Cannabis Musings - September 19, 2022
Updated: Sep 29, 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):
$100 owed to a bank, which has a lien on all of the assets of my company
$50 owed to an investor who made an unsecured loan to my company, and to trade vendors (potato growers, CBD extractors, schmaltz suppliers)
My common stock of the company
If we shut down my company and sell its assets for $125:
The bank happily gets its $100 paid in full, because the lien on the assets makes it “first”
The investor owning the unsecured loan and the trade split the remaining $25 pro rata
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.