Incorporate uncertainty into your marijuana business plan

cannabis investing, Incorporate uncertainty into your marijuana business plan

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Wouldn’t it be great if words that we’re tired of could just stop being part of our reality?

We’ve lived in “unprecedented” and “uncertain” times for nearly two years, thanks to the COVID-19 pandemic. It’s disrupted our daily lives and our business operations.

While we can’t make those realities just disappear, there are steps you can take to help offset the effect they have on your operations and your bottom line.

First, implement “uncertainty modeling.”

While this sounds complex and overwhelming to non-data people, it doesn’t have to be.

What it’s really about is inputting more data into your planning – from ordering to sales and everything in between.

That tracking might reveal patterns that aren’t immediately visible.

For example, Seattle-based analytics firm Headset recently looked at the spike in sales trends reported in 2020 that didn’t continue into 2021.

Looking at that data from this side, sales follow a logical pattern.

During the height of lockdowns and restrictions, consumer consumption behaviors shifted to different products and higher demand.

People were staying at home more and spending less of their disposable income on entertainment such as concerts or movies.

Now that the economy is returning to something a little closer to normal – or at least getting us out of our houses more – consumption is returning to pre-pandemic patterns.

Next, evaluate your supply chain and find alternative suppliers for critical items, such as packaging.

While a lot of the packaging supply has historically come from China, the average cost of shipping across the ocean on a container ship more than doubled in 2021.

Some individuals report increases of more than 700% for their products.

On top of skyrocketing prices, international shipping channels can be disrupted by extreme weather or labor disputes.

Build a relationship with domestic providers early so the option exists to pivot when the need arises.

– Jenel Stelton-Holtmeier

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Deal of the Week / In partnership with Viridian Capital Advisors

If a deal looks too good to be true, it just might be

On Jan. 6, Halo Collective (NEO: HALO; OTCQB: HCANF), a vertically integrated cannabis company with operations in California, Oregon and Canada, entered into an innovative loan facility worth 14 million Canadian dollars with Alpha Blue Ocean (ABO), a convertible arbitrage hedge fund.

At first glance, the deal seems almost too good to be true.

Details of the unsecured loan include:

  • Two tranches of CA$7 million each.
  • 8% interest rate (with payment-in-kind features, according to the subscription agreement).
  • Fully amortized over six months with level principal and interest payments of CA$2.39 million per month for six months, assuming all CA$14 million of the facility is drawn.
  • 2.6 million warrants with a CA$1.60 strike price (33% premium) and five-year expiration issued to ABO. The warrants will be issued in three equal tranches: one-third on the loan agreement date, one-third 30 days after the loan agreement date, and one-third after 60 days.

Halo said proceeds will be used to support its expansion into nutraceutical products, for the completion of Halo’s Budega retail stores in Hollywood, North Hollywood and Westwood, California, and for general corporate purposes.

Capital projects funded with a six-month loan begs the question of whether this is a bridge to a longer-term deal.

But it’s also a curious structure for a bridge: unsecured and only 8% coupon?

But remember, Halo is giving away five-year warrants for a six-month loan – and it turns out these warrants are quite valuable.

The Black-Scholes model indicates that each warrant is worth about $0.23, making the total warrant package worth $603,750, or around 4% of the principal.

Given amortization, the average loan life is only 3.5 months.

This combination of a short life and warrant value, along with the 8% coupon, produce an effective cost of 22.9%.

Which means Alpha Blue Ocean is getting paid quite well for extending a 3.5-month-average-life credit to Halo!

But here’s where the deal gets more interesting.

Simultaneously to the loan above, Halo entered into a subscription agreement with ABO that allows it to issue up to 15 convertible debentures, each with a principal amount of CA$1.23 million.

Halo paid ABO a CA$650,000 commitment fee in connection with this agreement.

Halo has the option to make payments under the 8% loan by issuing convertible debentures under the subscription agreement.

It would require two new debentures for each monthly payment on the loan, with the convertible issued at 97% of par.

These convertible debentures carry no interest rate and have a 24-month maturity. They are convertible at any time (and automatically at maturity) at the lower of CA$1.25 or the stock’s closing price on the conversion date.

If the stock price on the conversion date is higher than the lowest price in the 15 days before conversion, Halo will need to make a “make whole” payment to compensate the lender for the difference.

In addition, Halo can force conversion if the five-day, value-weighted average price of its stock exceeds CA$2.60.

There are two ways to look at this overall transaction:

  • The more generous view is that Halo is paying approximately CA$600,000 in warrants for a short-term loan bridge loan to a more attractive takeout financing, with the intention of utilizing the subscription agreement sparingly, if at all. However, it paid a $650,000 commitment fee for that option.
  • The less-generous view is that Halo intends to issue converts under the subscription agreement to make amortization payments.

We view the open-ended potential issuance of shares through the convertible debentures as dangerous for Halo’s shareholders.

Convertible arbitrage funds typically short a company’s stock against a long position in the convert, exerting downward pressure on the stock.

ABO is not at risk: It is buying the converts at a 3% discount, and it has an at-or-below market conversion price that it can exercise at any time.

ABO will make money regardless of whether Halo’s stock goes up or down.

  • If Halo’s stock begins to decline, it will need to issue an increasing number of shares, exerting more pressure on the stock. In the worst-case scenario, this could spiral the stock downward.
  • The CA$14 million loan is quite large relative to Halo’s market cap of CA$34 million, so a significant number of shares would need to be issued at current prices and proportionately more if the stock declines.
  • Furthermore, Halo has a 30-day average trading volume on the NEO Exchange of roughly 113,000 shares per day. Selling $14 million worth of shares would be difficult at that pace without affecting the price.