Cannabis companies are issuing equity, debt and warrants for acquisitions at a rapid pace right now, moves that require answers to key questions for keen investors.
- Do the deals provide management an opportunity to create or destroy shareholder value?
- Are the deals accretive or dilutive to your ownership stake?
Those questions can be difficult to answer when there are scant traditional financial metric details such as EBITDA, EPS or free cash flow to analyze.
But there are two quick methods to get your arms around deal economics with just some basic financial information:
- Return on capital (ROC).
- EBITDA per share.
Return on capital allows for review without relying heavily on projections of future growth or margin improvement.
If a conservative analysis indicates a company can produce an ROC greater than the cost of capital (COC), it indicates management has the opportunity to create shareholder value.
To calculate ROC, divide net operating profit after tax (NOPAT) by invested capital.
A good example to demonstrate this principle is the recent string of acquisitions announced by Medicine Man Technologies (OTC: MDCL).
MDCL invested approximately $200 million of capital (cash and shares) for the acquisitions.
For this example, let’s assume the company has COC of 8%. That means that the acquired companies need to produce at least an 8% return on $200 million of capital, or $16 million of NOPAT, to create shareholder value.
In a recent news release discussing the acquisitions, management estimated those companies will generate 2019 revenue of $170 million at a 20% EBITDA margin ($34 million EBITDA).
If we use $4 million of amortization ($200 million cost, 50% goodwill, amortize for 25 years) and the company’s most recent annual tax rate of 38%, the acquired NOPAT could reach $18.6 million.
| EBITDA ($ million) | 34.0 |
| D&A expense | -4.0 |
| Pre-tax profit | 30.0 |
| Tax at 38% | -11.4 |
| NOPAT | 18.6 |
That relatively simple ROC analysis indicates it’s reasonable that MDCL’s recent acquisitions can create shareholder value.
ROC analysis is a quick way to understand the economics of a deal, but it doesn’t provide a direct way to estimate how a deal might affect stock price. For that, we can look at acquisitions on an EBITDA per share basis to price our shares.
For simplicity, we assume legacy company revenue and EBITDA remain the same as 2018.
The newly combined entity is projected to generate about $36 million of EBITDA.
| Actual 2018 | Pending Acquires | Pro Forma 2019 | |
| 9.4 | 170.0 | 179.4 | |
| EBITDA margin | 21.8% | 20.0% | 20.1% |
| EBITDA | 2.1 | 34.0 | 36.1 |
Now for the important part: In order to know if our financial slice of the pie was diluted or not, we need to know the new share count.
With all of the recent capital raises and acquisitions, our pro forma fully diluted shares plus warrants stands at 85.2 million. Compare that with the most recently published share count of 29.9 million as of June 30, 2019.
The combined entities could produce $0.42 of EBITDA per share, hugely accretive on an EBITDA per share basis even with the significantly raised pro forma share count.
| Actual 2018 | Pending Acquires | Pro Forma 2019 | |
| EBITDA ($ million) | 2.1 | 34.0 | 36.1 |
| Fully dilluted shares + warrants | 29.0 | 56.3 | 85.2 |
| EBITDA per share | $0.07 | $0.42 |
With limited financial detail to look at, a quick ROC and EBITDA per share analysis indicates the recent string of acquisitions could be positive for Medicine Man Technologies shareholders.
There is a lot of clean execution required to actually produce those results, but initial projections indicate a significant opportunity for the newly combined entity.
Our goal is to provide you with valuable insight that will help you identify investment opportunities in the cannabis industry and how to capitalize on them.
Craig Behnke can be reached at craigb@mjbizdaily.com.
