VIRIDIAN INSIGHTS

• GTI SENDS SUITOR LETTER TO BOSTON BEER.
  • • GTI sent a letter expressing interest in a merger between the two companies. Interestingly, GTI’s stock rallied around 6% for the week, while Boston Beer fell around 9%.
    • The market is correctly reading that many impediments will likely keep the deal from happening. Boston would have to create a Canopy U.S. type of structure to hold GTI until federal legalization so as not to jeopardize its senior listing.
    • Boston is undoubtedly seeing the handwriting on the wall – declining alcohol sales but would probably prefer a more straightforward deal.
    • Still, deals like this are clearly coming; it’s just a bit premature.

• CANOPY HAS STABILIZED ACREAGE THROUGH THE PURCHASE OF $100M OF THE OUTSTANDING $136M SENIOR CREDIT FACILITY. ACREAGE FOLLOWED UP WITH A NEW (ALBEIT EXPENSIVE) $10M CONVERTIBLE DEBT RAISE.
  • Acreage filed a late 10Q on 5/31/24, and the results were generally disastrous.
    • As we reported last week, Acreage had a disastrous March quarter with steep sales declines and negative cash flow, and it defaulted on its Senior Credit Facility.
    • Canopy repurchased the interests of AFC Gamma for proceeds of around $100M, including the use of an escrow account that it established to guarantee the debt when initial financing closed.
    • Viridescent agreed to amend its part of the line and keep the same interest rate and maturity.
    • The net impact was a significant improvement in credit quality
    • Acreage is still weak and will likely need additional support from Canopy to develop its assets in Ohio and New York.
    • Acreage’s ranking in the Viridian Credit Tracker has been deteriorating for several months. Acreage is now ranked 24/30.
• THE CANSORTIUM/RIV MERGER CREATES A TOP-TEN CANNABIS CREDIT
  • The announced merger with RIV Capital enhances Cansortium’s credit profile, and the Viridian Credit Tracker model ranking improves from #18 to #8,
  • Cansortium’s net cash position goes from -$60.7M to $5.1M, dramatically improving its Viridian Capital Liquidity ranking from #23/30 to #9/30.
  • Leverage is also significantly reduced, predominantly from the conversion of $175M of Hawthorne debt into Cansortium equity. The conversion also demonstrates support from Hawthorne’s parent, Scotts Miracle Grow.
  • The combined company will jump to a #10 size ranking compared to the #21 ranking Cansortium had prior to the announcement.
  • The transaction significantly improves the combined company’s ability to attack potential rec conversions in Pennsylvania and Florida.
  • The deal risk arb spread now stands at over 90%, which is quite wide but probably appropriate for this stage of the process with a difficult-to-estimate closing date and a number of hurdles to complete. We will be ranking the proforma combined company going forward with the proviso that Cansortium’s credit ranking will fall precipitously if the deal is canceled.
• LESS RECOGNIZED BENEFITS OF RESCHEDULING: HIGHER SUSTAINABLE DEBT LOADS AND INTERNALLY FUNDABLE GROWTH
  • Key takeaways from the chart below
    • The analysis assumes a hypothetical company with $1 of sales, 50% gross margins, and 30% EBITDA margins.
    • The analysis shows that the hypothetical company experiences greater than 100% effective tax rates despite the allocation of 80% of depreciation expense and 25% of SG&A expense to COGS. The same company would have a combined state and federal effective tax rate of 27.32% without 280e
    • Debt levels of 3x EBITDA are not sustainable in a 280e world, but not because interest coverage is inadequate. Using 15% average debt, we get 2.14x EBITDA/Interest coverage. The issue is the debt payback period. We calculate a debt payback of over 14 years with the given assumptions, which no regular cannabis lenders (except sales leaseback providers) will accept. S3 reduces the payback period to a more acceptable 6.11 years.
    • If we assume ten-year payback periods, the removal of 280e would increase sustainable debt loads from 2.65x Debt/EBITDA to 3.91x.
    • The bottom set of numbers shows the impact 280e has on internally fundable growth. In this analysis, we utilize the capital/sales ratio of 1.54x, which we discussed in the Virdian Chart of the Week. With 280e and 3x debt, companies can only internally fund 4.2% sales growth. The elimination of 280e more than doubles internally fundable growth to 9.6%.

• The DOJ has signed off on S3, and the 60-day public comment period has commenced. Why does the equity market not care?
  • Investors are tired and have been spoofed too many times. When someone says, “It could take up to a year…” Cannabis investors immediately immediately think, “It’s never going to happen.” It now seems to us that it is overwhelmingly likely to happen, and the critical question is whether it will really happen as quickly as advertised.
  • Institutional investors who have avoided the space would rather miss part of the rally than jump in for another ride like the last two years. Talking to investors, rating agencies, and other constituents, we find deep distrust for administrative actions like rescheduling. It is ironic that the very lack of congressional involvement that makes S3 likely to happen also imbues it with an aura of impermanence. Like the Cole memo, the fear is that a new administration may delay implementation or even reverse course.
  • Many details still need to be worked out, and investors still question how the State programs, the FDA, and Big Pharma will interact in an S3 world. Widely differing opinions exist on when S3 will actually become effective.
  • S3 could potentially have some perverse results. The extra funds might be competed away in misplaced attempts to gain market share. Also, the additional cash could foster capacity additions that hasten oversupply and commodity price declines.
  • We generally give little credence to claims that the DEA and FDA will become more rigorous in enforcing federal laws requiring S3 products to be approved by the FDA. Our position is based on two words: politics and money. Rescheduling is only coming to fruition because Biden is desperate for youth votes, and his DOJ is unlikely to support a new crackdown on state-licensed cannabis programs that it didn’t do while cannabis was S1. It is likely to undertake actions detrimental to tax-paying state-based businesses.
  • Still, despite the uncertain timing, regulatory implementation, etc., our view is that the various regulatory, judicial, and legislative tracks for cannabis industry reforms are mutually reinforcing. We have never seen so many potential upside catalysts in any other industry. We still view a doubling in price levels as reasonably achievable.

• VALUATION, LEVERAGE, AND LIQUIDITY
  • The two graphs below show the Enterprise value to 2024 EBITDA multiples against two leverage measures. In the first graph, we have calculated an Adjusted Net Debt/ 2024 EBITDA figure by adding any accrued taxes over 90 days of tax expense to debt before subtracting cash to arrive at Adjusted Net Debt. We would expect any regular company to have accrued taxes equal to their last quarterly tax expense and consider that a standard working capital item. Several companies on the chart have far greater than 90 days of accrued taxes, and we consider the excess to be debt. Verano’s excess tax liabilities equal nearly 40% of its debt. Other companies with relatively high imputed tax debt include Curaleaf (CURA: CSE), 4Front (FFNT: CSE), and Terrascend (TSND: TSX). We have adjusted our accrued tax liabilities for comparability by adding back the tax liabilities that Trulieve, TerrAscend, and AYR moved into long-term liability accounts.
  • The first graph shows that twelve of the eighteen companies have net debt/ 2024 EBITDA over 3x, which we view as the cutoff of sustainability in a 280e world. We view 4x as sustainable in a post-280e environment, and nine companies are now over that threshold. This week, we included Cansortium, proforma for the merger with RIV. We analyze the credit quality of the combination further below in our credit modeling results but suffice it to say the graphs presented here make the case for significant uprating.
  • The second graph looks at leverage through the lens of total liabilities to market cap. This measure separates the companies into four groups:
    • On the bottom left are companies with low valuation multiples but also low market leverage.   The group includes Verano, Trulieve, Cresco, and MariMed. The other three show that the market is not yet willing to fully sign on to the Florida rec story.
    • In the middle, between 2x and 4x total liabilities/market cap, we see 4Front, Ascend, AYR, Goodness Growth, and Jushi. Each of these has more than 4x debt/ EBITDA, which is borderline in terms of sustainability, even in a non-280e world. However, each also has significant upside catalysts that could mitigate or exacerbate the excess leverage. FFNT is ramping up production at its mammoth Illinois cultivation facility. Ascend has a $275M term loan maturing in August 2025 that will need to be extended or refinanced. This loan is 110% of the company’s market cap, which is higher than the percentage of debt maturities that AYR restructured at the end of 2023. Jushi is levered to potential adult rec developments in Pennsylvania and Virginia.
    • On the right lie Cannabist and Shwazze. The high level of market leverage tells us that the market questions whether they can discharge their liabilities without significantly dilutive actions, doubts also shown by their 21/30 and 20/30 positioning in our weekly credit ranking.
    • At the top left are companies with high valuation metrics and low leverage. These companies should look to do an equity issuance depending on their positioning in the liquidity graph below.
  • The third graph introduces the free cash flow adjusted current ratio liquidity measure into the mix. Companies with less than 1x on this measure will likely have to raise capital next year. Surprisingly, eight of the companies fall into this bucket. This graph also breaks the sector into three distinct groupings. The bottom left group has low leverage but also modest liquidity. Some of the companies, including Verano, MariMed, and Cresco, have sufficient but not comfortable levels of liquidity, while others, including Curaleaf, TerrAscend, and Glass House, are below the critical 1x liquidity line. Companies on the lower right generally have constrained liquidity and high leverage, a potentially dangerous combination in a capital-constrained environment. Shwazze bears particular attention. The company has just changed auditors and has announced that it will be late in filing its q1 reports. Moreover, the company has $29M of debt maturing in February 2025, and progress toward refinancing this debt should be watched closely.
  • Looking at leverage in two ways and having a comprehensive measure of liquidity can give investors a good idea of possible scenarios for today’s overleveraged companies.

• • • CANNABIS STOCK LIQUIDITY FELL TO PRE-RESCHEDULING LEVELS
      • The average daily dollar volume of $20M was the second lowest of the year.
      • The Days to Trade Market Cap (DTTMC) series depicts the number of days it would take to trade the market cap of a stock or group of stocks. The weekly reading on 6/7/24 of 708 days was the second-worst in 2024. A 708 DTTMC implies that an investor who acquired a 5% position in the stock, assuming he wanted to be less than 25% of the average daily dollar volume, would require 142 days to trade out of his position.
      • The summer doldrums may have arrived, and it will likely take more than just rumors of the resurrection of the SAFER Act to move the needle. Investors are waiting for actionable developments in the S3 timeline.

• GIVING CREDIT WHERE CREDIT IS DUE
  • The chart below shows our updated 6/7/24 credit rankings for the 30 U.S. cannabis companies with over $5M market cap. The number below the ticker symbol indicates the change in credit ranking since last week, where a negative number suggests credit deterioration, while a positive indicates improvement.
  • The blue squares show the offered-side trading yields for each company. Trading yields have declined significantly since the HHS rescheduling announcement.
  • Cansortium held its position after jumping to #8 from #18 two weeks ago. The company gains significantly in liquidity and leverage from the combination and the conversion of Hawthorne debt to equity.
  • Acreage improved to #24/30 based on the resolution of its senior facility payment default and the closing of a new $10M convertible units deal. The issue was costly, coming in at close to 40% effective costs due to the 16.67 points of OID, the convertibility option, and the value of the 100% warrant coverage in five-year warrants.