Is MedMen’s restructuring through equitized debt a template for the industry?

MedMen Enterprises is undergoing a slow-motion restructuring of its capital structure and operations in public view as its lenders, led by Gotham Green Partners, equitized the company’s credit facility into something resembling preferred equity.

The Los Angeles-based multistate operator also appointed Tom Lynch as interim CEO.

Lynch came from a consulting firm with experience in “restructuring, workouts, recapitalizations, M&A, secondary market transactions as well as strategic planning and execution.”

MedMen’s equitizing will more than double shares outstanding to 1.44 billion, and there are plans to raise up to $100 million and increase the shares to a worst-case 2.75 billion. (All of this is before former CEO Adam Bierman’s payout to give up control, which should be public by April 21.)

A traditional company restructuring usually ceases trading the equity to restructure in private, while the debt holders sell their new equity to the public a year or two after the company shows sustainable profitability.

But cannabis companies cannot legally go bankrupt because marijuana remains federally illegal in the United States.

For equity holders, the end result is the same: Creditors take control and get equity, and existing equity gets diluted to little or nothing.

This restructuring was previewed when MedMen paid vendors (who are unsecured creditors) in equity, again when Bierman gave up control.

Not surprisingly, the company pulled 2020 guidance for positive EBITDA given by the previous management – even though it was reiterated but subject to future revision in February – blaming the COVID-19 outbreak.

While the health crisis certainly doesn’t help near term, pulling guidance lets the company’s new turnaround-specialist CEO, Lynch, execute a new plan.

MedMen provides cannabis restructuring template for sector with synthetic preferred equity

We suspect the MedMen saga will provide a blueprint for other cannabis businesses that are functionally bankrupt.

Though the funding source is a convertible credit facility, the complexity makes it act more like preferred equity in terms of the upside and downside exposure while paying the higher of 2.5% or LIBOR plus 6.0%.

The mechanism for additional funding reprices both existing and new capital at the future stock price of between $0.20 and $0.40, and though the existing credit facility strikes today at $0.26, history has shown it would probably be repriced if the stock drops dramatically.

Indeed, the structure of the warrants actually illustrates the traditional private-restructure-emerge timeline, as the replacement warrants cannot be exercised until 18 months after issuance. They expire if MedMen generates two consecutive quarters of positive after-tax free cash flow.

We can infer that the lenders believe it will take at least 18 months to generate the positive after-tax free cash flow, and if the company does it faster, the replacement warrants cease to exist.

On the one hand, this is a positive for equity holders, as Gotham Green and other credit facility lenders will not be paid for capital that is not needed. On the other hand, with those lenders in control, we would expect any early free cash flow to be reinvested into expanding the business to delay the free cash beyond the 18 month window.

Though this is much more complex, at the end of the day, the funding is just the equitization of debt. This is similar to Canada’s Aurora Cannabis effectively equitizing its convertible debt via a reprice in November 2019. 

Lots of debt due in the near term is the danger to equity holders, as shown in this list from November, topped by Ohio’s Green Growth Brands, which recently missed payroll.

What is a retailer worth?

The additional capital within a band of $0.20-$0.40, the new restructuring-focused CEO, the expansion of the board and the incentive structure might fundamentally salvage some value for equity holders longer term and start to put a floor on the MedMen saga.

The question is: Does the brand and the potential to turn around the current store base justify the current $406 million to $744 million pro forma valuation?

While MedMen has provided customers with a great experience and has shown some periods of four-wall profitability in California, consumers are generally quite fickle when it comes to retail brands, and no retailer has a monopoly on a way of selling.

History is littered with retailers who dominated with a great concept, yet no longer exist. Sears dominated for decades, as did Woolworth before them, Kmart and Toys R Us.

That fact is highlighted by any internet search of “bankrupt retailers” or a quick glance at this chart of 80 retail bankruptcies, totaling $45 billion in liabilities, since 2015 as tracked by reorg.com.

A retailer can gush cash flow when times are good and sales volumes are high, but fixed costs are high, and small drops in volume can quickly compress margins.

Ultimately, a retailer is just leases, product-purchase agreements, logistics, best selling practices and the buildup of good customer experiences that hopefully keep them coming back.

Barriers to entry are typically low, and while cannabis licenses can limit competition in some states, they can’t limit the scale or success of a competitor – and as Walmart and Amazon show, it takes only one competitor to dominate.

The cannabis industry remains quite nascent, and we wonder if MedMen can be turned around or if another (possibly future) retailer can execute a similar concept more effectively.

As discussed at our 2019 Investor Intelligence Conference, we wonder if this will look like Pets.com and Chewy.com, where the same successful concept is first executed poorly (Pets.com) and then done well by another retailer (Chewy.com).

Restructuring retailers typically refocus on the profitable stores and SKUs by canceling or renegotiating contracts such as leases of unprofitable stores, purchase contracts that no longer make sense and any union labor agreements.

Counterparties to MedMen should expect calls from the new management, which certainly have their work cut out for them.

Share dilution to 1.44 billion shares today, up to 2.75 billion shares with another $100 million

As shown below, we estimate that the current shares outstanding for MedMen are 1.438 billion, excluding out-of-the-money options and warrants and whatever shares are going to be issued to Bierman to compensate him for giving up control.

MedMen also outlined the structure to raise up to $100 million through this convertible credit facility with warrants at prices between $0.20 and $0.40 per share, regardless of the stock price.

This range limits the worst-case dilution to 2.75 billion (raising $100 million at $0.20), as shown in the table below, and yields a pro forma market capitalization of $406 million-$744 million. The total shares would be 2.41 billion if done at the close on March 30 of $0.27.

Gotham Green Partners and the other holders of convertible debt via the credit facility repriced the conversion prices to $0.26 per share from $2.10-$2.55, or down about 90%.

This means the existing $164 million credit facility is now converting into 631 million shares as long as the stock is above $0.26.

The additional capital raise of $12.5 million and the $8.2 million fee to alter the terms of the debt add 127.7 million shares at $0.26.

Another 32.5 million new warrants at $0.26 replaced 2.7 million existing warrants with an estimated average strike of $3.86, for additional dilution.

The future funding includes a mechanism to reprice the 24.9 million remaining warrants at a weighted average strike of $4.02. If no funding comes via the credit facility, these remain outstanding and will not be replaced.

Below is a table of MedMen’s current shares outstanding and the potential additional shares if they raise $100 million at $0.27.

Tranche 1-3 Convertible Credit Facility repriced              630.8  $               0.26  $            164.0
Tranche 4 Credit Facility Advance                 48.1  $               0.26  $              12.5
Tranche 4 Warrants                 48.1  $               0.26
Restatement Fee Convertible Notes                 31.5  $               0.26  $                8.2
Replacement Warrants                 32.5  $               0.26
Total New Shares 3/30/2020              790.9
Shares Outstanding 2/17/2020              322.1
MM CAN Redeemable Shares              298.7
MM Enterprise USA Units                 27.1
Total In the Money Shares 3/30/2020           1,438.8
Potential Future Funding              370.4  $               0.27  $            100.0
Potential Future Funding Warrants              370.4  $               0.27
Canceled Warrants               (21.6)  $               4.02
Replacement Warrants              250.0  $               0.27
Total Pro Forma In The Money Shares           2,408.0
Remaining Outstanding Warrants                   3.3  $               4.02
Options                 17.2  $               2.99
Total Fully Diluted Shares           2,428.5

The table below shows the net number of additional shares and warrants (in millions) when the dollar amount down the side (in $ millions) is funded from the credit facility at a MedMen share price of $0.20-$0.40 along the top, with the number of warrants striking at $4.02 already deducted.

If the stock price is higher than $0.40, it prices at $0.40; if lower than $0.20, it still prices at $0.20.

 $0.20  $0.22  $0.24  $0.26  $0.28  $0.30  $0.32  $0.34  $0.36  $0.38  $0.40
 $10 131.6 119.4 109.3 100.7 93.4 87.0 81.4 76.5 72.1 68.2 64.7
 $ 20 263.2 238.9 218.6 201.4 186.8 174.0 162.9 153.0 144.3 136.5 129.4
 $ 30 394.8 358.3 327.9 302.2 280.1 261.0 244.3 229.5 216.4 204.7 194.1
 $ 40 526.4 477.7 437.2 402.9 373.5 348.0 325.7 306.1 288.6 272.9 258.9
 $ 50 657.9 597.2 546.5 503.6 466.9 435.0 407.2 382.6 360.7 341.2 323.6
 $ 60 789.5 716.6 655.8 604.3 560.3 522.0 488.6 459.1 432.9 409.4 388.3
 $ 70 921.1 836.0 765.1 705.1 653.6 609.0 570.0 535.6 505.0 477.6 453.0
 $ 80 1,052.7 955.4 874.4 805.8 747.0 696.0 651.5 612.1 577.2 545.9 517.7
 $ 90 1,184.3 1,074.9 983.7 906.5 840.4 783.1 732.9 688.6 649.3 614.1 582.4
 $100 1,315.9 1,194.3 1,093.0 1,007.2 933.8 870.1 814.3 765.2 721.5 682.3 647.1

The table below calculates the total pro forma shares in millions by adding 1.438 billion shares currently outstanding to the table above. This excludes the out-of-the-money options and remaining warrants as well as any shares to be issued to Bierman.

 $0.20  $0.22  $0.24  $0.26  $0.28  $0.30  $0.32  $0.34  $0.36  $0.38  $0.40
 $ 10 1,570.4 1,558.3 1,548.1 1,539.6 1,532.2 1,525.8 1,520.3 1,515.4 1,511.0 1,507.1 1,503.6
 $ 20 1,702.0 1,677.7 1,657.4 1,640.3 1,625.6 1,612.8 1,601.7 1,591.9 1,583.1 1,575.3 1,568.3
 $ 30 1,833.6 1,797.1 1,766.7 1,741.0 1,719.0 1,699.9 1,683.1 1,668.4 1,655.3 1,643.5 1,633.0
 $ 40 1,965.2 1,916.6 1,876.0 1,841.7 1,812.3 1,786.9 1,764.6 1,744.9 1,727.4 1,711.8   1,697.7
 $ 50 2,096.8 2,036.0 1,985.3 1,942.5 1,905.7 1,873.9 1,846.0 1,821.4 1,799.6 1,780.0 1,762.4
 $ 60 2,228.4 2,155.4 2,094.6 2,043.2 1,999.1 1,960.9 1,927.4 1,897.9 1,871.7 1,848.2 1,827.1
 $ 70 2,360.0 2,274.9 2,203.9 2,143.9 2,092.5 2,047.9 2,008.9 1,974.4 1,943.9 1,916.5 1,891.8
 $ 80 2,491.6 2,394.3 2,313.2 2,244.6 2,185.8 2,134.9 2,090.3 2,051.0 2,016.0 1,984.7 1,956.6
 $ 90 2,623.1 2,513.7 2,422.5 2,345.4 2,279.2 2,221.9 2,171.7 2,127.5 2,088.1 2,052.9 2,021.3
 $100 2,754.7 2,633.1 2,531.8 2,446.1 2,372.6 2,308.9 2,253.2 2,204.0 2,160.3 2,121.2 2,086.0

Mike Regan can be reached at [email protected]