Harvest avoids 42% dilution after Verano deal terminated, but guidance cut likely on April 7

Another deal made in different times failed.

Harvest’s planned acquisition of Verano Holdings was called off, with both companies citing regulatory delays (exacerbated by the coronavirus response) and declines in capital markets.

Net implications:

  • Harvest avoids 42% dilution (161 million shares), bringing the Arizona company’s current shares outstanding today to 387 million.
  • The company’s 2020 sales guidance will come down on April 7.
  • Harvest will articulate a new strategy focused on getting to profitability with the current resources.

Walking away from the deal appears to be mutual, or at least triggered by some kind of “material adverse condition” clause, as neither side will have to pay the $20 million breakup fee.

This is in contrast to the Falcon International deal, currently in arbitration after Harvest requested termination. Harvest might end up paying a $50 million termination fee.

We also believe this might show a renewed focus by Harvest on stores that are already open since it seems Verano’s value seems to have been primarily in licenses rather than operations, per the original presentation. If Harvest doesn’t have the capital to build out the licenses, the premise for the deal evaporates.

FactSet estimated Verano’s total trailing revenue at $15 million, though Harvest expected the Chicago-based company to be a big contributor to pro forma revenue growth.

On Harvest’s April 7 earnings call, we expect the company to reduce its guidance of $700 million-$900 million for 2020, last reiterated on the third-quarter call, given that most of the increase in revenue was driven by the Verano and Falcon acquisitions. In addition, we have to consider the uncertainty that will come from the coronavirus.

Massachusetts-based Curaleaf removed its 2020 guidance for $1.0 billion-$1.2 billion of revenue during its recent earnings call, citing the uncertainty from the pandemic.

For Harvest’s third quarter of 2019, the implied revenue for the pending acquisitions was $62 million (from subtracting the actual revenue of $33 million from the pro forma of $95 million), or $248 million annualized. Chief Financial Officer Leo Jaschke confirmed on that call that the majority of the pro forma revenue was Falcon and Verano.

Consensus 2020 revenue of $562 million is already well below this guidance, but we believe it will need to come down even more if these two acquisitions comprised the bulk of the annualized revenue.

We also think growth from building out the licenses drove a lot of growth, and we suspect those plans will have to be pulled back.

Offsetting some of the lost Verano and Falcon revenue is the closed acquisition of Interurban, which will contribute to actual reported revenue starting March 13.

Interurban operates the Have a Heart cannabis chain, with two stores in California, two in Iowa and six in Washington state. In addition, the company lists seven stores as “coming soon” in California.

However, CEO Steve White’s comments in Thursday’s news release do not mention the states in which Interurban operates, referencing only “core markets including Arizona, Florida, Maryland, and Pennsylvania.”

We look forward to hearing the new strategy on April 7.

42% share dilution avoided

As we wrote Wednesday regarding the Cresco-Tryke deal, deals with a fixed-dollar amount of consideration paid in equity are more at risk of deal failure when stock prices drop considerably.

The Verano deal was primarily a share swap, whereby Verano shareholders would get 4.7625 Harvest shares for each Verano share, seemingly capping the dilution at 129.5 million Harvest shares.

However, there was a fixed-dollar component of the Verano deal that was minor at the announcement but huge now – the $36 million of Verano pipeline acquisitions to be paid in Harvest shares:

“The all-stock Transaction will result in the issuance of approximately 129,550,579 Subordinate Voting Shares, on an as converted basis. In addition, the Transaction will include the completion of various Verano pipeline acquisitions, with a combined value of approximately $36 million, and additional pipeline acquisitions that are in negotiations and may include certain entities that are not ancillary to the Company’s business, payable in shares of the Resulting Issuer.

– Harvest’s management discussion and analysis dated Nov. 29, 2019 (emphasis in bold added)

As Harvest’s share price has dropped from $6.37 the day before the deal announcement on March 11, 2019, to $1.13 Wednesday, this comparatively small consideration is now 31.9 million shares, up from 5.6 million when the deal was announced.

This small clause has gone from 4% of the shares issued to Verano to 20% of the shares to be issued, and Verano would have owned 29% of the pro forma Harvest. This is actually down compared with 33% at deal announcement, since Harvest has increased the base share count by 40% since the deal was announced.

By walking away from Verano on Thursday, Harvest avoids issuing 161.4 million shares or 42% of dilution of the 386.6 million existing shares.

With Harvest’s stock at $1.13, the deal would have valued Verano at $182 million compared with $861 million at deal announcement. While we think the total deal value is less relevant for equity swap mergers, Verano had reportedly raised more than $140 million as of March 2019, giving its investors a paltry 30% return along with lock-up commitments slowing their own liquidation.

Verano likely believes it is better off on its own.

Core Verano Share Exchange Pipeline Acquisitions $ HRVSF Share Price Pipeline Acquisition Shares Total Verano Shares Fixed $  % of Total Verano Harvest Shares Harvest Shares if Verano Closed Verano % of Harvest Verano Value Verano ROI on $140m
3/10/2019 129.5  $    36.0  $6.37 5.6 135.1 4% 275.7 410.9 33%  $861.3 515%
3/25/2020 129.5  $    36.0  $1.13 31.9 161.4 20% 386.6 547.9 29%  $182.3 30%

We also believe the second $44 million offering of Harvest shares planned to occur by March 31 is at risk, especially since it would add 38.9 million shares, or 10% dilution, at the March 25 close of $1.13.

While Thursday’s announcement noted that “recent capital-raising efforts have afforded the company sufficient resources,” it also seems Harvest does not need the additional funds next week as originally planned.

By our current calculations and updating the vote and share and table from our look at the share exchange involving CEO White and former Harvest Executive Chair Jason Vedadi, the company now has shares outstanding of 386.6 million, with White controlling 54% of the vote and 6% of the economics.

 Vote  Economic  Vote /Economic
White 54% 6%                        8.7
Vedadi 5% 11%                        0.5
3/10/20 MVS Buyers 5% 10%                        0.5
Other MVS Holders 16% 33%                        0.5
Interurban with Option 8% 16%                        0.5
Verano 0% 0%
Public SVS Shareholders 12% 24%                        0.5
3/26/2020 Shares                    784.6                    386.6                        2.0
3/31/20 MVS Buyers (unlikely) 5% 9%                        0.5
Total Pro Forma Shares                    823.5                    425.5

Mike Regan can be reached at [email protected]