What do Acreage’s moves to leverage international brand rights mean for Canopy & Constellation?

Acreage Holdings announced a complex financing on Feb. 7 in which the New York company is raising a net $79 million, with plans for at least $65 million more.

The raise could give CEO Kevin Murphy and a lending group leverage over Canada’s Canopy Growth – and, ultimately, its largest shareholder, alcohol giant Constellation Brands – if the United States federally legalizes marijuana and Acreage does not repay a loan.

Shares outstanding have increased at least 7.1 million through the deal and could potentially increase by another 22.3 million.

Acreage is raising much of the capital ($50 million) by creatively carving out and borrowing against an existing asset that doesn’t really exist yet, classified as “non-U.S. intellectual property.”

In other words, Acreage is selling the rights to sell its brands outside the United States, since the multistate operator lists no actual international assets in its filings.

Will Canopy have to pay more for Acreage Brands?

As detailed below, there is a scenario in which the intellectual property lender would own the rights to sell Acreage brands outside the United States if Acreage decides not to repay the IP loan due in February 2021. The IP lender would then sell the rights to recover the loan.

This structure would create a conundrum for Canopy should it exercise its option to acquire Acreage after U.S. legalization.

Under this arrangement, Canopy (and Constellation, its 35% owner) would not own the rights to sell Acreage brands in Canada – or any other non-U.S. location. This is akin to Molson buying Coors but not owning the right to sell the Coors brand outside the United States.

Presumably, Canopy would want those rights in Canada for at least pancontinental marketing – and, ideally, global marketing – and to prevent competitors from diluting the Acreage brands.

New Canopy CEO David Klein (and formerly chief financial officer at Constellation) said in his first Canopy conference call that his goal is to build a “world-class company with brands that consumers trust.”

If Acreage sells these territorial rights, there are three options for Canopy and/or Constellation:

  1. Buy back the rights entirely from the IP lender to control the Acreage brands and enable global marketing.
  2. Negotiate a licensing agreement with the new owner (either the IP lender or the buyer of the rights from that entity).
  3. Abandon the Acreage brands and refocus any marketing efforts on different brands (either owned or new).

Canopy would need to weigh these against each other, as well as the risk of a cannabis competitor buying the rights and confusing the global branding – akin to AB InBev (Budweiser) buying the rights to sell Coors in Canada and the rest of the world, while Molson sells Coors in the United States but can’t in its home market.

This final scenario just doesn’t seem tenable.

New York-based Constellation Brands has its own stable of global brands to leverage and is no stranger to brand creation/acquisition/management.

We agree with Klein that it is the “early innings of brand building in cannabis,” so Canopy could decide just to abandon the Acreage brands and focus elsewhere.

Total loan rate of 22.0% on $49 million, but low risk for lenders

To borrow a net $49 million, Acreage is paying an annual rate of 22.0%, including 19% to the IP lender and 2.25% on a risk-free credit facility. Despite the high rates earned, the lenders shoulder very little risk of loss.

Acreage provided put options on the interest shares, and will provide up to 20 million shares and potentially more unspecified assets should a sales of the international IP fail to repay the value of the loan and interest.

For the $49 million credit facility, Acreage has deposited $50 million, equal to the principal and nearly all of the cash interest, up front.

It is also a related party transaction with $21 million of the $50 million provided by Murphy.

While this is a vote of confidence by the CEO, it also creates a potential conflict of interest with regards to deciding whether Acreage should repay the loan and keep the IP or transfer it to the IP lender, especially in light of the negotiating leverage this IP could give with regards to Canopy.

The mechanics of the IP loan and credit facility transaction are as follows:

  • Acreage borrowed $50 million against the international IP and will repay $55 million in February 2021. This is basically a zero coupon cash loan at 10%.
  • Acreage will pay 83,333 shares per month over the course of the loan, or 1.0 million shares by February 2021. These shares have a put option back to Acreage at $4.50, which means the IP lender can force Acreage to buy the shares back for $4.5 million should the public stock price drop below $4.50. This yields a cash cost of at least $4.5 million below $4.50, and share count dilution of 1.0 million shares above $4.50.
  • Combining these, Acreage is paying $9.5 million to borrow $50 million, or 19% for the one year on the IP loan.
  • This $50 million is deposited and used as collateral to secure $49 million on the credit facility. The credit facility carries a rate of 2.55%, or another $1.3 million of cash interest, to borrow $49 million.
  • Combining $1.3 million interest with the $9.5 million interest, that is $10.8 million to borrow $49 million, or 22.0%.

Because $50 million of cash is already deposited on a loan of $49 million and cash interest expense of $1.3 million, the repayment of the loan and the collection of the interest is nearly risk-free to the credit facility lender.

The straightforward portion of the financing was a Feb. 10 private placement of 6.1 million shares and 6.1 million warrants striking at $5.80 for $30 million.

The units of one share and one warrant were sold for $4.93, a 17% discount to a Feb. 6 close of $5.92, and the warrants striking at $5.80 were basically at the money.

Such expensive terms led by the CEO of a large operator highlight a difficult financing market for cannabis companies and the opportunities available to those willing to allocate capital.

Plans for another $20 million by March, at least $45 million by June

The terms of the lending agreement require Acreage to issue another $65 million “within the next four months,” or by about June 7. Otherwise, the company will have to repay $20 million of the $50 million IP loan.

It seems Acreage hopes to sell another $20 million of the shares and warrants (described below) by March 16 and will try to borrow another $50 million against the international IP to secure access to the rest of the $50 million credit facility before June and cover the needed $65 million.

The lead subscriber of the private placement has an option to buy another $20 million of these units by March 16. Assuming the same terms, this additional $20 million would add another 4.1 million shares and 4.1 million nearly-in-the-money warrants.

The total credit facility is $100 million; the other $51 million becomes available should Acreage deposit another $52 million, and it carries a lower interest rate of 1.25%.

Should Acreage successfully borrow another $50 million against the IP, it would have $110 million due to the lenders in February 2021 and will issue about 1.6 million to 2.0 million shares (depending on timing) as interest with a floor value of $4.50.

Total pro forma dilution is 22.3 million shares to 152.1 million below $19

By our calculations, Acreage currently has 143.4 million pro forma shares outstanding, including the almost-at-the-money warrants at $5.80 and the 1.0 million shares for the interest on the IP loan.

Assuming Acreage achieves the implied plans, it will issue another 4.1 million shares and 4.1 million warrants striking at $5.80 as well as another 1.0 million shares in interest on another $50 million IP loan. That would bring the total pro forma shares outstanding to 152.5 million shares.

This excludes another 7.0 million options and warrants at $19.30 and $25; if the stock rises above these strikes (up roughly 4X), these shares would need to be included as well.

This share count also excludes the potential for up to 20 million more shares to be issued if the sale of the international branding rights is less than $55 million (or $110 million if Acreage borrows another $50 million against the IP), described below.

Our comp table assumes Acreages successfully raises the additional $65 million, as outlined below, and counts only in-the-money options. As a result, the $5.80 warrants will bounce in and out of the share count at $5.81.

Pro Forma Acreage Shares Outstanding
Base Shares 11/22/2019          90.4
+Convertible Units 9/30/19          25.5
+Vested RSUs 9/30/19            8.1
+Unvested Restricted Shares 9/30/19            1.4
+Deep Roots Acquisition            4.8
=2/6/2020 Pro Forma Shares        130.2
+2/10/20 Private Placement Shares            6.1
+2/10/20 warrants @ $5.80            6.1
+Share Interest on $50m IP Loan            1.0
=2/10/2020 Pro Forma Shares        143.4
+$20m Probable Private Placement Shares by 3/16/2020            4.1
+$20m Probable Private Placement Warrants @ $5.80 by 3/16/2020            4.1
+Probable Share Interest on 2nd tranche $50m IP Loan by 6/7/2020            1.0
=6/7/2020 Pro Forma Shares        152.5
Add If Stock Rises Above $19-25 Strike:
Options Granted in 3Q19 @ $19.30 Strike            1.0
Warrants at 9/30/19 @ $25 Strike            2.0
Existing Options 9/30/19 @ $25.06 Strike            3.9

Tail risk of 20 million more ACRG shares if Acreage doesn’t pay and the non-U.S. branding rights are worthless

If Acreage does not repay the IP loan at maturity in February 2021, Acreage will transfer the “international IP” asset to the IP lender – basically executing a prearranged sale.

The IP lender (which would now be the owner) would then sell the IP. If the IP sells for less than the loan value, Acreage would issue up to 20 million shares for the IP lender to sell to the open market to make the lender whole.

For example, if the lender is owed $55 million and sells the IP for $40 million, and ACRG stock trades at $5.00, Acreage will issue 3.0 million shares ($55 million – $40 million = $15 million, divided by $5.00 per share = 3.0 million shares), which the IP lender would then sell.

If Acreage issues another $50 million by June as planned and owes $110 million in February 2021, it still can issue only another 20 million shares to cover the delta.

Should the 20 million shares not fully cover the amount owed, Acreage must provide more “secured assets” to the IP lender to make them whole. This scenario requires the lender to get $0 for the international IP and the stock to drop below $2.75 (assuming a $50 million loan) or $5.50 (assuming the $100 million loan).

Is the non-U.S. IP worth $55 million-$110 million? Maybe …

Selling territorial branding rights is a common practice. 

The basic business model is essentially a franchise fee model, where the brand licensor receives a percent of all sales in a territory produced by the operator licensing the brand. It could also be structured as a fixed amount per unit (such as per gram) or a blanket fee per region.

With almost no costs except for some administration expense, the licensor has very high (90%+) EBITDA margins. The licensee, which, in this case, would be a non-U.S. cannabis operator willing to pay for a brand, agrees to pay the fee because it views it as an advertising cost and believes it can sell more product with the brand than without.

If the IP lender became a separate entity, and we use a 10-20X EBITDA multiple and an assumed 5% license fee on gross sales with a 90% EBITDA margin, a $55 million valuation could be supported by $61 million-$122 million gross licensed sales; at the $110 million level, it would require double or $122 million to $244 million in gross sales.

For reference, other heavily franchised business models such as Dunkin Brands (Nasdaq: DNKN) and Restaurant Brands International (TSX: QSR, which franchises the Burger King, Tim Hortons and Popeyes brands) both trade at 18X EBITDA, according to FactSet, though the two companies have lower margins from corporate-owned stores.

Gross Non-U.S. Brand Sales at 5% Fee $122.2 $81.5 $61.1 $244.4 $163.0 $122.2
Revenue at 5% Fee $6.1 $4.1 $3.1 $12.2 $8.1 $6.1
EBITDA at 90% margin $5.5 $3.7 $2.8 $11.0 $7.3 $5.5
EBITDA Multiple 10.0X 15.0X 20.0X 10.0X 15.0X 20.0X
Enterprise Value $55.0 $55.0 $55.0 $110.0 $110.0 $110.0

Mike Regan can be reached at [email protected].