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 12/06/2024
Viridian Capital Chart of the Week: What Are Stock Prices Telling Us About the Recovery Potential for Cannabis Liabilities?
- Viridian Capital maintains that the most meaningful leverage indicator is Total Liabilities to Market Capitalization
(“TLMC”). One of the reasons for this belief is the straightforward algebraic manipulation of this ratio into the Market Value
of Assets to Total Liabilities. Here’s the math:- Total Liabilities / Market cap can be rewritten as Total Liabilities / (Asset Value-Total Liabilities). From this, we see that the
Market Value of Assets/Total Liabilities =(1+TLMC)/TLMC. - There is a significant issue, however, with the direct application of this approach, in that the algebra would tell us that we
always have more than 1-to-1 coverage of liabilities. - The derivation above is still helpful because as TLMC gets higher and higher, the Asset Coverage ratio approaches 1x.
- Total Liabilities / Market cap can be rewritten as Total Liabilities / (Asset Value-Total Liabilities). From this, we see that the
- The key flaw in the approach stems from the fact that even deeply out-of-the-money options are worth more than zero. So
simply because a stock is trading above zero does not mean that there is more than one times asset coverage of debt. A
more sophisticated iterative approach using Black Scholes is necessary to arrive at consistent values of Assets/Liabilities that
correspond with the observed TLMC. - Several assumptions are necessary to carry out this analysis:
- Risk-free rate: 4.25%
- Volatility: 40%
- Maturity: two years (corresponding to the approaching maturity wave at year-end 2026)
- The green bars on the chart show the resulting estimates of Asset value/ Total Liabilities. The three companies on the far
left, Grown Rogue (GRIN: CSE), Glass House Brands (GLASF: OTCQB), and Green Thumb (GTII: CSE), have 7.0x, 4.5x, and
3.7x asset coverage, respectively. - At TLMC values of 5x or higher, we begin to see asset values that do not cover total liabilities. A TLMC of 10x implies about
a 72% overall liabilities recovery. At the far right of the graph, we see liability recoveries of under 40%. Note that these
values treat the entire liability stack as pari-pasu, not considering seniority or collateral. Still, the values also neglect the
time value of money, which may require further discounting of these values. - Both equity and debt investors should keep a close eye on the total liabilities to market cap ratio. Values over 5x indicate
that the equity is becoming an out-of-the-money option. Equity owners are playing for time and volatility, while debt investors
need to check their covenant packages. Currently, Jushi, Ascend, 4Front, AYR, and Cannabist are all over this threshold. Credit
investors are encouraged to monitor more standard measures like debt/ EBITDA or our more comprehensive Adj. Net
Debt/EBITDA as these ratios are widely used by lenders in incurrence and maintenance covenants. - Option pricing and the Total Liabilities to Market Cap ratio are essential early warning tools for investors.
