Harvest Health dodges a bullet but might offset revenue declines with new deal

Arizona-based Harvest Health & Recreation wants to swap a problematic deal and avoid a potential lawsuit with another acquisition that will still give it access to California and mitigate the reduction to revenue and EBITDA guidance.

Harvest Health sued Falcon International to exit a deal originally announced in February 2019. That deal was repriced on June 7, 2019, but the complaint, filed in U.S. District Court in Arizona, indicates this action is more than negotiating price amid falling stock prices.

The Falcon acquisition dropped in value by 45%-55% because of a decrease in price for Harvest shares.

But the court filing provides more details about the troubled deal, including: “Falcon’s reckless business practices have also threatened to put Harvest at risk of being named as a defendant, along with Falcon, in a whistleblower lawsuit in California, if it were to proceed to closing the planned merger with Falcon.”

Also alarming to shareholders, Harvest alleges that Falcon has violated California Bureau of Cannabis Control laws by transporting marijuana across state lines.

Regardless of the deal price, avoiding a lawsuit and illegal activity is key for investors in Harvest.

Besides these issues, the court filing also makes the proposed acquisition sound quite problematic.

Falcon management kept trying to raise the deal price as the value of Harvest’s stock fell (doing so successfully in June and unsuccessfully in September) while taking cash loans from Harvest. And the Falcon failed to provide financials starting in October.

Falcon owes Harvest $47.9 million in convertible notes (though these are listed as totaling only $45.5 million on the third-quarter balance sheet given that the “contingent” portion is not included).

Harvest is suing for the return of this and the $4.1 million cash payment paid personally to Edlin Kim and James Kunevicius as a “control person premium” to prevent them from leaving Falcon, for a total of $52.0 million.

We are not sure of Falcon’s finances – Harvest alleges the California company misrepresented its liabilities – and lawsuits are unpredictable, so we conservatively assume this amount will not get recovered in full.

Below is a table of the deal value over time. Canceling this deal would prevent about 34 million Harvest Health shares from being issued; all numbers, except per share, are in millions.

2/14/19 6/7/19 6/7/19 9/5/19 10/30/19 1/7/20 1/9/20
Headline Deal Consideration in USD  $        155.0  +  $          85.0  =  $        240.0  $        240.0  $        240.0  $        240.0  $        240.0
CAD Deal Price for Share Calculation 9.33 9.33 9.33 9.33 9.33 9.33 9.33
USD Deal Price for Share Calculation              7.00              7.02              7.02              7.05              7.08              7.17              7.12
Shares For Equity Consideration              22.1  +               12.1  =               34.2              34.1              33.9              33.5              33.7
HRVSF USD Trading Price  $          8.03  $          6.44  $          6.44  $          5.42  $          2.74  $          2.88              3.12
USD Trading Value of Equity  $        177.6  $          77.9  $        220.1  $        184.5  $          92.9  $          96.5  $        105.1
   Plus Cash Loans from Harvest to Falcon  $          24.5  +  $          23.4  =  $          47.9  $          47.9  $          47.9  $          47.9  $          47.9
   Plus “Control Person Transaction”  $               –  +  $            4.1  =  $            4.1  $            4.1  $            4.1  $            4.1  $            4.1
Total Consideration  $        202.1  +   $        105.4  =   $        267.9  $        232.3  $        140.7  $        144.4  $        153.0
Notes Original Deal Incremental Consideration Total Deal Reprice Falcon says Harvest in Default Standstill; No Falcon Financials Lawsuit Filed Today

Harvest also disclosed it is in discussions to potentially acquire Interurban Capital Group, the Seattle-based owner of Have a Heart and the CannaMLS listing service. This would give Harvest access to the California market as well and allow it to replace some of the revenue lost if Falcon does not close.

By our math, the total acquisition price for Interurban is $150 million when the multiple voting shares (MVS) are included, as shown in the table below. The 205,594 MVS that convert to single voting shares (SVS) at 100:1, for 20.6 million SVS equivalents and a total of about 50 million shares.

Terminating Falcon (-34 million) and executing Interurban (+50 million) adds a net 16 million incremental shares to the share count.

Date 1/7/20 1/9/20
Headline Equity for Interurban  $      87.5  $      87.5
HRVSF USD Trading Price  $      2.88  $      3.12
Estimated SVS Shares for $87.5 million          30.4          28.0
Multiple Voting Shares        0.206        0.206
MVS to SVS Convert Ratio           100           100
SVS Equivalent Shares          20.6          20.6
Total SVS Shares for Interurban          50.9          48.6
Interurban Deal Value  $   146.8  $   151.6

Assuming Harvest successfully exits the Falcon deal, it will have to adjust its revenue guidance of $700 million to $1,000 million for 2020.

But the company noted in a news release that EBITDA will actually increase compared to the $140 million to $300 million (based on the 20-30% EBITDA margin guidance) as Falcon was losing money.

Interurban would presumably replace some of this revenue.

We do not know the specific contribution to 2020 from Falcon but is significant; Harvest said on previous calls that it was a large contributor to the pro forma revenue.

On Harvest’s third-quarter call, CFO Leo Jaschke said:

“So, our pro forma revenue, the majority of that is coming from Harvest and our two larger acquisitions, Verano Holdings and Falcon. All of those entities have had substantial growth. Harvest was 25% over the previous quarter, and the other entities are in line with that.

“The smaller acquisitions that we have completed – although we’re not going to disclose the amounts – I would say, are substantially less than those three core components.”

Risk to Halo Labs’ revenue?

We would also note that Toronto-based Halo Labs (NEO: HALO) has a distillate supply contract with Falcon that drives $4.8 million-$6.6 million in quarterly revenue.

That appears to be the bulk of Halo’s revenue of $7.2 million in 3Q19 and its $7.6 million 4Q19 consensus revenue estimate.

Given the potential troubles outlined in the complaint at Falcon and the fact this contract would no longer be implicitly backed by Harvest, we wonder about the stability of Halo’s revenue line as well.

Mike Regan can be reached at [email protected].