Debt market cautious about Hexo’s ability to integrate cannabis acquisitions

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Hexo CEO Sebastien St. Louis

Hexo Corp. CEO Sebastien St. Louis.

Deal of the Week / In partnership with Viridian Capital Advisors

Last week, Hexo Corp. (TSX: HEXO; NYSE: HEXO) closed a public offering of $360 million principal amount of senior secured convertible notes maturing May 1, 2023.

Here are some of the key elements of the debt financing:

  • Proceeds will be used to fund the $331 million cash payment in Hexo’s $766 million acquisition of Redecan in Ontario, the largest private licensed producer in Canada.
  • The notes were issued at a 9% discount and bear no interest.
  • They are secured by substantially all the company’s assets.
  • The conversion price of $6.80 is a 3.8% premium to the stock price before the issue.

The discount on the notes creates a yield to maturity of 5.0%, roughly in line with what one would expect for a large Canadian LP.

The low exercise price, however, raises the effective cost of the issue to 14.4%, significantly higher than what similar-sized Canadian LPs or top-tier U.S. multistate operators pay on debt.

The high cost reflects market recognition of the significant execution risk that Hexo is taking on with three acquisitions announced in the past three months.

The integration of Redecan, 48North and Zenabis will not be easy. The company needs to coordinate branding, distribution and marketing as well as rationalize production across four different platforms.

On a conference call, Hexo acknowledged the magnitude of this task and said it expects the process to take three to four quarters to complete.

The issue is that every acquisition starts out with positive plans to achieve great synergies and yet the majority of acquisitions fail. Why? It’s just one of the most difficult things to get right in business.

The equity market generally seems to be willing to look ahead to the consolidated market position that Hexo can achieve; the company’s stock price was up 9.5% on the Redecan announcement. The debt market is clearly more cautious and extracting lucrative terms to compensate for the perceived risks.