We suspect the fixed-dollar structure of Cresco Labs’ acquisition of Tryke likely will result in the deal’s downfall – either through an amendment or outright termination.
As currently structured, Cresco’s 60% share-price decline gives Las Vegas-based Tryke 16%-21% of the new company for only 7%-10% of the pro forma sales.
To be clear, our conclusion is based purely on our analysis of this deal structure with a fixed-dollar consideration paid in equity, which increases deal-execution risk when stock prices change dramatically from the price at the deal announcement.
We have not heard anything specific, and the company provided no comment in response to questions.
Deals structured with fixed-share exchanges have lower execution risk when stock prices are volatile because each party’s percentage of ownership in the new entity does not change with stock prices.
Given the optimistic long-term investment outlook for the cannabis industry but recent short-term volatility of stock prices, we would encourage buyers and sellers structuring mergers or acquisitions with an equity component to focus on the percentage of the new entity they will own upon deal completion.
Tryke gets 32 million shares at $7.14 or 75 million at $2.80
As shown in the Tryke deal presentation, the company will receive a minimum of $209 million of consideration and a maximum of $242 million payable in Cresco shares.
The number of shares that will be issued to Tryke has more than doubled since the deal announcement, as Cresco’s stock price has dropped 61% – from $7.14 to $2.80 on March 23. This will give Tryke 16% of the pro forma entity, compared with 8% at the time of announcement.
If the deal had closed at Cresco’s March 18 low of $2.05, Tryke would own 21% of the pro forma Cresco. If Cresco shares hypothetically drop to $1.50, Tryke would get 139 million shares or 26% of the company, and at $1.00, Tryke would get 209 million shares, or 35% of the company.
When the deal was announced on Sept. 16, 2019, the equity consideration was stated at $227.5 million, but we assume Tryke gets only the guaranteed minimum of $209 million with the stock down 61%. Getting $227.5 million makes the dilution about 9% worse.
|CL Stock Price||CL Shares to Tryke||CL Shares Ex Tryke||Total Pro Forma CL Shares||Tryke Ownership||% Change in Price Since Deal|
Though the structure is termed a “collar” by Cresco management, it is not what financial professionals usually think of when they hear “collar” – a structure where options are used to hedge the consideration and share price within a certain price range.
It is instead a collar on the total dollar amount of equity given to the seller, which provides no protection to shareholders on dilution on the downside.
Tryke provides 7%-10% of revenue for 16-21% ownership?
The presentation notes that Tryke had $70 million of revenue in 2018 (of which 70% was in Las Vegas). Assuming Tryke merely maintained market share as the Nevada market grew 28% in 2019, Tryke would have about $90 million of revenue for 2019.
This is a big assumption, however, given that competitor Planet 13’s flagship opened across the street only in late 2018, meaning the reported 2018 revenue of $70 million came before a significant change in the competitive landscape.
The one reported figure for Tryke implies that revenue might be declining.
Cresco reported that Tryke had $17 million of sales in the third quarter of 2019, a period that represented 25.4% of Nevada’s total 2019 revenue. Assuming similar seasonality for Tryke yields a 2019 estimate of $67 million of revenue ($17 / 25.4%) – or down 4% year-over-year – and a drop in Nevada market share from 12% in 2018 to 9% in 2019.
Consensus estimates are for revenue of $908 million for Cresco overall in 2021. That means Tryke’s potential $67 million-$90 million of sales would be about 7%-10% of the total company’s revenue.
Despite that, Tryke will own 15%-20% of the equity if the acquisition closes as first structured at Cresco’s current stock price – and Tryke might have declining sales.
To align the ownership percentage with the revenue, Cresco’s share price would need to rise back to $4.80 to give Tryke 10% of the pro forma company and 155% back to the deal price of $7.14 to give Tryke 7%.
MGM’s temporary closure of its casinos because of COVID-19 certainly doesn’t help either Tryke or Planet 13 in the near term, though the coronavirus is (hopefully) temporary and arguably should not influence a long-term merger decision.
Fixed share deals more likely to close
A fixed-dollar consideration paid in equity is riskier amid volatile stock prices, since that structure is effectively an equity offering at a future unknown price. Given the recent big moves in cannabis company equity prices, we believe such deals are more at risk of being renegotiated or failing completely.
Sellers have an interest in the success of the combined entity when they accept equity as consideration. In these cases, the most important figure is the percent of ownership of the future entity. The headline deal value is not really relevant and will change with the stock price of the underlying equity.
Share swaps with a fixed number of shares or a fixed exchange ratio, such as Cresco’s acquisition of Origin House and Charlotte’s Web’s planned purchase of Abacus Health, have a greater chance of closing amid volatile equity prices.
Sellers that plan to continue to own a part of the new company should ignore headline value and instead focus on the number of shares they will own of the new company. Sellers that want to just cash out should ask for cash, and they can do this by hedging the stock they will soon acquire (if the market is deep enough).
While we have highlighted the risk of the Cresco-Tryke transaction, there are other pending deals that contain a fixed collar consideration paid in equity:
- Columbia Care’s acquisition of The Green Solution has 79%, or $110 million, of the consideration to be paid in CCHW equity, though the company has not disclosed the exact structure. It could be a fixed $110 million amount, which would mean the number of shares has risen to 81 million at $1.36 from 35 million at $3.15 at the announcement, or it could just be 35 million shares, or something in between. The deal sounded on track in the most recent earnings call.
- Curaleaf’s acquisition of Grassroots has $40 million of consideration at close and a potential $200 million earnout in 2021 to be paid in CURA equity. At the March 23 close of $3.09 (down 60% from the deal announcement), puts the $40 million at 12.9 million shares, and the $200 million earnout is potentially 64.7 million. Given that most of the consideration is a fixed amount of 103 million shares and $75 million in cash (which have not changed), however, we believe this deal is likely to close.
Mike Regan can be reached at [email protected].