Warrants can align stakeholder incentives with shareholder interests, but they complicate the share count at different valuations and can cloud what you really own.
There are two essential steps to valuing equity:
- Value the underlying business.
- Divide that by the stakeholders – first the debt holders, then the rest by the shares outstanding – to figure out what an equity holder gets.
In other words, first figure out the size of the pie and then how many slices there are.
Given the complex capital structures, we at Investor Intelligence will scrub them and provide proper pro forma share counts under reasonable outcomes to ensure that you, the cannabis investor, understand what exactly you own.
Measuring your slice of the pie
Here’s an analogy. There are two round pies in an oven, one 8 inches across and one 12 inches, and you don’t know which the baker will bring out. You get either half the 8-inch pie or a quarter of the 12-inch pie.
Ultimately, you care only about the size of your piece. So, which is bigger?
Your slice of the 12-inch pie is 13% bigger than the slice of the 8-inch pie, even though it’s only a quarter of the pie. But the pie overall is 125% bigger – and the other slice is 238% bigger.
A 13% bigger piece is good, but who got 238% more pie? The holder of the warrants.
Warrants, options and convertible debt change the number of shares outstanding (the slices) depending on the price of the shares (the size of the slices, which are driven by the size of the pie).
If you hold common equity in a company with a lot of warrants, options and converts:
- Your percent of ownership changes with the moves in the stock prices.
- The size of the company changes by both the change in the stock price and the number of shares.
Given the dynamic nature of the cannabis space, a lot of companies possess complex equity that implies more than the shares outstanding suggest.
As an investor, you need to apply the right share count to your estimate for the company’s valuation to accurately assess your opportunity.
The most painful mistake is correctly finding a 12-inch pie, expecting to get half and then being surprised when you get only a quarter.
Medicine Man shares: 36 million or 67 million?
A live example of the complexity of warrants is Medicine Man Technologies, a Colorado-based company in the process of vertically integrating via acquisitions. It has secured a private equity sponsor, Dye Capital, with much experience in grocery and consumer packaged goods.
Medicine Man trades on the American OTC markets under the ticker symbol MDCL.
The headline shares outstanding from the most recent 10Q SEC filing is 35.8 million, but it’s more likely the shares are 64.1 million if they stay above $3.50, at which point the company will have a market capitalization above $224 million.
On Aug. 15, Dye Capital purchased at least 3 million shares – and possibly 5.5 million with warrants – bringing the total to 41.3 million shares.
|Average Fully Diluted 6/30/19||29.9|
|Common Stock 6/30/19||31.8|
|July 16 Share Sale to Dye Capital||3.5|
|Aug. 14, 2019 Shares Outstanding||35.8|
|Aug. 15 Share Sale to Dye Capital||3.0|
|Aug. 15 Upsize Option to Dye Capital||2.5|
|Total Current Shares Regardless of Price||41.3|
On top of the 41.3 million shares, we must consider the contingent equity: the warrants and the acquisitions.
The announced but not yet closed acquisitions include another 12.9 million shares to be issued, bringing the baseline total shares to 54.2 million. Until these close, the 12.9 million shares will be excluded from headline shares.
But they will probably be issued, and any forward estimates – including the operations and synergies of these acquisitions – should include them
While these deal shares are not technically contingent, they effectively are. If the MDCL stock price collapses well below the deal prices in the $3-$4-per-share range, the deals could fail (no shares issued) or be renegotiated (maybe more, maybe less).
|Pending Acquisitions:||Shares (millions)||Deal Price|
|June 5 Los Sueños||3.2||$ 3.01|
|June 5 Purplebees||2.8||$ 3.43|
|June 12 Green Equity SAS||1.3||$ 3.83|
|August 15 Dabble Extracts||1.0||$ 3.01|
|August 15 Edible Acquisition||4.7||$ 2.95|
|Total Pending Acquisition Shares||12.9|
|Pro Forma Shares Before Warrants||54.2|
While we cannot do hard math on deal outcomes, we can do hard math on the warrants, which probably add 9.9 million shares and maybe 11.2 million.
A warrant is a contract that lets the holder buy shares at a certain price, called the strike, within a certain time frame.
If the stock is above the strike price, the holder will exercise and new shares will be created. If the stock remains below the strike, it will expire and shares will not be created. It is effectively the same as a call option on new shares.
In the Medicine Man example, there are about 1.2 million warrants with a strike of $1.33, so with a stock price of $3.01, these will likely convert to shares, bringing the share count to 55.4 million.
Dye Capital also has warrants to buy 8.7 million shares of MDCL at $3.50. They will be exercised only if the stock rises above $3.50 in the next three years.
Thus, at about a $200 million market capitalization ($3.50 X 55.4 million=$194 million) the warrants probably get exercised, the company gains $30 million more cash and the outstanding shares jump to 64.1 million.
There are 2.5 million more warrants granted to officers with a strike of $8, or a market capitalization of about $500 million.
The purpose of the warrants is to align the incentives of Dye Capital and the officers with shareholders to get the stock above $3.50 and $8, respectively.
In other words, bake a really big pie.
When conducting your valuation for the next three years, if you think Medicine Man is worth $200-$500 million, use 64.1 million shares.
If you think it is worth more than $500 million, use 66.1 million. And if you think it will not trade above $200 million, use 55.4 million.
|Shares (millions)||Strike Price|
|Pre-2019 Warrants||1.2||$ 1.33|
|Share Count with the stock at $3.01||55.4|
|Dye Capital Warrants||8.7||$ 3.50|
|Share Count from $3.51-7.99||64.1|
|Officers’ Grants Warrants||2.5||$ 8.00|
|Share Count above $8.00||66.6|
Mike Regan can be reached at firstname.lastname@example.org.