Aurora sets terrible precedent, Cronos looks to disruptive technology, Canopy pulls guidance and more

Aurora’s bad move for common equity holders

Canadian firm Aurora Cannabis (TSX: ACB) announced a stunning reprice of its convertible debt due March 2020, reducing the conversion price from CA$13.05 to a 6% discount on the trading price next week.

This sets a terrible precedent for cannabis sector companies by basically telling investors to “buy convertible debt and play hardball when the going gets tough.”

As company fundamentals weaken and capital gets tight, common equity investors need to recognize the increasingly real possibility of dilution from equitization of any debt due soon. This raises the cost of capital for equity offerings in companies with debt.

For Aurora, this conversion is an efficient direct equity offering of at least CA$155 million to convertible debt holders, with the potential for the remaining $75 million of debt to participate.

The company would have had to issue equity anyway in March to pay off its debt since, as of Sept. 30, it had only CA$152.5 million in cash.

The stock declined 18% on Friday to CA$3.59; at this price, the conversion adds at least 45.9 million shares and up to 68.2 million shares with full participation.

We will publish a more in-depth look at other companies that might be faced with similar financing decisions in the near future.

cbdMD not seeing CBD sales weakness like peers

Very tough competitive conditions in the natural-stores channel cited by CV Sciences may be more of a firm-specific issue.

North Carolina-based cbdMD (OTC: YCBD) is not seeing the CBD sales weakness that CV Sciences reported in its fiscal 3Q19 news release on Nov. 5.

Martin Sumichrast, CEO of cbdMD, said in the company’s fiscal fourth-quarter announcement that “our December 2019 quarter has begun with a very strong start as well. We are very optimistic that our fiscal 2020 results will be another record growth year for cbdMD.”

Colorado-headquartered Charlotte’s Web (TSX: CWEB) also reported healthy market conditions, saying in its 3Q conference call that the sales impact in the natural channel was modest, at only a 1% decline compared to the second quarter.

Valens GroWorks buys beverage maker

Valens GroWorks (TSX: VGW) is expanding its product offering ahead of the cannabis 2.0 regulation changes in Canada with the acquisition of Pommies Cider Co. and won’t need to raise capital to fund its CA$10 million planned expansion.

We see multiple positive points of VGW’s purchase of Pommies Cider:

  • It is a relatively small price tag (CA$7.5 million) for the business.
  • VGW gets a fully functioning, 32,000-square-foot facility for beverage manufacture and distribution.
  • The founders of Pommies are joining VGW, bringing their 20 years of industry experience.
  • Planned expansion will be paid for from internally generated cash flow, not a dilutive capital raise.

Summary structure of the deal from the news release:

The purchase price at closing was CA$6.0 million, comprised of CA$3.5 million in cash and 604,052 shares of VGW, valued at CA$2.5 million.

Pommies Cider can earn up to an additional CA$1.5 million upon achievement of certain earnout milestones relating to licensing, operational and financial performance.

Medicine Man Technologies driving deeper into Colorado market

Medicine Man Technologies (OTC: MDCL) reported its third-quarter results this week. As outlined in our deep-dive analysis, the story is really how MDCL will build a Colorado-focused vertically integrated operator via consolidation of key players; the company just needs to raise the cash to execute it. Assuming MDCL finances the cash needed with debt, our updated pro forma shares outstanding are 93.3 million below $3.50 and 103.1 million above $3.50.

The key takeaways from the conference call, third-quarter report and 10Q filing are:

  • The Colorado market is still growing despite being usually termed “mature.” We assumed only 5% revenue growth in our analysis, yet Columbia Care recently guided to 19% revenue growth for The Green Solution in 2020.
  • Regarding the acquisition of MedPharm, MDCL is “currently updating the valuation and finalizing the audits and plans to close as soon as practical,” presumably by the end of 2019. This acquisition had been expected to close within the third quarter.
  • CEO Andy Williams’ ownership of MedPharm is now 29%, up from 10% at the last 10Q filing on Aug. 14. His ownership in Medicine Man Denver is unchanged at 38%.
  • MDCL will not pursue the acquisition of the operation in Colombia, Green Equity SAS. We view this as a positive for the story as this focuses the company entirely on the strategy to consolidate the Colorado market and reduces the equity dilution by 1.3 million shares and cash needed by $450,000.
  • The latest 10Q states that Medicine Man Technologies will burn cash until it closes the acquisitions but will be cash-flow positive after. This is consistent with our deep-dive analysis. We would note that this cash burn is because MDCL is currently supporting the G&A infrastructure to support the consolidated entity; if none of the acquisitions close, MDCL would presumably scale back its G&A to match the profits of stand-alone MDCL.

Village Farms drives production costs lower

Village Farms International (Nasdaq: VFF) is positioned to be among the low-cost producers that survive the building overcapacity in the Canadian cannabis market.

In its third-quarter 2019 earnings announcement, VFF posted CA$0.63 all-in cost per gram for cannabis production. That is among the lowest production costs for Canadian producers.

With the potential for significant production overcapacity looming, as we previously noted, the companies best positioned to survive are those low-cost producers.

Village Farms is applying its expertise in mega-scale, precision, efficient greenhouse agriculture to cannabis and hemp production.

For further information about Village Farms, watch for our deep dive scheduled for release Nov. 27.

Cronos’ losses continue, but firm progresses on disruptive technology

Cronos Group (TSX: CRON) is very fortunate to have almost CA$2 billion of cash to fund its continued EBITDA losses while it makes progress on potentially disruptive cannabinoid fermentation technology.

Peers without such a large balance-sheet war chest don’t have the luxury of posting EBITDA losses 2X of revenue (CA$24 million EBITDA loss on CA$12.7 million of revenue). Their stocks would be sent significantly lower.

With its massive cash balance, Cronos can fund current losses and invest heavily in future technology development such as lab-grown cannabinoids.

If successful, Cronos’ technology could serve to exacerbate the growing oversupply risk in Canada. Planned increases in cannabis production capacity of the top 11 Canadian licensed producers could put capacity far ahead of demand for the next few years.

Cronos’ management indicated the company is targeting commercial-scale rollout in the future.

Sales from the recently acquired Redwood Holdings, a U.S. CBD-focused company, totaled just CA$900,000. Because Redwood contributed less than one month of revenue, we’ll have to wait until next quarter for any meaningful takeaways about that business.

Canopy changes almost everything

Canopy Growth packed a lot into their fiscal second-quarter 2020 earnings announcement and call.

The company massively missed revenue expectations, took an inventory and price adjustment write-down and pulled its CA$1 billion run rate guidance for fiscal 4Q 2020.

We detailed several of the issues in this story.