VIRIDIAN INSIGHTS

• WAIT, YOU WANT TO RAISE EQUITY NOW?
  • VIRIDIAN INSIGHT
    • IS THE POOL NOW OPEN? ASCEND WELLNESS (AAWH: OTCQX) ANNOUNCES A $215M DEBT DEAL, THE FIRST U.S. CULTIVATION COMPANY TO RAISE OVER $100M IN A DEBT ISSUE SINCE 10/22.
      • Ascend announced commitments for a $235M principal amount of Notes with a 12.75% coupon and five-year maturity.
      • The Notes will be issued at a price of 94.75$%, which produces a yield to maturity of approximately 14.25%.
      • The Notes are secured by substantially all assets of the Company and certain subsidiaries subject to certain carveouts.
      • The Notes are callable at par for the first two years.
      • The yield at first blush seems high, given where the Company’s debt has been quoted in the market recently; however, there appear to be no equity kickers, and the $275M issue that was maturing in August 2025 represented nearly 140% of the Company’s market cap.
      • The last time such a significant maturity issue was addressed was the AYR exchange completed in February 2024. We expected AYR to have to pay a high rate of interest to complete that deal, but we were shocked to see AYR giving up nearly 25% of the Company’s equity for a two-year extension. Admittedly, Ascend is a stronger credit than AYR was at the time of its exchange, but the difference is still striking.
      • Ascend noted that all of the four largest previous lenders, along with several new institutional investors, participated in the transaction.
      • The transaction shows a substantial thawing of the cannabis credit markets ahead of the final enactment of S3. We expect refinancing news from TerrAscend and GTI to be forthcoming.
      • The thawing of the debt market will take time to filter down to lower credit quality companies, as the Schwazze extension below demonstrates.

     

    • SCHWAZZE (SHWZ: Cboe)(SHWZ: OTCPK) KICKS THE CAN 9 MONTHS DOWN THE ROAD AND WE APPLAUD.
      • Schwazze extended the maturities of its $15M Altmore, LLC loan and its $17M Promissory Note owed to Reynold Greenleaf & Assoc. LLC, to November 2025. Both obligations were previously due in February 2025.
      • SHWZ also obtained a $450,000 reduction in principal payments under the Altmore loan.
      • SHWZ disclosed that it will pay a $75,000 quarterly administrative fee to Altmore.
      • The extra fees (we calculate a total of 5 quarters for $375,000) seem like a bargain for the extension, more in keeping with what such fees used to be before creditors got more demanding in 2023.
      • Interest rates of 15% for Altmore and 5% for R. Greenleaf are pretty attractive, given our assessment of SHWZ credit quality.
      • Presumably, SHWZ surveyed the landscape for a more long-term financing solution but was not happy with what it saw. Frankly, we think this extension is close to ideal for the Company. It is low cost and covers the likely period in which S3 should be fully enacted, after which the Company may have better alternatives. 
    • UPDATE TO THE DELTA 9 / SNDL STORY FROM LAST WEEK: AS EXPECTED (ONLY SOONER) DELTA 9 FILED FOR CCAA BUT WITH A MAJOR TWIST
      • As we expected, Delta 9 filed for Canadian bankruptcy protection, but with a significant twist.
      • We had expected SNDL to provide DIP financing and eventually credit bid for the Company exiting CCAA.
      • Instead, Delta 9 announced it had received a binding term sheet from the FIKA Company as a plan sponsor for the CCAA proceedings and acquirer of the D9’s cannabis retail store business and logistics and distribution business. The term sheet has FIKA providing up to $16M in interim financing, including up to $3M to fund the costs of the CCAA proceedings and up to $13M to repay the second lien-secured convertible debentures. FIKA is also proposing to provide up to $2M of its shares to existing D9 shareholders and to make available up to $4M in its shares for existing D9 unsecured creditors electing to convert into FIKA shares. FIKA is also proposing to repay the approximately $27.9M of additional 1^st priority senior debt of D9 that SNDL recently purchased.
      • FIKA is a leading Canadian cannabis retailer, operating 144 stores across Canada. Little is currently known about FIKA’s financial strength and its ability to perform its obligations under the submitted term sheet. The court will clearly want to see this information when evaluating options in the D9 CCAA case.
      • Does this mean SNDL is OUT? We are not sure how surprised they were to see D9 produce a sponsor entering CCAA, but we doubt we have seen the last of SNDL in this ongoing story.
      • Background:
        • On May 24, 2024, Delta 9 Cannabis announced that it had received a demand letter from SNDL for the repayment of its 10% Senior Secured second lien convertible debentures for a total of about $10M. Delta 9 replied that it was not in payment default on the notes, leaving open the question of whether it violated the covenants. Delta 9 promptly formed a committee of its Board to review “strategic alternatives.”
        • On July 5, 2024, SNDL stepped up the pressure with an announcement that it had acquired $20.7M of Delta 9’s First Priority secured debt from Connect First and Servus Credit, gaining a first priority secured interest in substantially all of Delta 9’s assets. SNDL’s playbook is pretty straightforward. Look for them to play tough enough as creditors that Delta 9 falls into bankruptcy, and then SNDL will credit bid its debt for ownership of the assets. Delta 9 is in pretty tough financial shape. It ranks #27/31 in the Viridian Capital Credit model for Canadian Cultivation and Retail companies with less than $50M market cap. Its total liabilities to market cap ratio of 40x basically says it all.

     

     

    • STILL UNDER DEBATE: WILL THE CHEVRON DECISION IMPACT S3?
      • On Friday, June 28, the Supreme Court overturned a 40-year-old doctrine called “Chevron deference,” dating back to a 1984 case Chevron v. Natural Resources Defense Council. The ruling in the 1984 case required Federal Courts to defer to federal agency interpretation of statutes so long as those interpretations were reasonable. Friday’s ruling overturned the earlier ruling and cited the principal as “fundamentally misguided.”
      • The decision fundamentally weakens the ability of federal agencies, including HHS and DEA, to promulgate rules without Federal Judiciary oversight.
      • The ruling could theoretically result in increased court challenges to rescheduling and other cannabis regulatory rule interpretations, although more authoritative legal voices have minimized the impact. We believe that stocks did not react negatively to the rule, mainly because the potential for delays in S3 implementation had already been baked into prices.
      • We are reminded of the ancient Chinese curse, “May you live in interesting times.” Times have never been more interesting in cannabis.

     

     

    • THE RIGHT TIME TO SELL IS WHEN EVERYONE ELSE IS BUYING
      • On June 17, 2024, Cannabis Company (CBST: Cboe)(CBSTF: OTCQX) announced it was swimming against the tide and selling out of Florida, just as other MSOs struggle to build their Florida positions in anticipation of the State going rec.
      • Assets for sale include 14 dispensaries, three cultivation and manufacturing facilities, and its medical cannabis license.
      • Cannabist has not done well in the Sunshine State, losing approximately $4.8M on around $6M in revenues in the most recent quarter. The Company blames the losses on the fact that its “asset base is not commercially optimized with more cultivation capacity than our retail locations require.”
      • One thing is for sure: the Company needs the cash. With total liabilities to market cap of 7.45x and net adjusted debt/ 2024 EBITDA of 7.58x, Cannabist stands out as an outlier on our leverage graphs. Its 22/31 credit ranking in the Viridian Credit Tracker model has improved by one slot since it announced the sale, but the Company still appears as an outlier on our credit charts.
      • Against this backdrop, we applaud the Company’s decision to take some chips off the table, and we sincerely hope that some of the proceeds will be earmarked for de-leveraging.
      • Cannabist said that it has $2.75M in escrow from “multiple transactions,” but further details of the divestiture transactions were not released.

     

    • THE CANSORTIUM/RIV MERGER WILL CREATE 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.
      • Cansortium is “all in” in Florida, and the transaction significantly improves the combined company’s ability to attack the potential conversion to rec of the State.
      • The deal risk arb spread now stands at 31.9%, the lowest it has been since the deal was announced. We will be ranking the proforma combined Company from now on with the proviso that Cansortium’s credit ranking will fall precipitously if the agreement 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 Viridian 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?
  • It now seems 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 unlikely 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 a 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, and doubts are also shown by their 22/31 and 20/31 positioning in our weekly credit ranking. Cannabist has seen the writing on the wall: to levered to issue equity or debt, its only option was asset sales, and its exit from Florida was a recognition of this.
    • 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.
  • Schwazze has alleviated some, but not all, of its near-term liquidity problem by extending the maturities of $32M to its debt. Its free cash flow adjusted current ratio remains under 1x, indicating additional financing may be required. Additionally, the market is still skittish about the Company, as is evidenced by its 12.12x status on total liabilities to market cap.
  • Ascend’s new financing significantly improves the Company’s liquidity. However, its free cash flow adjusted current ratio remains unchanged since the original debt maturity was not yet included in current liabilities.

• • • CANNABIS STOCK LIQUIDITY REBOUNDS OFF LOWS
      • The average daily dollar volume of $15M was the second lowest of the year, with little bounce back from the holiday week. Liquidity, both in terms of dollar volume traded and Days to Trade Market Cap (see below), was worse than the corresponding period in 2023 despite several uplistings in the interim.
      • 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. Despite the positive progress since last week, the weekly reading of 953 days on 7/12/24 was the second worst reading of the year. A 953 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 191 days to trade out of his position. The age-old chicken and egg question: are there no institutional investors because market liquidity is so low, or is market liquidity so low because there are no institutional investors? The cannabis debt markets are thawing, as evidenced by the Ascend new issue and the Schwazze extensions, but we don’t have much to cheer about with regard to equity pricing.
      • We are firmly in the grip of the summer doldrums, but exciting macro events seem likely for the month ahead. Will trading volumes accelerate accordingly?

• GIVING CREDIT WHERE CREDIT IS DUE
  • Viridian added a new company to our weekly credit screen: CLS Holdings (CLSH: CSE)(CLSH: OTCQB), a $5.7M market cap integrated Nevada operator and owner of City Trees brand, which is sold in Nevada, New Mexico, and York. CLS enters the Viridian Capital Credit Tracker ranking at #28/31. CLS rankings are hurt by its low liquidity (#29/31 ranked), low profitability ranking (#31/31), and small size (#28/31), mitigated by a somewhat better leverage ranking (#23/31). The Company principally competes in the difficult Nevada market, limiting its near-term improvement potential.
  • The chart below shows our updated 7/12/24 credit rankings for the 30 U.S. cannabis companies with over $3M 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.
  • The most significant move this week was the two-notch improvement in Schwazz (SHWZ: Cboe)(SHWZ: OTCPK) from #22/30 to #20/31, attributable to the positive liquidity impact of its announced debt maturity extensions. Schwazze continues to have extremely high (12x) total liabilities to market cap, levels that typically indicate trouble. Moreover, the Company’s free cash flow adjusted current ratio is still below 1x proforma for the debt extensions. Continued close attention is suggested.
  • Although Ascend’s announced new financing materially improves the Company’s medium-term liquidity, it did not change its Viridian credit rankings because the previous debt maturity was still outside the range of inclusion in current liabilities. See our comments about the deal above.