April 6, 2022 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Transactional Activity: There were two more transactions but a $51.3 million lower volume than the prior week. Compared to last year’s same week, eleven fewer transactions closed with a $57.3 million lower volume. The average deal size was $1.4 million this week vs. $4.2 million in the same week last year.
The cannabis equity markets rallied past disappointing earnings, ongoing supply chain disruptions, rampaging inflation, an increasingly brutal war in Ukraine, new COVID lockdowns, and…. So what, one might ask, was the good news? We can only point to two things: the MORE Act passing the House again and the M&A market seemingly indicating that practically everyone is a takeout candidate.
Concerning the legislative front, be prepared to be disappointed again. We keep hearing the old WHO song “won’t get fooled again.” Let’s be clear, we believe the likelihood of any substantive bill passing this year is very low, and the only thing that has even a fair chance is some slightly social equity augmented version of the Safe Act. Unfortunately, once MORE fails in the Senate and the Schumer//Booker circus leaves town, we are afraid that the downward drift in cannabis is likely to return.
Continued consolidation activity is a better bet to support the market. We were gratified to see that the 2nd tier competitors we have advocated have outperformed their larger brethren YTD. And part of that relates to the fact that many of them are poised to be acquired. Our valuation gap graph presented in the M&A section supports the idea that accretive financial M&A is also on the docket.
This quarter, earnings comps were bound to be challenging since we were comping against a stay home and spending your incentive check on the cannabis environment. Second-quarter comps should be better, potentially buoying the market, but those releases are months away. Meantime, batten the hatches; it could be a bit scary out there.
One of the most significant risk-off indicators, an inverted yield curve, is flashing red for the first time in years. The two-ten spread inverted on April fools day, and it is a reasonably good indicator of the year ahead recession risk. So there you have it: war, inflation, recession, & pestilence. Oh My!
Off 74% YTD, cannabis capital raise activity was the slowest 1st quarter since 2017. Reduced equity issuance (down 86% y/o/y in the U.S. and 97% in Canada) was partially compensated for in the U.S. by solid debt issuance (up 392% y/o/y, however, Canada’s debt decline of 93% brought total debt issuance down as well. As the graph below shows, capital raises for the first twelve weeks of 2022 were dominated by U.S. activity. Additionally, a higher percentage of capital raises came from international locations than in any recent year’s first quarter.
There were only four closed capital raises for $5.4M this week, the eighth slowest week since 2019. The graph below clearly shows the sea change in financing as debt (light green) replaced equity (dark green) as the market slid.
Debt seems likely to remain the financing vehicle of choice. Still, we are interested to see if floating rates and shorter durations become more common as investors have an apparent reason to fear increasing rates.
Equity prices were up 1.06% for the week, as measured by the MSOS ETF. The ETF is now down 18.8% for the year.
Last week we reported little correlation between earnings misses and stock performance. Since our original chart of the week, we have added 4Front, Planet 13, and Trulieve to the graph, and the trend line looks more pronounced, forcing us to revise our opinion: Earnings misses do matter!
The biggest winners and losers: Interestingly, the week’s biggest gainers were an eclectic mix of two second-tier names that we think to be excellent acquisition targets and three tier-one competitors that do well in the no legalization environment. However, the losers were dominated by Canadian competitors, realizing that they had fallen for the legalization head-fake one more time. YTD gainers show a strong California theme.
Largest Equity Raise: On March 31, 2022, Avicanna (TSX: AVCN) (OTCQX: AVCNF), a commercial-stage international biopharmaceutical company focused on the commercialization of cannabinoid-based products, closed a non-brokered private placement of units for approximately US$2.02M.
Each unit consisted of one common share and 1/2 warrant with a $.32 exercise price (14% premium) and a three-year expiration. This warrant package is worth approximately $0.024 per unit, contributing to the modest 11.3% discount to pre-announcement prices.
The issue implies a $13.6M market cap and an EV 2021 Revenues of 7.24x, a modest discount to the 9.86x median for the Canadian biotech sector companies in the Viridian Value Tracker with market caps between $10M and $100M.
Proceeds will be used for general corporate purposes.
Public Company Listings: Both companies that raised capital this week were public. Both companies trade in Canada (one on TSX and one on CSE), and both trade in the US on OTC.
Equity vs. Debt Cap Raises: Equity accounted for 51% of the week’s capital raises.
Debt accounted for 60% of trailing 4-week capital raises. We continue to foresee a strong debt issuance climate ahead as issuers are loathed to accept issuance at prices perceived to be well below intrinsic value.
Only two debt transactions closed this week, and neither ranked highly in our credit scoring methodology; the point was not lost on the market as the two had effective costs of 23.56% and 34.4%.
The Largest Debt Deal: On March 28, 2022, Empower Clinics Inc. (CSE: CBDT) (OTCQX: EPWCF), an integrated healthcare company that serves patients through its clinics and telemedicine system, and also operates a medical device company and diagnostic labs, raised $1.65M in a private placement of convertible notes:
The notes have a 6% coupon and a two-year maturity.
The conversion price of $.16 per share is a 12% discount to the share price at issuance.
Each unit contains 5000 warrants with 2-year maturities and $.24 strike prices. The warrant package gives 150% coverage. Total coverage, including the conversion option, is 250%, one of the highest total coverages we have seen.
Not surprisingly, 250% coverage with 100% at a discount produces a high effective cost of 34.4%.
Investors may have a right to be skeptical. This is the second time Empower has tapped the debt market in 2022 and the -.59 free cash flow adjusted current ratio we calculate proforma for this transaction suggests, the company will be back quite soon.
Empower has had 15 quarters of consecutive negative EBITDA, and its financial statements contain going concern qualifications.
MERGERS & ACQUISITIONS
Transactional Activity: Three M&A transactions closed this week with a total transaction amount of 474.88M compared to five transactions for $18.32M in the prior year. All of the buyers in this week’s transaction were public companies.
Total YTD M&A volume is up 19.6% from 2021, with $3.05BM in consideration and 58 deals closed. The top eight transactions greater than $100M account for 80.4% of YTD closed deals.
U.S. Transactions have been significantly weaker, with total consideration down 8.3%, with 52% fewer transactions. The average transaction size of $54M is up nearly 52% and is expected to grow considerably as large public/public transactions such as Verano / Goodness Growth and Cresco/ Columbia Care close.
Stock as a percent of total consideration continues to increase, and this trend should continue as we see large all-stock deals like Cresco / Columbia Care close.
We like to monitor the risk arb spread on transactions such as Cresco/Columbia that have many hurdles to overcome to close:
Significant overlaps require asset/license sales
Significant integration challenges
Relatively low initial premium to market paid
The current spread of 13% is significantly wider than the median spread of 5.9% measured by fund group GMO in a study of nearly 1,700 transactions. We are unaware of a cannabis-specific analysis of these spreads but consider this to be very early going, and over time the direction of this spread will be instructive.
One driver of M&A activity has become more favorable over the last two weeks. The valuation gap between the largest MSOs and the less than $300M market cap group, which are their primary targets, has been a significant driver of M&A activity since it creates the regular opportunity for accretive transactions. In the last several weeks, this gap has widened to around four multiple points, still low by recent historical standards but at a level that incentivizes financially driven deals. Interestingly, we can observe that the value gap tends to widen when stocks gap upward and decline when they have significant declines.
The largest M&A Deal of the Week: – On March 31, 2022, Sundial Growers (Nasdaq: SNDL) announced the closing of Its acquisition of all outstanding shares of Alcanna Inc. (TSX: CLIQ), one of the largest private-sector retailers of alcohol in North America, and the largest in Canada.
Consideration for the deal includes 8.85 Sundial Shares per Alcanna share (worth $230.26M in total) plus approximately $1.20 cash for each Alcanna shares (worth roughly $43.55M in total). In addition, Sundial is assuming approximately $179.6M of Alcanna’s debt.
Total Transaction value of $453.4M represents approximately .6x 2022 Revenues and 10.2x 2022 EBITDA.
The acquisition gives Sundial a 63% equity interest in Nova Cannabis, one of Canada/s largest value-priced retailers with 78 retail locations across Alberta, Saskatchewan, and Ontario. Together with Sundial’s existing operations, the combined company will have Canada’s largest retail cannabis network.
Sundial now operates across three segments: Cannabis Operations, Cannabis Retail (which will now include liquor retailing), and Investment operations.
Sundial has executed one of the most brilliant turnarounds we have ever seen. We are not saying that they are brilliant strategists, although they may be. Frankly, they are in so many businesses and investing in so many more that we doubt any management team could excel at it. What we mean is captured in the following two graphs.
M&A Deal of the week: Sundial’s 3rd quarter 2020 financials carried a going concern qualification and noted that the company was likely to be in default of its debt agreements by December 2020. The graph above shows that Debt/Market Cap, which we believe to be the best single number credit indicator, reached a peak of 5.46x in September 2020. This level generally indicates imminent failure. Sundial was on the edge of bankruptcy, and then something miraculous happened.
Sundial became a MEME stock, thanks to the merry bunch of Redditors. Note the spike in the stock around February 2020. One might expect that some big financial event caused this, but that is not the case. Looking at the quarterly statements from March 2020 through March 2021, you will not discern any operational turnaround.
This is where intelligent management comes in. The management called the market’s bluff and said, “if you think our stock is worth $2, how would you like a BILLION more shares?” The chart shows a billion shares issued between February 2021 and June 2021. Then to their credit, they just kept going, topping out at 2 billion shares before the Alcanna deal, resulting in an additional 400 million shares.
They took out their debt and maintained large cash balances, essentially bulletproofing their credit, and then started buying and investing in other businesses. They knew that the massive influx of cash couldn’t be appropriately employed in their own business, so they diversified.
Were they lucky or brilliant or both? You decide. Either way, it’s the best turnaround story we have witnessed in cannabis.
VIEW DEAL TRACKERS
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.
Launched in January 2015, and having analyzed more than $60B in deals, the Viridian Cannabis Deal Tracker is a proprietary data service that monitors and analyzes capital raise and M&A activity in the legal cannabis and CBD industries. Each week the Deal Tracker provides proprietary data and market intelligence on transactions, including:
Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors – from Cultivation to Brands to Software)
Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A)
Principals to the Transaction (Issuer/Investor/Lender/Acquirer)
Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)
Deals by Location of Issuer/Buyer/Seller ( To Track the Flow of Capital and M&A Deals by State and Country)
Credit Ratings (Leverage and Liquidity Ratios)
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