Consolidating power to a single individual, as seen with Harvest Health and Recreation’s announcements this week, can be a risky proposition for any company. It’s not an automatic red flag, but it is something that investors should keep a close eye on.
Executive Chairman Jason Vedadi resigned from Arizona-based Harvest after trading his controlling shares to CEO Steve White in exchange for a license and lease from the company.
White now has 44% of the vote and 4% of the economics on a pro forma basis; Vedadi has 4% of the vote and 8% of the economics, and all other shareholders have 52% of the vote and 88% of the economics – putting White firmly in control.
Previously, White had 33% of the vote, Vedadi had 35%, and all other shareholders had 32%, making all of their stakes roughly equal.
The stock has declined 45% in two days after a $56 million share sale at $1.41, with plans for $44 million more. Though partially mitigated by a 15% decline in the broad market S&P 500, we think a significant portion of the drop is due to the stock offering and the consolidation of the vote.
White consolidates Vedadi’s votes; Harvest transfers license to Vedadi
It seems that CEO Steve White has consolidated his control of Harvest votes through a direct exchange with Vedadi, while Harvest (the company) has provided a license to Vedadi as consideration for transferring his votes to White.
A news release announcing the exchange notes that “Messrs. Vedadi and White have agreed to exchange the 1 million Super Voting Shares held by Mr. Vedadi for an equivalent number of Multiple Voting Shares (on an as-converted basis).”
Neither the news release nor the company specified how exactly that conversion will take place nor the conversion rate of super voting shares to multiple voting shares, but the verbiage implies it is a direct personal exchange.
We calculate that Vedadi’s 1 million super voting shares are equivalent to 10,000 multiple voting shares (see page 89-90 of the management information circular), based on a super voting share converting to one subordinate voting share and each multiple voting share converting to 100 subordinate voting shares. (An MVS share is essentially 100 subordinated vote shares bundled together.)
This would mean White will personally transfer 10,000 of his 229,966 MVS to Vedadi, who will then personally transfer his 1 million super voting shares to White.
The shift will increase White’s vote by a net 199 million votes (losing 1 million votes on the MVS and gaining 200 million votes on the super voting shares), while Vedadi’s vote will decrease by a net 199 million – making Vedadi like any other minority shareholder.
White will have 2 million super voting shares and 219,966 MVS shares, and Vedadi will have 427,541 MVS shares and no super voting shares (page 32).
In exchange, Vedadi will receive a license in Arizona from Harvest (an asset from the corporation), assume a lease (a liability from the corporation) and forgo 2.5 million options (though these are not currently worth very much, with strikes between $6.55-$7.65 and the current price at $1.02).
Unless the value of the lease liability is more than the value of the license, it seems that shareholders have given a net asset to Vedadi so White can personally gain control the company.
In White We Trust?
CEO White now controls Harvest with 44% of the vote and only 4% of the economics – so his vote is 10X his economics – as outlined in the table below.
Public shareholders have 17% of the economics but only 10% of the vote, and all shareholders excluding White have 56% of the vote but 96% of the economics – or votes of only 0.6X of their economic stake.
Shareholders of companies with super-voting shares are basically trusting those with the super-voting shares to act in the economic interests of all shareholders and not their own despite the economic incentive to do otherwise.
This mismatch of economics and control is a big risk for investors and should be the first question asked when considering an investment.
While the 1,000:1 supervoting shares at MedMen were particularly egregious, the dilution and mismanagement there is a cautionary tale of what can happen with mismatched control and economics. Additional share issuance does not threaten the control as it would in a balanced situation with equal voting and economics.
This table ignores the 29.2 million potential shares from options and warrants (striking between $2.89 and $13.50) and treats the $100 million of convertible bonds maturing May 9, 2022, with a conversion of $11.42 as debt because they are so far out of the money.
It also assumes Harvest sells the remaining $44 million of MVS shares by March 31 – not at $1.41, as the news release implies, but at the current price of $1.02.
Finally, it includes the optional purchase of a controlling interest in five Washington dispensaries from Interurban for $12.5 million at $1.02 per share. This option is a fixed-dollar amount paid in shares, so declines in the share price will lead to an increase in the number of shares needed and vice versa.
|3/10/20 MVS Buyers||4%||7%||0.6|
|3/31/20 MVS Buyers||4%||8%||0.6|
|Other MVS Holders||13%||22%||0.6|
|Interurban with Option||7%||11%||0.6|
|Public SVS Shareholders||10%||16%||0.6|
|Total Pro Forma Shares||958.7||560.7||1.7|
Source: Company filings, news releases and Investor Intelligence analysis.
Since Vedadi was in charge of mergers and acquisitions at Harvest (page K-3, “leads the company’s acquisitions, capital infusion, development, investor relations and expansion to new states”), it seems he may be taking the fall for the Falcon acquisition fiasco, which may still cost the company another $50 million termination fee on top of the $47.9 million in convertible loans owed by Falcon to Harvest that seem unlikely to be repaid.
The potential Falcon termination fee may also be why Harvest needs to raise another $56 million of cash today and potentially $44 million more in the next two weeks via the sale of multiple voting shares in a private placement.
Perhaps Falcon could repay the $47.9 million of debt with the $50 million termination fee, limiting the loss to $50 million.
Harvest noted in the news release that it had $50.9 million in cash on Feb. 29. We confirmed with the company that it requested to terminate the Falcon acquisition and that the only other outstanding deals that need cash are:
- Franklin Labs at $26 million, composed of $15 million in cash and $11 million in assumed debt notes.
- Devine Holdings, which has no disclosed price but is small.
The $35 million for GreenMart Nevada has been paid for already, so no more cash is needed there.
The company’s guidance was based primarily on the Verano and Falcon deals. Now it is buying Interurban instead of Falcon, but it has not yet updated its guidance.
The question will be whether Interurban revenue and EBITDA can offset that lost by abandoning Falcon.
14% dilution from share offering and Interburban deal
We calculate that Harvest Health has pro forma shares outstanding today of 560.7 million, representing dilution of 14% from the 491.6 million in our comp table prior to the deal, which had estimated Interurban at 73.2 million shares.
The new share count includes 39.7 million shares sold at $1.41, 51.5 million shares issued to Interurban and 129.8 million shares issued to Verano.
This brings the total pro forma share count to 505.4 million shares, or about 8% dilution compared to our previous pro forma share count.
The pending share sale of $44 million of stock adds 44 million shares at Thursday’s close of $1.02 (and not the $1.41 used for previous deal since it would be impossible to sell shares at a 38% premium), and the $12.5 million Interurban option is now 12.2 million shares instead of 6.9 million shares, bringing total shares to 560.7 million.
The table below ignores the 29.2 million potential shares from options and warrants (striking between $2.89 and $13.50) and treats the $100 million of convertible bonds maturing May 9, 2022, with a conversion of $11.42 as debt.
Any target prices above these strikes would need to include the additional dilution as well.
|Outstanding at 9/30/2019||284.4|
|3/10/20 MVS Sale at $1.41||39.7|
|Pro Forma 3/11/2020||505.4|
|3/31/20 Offering at $1.02||43.1|
|Total Pro Forma||560.7|
Source: Company filings, news releases and Investor Intelligence analysis.