California-based MedMen’s attempts to renegotiate payment terms with vendors – including the use of equity for those payments – raises some big questions about the health of the multistate operator.
MedMen (OTC: MMNFF) confirmed to Marijuana Business Daily that the negotiations are part of an ongoing restructuring, but this move is worrisome for shareholders.
As a retailer, MedMen needs to secure inventory to generate cash flow, and its inventory and payables have already soared through September.
Using equity to pay suppliers opens MedMen shareholders to even more dilution on top of the 607 million shares currently outstanding – and it is not a standard industry practice for retailers.
The company’s stock price has fallen 25% since the rumors of renegotiation emerged.
The only potential positive interpretation is that management is using greater buying power to push for better terms from suppliers.
But the working-capital analysis shows the issue is the increasing inventory and that MedMen has already pushed vendor terms pretty hard.
(See this article to learn how to analyze working capital and calculate days outstanding, which will be used in the analysis below).
Equity for vendors = dilution to shareholders
Using equity to pay vendors raises an eyebrow, especially for vendor payments in arrears. When equity is used with vendors, which is rare, it typically is only for long-term strategic vendor relationships – and even then, it is not for the direct payment of goods.
In September 2019, MedMen reported $53.8 million of accounts payable and $17.6 million of current lease liabilities. Our estimate places MedMen’s in-the-money shares at 607.2 million (as used in our comp table).
With a closing stock price of $0.47 on Jan. 23, MedMen paying the entire $71.4 million in current vendor liabilities entirely in equity would amount to 152 million additional shares, or about 25% additional dilution.
We do not expect the vendors to accept the entire payment in shares, but 152 million shares would be the theoretical worst-case scenario. If MenMen gets vendors to accept 25% of the amount owed in equity, it would equal 38 million shares (152 million x 25%).
We also do not know the current level of payments, and of course, declines in the stock price lead to more dilution, all else being equal.
Payables have increased by 17 days quarter-over-quarter through September, and current consensus sales and EBITDA estimates imply that the same level of payables would yield 101 days, or 45 more days than June.
Reducing payables to June 2019 levels would require $24 million to be paid down, another 51 million shares or 8% dilution.
Retail-vendor relations – death spiral or power play?
The question for MedMen investors: Is extending vendor terms a sign of weakness – in that, the company cannot pay its bills – or is it a sign of power over its suppliers?
A retail operation needs merchandise to sell at a gross profit and pay the expenses (rent and labor) to make the sale. Retailers need new inventory today to generate future gross profit to pay future expenses.
Retailers usually fund some of that inventory with payment terms from the vendors. Otherwise, it must come up with cash for the inventory.
The amount effectively borrowed from suppliers comes down to the balance of power between the retailer and the vendor.
Most retailers have to tie up some capital in inventory, i.e., paying the vendor before it sells the merchandise.
Amazon is one of the few exceptions among companies with negative working capital: It sits on the customer’s payment for the merchandise for 29 days before paying its suppliers. Even Walmart must tie up two days worth of sales in its working capital.
A retailer failing to get supply of additional product leads to:
- Bare shelves.
- Declining traffic as customers go elsewhere.
- Decreased sales and gross profit.
Meanwhile, the fixed costs of rent, utilities and employees must still be paid, so operating cash flow quickly goes negative. This can become a vicious circle where the retailer implodes.
Vendors also are aware of this potential cycle, so if they suspect cash-flow issues with a retailer, they do not want to send product and then worry if they will get paid. Vendors don’t even need to halt payment; they can just request shorter payment terms, such as going to 15 days from 30 days or cash on delivery.
If one vendor requests better terms, others – fearing they won’t get paid – might demand the same terms or halt shipments rather than fight for greater share of dwindling sales and payments.
This is basically what happened to Toys R Us in fall 2017.
Toy vendors saw the declining sales, increasing cash losses and mounting debt and requested faster payment terms for inventory ahead of the holiday season.
Since Toys R Us made all its money during the holiday season, the retailer couldn’t get inventory and sales and therefore preemptively filed for bankruptcy.
In contrast, strong retailers such as Amazon or Walmart with multiple vendors vying for shelf space can essentially let the vendors bid for space via better terms. You can usually tell which is which based on the cash-conversion cycle.
MedMen’s working capital soars in September
Looking at MedMen’s working capital, inventory has exploded but payables have not kept pace, resulting in consumption of cash. Note that we have adjusted the calculations to include only cash COGS and cash operating expenses, since that is what MedMen owes vendors.
As of Sept. 28, 2019, MedMen had 200 days of total inventory (and 102 days of finished inventory, or the inventory on the shelves for sale excluding the “raw material” and “work-in-process” inventory). Days sales in inventory (DSI) spiked by 93 days in September versus June and 160 days compared with the prior year.
This is not entirely surprising as they expand stores, but how are they funding the inventory?
The days payables outstanding (DPO) has increased 44 days year-over-year and 17 days quarter-to-quarter, to 73 days at the end of September. This indicates that MedMen extended payables to vendors in September in an attempt to fund the month of inventory, so extensions today must be well beyond the 73 days.
This is a lot for the vendors but far less than the inventory: 73 average days to pay is a pretty long term in general, especially since this figure includes employees that are probably paid every 14 days. That boosts the vendor average above that 73-day mark.
Also note this does not include the $17.4 million of current lease liabilities (store rent) that have shifted to a separate line item in the balance sheet because of the accounting.
We do not yet have figures for the quarter ended December; those will be released Feb. 28. Any vendor payment term extensions occurring now will not impact those reported financials until the March quarter results, which likely will come out in May.
MedMen CEO Adam Bierman hosted an “ask me anything” thread on Reddit on Jan. 24; it’s an investor and vendor relations strategy we haven’t previously seen in a public company.
|Three Months End:||6/30/2018||9/30/2018||12/29/2018||3/30/2019||6/29/2019||9/28/2019||9/19 Y/Y Change||9/19 Q/Q Change|
|Days Sales in Inventory||40||92||74||102||107||200||160||93|
|Days Payable Outstanding||29||46||30||41||56||73||44||17|
|Days Sales Outstanding||1||1||2||3||3||7||5||3|
|Cash Conversion Cycle||12||47||46||65||54||133||121||79|
Inventory and payables per company filings, in millions.
|Raw Material||$ 0.2||$ 0.5||$ 1.7||$ 2.5||$ 3.8||$ 5.3|
|Work in Process||$ 0.8||$ 1.0||$ 0.3||$ 1.9||$ 7.3||$ 14.5|
|Finished Goods||$ 5.3||$ 8.0||$ 11.1||$ 17.4||$ 18.1||$ 20.7|
|Total Inventory||$ 6.2||$ 9.5||$ 13.1||$ 21.8||$ 29.2||$ 40.5|
|Accounts payable and accrued liabilities||$ 17.1||$ 34.6||$ 26.2||$ 36.9||$ 49.8||$ 53.8|
|Current Portion Lease Liabilities||$ –||$ –||$ 0.3||$ 3.0||$ 2.5||$ 17.6|
|Total Vendor Payments||$ 17.1||$ 34.6||$ 26.5||$ 39.9||$ 52.3||$ 71.4|
Mike Regan can be reached at [email protected].