This week’s headlines highlighted a critical shift in the cannabis industry: Cash is becoming tight for companies, but it’s still available for those with good business plans and realistic outlooks.
MedMen (TSX: MMEN), The Green Organic Dutchman (TSX: TGOD) and Hexo (TSX: HEXO) drew attention for financial and operational travails, but the news was offset by well-executed deals by cbdMD (ASE: YCBD), Village Farms (TSX: VFF), Harborside (CSE: HBOR) and Innovative Industrial Properties (NYSE: IIPR).
First the troubled: Get your balance sheets and growth targets aligned
The key for these companies is to scale their ambitions to their balance sheets and not to assume that funding will be available on good terms when they need it.
This week we took a deeper dive into those companies with and without enough cash for their plans and those with potentially too-aggressive revenue-growth targets.
These include:
- MedMen cut its EBITDA guidance to break-even at the end of 2020 versus consensus expectations of $53 million, terminated its PharmaCann acquisition and fired its CFO after only 10 months. The moves sent the stock down 28% for the week and it’s now down 57% year-to-date.
- Days after Hexo’s CFO resigned, Hexo announced a huge miss to fiscal fourth-quarter revenue and withdrew its 2020 guidance for CA$400 million in revenue, sending the stock down 31% since the miss and 38% since the CFO’s departure.
- The Green Organic Dutchman noted it might have to delay expansion plans after experiencing difficulty getting financing from commercial banks and equipment leasing (which should actually be easier to finance than equity). The stock ended down 32% on the potential delay in the business plan but rose 7% on Friday – implying that perhaps the stock price now appropriately reflects the lowered expectations.
These dramatic declines represent the resetting of overly optimistic projections by the market and the management teams for these companies and represent an increase in the cost of capital – not only for these firms but for the entire cannabis sector as investors become more wary of sector projections.
But the broad skepticism can lead to more attractive values for investments with more realistic projections and the cash to execute them.
Now the not-so-troubled, starting with cbdMD
On Friday, cbdMD announced a $5 million offering of convertible preferred stock with an 8% coupon and convert price of $6.00, or a 137.5% premium.
These are pretty good terms for cannabis and doesn’t dilute the stock by much since it converts into 833,500 shares at a much higher price.
It also doesn’t have a maturity, so it does not carry refinancing risk; the company pays only 8% until the shares convert.
However, the shares get converted in the event of a sale at $11.00, so hopefully for common shareholders, the stock doesn’t get acquired below $11.00.
This now gives YCBD $19 million of cash pro forma compared with its cash required of $14 million, increasing its years of cash coverage to 1.4X from the 1.0X calculated in our recent analysis. The market reacted favorably, sending the stock up 10%, as the increased cash and reduced financing risk more than offsets the dilution.
… and Village Farms, which raised CA$25 million
In our Executive Webcast series this week, Mike DeGiglio, CEO of Village Farms International, walked through the company’s strategy to be a low-cost producer of cannabis – just a few days before announcing an equity offering.
The key takeaways from the webcast are below. You can listen to the Village Farms replay here:
- Village Farms is profitable now, reporting $17.5 million net income on revenue of $73.5 million for the first six months of 2019.
- The company believes it is the low-cost Canadian producer with an all-in cost of goods sold production cost of CA$0.65 – and will be able to compete with Latin American producers.
- As cultivation gets commoditized, value add services such as extraction, processing, brands and product form factors will be the drivers of value creation, so the company is focusing efforts in those areas.
Village Farms also raised CA$25 million in equity with 2.66 million shares priced at CA$9.40, to be used for “working capital and general corporate purposes.”
Given the CEO’s focus on profitability and shareholder value and the fact that Village Farms is “self-funded” in our analysis, we expect this capital to be effectively deployed.
Harborside builds on existing assets
Harborside announced Friday that it will acquire the other 50% of a joint venture operating a dispensary to consolidate operations.
You might recall that, in August, the company walked away from some acquisitions to focus its cash on their existing operations.
We will be speaking with CEO Andy Berman on Oct. 24 as part of our Executive Webcast series.
IIPR opens door for nonequity capital
In other alternative-financing news, Innovative Industrial Properties, a REIT focused on the cannabis space, did a sale-leaseback totaling $42.0 million with LivWell Enlightened Health, a Colorado-based, vertically integrated operator.
IIPR will buy a warehouse in Michigan that will serve as a cultivation and processing facility.
The rent terms were not disclosed, but IIPR’s current yield on its investment properties is stated at 14.1%. Despite the high rate, sale-leasebacks can be a cheaper source of funding for cannabis companies compared to excessively dilutive equity.
Management turnover is usually a red flag
Management turnover at any company should usually be taken as a warning, especially when the change is effective immediately (in contrast to planned transitions over many months) and not for an obvious promotion at another firm.
As noted previously, the CFO of Hexo resigned shortly before the company missed and abandoned revenue guidance.
Only a few days after firing its CFO, MedMen announced that board member Stacey Hallerman resigned effective immediately to become the chief administrative officer and general counsel of Lowell Herb, an organic cultivator in California supplying pre-rolls to MedMen.
While this is an improved opportunity for Hallerman, more executive turnover doesn’t help MedMen.
… but not always, with Trulieve up 2% on COO departure
Trulieve (CSE: TRUL) announced on Friday the resignation of its COO, Kevin Darmody, who took the post in April 2019 after being a nonemployee director of investor relations since at least July 2018.
The announcement also noted that Trulieve is planning a national expansion from its dominance in Florida and is splitting the COO role between the chief sales officer and chief production officer.
Darmody’s background shows only banking and branch management and no national retail expansion experience, so this resignation makes sense, despite the suddenness. The stock closed up 2% after the news, so the market isn’t worried.
Ongoing vape crisis
Finally, this week Craig and I were guests on InvestorIdeas.com podcast, where we discussed opportunities and risks stemming from the vape crisis. Check it out and let us know your thoughts.
Mike Regan can be reached at miker@mjbizdaily.com
