Capital is tight in the industry, but there is incremental capital on the sidelines from new investors waiting to enter.
Capital is shifting to focus on profitable business models – either positive EBITDA today or a clear path to positive EBITDA with the deployment of incremental capital – and it is shifting to nonequity sources.
Those are the key takeaways from the two cannabis conferences that Craig and I attended this week, the IC3 Conference in New York City and the Benzinga Cannabis Capital Conference in Chicago.
Sale-leaseback for Acreage via GreenAcres raises cash and cash costs
In keeping with this theme, Acreage announced on Friday a sale-leaseback with GreenAcres, its 20%-owned REIT subsidiary formed in May, sourcing $72.3 million for Acreage and another $5 million to an unidentified third party that appears to be an owner of the assets Acreage is using – which would effectively remove a $5 million liability from Acreage.
Of this amount, only $23.3 million has closed and another $10.1 million will close within 30 days, so we will see this impact the Dec. 31 balance sheet rather than the next quarterly report.
More importantly, $43.9 million is for “construction commitments,” which means the REIT is funding not only the land but also the capex build-out of the facilities.
Because these are cannabis build-outs, it is unlikely that this spend will be very fungible (compared to, say, landlord improvements for a clothing retailer), and only Acreage can use them. Thus, this spend is theoretically a little more like preferred equity for GreenAcres, justifying much higher cap rates than standard REITs.
Such deals make sense for Acreage and other operators as it provides nondilutive capital and lets them focus that capital on aspects of the business – cultivation, branding and selling – where they can achieve a competitive advantage.
However, leases are effectively off-balance sheet debts that increase the fixed cash costs for Acreage.
The terms of the multiyear, triple-net lease were not disclosed, but Curaleaf cited a “low-double digit” cap rate for their leaseback in August, and Acreage used an 11.9% rate in filings for its lease commitments in an Aug. 23 MD&A filing.
Applying an 11.9% cap rate to the $77 million would mean that Acreage’s rent expense will increase to about $9 million per year for this transaction, versus the lease liabilities at Jan. 1, 2019, of $12.6 million.
Harborside focuses on margin expansion to profitability, benefits from tax ruling
Also within this theme, we hosted an Executive Webcast with Andy Berman, CEO of Harborside, this week – which you can listen to here and find the slides for the presentation here.
Harborside received a favorable ruling on its 280E liability, which was reduced to $11 million from a potential $36 million. Of that, $6 million is a tax penalty.
Highlights from the webcast include:
- Berman reiterated Harborside’s sales guidance of $55 million-$57 million and “adjusted EBITDA positive” for calendar 2019.
- While Berman did not give guidance on 2020, it seems that profit should improve with revenue growth from addition of dispensaries and new products. The company is ramping up its Salinas greenhouse, so margins should expand with the launch of more private label products.
- Harborside plans to reduce SG&A by 500 basis points, bringing those costs to 35%; a gross margin of at least 50% would then yield a margin of at least 5%.
- Capital spend is expected to decline.
- Harborside is still well capitalized with $13 million-$14 million in cash today versus $19 million at June 30.
- The stores in Oregon are part of the “California focus” since Oregon is next to California – though I do wonder if these could be sold to focus solely on California in a cash crunch.
- The company plans to appeal the tax ruling, and lawyers have told them that appeals typically take two years, so the cash liability is still a ways off.
Hexo converts, layoffs and forthcoming results
Investing is as much about gauging management behavior over time as about the numbers.
With senior executive turnover, with some pretty big holes in the senior team, no guidance for 2020 yet and mischaracterizations of recent headlines and conference calls, we believe there is more bad news to come for Hexo.
This week, the company issued a $70 million convert and disingenuously called it “nondilutive.”
The next day, it laid off 200 employees – about 20% of its workforce – including the chief of marketing and chief of manufacturing.
Hexo’s news release announcing the cuts called it “aligning with 2020 expectations,” but the company has not actually laid out that guidance yet.
While reducing the cost structure and raising capital to match a depressed environment is a positive for the business, saying it “aligns” with expectations that have yet to be officially laid out is, at best, sloppy.
We would expect guidance to come with the 4Q2019 release after the close on Monday, Oct. 28, or the call Tuesday, Oct. 29, at 8:30 a.m. ET.
The guidance will be compared to the consensus expectations for the year-end July 2020 of revenue of CA$169 million and an EBITDA loss of CA$7 million.
These characterizations follow very strong statements by CEO Sebastien St. Louis regarding transparency and execution on the 3Q19 call in June.
Forty-four days through a 92-day fiscal fourth quarter, St. Louis strongly reiterated: “We’re delivering a double this quarter.” In October, the company guided to a 46% revenue miss.
From page 39 of the transcript of the F3Q19 call on June 13, 2019:
Q: Krishna Ruthnum, analyst, CIBC World Markets
Okay. Thanks for that. And one last question just on your guidance for Q4. Just given where we are in the quarter, just wondering if you can give us some comments on the trend to-date, as well the pace and sort of your confidence of reaching that target?
A: Sebastien St. Louis, co-founder, chief executive officer and director, HEXO Corp.
We’re going to reach the target. I mean I’d ask you and I continuously I would welcome a challenge as I think at the analyst community is doing a phenomenal job in that space. I welcome more transparency in our space. I welcome a broader discussion for investors. If you ever hear me say something and not deliver, you have to call me out. And in reverse, I would tell you today, nobody’s ever called me out on anything because Hexo has always delivered what we said we would. We’re delivering a double this quarter.
Mr. St. Louis, as requested, we are calling you out, and we look forward to the F4Q19 call on Tuesday.
Mike Regan can be reached at miker@mjbizdaily.com.
