As cannabis company fundamentals weaken and capital gets tighter, common equity investors need to recognize the possibility of major dilution from the equitization of debt that is due soon. This raises the cost of equity for any companies with debt.
The convertible repricing by Aurora (TSX: ACB) and the new convertible announced by The Green Organic Dutchman (TSX: TGOD) highlight a larger truth about capital structures amid stressed fundamentals and markets: Debt becomes equity and dilutes existing equity holders.
Many companies have talked about “nondilutive” financing that actually becomes dilutive in the future – and investors are always forward-looking in both the business and the capital structure. Something that is dilutive in six months will get priced into the share price today.
If you are looking to invest in the cannabis sector, recognize that debt currently is really more like equity. Convertible debt gives you a return today and the ability to participate in equity upside – and, if its situation like Aurora Cannabis’, the possibility to get equity on the downside via a repricing.
Aurora repriced its strike price is an efficient direct equity offering of at least CA$155 million to convertible debt holders, with the potential for the remaining $75 million of debt to participate.
A more traditional route would be to raise cash via a secondary equity offering, and use that cash to pay off the convertible debt at maturity in March. Aurora’s route means only the convertible holders can preferentially participate. However, the converted shares will not be subject to a lock-up, so they might hit the market soon anyway.
The holders of the 2020 convertible have been paid a 5% coupon since March 2018 and, until last week, had the option to convert to equity at CA$13.05 – hopelessly out of the money given the CA$4.38 share price before the repricing and effectively rendering convertible debt as straight debt.
Since Aurora very likely couldn’t pay off the debt at maturity, it had to be refinanced with equity.
Now, those convertible debt investors get straight ACB equity at a 6% discount to the volume-weighted average price between Nov. 18-22 – in other words, whatever ACB trades at this week after the announcement of the repricing.
What it means: Investors who wanted exposure to ACB in 2018 have earned a 5% return, avoided the equity decline and now get the ability to purchase equity at a discount to market price.
ACB’s stock declined 18% on Friday to CA$3.59. At this price, the conversion adds at least 45.9 million shares for the $155 million of the convertible and up to 68.2 million shares with full participation.
Is Aurora in a better financial position now? Yes, the equity overhang is almost removed, but it is still subject to further dilution until the strike is set this week.
Also last week, The Green Organic Dutchman announced financing that includes a convertible note of $30 million, yet the company can access only $10 million until the stock price rises above a yet-to-be-determined strike price. The 5% rate is on the full $30 million for $1.5 million of interest per year, so it is really an effective 15% rate on the cash available today.
Though the mechanics are not yet fully disclosed, it seems if the stock rises to a level expected to be determined in December (and since it is to be determined, it will likely be at lower levels post-announcement), TGOD gets another $20 million.
So this really sounds like a $10 million convertible note and $20 million in warrant proceeds – both are a commitment to issue equity should the stock price rise.
If the stock price falls, TGOD owes at least $10 million and possibly $30 million. At the close on Nov. 15 of CA$0.70, the convertible adds 19 million shares on the first $10 million and 57 shares million on the full $30 million – though it is possible the strike is at a higher stock price.
One could see the coming equity offering by looking at the debt due in March for Aurora and by looking at the coming cash flow losses for TGOD.
Below is a list of our comp table companies with debt, highlighting short-term debt (debt due within 12 months of the last filing) and debt due in 2020 and in 2021.
Also listed is our estimate of pro forma contingent debt. This is usually out-of-the-money convertibles but can also be debt used to finance pending acquisitions that are at risk of failing.
Short-term debt and the debt due in 2020-2021 are the most concerning for equity holders today, as it will be difficult to refinance amid very skeptical capital markets.
If this debt cannot be refinanced with new debt, it will have to be refinanced with new, dilutive equity or at least convertible debt. Aurora is first on the list due to the CA$230 million convertible that is now equitized, so the true pro forma short-term debt is currently $33 million.
Aurora remains at the top of the list on the pro forma contingent debt (adjusted for the pending conversion) because it has another $345 million convertible striking at $7.23, but this is not due until 2024. ACB’s stock price just needs to increase 2.6X in the next four years to consider this equity without a repricing.
Cansortium and Green Growth Brands both have convertibles due in 2020.
All figures in millions of U.S. dollars.
|Name||Ticker||Market Cap||Enterprise Value||Short- Term Debt||Debt Due 2020||Debt Due 2021||Pro Forma Total Debt||Pro Forma Contingent Debt|
|Green Growth Brands||GGBXF||310||409||89||–||–||110||64|
|Canopy Growth Corp.||CGC||5,355||3,687||38||–||–||632||454|
|Trulieve Cannabis Corp.||TCNNF||1,244||1,375||20||14||3||121||–|
|New Age Beverages Corp||NBEV||179||191||17||0||–||83||–|
|iAnthus Capital Holdings||ITHUF||221||176||12||–||50||108||–|
|Harvest Health & Recreation||HRVSF||1,100||1,172||9||–||–||170||100|
|Village Farms International||VFF||326||399||8||–||33||104||–|
|MediPharm Labs Corp.||MEDIF||392||402||4||–||–||4||–|
|Charlotte’s Web Holdings||CWBHF||1,021||999||3||–||–||20||–|
|Vireo Health International||VREOF||143||121||1||–||–||26||3|
|Planet 13 Holdings||PLNHF||213||198||1||–||–||11||–|
|The Green Organic Dutchman Holdings||TGODF||137||103||1||–||–||22||10|
|Supreme Cannabis Co.||FIRE-CA||167||231||0||–||77||66||–|
|Corbus Pharmaceuticals Holdings||CRBP||283||241||0||–||–||8||–|
|Neptune Wellness Solutions||NEPT-CA||248||236||0||–||–||1||–|
|Green Thumb Industries||GTBIF||1,812||1,508||0||–||–||123||–|
|Medicine Man Technologies||MDCL||264||372||0||–||–||127||126|
|Emerald Health Therapeutics||EMHTF||45||59||–||–||–||4||–|
|4Front Ventures Corp.||FFNTF||175||220||–||–||–||84||34|
|Innovative Industrial Properties||IIPR||1,142||853||–||–||–||134||–|