Hexo needs more capital; shareholders to be further diluted

Hexo Corp.’s (TSX: HEXO) fiscal second-quarter 2020 results, released Monday, were in line on revenue at CA$17.0 million and beat on EBITDA (a loss of CA$10.3 million versus estimated loss of CA$11.7 million).

More importantly, the company disclosed that it needs to raise an additional CA$23.6 million – at least – just to satisfy cash needs for fiscal 2020, which total CA$105 million.

The Ottawa, Ontario-headquartered company provided a detailed breakdown of its obligations due in fiscal 2020 through fiscal 2024 as shown below:

Values in CA$ (000s) F2020 F2021-2022 F2023-2024 Thereafter Total
Accounts Payable & Accrued Liabilities 45,131 45,131
Excise Tax Payable 5,473 5,473
Onerous Contract 3,000 3,000
Convertible Debentures 47,274 47,274
Term Loan 3,500 28,875 32,375
Lease Obligation 2,208 9,865 8,926 36,802 57,801
Capital Projects 23,266 23,266
Investment in Associates 8,075 8,075
Service Contracts 10,917 1,526 329 37 12,809
Purchase Contracts 1,530 1,530
Operating Leases 13 48 61
Lease Based Operating Expenses 1,923 7,676 6,872 20,348 36,819
Total Obligations 105,034 95,264 16,127 57,187 273,612

As of right now, Hexo’s $81.4 million of cash on hand isn’t enough. However, the company’s management discussion and analysis (MD&A) explains how the additional capital will be raised through amended covenants for a credit facility.

Terms of the credit facility with CIBC indicate that Hexo will:

  • Raise at least CA$15 million through an equity offering by April 10.
  • Raise at least CA$40 million total through equity offerings by April 30.

If Hexo can raise CA$40 million, that will provide the company with about CA$120 million to satisfy its CA$105 million of obligations.

Raising that amount at the current price of $1.14 would require about 35.1 million new shares to be issued, resulting in a roughly 9.3% dilution to the total share base. If the shares are sold for less than the current stock price $1.14 – which we believe is likely – the dilution will be even greater.

Existing Share Count 341,983,225
New Shares to be Issued 35,100,000
Total NEW Shares 377,083,225
Percentage of Dilution -9.3%

Hexo needs to start producing positive cash flow very soon because the company has another CA$95 million of obligations due in fiscal 2021-2022. While the equity raise will get the company through the next 6-12 months, management still has a difficult road to travel on its way to becoming a healthy, self-funding business.

Unfortunately, this type of massive, persistent dilution is all too commonplace for cannabis equity holders.

Investors should focus on cannabis companies that:

  • Are generating positive cash flow to fund their business plans.
  • Have ample funds on hand to reach cash-flow positive so they don’t have to massively dilute shareholders on their path to profitability.

Craig Behnke can be reached at [email protected].