Cannabis Musings - September 6, 2022
Updated: Sep 29, 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.