Hexo raises capital but doesn’t learn its lesson

You would think the sting of a 30% stock price drop after Hexo Corp.’s preannouncement of a huge miss for fiscal fourth-quarter revenue and withdrawal of 2020 revenue guidance would have persuaded company management to introduce some conservatism when communicating with investors.

It didn’t.

On Wednesday, Hexo issued CA$70 million three-year convertible debentures at 8.0% interest and convertible into common shares at CA$3.16.

It is a positive that Hexo – which trades on the Toronto Stock Exchange and New York Stock Exchange – has locked up much-needed capital to fund its operations, but it is very expensive capital.

The 8.0% rate is a huge spread over U.S. and Canada three-year government yields, as well as B-rated U.S. corporate spreads of consumer nondurable companies.

Yield Hexo Spread
Hexo 3-year convert 8.00%
U.S. government 3-year bond 1.58% 6.43%
Canadian government 3-year bond 1.64% 6.36%
B-rated corp. spread 1.66%

Sebastien St. Louis, CEO and co-founder of Hexo, noted in the company’s news release that the financing “does not dilute current shareowners’ ownership of the company in the short term.”

While it’s technically true – the conversion feature starts one year after issuance – after that one-year period, shareholders are exposed to potentially large dilution for two years after that!

Let’s look at the numbers.

If Hexo stock rises above CA$7.50 for 15 days and the company forces conversion, it must issue 22.2 million new shares.

Compare that with issuing new stock at a price of CA$ 7.50, which would require issuing only 9.3 million new shares to raise the same CA$70 million.

Issuing up to 22.2 million shares compared with 9.3 million shares? That qualifies as dilution to us.

To say the financing does not dilute shareholders in the short term is disingenuous and ignores the major dilution potential in Years Two and Three.