OUR 9TH YEAR OF PROVIDING PROPRIETARY CAPITAL MARKETS INTELLIGENCE ON THE CANNABIS / HEMP / PSYCHEDELIC SECTORS
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Chart of the Week
Chart of the Week
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from that week’s Deal Tracker that we believe are impactful for investors, companies and acquirers.
Week ended 06/06/2025
Viridian Capital Chart of the Week: Option Based Valuation of Distressed Cannabis Equities
- Analysts have a range of choices when valuing cannabis companies. Viridian commonly uses Discounted Cash Flow Analysis, Public Company Comparables, and M&A Precedent Transactions to value both small private companies and larger public companies.
- But consider the task of valuing a company where the current asset value is close to or even below the value of the debt. The companies in the chart all have total liabilities to market cap in excess of 5x, a good measure of distress, and a level that generally indicates a lower than 1x asset value coverage of liabilities.
- Does that mean that the equity is worthless? No, it doesn’t. Finance theory teaches us that we can view equity as a call on the value of the assets with a strike price equal to the liabilities. If the value of the assets exceeds the value of the liabilities, then equity holders have the option to liquidate the assets for the difference. If the asset value remains less than the debt, the equity holders can hand the keys to the debt holders and walk away with no further liabilities. Within that framework, corporate equity can never be worth zero unless the option’s time to exercise expires. The chart compares our option valuation with the current market cap of each company.
- The application of this simple idea is less obvious. How do we get the current value of the assets, for example? Our recent work has solved for this value using the equity value as a given. But what if we really want to value the equity? Then, we do need to have an indicator of current asset value, and we have chosen 1x sales for our estimate. We have chosen two years as option life.
- Volatility is a crucial assumption of any option model, and we have chosen 40% as our number. We have found this to be a pretty good value, lower than observed volatilities of equities but responsive to the fact that cannabis equities option valuation is constrained by the difficulty and expense of shorting the stocks. It should be a reasonable, although arguably conservative, estimate of asset value volatility.
- We use the Black-Scholes model as our valuation engine since none of these companies are likely to pay a dividend in the near future.
- Several of these companies, including 4Front and Gold Flora, are currently in receivership and liquidating assets. Others, like AYR, have hired financial advisors to help restructure their balance sheets.
- Note that six of the eleven companies have option valuations below their current market caps, while five are considerably higher. The most reasonable interpretation of an option value that is lower than the current market cap is that investors are ascribing higher volatilities to the assets than our 40% assumption. On the other hand, an option value that greatly exceeds current market caps might indicate an expectation of a likely liquidation that could impair or wipe out the equity.
- It is natural to view volatility as a negative, but investors should remember that the opposite is true. Distressed cannabis equities possess two critical assets that are not reflected on the balance sheet: time and hope. With numerous potential positive catalysts on the horizon, option valuation techniques are a crucial tool to consider, particularly for higher-risk equities.
