Amid volatile stock prices, acquisitions based on share-swap agreements are more likely to close than those with a lot of cash consideration or with a fixed-dollar amount to be paid in equity.
We saw this again Tuesday as Cresco walked away from its pending acquisition of VidaCann to focus its cash on existing operations and announced a $38 million sale-leaseback to help fund its growth plans and the pending Tryke acquisition.
Share swaps spread the rise or fall in stock prices more evenly between buyer and seller, while cash or fixed equity favor the seller if the buyer’s stock falls.
It seems the VidaCann deal was actually almost entirely cash, since abandoning it saves Cresco from the $120 million outlay. As recently as Sept. 18, the company described it as a “mix of equity, which will be subject to a 6- to 12- month lock-up agreement following closing, and cash.”
The equity component also could have been tied to a fixed-dollar amount; such a structure is almost the same as a cash deal and doesn’t actually shield the deal from price changes. For a fixed amount of equity, stock price declines result in more shares issued, where rises result in fewer shares.
In contrast, the Origin House deal had a larger equity component, which was successfully renegotiated.
Coincidentally, Akerna this week announced the acquisition of 80% of Solo Sciences for 1.95 million shares of KERN. Akerna cited $8.00 as the share value, implying the company signed the letter of intent on Sept. 23, and a 31% premium to the preannouncement close.
But the value assigned to the shares is irrelevant; the only important metric is Solo owning 15% of the pro forma entity. This deal will almost certainly close given that it is share based.
The VidaCann deal was announced March 18, and Cresco’s stock has since declined by 40%. Because the company has never had $120 million in cash for this acquisition, the funding would have had to come from either equity or debt. Assuming all equity, the VidaCann acquisition would have required 12 million shares on March 18 and 21 million shares today.
Tryke still pending but more likely to close
Cresco’s acquisition of Tryke is still outstanding, though the deal seems more likely to close (expected in the first half of 2020). It will require $55 million in cash as well and another $30 million for the Tryke real estate that presumably will be sale-leasebacked as well.
Cresco’s stock has declined 26% since that deal was announced, and as of Sept. 30, the company had $73.7 million cash.
Cresco also announced a leaseback on Sept. 27 worth $46 million.
But the leasebacks aren’t entirely cash for Cresco. The $38 million sale-leaseback is comprised of half cash and half tenant improvements, while “the majority” of the $46 million leaseback is tenant improvement avoided. Thus it seems that Cresco conservatively has $93 million in cash pro forma – enough to close Tryke without assuming a further sale-leaseback on the Tryke real estate.
Tryke generates positive EBITDA, however, so it is possible this could be levered with debt to make the deal self-financing.
The Tryke transaction has passed Hart-Scott-Rodino scrutiny, and most of the consideration is equity at $227.5 million – though the question remains whether the dollar amount or the shares are fixed.
Sale-leasebacks raise cash but reduce EBITDA
The sale-leaseback of two properties (Yellow Springs, Ohio, and Marshall, Michigan) will provide much of the cash for the Tryke transaction, and the company will get a cash boost from the expected sale-leaseback in the Tryke deal.
As recently written on Investor Intelligence by our partners Viridian Capital, sale-leasebacks have increased in popularity as equity funding has become scarce.
While sale-leasebacks do indeed free up cash, reduce capex, and do not dilute equity, they also reduce EBITDA and increase operating leverage, as a leaseback effectively converts a financing expense into an operating expense – as shown in our pro forma Tryke analysis.
If a property is funded with equity, the cost comes via dilution. If the property is financed with a secured loan, the cost comes as interest expense below EBITDA.
In a sale-leaseback, the cash is received upfront and tenant improvement capex is avoided, but the company then incurs a rent or lease expense for many years. Thus, all else equal, any EBITDA expectations need to be reduced by the size of the lease expense.
Real estate investment trust Innovative Industrial Properties has reported a blended yield of 13.8%, Curaleaf reported a “double-digit” cap rate on its leasebacks and Cresco confirmed the rate was “at market” – so 10%-15% seems to be the going rate.
At these rates, the new $38 million leaseback will add $3.8 million-$5.7 million in lease expense going forward, and the $46 million sale leaseback will similarly add $4.6 million-$6.9 million in lease expense.
The total impact to EBITDA from these two leasebacks is $8.4 million-$12.6 million – a not insignificant amount compared to the consensus EBITDA estimate of $190 million for 2020.
Mike Regan can be reached at [email protected].