Cannabis Musings - September 29, 2022

Friends – earlier this week, think tank The Brookings Institution published a fascinating and unsurprising study explaining that Congressional primary candidates simply don’t see cannabis as a policy priority. Indeed, the analysis of positions announced by candidates found that “clashing against the idea that the popularity of cannabis reform should be pushing legislators to make clear statements of support for reform, 86.4% of candidates either made no mention, staked out an unclear position, or explicitly opposed cannabis reform”.

Long-time readers of these Cannabis Musings know that I’m something of a skeptic when it comes to the industry’s wishful thinking about Congress. How many times has SAFE been submitted for consideration? The entire state-legal industry exists solely as a matter of the grace of the federal government, but that doesn’t mean that the government must or will (note that I didn’t say “should”) do anything to make it easy. Why? Well, in my slightly realpolitik opinion, there are simply bigger problems in the world than assisting the cannabis industry, at least from a political capital perspective. Expecting Congress to act because it’s the “right thing to do” es iz vet a zets in drerd (it’s as pointless as punching the ground).

If anything is going to happen, there’s a real need to change perceptions about cannabis. We’ve talked before about this problem – the industry is fighting against a history of D.A.R.E., Just Say No, very special episodes of The Facts of Life and Diff'rent Strokes, and other programming that, correct or incorrect (or both), shaped the opinions of those who are now either in government or driving the message. Is it really that much of a surprise that cannabis either isn’t major issue for candidates, or there’s still too much political risk for making it an issue?

What’s to be done? Well, one should generally not take marketing advice from an ex-lawyer turned consultant, so instead one should look at what the Cannabis Media Council is doing. Announcing its launch earlier this week, this non-profit group, founded by a team of media and marketing makhers, is going to work to change the narrative about cannabis through mainstream media channels. (Full disclosure – I’m proudly an advisor to the CMC; unpaid, lest anyone think I’m shilling for it). It’s a trade group that represents the entire industry, and is doing something to rewrite the agenda into something positive.

If cannabis is going to be truly accepted as a legitimate, safe, and acceptable adult recreational and medical product; if the industry is going to be integrated into the national marketplace; and if there’s ever any hope of getting Congress to act, the industry needs to do everything it can to shed the image that’s been created for it.

Finally, I was quoted! Thanks to Jeremy Berke @ Insider for talking to me about the capital challenges facing cannabis companies today.

Be seeing you.

© 2022 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - September 19, 2022

Friends – we recently talked in these Cannabis Musings about Glass House’s preferred offering, which kinda sorta looked like a debt restructuring. With cannabis being the gift that keeps on giving, we’re now treated to news of an actual debt restructuring, this time by multistate operator Red White & Bloom.

Per its press release, RWB apparently changed the terms of some of its debt owed to “arm’s length lenders” (this usually signals that the parties are independent, but it’s not clear from the press release what they mean) by extending out maturity dates to 2024 and borrowing more to repay other debts. The release is unclear about what debt is being extended, who the lenders are (other than being distanced beyond the length of an arm), the new interest rates on the debt, and many of the other terms investors would want to know, although it does tell us two interesting facts.

First, “strategic investor” (the press release’s term) Colby De Zen is now President and a board director of RWB, although I can’t tell whether Colby De Zen is an RWB shareholder or lender (he was named to the RWB board of directors back in October 2021, but apparently not appointed until now). Second, about CDN$31 million of the restructured debt (plus interest) may be converted by its holders into RWB common stock at a fixed share price above the current trading price, giving the debtholders some upside if the stock price goes up.

This is a good example of a standard, out-of-court (bankruptcy) restructuring – a borrower giving up a fair amount of equity and control in exchange for the creditors not foreclosing on their debt and taking over the company. The existing shareholders are diluted, but not wiped out – with about 400 RWB million shares outstanding (per their June 30 financials), these convertible rights represent a fair amount of potential dilution to the existing shareholders.

Sometimes, though, in a restructuring, the debt isn’t just modified, but is swapped for the equity. This sometimes happens in a negotiated workout, because it reduces the amount of debt on the company, and is also a key aspect of a loan-to-own strategy (something we talked about here a long time ago, but, alas, years of Musings are no longer posted on the interwebs). Let’s say my CBD knish company has the following capital structure (meaning all 31 flavors of equity and debt):

1. $100 owed to a bank, which has a lien on all of the assets of my company

2. $50 owed to an investor who made an unsecured loan to my company, and to trade vendors (potato growers, CBD extractors, schmaltz suppliers)

3. My common stock of the company

If we shut down my company and sell its assets for $125:

1. The bank happily gets its $100 paid in full, because the lien on the assets makes it “first”

2. The investor owning the unsecured loan and the trade split the remaining $25 pro rata

3. I get bupkes, because debt (almost always) gets paid before equity under US law (not legal advice)

Now, if I instead filed my CBD knish company for bankruptcy restructuring (Chapter 11, not Chapter 7 liquidation), the bankruptcy court would (probably) hand the keys to the unsecured loan investors and the trade, and my stock would be wiped out (I’m skipping over a lot of detail to keep this as un-boring as possible). In both scenarios, the unsecured loan is referred to in finance parlance as the “fulcrum security” (ignore the trade vendors here), because it’s the level in the capital structure that isn’t going to fully recover the amount its owed (also known as “impaired”).

Back to the loan-to-own strategy, an investor buys the fulcrum security with all of this in mind (hence, the “strategy”). If my CBD knish company does fine and pays back the unsecured loan with interest, a glick ahf dir! If my company defaults, it ends up in bankruptcy (either I file it, or my creditors force it) and the investor (probably) gets my company.

The thing is, however, bankruptcy still isn’t available to US cannabis companies, so a textbook loan-to-own strategy (wiping out the equity in bankruptcy) doesn’t really work in this industry. Instead, the investor is left persuading the company to exchange modifying the fulcrum security for a large chunk of the equity, control of the company, and other investor-friendly things. The downside, from the investor’s perspective, is that the existing equity remains in place, however deeply diluted, so it’s more like loan-to-own-ish.

Interestingly, Ayr Wellness, another multistate operator, issued CDN$110 million of promissory notes (mostly interchangeable with “loans”) due in December 2024 that trade on the Canadian Securities Exchange (meaning that investors may buy and sell those notes similar to stock). Notes are typically issued at “par”, or 100, meaning that each $1.00 of principal amount is sold by the issuer (borrower) for $1.00. On September 15, 2022, someone sold CDN$58 million of principal (face) amount of these Ayr notes at 90, meaning they sold for CDN$52.2 million, below par.

Why would these Ayr Notes due 2024 sell below par? Well, assuming the market is efficient, the buyer and seller of those think that, currently, only CDN$0.90 of every CDN$1.00 gets paid back in a liquidation/sale. In other words, the market may be signaling that it thinks that Ayr’s assets are worth less than its total debt, and these notes are a fulcrum security.

For the record, I certainly don’t know enough to know whether this large trade of Ayr notes is someone trying to position into a loan-to-own-ish strategy – my general sense is that lenders in this industry aren’t looking to own these companies, and there simply aren’t that many distressed funds playing in cannabis yet. Nor am I making any kind of statement about Ayr’s (or any other company’s) creditworthiness.

As the general malaise in the cannabis industry lingers, we’re likely to see more of these fairly traditional workout strategies utilized both offensively and defensively.

Be seeing you.

© 2022 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - September 6, 2022

Friends – last week, Glass House Brands, a California-based operator, announced that it raised $14.7 million through an offering of preferred stock and warrants. It’s been a while since we’ve deconstructed a financing in these Cannabis Musings, and this one merits further exploration because, to me, it captures the challenge of raising capital today.

Glass House is a public company, and in many ways, it’s easier to raise money as public company relative to a private company. There’s a built-in marketplace for buyers (in this case, the Canadian NEO Exchange, on which Glass House’s stock trades), and broker-dealers (basically, institutions that are licensed to sell someone else’s stock to investors) are eager to help sell that that stock to investors (we’ve talked about different types of public offerings before – underwritten, best efforts, at-the-market, etc. I can’t link to those past Musings anymore, but let me know directly if you want that content).

On the other hand, when you’re a public company, selling more equity to investors can be problematic when your stock price is depressed (which is generally the case for most public cannabis companies these days) and investor capital is fairly elusive (which is generally the case for most public companies these days). Big, institutional investors, which are usually the buyers of newly-issued stock (because they’re the ones with the relationships with the broker-dealers), like to pay a discount to the current market price, and fiercely negotiate the right to sell the stock as quickly as possible after the purchase is announced (the “lockup” period is a key negotiating point, and is driven mainly by boring securities laws). When your valuation is soaring and there’s broad investor demand, you have a lot more control over the terms of your offering than when those factors are no longer extant. A highly-dilutive, below-market offering risks driving down the market price for a company’s stock even further, in real time.

Per its press release, Glass House issued preferred stock and warrants. To start, preferred stock is equity of a company that has a preference over the common stock in terms of payment, so if the company sells all of its assets and then pays out its cash to its equity holders, the preferred gets paid a set amount before the common (and sometimes the preferred additionally gets paid alongside the common). Preferred often also requires payment of a dividend on the notional (dollar) amount of the preferred, similar to interest on a loan (paid in cash or added (compounded, or “PIK’ed” if you want to sound cool) to the amount of the preferred). It’s all very similar to a loan, but it’s equity, so the preferred owner isn’t a creditor of the company (which really matters most in bankruptcy, although cannabis companies in the US can’t file for bankruptcy protection, which makes this even more interesting). That last part is important because, while a loan eventually becomes due (matures), preferred usually doesn’t (you may see preferred that must be redeemed (paid back) on a fixed date, but that’s atypical), so the issuer doesn’t have default risk, and it shouldn’t show up as debt on the financials (a reminder that this is neither accounting nor legal advice (some things never change)).

Why then would an investor want to invest their money as preferred rather than debt, if they don’t get the delicious benefits of being a creditor? First, the preferred usually (but not always) may be converted into common stock (sometimes at a multiple), so if the company’s common stock skyrockets, that may be more valuable than just getting the preferred amount back (although it’s worth noting that convertible notes do offer this upside). Second, preferred stock usually comes with antidilution protection, meaning the value is ratcheted down if the company issues more stock and “dilutes” the value. Third, preferred stock often has voting rights alongside the common stock, something debt (including convertible debt) doesn’t offer. Finally, the preferred stock could register the equity so it may be traded on an exchange similar to the common stock, while debt almost never trades (at least, not easily).

Here, Glass House reportedly issued $14.7 million of new preferred stock, carrying a dividend ranging from 20% and 25% (based on the timing) that’s paid partially in cash (10% on the preference amount), with the rest compounding (PIK’ing). It also reportedly converted $22.6 million of existing preferred into this new series (class/type/ilk) of preferred stock, so there’s now reportedly at least $37.4 million of preferred stock ahead of the common (and the press release notes that they may continue to issue more preferred in the short term, up to $50 million outstanding).

The preferred stock also came with what’s known as “warrant coverage”, basically meaning Glass House further incentivized its investors to buy the new preferred stock by issuing them the separate right to buy Glass House common stock at US$5.00 per share some time in the next five years (specifically, warrants to acquire 200 common shares per $1,000 of preferred stock purchased). Warrants (effectively the same thing options) help schmaltz up the investor’s returns if the stock does well, enticing the primary investment; however, the tradeoff for the company is that, if the warrants are exercised, the company issues stock at the strike (exercise) price instead of being able to sell that same stock at the market price (which will always be higher because why exercise the warrant if the stock is trading below the strike price). So, part of the negotiation between issuer and investor is the amount of the warrant coverage.

Glass House is reportedly using some of the proceeds of its preferred offering to pay down existing debt, with the rest being used for working capital. So, one way to look at this transaction is that it’s delevering, meaning that it’s reducing the company’s debt burden (leverage) and improving its cash position. However, they’re doing so by replacing one obligation with another, so from that perspective, this transaction is a sort of a restructuring. The magic of finance is that it can be both things at once.

Going back to my initial point, the fact that Glass House had to raise capital by issuing a 20%+ preferred with zaftik warrant coverage, instead of issuing debt or common stock, is a prime example of how hard it is right now for cannabis companies to find new money, and how expensive that money is becoming in a rising interest rate environment. I’ve been hearing and seeing this for a while now across the industry – large and small, east and west – and I expect it’ll be the main topic of conversation at Benzinga’s Cannabis Capital Conference next week (as I mentioned, I’ll be loitering in the lobby of the Palmer House). Who knows if we’ll ever return to the easy money days of 2017-2019 (early), but it seems to me that we’re likely to remain in this tight money phase without a real catalyst like legalization or some sort of definitive federal protection for investors (the SAFE Banking Act doesn’t do that). And that’s not investment advice.

Be seeing you.

© 2022 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.