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.
Viridian Capital Chart of the Week: Better Restructuring Outcomes Depend on Early Credit Problem Recognition
- One of the panels that Viridian is moderating at the upcoming MjBiz conference addresses the future of cannabis restructurings, both pre- and post-rescheduling.
- One point that nearly all parties can agree on is that restructuring efforts, whatever path they take, are more successful if action is taken before liquidity becomes critical or the firm’s resources are depleted.
- The Viridian Chart of the Week shows the Viridian Credit Score (green line) for the 25 operators that we rank each week against another less robust indicator that investors should nevertheless be watching- total liabilities to market cap (purple line)
- The Viridian Credit Model utilizes eleven financial and market variables to measure four primary credit factors: Liquidity, Leverage, Profitability, and Size. These factor scores are synthesized dynamically into an overall credit score shown on the graph. Total liabilities to market cap is one of four ratios we use to create our overall Leverage score.
- We have been running and refining this model for almost 5 years, and it has shown both to correlate well with market trading levels of cannabis debt and to predict distress/restructuring. Followers of our research would have seen the deterioration of such credits as Lowell Farms, StateHouse, 4Front, AYR, Schwazze, and Gold Flora, in time to take protective actions. Our claim that “credit analysis is the new equity analysis” is only slightly overstated. In the current environment, growth is less important than the company’s clear survivability. If you are wrong on the credit analysis, your growth projections are meaningless.
- The purple line depicts a much simpler indicator – total liabilities to market cap. Variations of this measure, usually employing total debt rather than total liabilities, have a rich history. These ratios are used in the bankruptcy prediction models of Merton and Altman, and they were used at Drexel Burnham in High-Yield bond analysis in the early days of the high-yield market. We choose to use total liabilities instead of total debt to capture the effects of operating leases and tax liabilities, both of which are critical.
- The advantages of total liabilities to market cap are:
- Simple to calculate
- Changes daily with respect to market price movements
- Can be shown to relate to asset value coverage of Liabilities through option price modeling
- Investors should monitor this ratio over time. Is it just fluctuating with the market, or is it consistently moving in a particular direction?
- We have established two warning levels for investors to note: when the ratio moves above 5x and above 10x. The 5x level typically coincides with an implied asset value coverage of 1x, so high levels indicate that creditors are beginning to take on equity risk. Meanwhile, the 10x level denotes significant credit impairment with asset values well below liabilities.
- The companies currently in the first warning zone include Ascend (7.77x), Jushi (6.40x), 1933 Industries (8.99x), and Fluent (8.37x). We want to be clear: numbers at this level do not scream imminent default, but they do put investors on notice. Check the liquidity and potential trigger events for these companies.
- More serious issues are often signaled when companies pierce the 10x level. These companies included Cannabist (32.96x), Red White & Bloom (31.34x), Body & Mind (10.69x), Vibe (51.28x), and Tilt Holdings (69.82x). For most of these companies, the equity value damage has already been done, but investors exposed to the credit via debt positions or receivables need to
- Investors need not be surprised by credit issues. Monitoring the Viridian Credit ranking and total liabilities-to-market cap will often provide critical early warning signals.
