Weekly Sector Credit – The Software/Media Sector – Piecing together the confusing array of sector credit stats

• • At first glance, the sector credit stats for 14 companies in the Viridian Software/Media sector appear encouraging: Leverage looks pretty good. The median Debt/ Mkt cap is only .39x, and the median total liabilities to market cap is only .55x. Both suggest solid asset value coverage.
  • However, when we look at liquidity, we see an entirely different picture. The median current ratio for the group is only .27x. Somewhat mitigating this low number, which bespeaks difficulty in servicing near-term liabilities, is the fact that approximately 80% of current assets for the group are cash. We at least don’t have to worry about an overhang of bad receivables or stale inventory. The picture looks worse when we look at the median free cash flow adjusted current ratio of .02x. This ratio adjusts the normal current ratio to account for projected cash burn. The fact that it is lower than the current ratio is due to the annualized negative free cash flow of the companies. The ratio suggests a pressing and relatively urgent need for additional funding in order to dispatch current liabilities.
  • Given the low liquidity and low leverage, one might wonder why the sector doesn’t add more debt to fix its liquidity problem, but here we run into another issue.
  • Funds from operation (net income plus noncash charges like depreciation) is negative for 8 of the 14 companies, and even the top quartile of companies only have funds from operation/ total liabilities of .08x, indicative of low single b credit.
  • 280E is not an issue here; this sector is not plant-touching and is not subject to 280E. The problem is more simple: the industry is primarily equity financed in a climate where new equity for anything cannabis related is scarce. We do think 280E relief would be a significant benefit, loosening the purse strings of the sector’s MSO clients and encouraging the purchase of more efficiencies-enhancing but not strictly necessary systems. Meanwhile, the sector seems ripe for consolidation.