounted for 73.8% of total financing YTD, down from 83.1% in 2021.
The U.S. Cultivation & Retail sector has experienced the sharpest changes in capital raise activity.
Total capital raised is down 66.4%, but equity capital raised is down nearly 97%!
Debt financing is down 9.6% YTD and accounts for approximately 94% of all capital raised; private companies raised a record 36% of it.
63.3% of total capital raises YTD were completed by public companies, down from 80.7% in the same period in 2021.
Cannabis stock prices (measured by the MSOS ETF) were up 3.15% from last week.
The ETF is down 52.7% YTD compared to a 10.2% decline in the S&P 500. Discussion of Banking reform and federal legalization has died down and has moved to behind-the-scenes negotiations. We see the passage of a SAFE+ Act with relatively watered-down social equity provisions as the most likely case, although nothing is certain in an election year.
The snapback in valuation multiples could be highly significant, with NTM revenue and EBITDA multiples for Tier one MSOs exceeding 4x and 14x, respectively, vs. their current values of approximately 2.3x and 7.8x. Most of this gain will be from the indirect impacts of banking reform, including increased willingness to provide custody for U.S. listed equities and eventual uplisting of larger competitors to senior exchanges. These indirect impacts will significantly exceed the direct effects of easier account access and availability of bank credit, at least for the Tier 1 MSOs. Smaller companies will benefit from these direct effects and indirectly benefit from becoming more likely acquisition targets for MSOs with improved equity currency.
The majority of Q2 earnings releases are now in, with Cresco (CL: CSE), AYR (AYR.A: CSE), and Jushi (JUSHF: OTC) remaining. The table below summarizes the results, arranged by % revenue miss within each company type.
Non-plant-touching companies generally faired the worst. Greenlane (GNLN: Nasdaq), for example, reported a 21% miss on revenues, a 57% miss on EBITDA, and a 98% miss on EBITDA margin. The company withdrew its guidance of positive 3rd Quarter EBITDA and is now looking to sell its packaging business to focus on Greenlane branded product sales. WeedMaps (MAPS: Nasdaq) similarly shocked the market by reporting a 150% EBITDA miss with a negative adjusted EBITDA.
Tier one MSOs reported largely unsurprising results, with two exceptions. TerrAscend (TER: CSE) and Columbia Care (CCHW: CSE) missed EBITDA estimates by more than 45%. The Columbia Care release contrasts sharply with the Ascend Wellness (AAWH: OTC) report and reveals the widely disparate dynamics of the Eastern limited license markets vs. western unlimited license markets. Colorado and California, two regions experiencing notable pricing weakness, reduced Columbia Care’s EBITDA margins by more than 500 basis points. In contrast, Ascend beat estimates on revenues, EBITDA, and EBITDA margin, mainly on the strength of the New Jersey market.
Ascend further surprised the market by announcing it was abandoning its acquisition of NY assets from MedMen, citing the deterioration of the assets and the increasingly uncertain regulatory environment in the state. MedMen has expensive retail locations in a city overrun by illicit operators. The termination of this transaction is a strong statement on the value of NY licenses.
We continue to focus more on the revisions to guidance and consensus estimates. The table below shows the modifications to consensus estimates that have occurred in the last two weeks. 2023 EBITDA estimates have been revised downward for all 16 companies on the chart in amounts that range from 1.3% for Verano (VRNO: CSE) to 88.6% for Hydrofarm (HYFM: Nasdaq). The subdued tone of company guidance relates to wholesale pricing declines, inflationary cost increases, and the uncertain macroeconomic outlook. While scale economies can provide some shelter against these forces, we believe further decreases in EBITDA margin assumptions are likely.
The revisions are not particularly surprising when one considers the motivations of sell-side analysts. We call this the “Flight Delay Theorem.” Have you ever noticed that when you are at the airport and they announce your flight is delayed, they often come back later and announce a further delay? Corporate earnings guidance (and analysts’ estimates) follow a similar pattern. No one wants to appear overly pessimistic and overshoot on the downside. So estimates are not cut sufficiently and must be cut further when initial hopes for faster turnarounds prove unrealistic. We hope to be proven wrong, and that subsequent revisions are upward, but…
We believe that a recession is likely in 2023, although economists are sharply divided on the topic. The yield curve, particularly in the closely watched 2yr-10yr range, continues to be around 41 basis points inverted, which has been a solid indicator of future recessions. The downturn, if it happens, won’t look like traditional recessions: low unemployment, high inflation, ongoing supply chain issues, etc. High inflation is the most concerning aspect for cannabis. We do not see cannabis wholesale prices rising to match inflated costs, and we think consumers will have to cut back on discretionary spending. So although we understand the low price elasticity of the product, we still see negative impacts on cannabis profit margins
YTD Returns by Business Type
The significant changes in the chart from last week are relative outperformance of large Canadian LPs versus the Tier 1 MSOs. Returns on Psychedelics companies also improved relatively, earning them a fourth-best return YTD spot.
Best and Worst Performers of the last week and YTD
Nova Cannabis (NOVC: CSE) was the week’s best performer, up 66.3%, after beating revenue estimates by 39% and EBITDA estimates by 230%. NOVC also achieved a breakeven cash flow from operations in the quarter, its best in the last five quarters.
Stem Holdings (STMH: CSE) was the week’s second-best performer, up 46.7%. The company filed a 10Q for June, but we did not see any significant news to account for the gain.
TerrAscend (TER: CSE) was among the week’s worst performers, down 12.1% after significantly missing revenue and EBITDA estimates. 2023 EBITDA estimates have been reduced by 35% over the last two weeks.
The Week’s Largest Equity Transaction:
On August 11, 2022, Reunion Neuroscience, formerly Field Trip Health (FTRP: TSX)(FTRP: Nasdaq), a firm engaged in developing technology-enabled psychedelic therapies, closed a non-brokered private placement for gross proceeds of $15.7M. The transaction is part of a corporate reorganization that resulted in the spinout of the company’s Field Trip Health and Wellness Ltd subsidiary into a standalone public company that will be listed on the TSX. Reunion will continue to own 21.8% of Field Trip after the completion of the transaction. Reunion Neuroscience will begin trading on the TSX with a new symbol: (REUN: TSX)
FTRP sold 35.6M shares at $.44 per share
Oasis Investments II Master Fund Ltd subscribed for approximately 15.9M shares, representing 44.6% of the issue.
Psychedelics companies like Field Trip companies are an interesting bunch:
The blue line in the chart below (measured on the left axis) shows the percentage of the market cap composed of cash. Eight companies have more than 50% of their market cap in cash, including Field Trip, where cash accounts for 87% of the market cap.
Liquidity is quite mixed. The red line measures free cash flow adjusted current ratio, and companies with ratios under 1 (9/18) likely need financing within the year. Seven of these companies have ratios below zero indicating significant liquidity stress. Field Trip has a 3.05x ratio indicating comfortable near-term liquidity.
Public Company Raises:
Two of the three companies that raised capital this week were public. One trades in Canada on the TSX and both trade in the U.S. on Nasdaq.
Equity vs. Debt Cap Raises:
Equity accounted for two of this week’s raises and 51.1% of the funds raised.
Debt accounted for 45% of trailing 4-week capital raises, a small bounceback after a three-week decline.
We expect this trailing average to return to its LTM average of approximately 60%.
The Week’s Largest Debt Raise:
On August 11, 2022, Greenlane Holdings (GNLN: Nasdaq), one largest global sellers of premium cannabis accessories, child-resistant packaging, and specialty vape products, closed on a $15M asset-based loan
The facility has a three-year term with an interest rate that was not disclosed.
WhiteHawk Capital Partners is the agent for the Lenders.
Greenlane paid off $8M of debt early in the third quarter, releasing inventory and receivables collateral for the new asset-based line.
As of June 30, 2022, Proforma debt is approximately $27.6M including the $15M asset-based loan. Debt represents about 1x market cap, a relatively high figure given the company’s ongoing negative EBITDA, and substantially all of its assets are now pledged.
Still, the asset-based loan seems to have a relatively low advance rate against the $60M of inventory and $15 of Accounts Receivable on the books at the end of Q2.
The company withdrew its guidance for positive adjusted EBITDA in Q3, and we note that analysts are projecting approximately $11M of negative free cash flow for 2023.
Liquidity should be sufficient to last until proceeds from planned asset sales can supplement cash flow. However, things look tight for 2023 if asset sales do not materialize as planned.
MERGERS & ACQUISITIONS
Two M&A transactions closed this week with a total disclosed transaction value of $3.9M compared to two transactions for $21.9M in the prior year.
Total YTD M&A volume is down 79.9% from 2021, with $4.04B in consideration and 122 deals closed versus $20.04B in transaction value and 211 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 51.6% YTD.
U.S. volume is down 61.8%, with 36.3% fewer transactions.
The average transaction size of $32.7M is down 40.1% 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
The Cresco/Columbia deal spread widened by 70bp to 12.3% on 8/12/22. The deal still requires some state approvals and the completion of significant asset sales, which may be more difficult in the current financing environment. Ascend walking away from the MedMen purchase makes the Cresco/Columbia deal a bit riskier as it puts another NY asset on the market to compete for buyer interest.
The Verano/ Goodness Growth spread widened by 496bp to 12.0% as of 8/12/22, giving back all of its gains from last week. Q2 earnings announcements impacted the spread: Verano missed expectations by a much narrower amount than Goodness Growth.
The valuation gap remained unchanged at 3.33 on 8/12/22 vs. 3.06 last week. 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, which has averaged around 4 points in 2022, tends to increase in improving markets while declining in retreating markets.
The Largest M&A Deal of the Week:
On August 10, 2022, Auxly Cannabis (XLY: TSX)(CBWTF: OTC), the eleventh largest Canadian cultivation & retail sector company by market cap, completed the sale of an outdoor cultivation site in Hortonville, Nova Scotia, for $3.2M to an unidentified party.
Auxly had spent around $9M to build and develop the site and anticipated spending another $2.7M to finish it.
Auxly has reasonable short-term liquidity, but it is overlevered with total liabilities to market cap of 3.8x, the highest of any of its seven peers with market caps between $50M and $500M.
The Viridian Capital credit model ranks Auxly as the third weakest credit in the peer group, primarily due to this excessive leverage, as shown in the table below.
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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