Making sense of a questionable cannabis investment & acquisition tips

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Deal of the Week / In partnership with Viridian Capital Advisors

While capital has become more accessible for many marijuana firms, sometimes the decision to extend funds is more about protecting a position than actually supporting a cannabis operator’s trajectory.

Consider this: Entourage Health (TSX: ENTG; OTCQX: ETRGF), formerly WeedMD, closed an upsized credit facility with an additional 20 million Canadian dollars ($15.6 million) of funding right before Christmas.

Deal details

• A 15% interest rate with payment-in-kind ability.
• No warrants or equity kickers.
• Maturity in August 2022 – an eight-month period.
• The second priority debt with liens on substantially all corporate assets but junior to the company’s senior secured debt, which matures in March 2022.
• LiUNA Pension Fund as the lender. LiUNA is the largest construction union in Canada and owns more than 20% of Entourage.

We are a bit dumbfounded that anyone would step up and loan CA$20 million to Entourage at this point.

Of the 28 Canadian cultivation and retail sector companies with market caps of more than $20 million in Viridian’s database, Entourage ranks dead last on the Viridian Capital Credit Tracker ranking model.

It is quite an accomplishment to be at the bottom of a class that includes Aurora Cannabis and Hexo Corp.!

Entourage also had negative gross profit for 12 consecutive quarters and negative cash flow from operations for 13 of the past 15 quarters.

This illiquidity figures prominently in the company auditor’s “going concern” footnote in a September quarter filing.

As of Sept. 30, 2021, Entourage had negative working capital of CA$41.6 million, primarily stemming from the upcoming March 2022 maturity of its senior credit facility.

The short-term nature of the new facility does not boost this profile.

Entourage has a total of CA$98.6 million in debt maturing over the next 12 months.

In addition to the CA$39.4 million in its senior first priority credit agreement due in March and the CA$50 million from the second priority secured credit agreement (which includes this new CA$20 million advance), the company also has $10.8 million in unsecured 8.5% convertible debentures due in September. These have a CA$1.6 conversion price.

The debt structure also is problematic, primarily because of the first priority maturity in March.

Will the senior lender – the Bank of Montreal – agree to a longer-term credit agreement without a restructuring that keeps the junior debt from maturing before it? Or is the idea that the new advance from LiUNA pays out the maturity of the converts and keeps the ball rolling?

At a minimum, Viridian believes the maturity of the LiUNA facility would have to be pushed out well beyond any new maturity of a first priority facility.

The debt/market cap ratio does an excellent job of predicting distress across a wide range of industries. Typically, any value over 3X indicates distress. Entourage weighs in at 3.13X, the highest number in its peer group.

The stock market appears to agree with Viridian’s assessment.

Despite acquisitions and highly publicized relationships with Mary’s Medicinals and Boston Beer, Entourage’s stock is down 60% since the end of the third quarter, compared with a 21% decline in the MSOS ETF, seen in the chart above.

LiUNA could be extending CA$20 million in additional funds to protect its second priority loan and its CA$4.8 million market equity value. Still, Viridian doesn’t believe the 15% rate is nearly enough to take Entourage’s risk.

How to avoid an ‘ugly’ integration after an acquisition

By now, you’ve likely seen the news: MJBiz was acquired by Emerald X.

It’s big news for us, and, as we said in our MJBizCon Buzz newsletter, we’re all excited about the new opportunity.

But now we also enter a phase that many of you who have been through acquisitions (on either side of that equation) have been through and a critical process for ensuring that your deal is successful: integration.

Everyone has an opinion on how to do this correctly.

Just Google “successful acquisition integration” and you’ll get a million lists (yes, that might be an exaggeration).

But there are some common themes in there that will help you get the most from your investment in another company (Note: These tips are not specific to the MJBiz acquisition.):

• Keep a customer focus. There will be challenges in the process. That’s just the nature of the game. But don’t let your internal challenges affect how you serve existing customers.
• Have a solid communication strategy. Be as transparent as possible with your employees and don’t worry about overcommunicating. Your staff will have questions about what comes next. Avoiding the questions will only add more stress and uncertainty to the situation.
• Don’t forget the culture. Chances are the employees are part of the reason a company was acquired. So even if you think you’re bringing them into a great culture, remember that they probably thought they had one, too.
• Make sure your integration strategy is in line with the goals of the acquisition. You bought the company for a reason. Don’t let the process of bringing that company into the larger organization make you lose sight of that reason.

In my career, I’ve witnessed many acquisition integrations – and experienced a few as well.

They fall into three categories: the good, the bad and the ugly.

The good ones ultimately see the expected accretion on the forecast timeline and sometimes faster.

The bad tend to have a few more bumps in the road but are not automatically failures. Hopefully leadership at the acquiring company takes lessons from the problems and makes the next opportunity better.

The ugly? Well, that can set you up for long-term challenges, low morale and high turnover in both the acquiring company and the company being integrated.

– Jenel Stelton-Holtmeier