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: How Much Does Partial 280E Forgiveness Improve Asset Coverage of Liabilities?
- Option pricing can be used to evaluate the asset value coverage of U.S. cultivation and retail sector companies. The basic idea is that we can consider the market cap of a company as a call option on the value of the firm’s assets, with a strike price of its liabilities, a time to maturity equal to the average maturity of its debt, and appropriate assumptions for volatility and risk-free rate.
- In this framework, we know all of the variables except for the asset value, and we can backsolve to find the asset value that makes the other inputs align.
- The theory coincides with the common wisdom that some of the distressed cannabis equities are “out-of-the-money”, which means that if the firm’s assets were sold, the stockholders would receive nothing. The stock still trades above zero, though, because the equity holders do have two key assets: time and volatility.
- The green bar on the graph shows the market-implied asset value coverage of liabilities for eighteen MSOs. Those on the right-hand side, beginning with Jushi, have less than 1x asset value coverage, implying that their debt would take a haircut in liquidation. This explains the desire by both debtholders and stockholders to “kick the can down the road” or to “Amend, Extend, and Pretend.”
- Critics of this approach raise the reasonable claim that if push came to shove, the IRS would almost certainly settle 280E liabilities at a fraction of their face value. They point to the 2022 settlement between StateHouse (formerly Harborside) and the IRS in which the back 280E taxes were settled for around 26% of their value, along with an extended payment plan.
- One of the key reasons behind this large discount is that the IRS takes into account the collection potential of the tax debt in its settlement discussions. They are aware that one cannot get blood from a turnip. Harborside was borderline insolvent at the time of the negotiation and, therefore, extracted a large discount.
- Viridian employed this logic and calculated discounts to face value of between 25% (for the most healthy companies) and 75% for those with steep asset value coverage deficits. The red bars show the additional asset value coverage gained by the 280E forgiveness. Clearly, the gains are relatively small.
- Partial forgiveness of 280E liabilities does not make enough difference to right the ship for the ‘out-of-the-money” companies on the right. However, the difference can be important for those, like Jushi, who appear to be close to the line. Stakeholders need to look for more substantive solutions to the overleveraged balance sheets.
