Viridian Key Insights

        VIRIDIAN INSIGHTS

• 4FRONT (FFNT: CSE) HIRES CANACCORD TO EXPLORE OPTIONS
  • Last week, we reported on short-maturity debt taken on by FFNT, which was pretty clearly a bridge to a more global fix of the company’s cap structure.
  • The key language in the deal was the description of the maturity: December 2024, unless subordinated debt maturities were extended. Its kind of a classic finance problem:  What is the point of being senior debt if the junior debt is maturing before you?  So maybe you give the junior guys some comfort by saying that if they extend, then the senior will extend and at least give the company some breathing room? Ok, but do I really want to stay in an overleveraged company, or do I just want out?
  • Interestingly, our credit model ranks FFNT as #21/31, certainly in the bottom 1/3 of companies but nowhere near StateHouse.
  • It’s interesting to game out the options the company has.  Let’s take one off the table right now:  Go out and issue new equity.  That, in our view, is a non-starter.  First off, the mere announcement that anyone wants to issue equity in this environment, where prices are super low with no benefit built-in for 280e going away, will crush the stock.  Why?  Because it makes you look desperate.  Why would anyone raise equity now unless they REALLY need cash and it’s the only way to get it etc.
  • How about raising more senior debt? Well, the market seems pretty hot for refinancing, but FFNT may be a bit too much of a reach.
  • So what does that leave? They could merge with a stronger credit.  By all accounts, FFNT is a good builder of cultivation capacity and a good operator. The vast project coming online in Illinois is reported to have quite low unit costs.  All of this could make them attractive as a target.  This option is enhanced by the fact that they are only in Illinois, Massachusetts, and Washington, thereby minimizing overlap issues.  There may be some stickiness regarding Washington, which has some very strict local residency rules, but let’s assume that some form of option or MSA can get around that. The issue here is that an acquirer would be inheriting a messy capital structure with a number of different insider and unaffiliated lenders.  Presumably, a new owner would want to clear out all of this.
  • Could they sell assets? We have already mentioned the problems of selling Washington’s assets. FFNT’s big upside play is to operate the new cultivation asset and make lots of free cash flow.  So selling Illinois seems like a non-starter.  Which leaves Massachusetts.  Could they peal off that state in an advantageous manner? A difficult exercise at best.  Massachusetts has a 3 adult dispensary limit and nearly every major MSO except TerrAscend is already in the state. So selling Massachusetts would be tough.
  • Would some form of debt-to-equity swap work? The reason for thinking it might be is that there are insider debtholders.  And in theory, swapping debt for equity doesn’t change the overall EV, so it ought to be kind of a value netural exercise. Ie the value of the debt you swap increases the equity value by the same amount.  Recall that FFNT did one of these transactions in January 2024 exchanging  40% ($23M) of its senior secured debt into equity. They offered a 15% warrant coverage in three year warrants at 15% exercise premiums along with the equity to get the deal done?  Could they do something like this again?  The previous deal was made at US$.095 per share, and the current price of US$.052 implies that the investors who made the swap took a 45% hit.  Our read at the time was that $23M was just not big enough to really fix their capital structure, and for it to work this time, it needs to be seen as a real remake of the cap stack that ensures another restructuring move is not needed in the future.  That could be a painful step to take in advance of any S3-influenced stock pop. So, bottom line: to execute a permanent capital structure fix for FFNT is a tough exercise, and Canaccord will almost certainly be earning their fees.
• MOST MSO WILL BE SELF-FUNDING IN 2025 IF 280e IS ELIMINATED.
  • The graph below, taken from our Chart of the Week, shows that estimated 2025 EBITDAR is nearly sufficient to cover all fixed charges, including taxes, interest, rent, capex, and debt maturities if 280e is eliminated by the end of 2025. If not, cash balances are generally sufficient to make up the difference.

• TILRAY ENTERS THE U.S. THC BEVERAGE INDUSTRY (via hemp-derived D9)
  • Last week, Tilray Brands (TLRY: Nasdaq) announced that it would enter the legal hemp-derived U.S. cannabinoid market via a new line of Delta-9 THC-infused beverages
  • Tilray created a new Tilary Alternative Beverage unit to house the new offerings.
  • Tilray follows Curaleaf (CURA: TSX) and Canopy (CGC: Nasdaq) in entering the legal hemp market.
  • The hemp-based cannabinoid market, by some estimates, is ballpark as large as the legal cannabis market, despite a number of states’ attempts to stamp out the flame.
  • The economic advantages of hemp-derived cannabinoids are too significant to allow the Genie to be stuffed back into the bottle.
    • No 280e: As federally legal products under the 2018 Farm Bill, hemp-derived intoxicants are 280e exempt.
    • Favorable production economics. As a federally legal agricultural product, hemp avoids some of the borderline ridiculous requirements of legal cannabis, like tagging each plant and tracking it from seed to sale.
    • Ability to market through direct-to-customer (DTC) channels, often on an interstate commerce basis. Is there any doubt that this is the way of the future? Or am I the only one who looks forward to Amazon delivering weed?
    • Look for the hemp/ cannabis civil war to continue escalating, as these advantages are too powerful to resist. Why not join them instead of fighting them?
• LEAFLINK EXPANDS IS CREDIT BUSINESS
  • Leaflink announced a first-of-its-kind payment option that guarantees payments to brands as retailers sell through their products.
  • Fintech is finding ways to address the impediments faced by the cannabis industry due to the failure of banking reform.
  • In a post-SAFER Act world, we would envision banks reclaiming some of this territory. Meanwhile, Leaflink should be applauded for designing a product that mitigates an existential risk facing many small brands: ballooning delinquent receivables from retailers.
• PELORUS FINALLY PULLS THE PLUG ON STATEHOUSE
  • Pelorus Fund REIT, the largest lender to Statehouse Holdings (STHZ: CSE)(STHZF: OTCQB), filed a complaint in California about the immediate appointment of a Receivership over the company.
  • Is this really the end of the road for our favorite zombie cannabis company? We define zombies as companies that refuse to lie down despite it being clear to nearly everyone that they are actually dead. They may have negative cash flow. Total liabilities to market cap is well over 10x. They have received a number of extensions, amendments, and periodic small cash infusions.
  • This is hardly a surprise, as StateHouse has been hovering near the bottom rung of our cannabis credit rankings for over a year. (See the rankings below)
  • We uncharitably accused Pelorus of throwing good money after bad when they advanced more cash and extended maturities in August 2023 But, Pelorus was simply following the time-honored strategy that Gotham Green originated years ago with MedMen, the O.G. of cannabis zombies.
    • Play for optionality. With so many catalysts in the air, maybe something good will happen that bails you out. Is interstate commerce possible?
    • Provide minimal liquidity to keep the equity alive while waiting for miracles to present themselves.
    • Continue to receive more warrants and stock and basically become a larger and larger effective owner over time so that if a miracle does happen, the lender does much better than getting repaid.
  • Why don’t zombies die?
    • No lender (with the possible exception of SNDL) actually wants to take possession of the assets.
    • The lack of bankruptcy makes the process unpredictable.
    • It is virtually impossible to restructure a negative cash flow company.
    • So, amend, extend, and pretend become a way of life. In high-yield bond trading, we used to call it “Yield to your next job.”
  • THE IRS IS UNHAPPY ABOUT COMPANIES NOT PAYING THEIR 280e TAXES
    • Luke Orner, a senior IRS lawyer, reiterated the IRS’s uncompromising position on 280e at a recent conference:
      • The IRS believes the outside counsel’s opinions that 280e is unconstitutional are not “bulletproof,” and it will continue to defend and enforce 280e unless the Supreme Court issues a different interpretation.
      • The IRS will continue to enforce 280e for all years prior to rescheduling, potentially a big deal with around $700M to $1B on the line for the top MSOs for 2024 alone.
• MSO FINANCIAL FLEXIBILITY DEPICTED BY FOUR GRAPHS FEATURING OUR NEWEST VALUATION AND LEVERAGE METRICS
  • The three graphs below seek to map the financial options available to eighteen of the largest MSOs based on their Valuation, Leverage, and Liquidity. We have updated our measures to look at 2025 EBITDAR estimates as we believe most investors are now looking to these values in their valuations.
  • The first two graphs present different versions of EV/EBITDA on the vertical axis and Debt/EBITDA on the horizontal axis.
  • The first graph presents our latest view of the most appropriate valuation and financial statement-based leverage metrics: Adjusted E.V. / 2025 EBITDAR and Adjusted net debt / 2025 EBITDAR. In calculating Adjusted Net Debt, we make several key assumptions: 1) Leases that are included on the balance sheet are considered debt. We view most leases in the cannabis space as equivalents to equipment loans or mortgage loans. While it is true that a lease default does not necessarily trigger a cascade of events leading to bankruptcy, the distinction is often meaningless in cannabis due to the mission-critical nature of many long-term leases and the absence of bankruptcy protection in cannabis. 2) We consider any accrued taxes (including uncertain tax liability accounts listed as long-term liabilities) in excess of the most recent quarterly tax expense to be debt. Our calculation of enterprise value is now market cap plus debt plus leases plus tax debt minus cash. We now use EBITDAR rather than EBITDA since lease expense is taken out prior to EBITDA.
  • The second graph utilizes EBITDA and employs the traditional calculations of both debt and enterprise values, leaving out leases and taxes.
  • Our adoption of new metrics tends to make the company’s look less cheap, and more levered.
  • Surprisingly, eight of the companies on the enhanced metric chart are still above 3x leverage, which we have identified as the boundary of sustainability in a 280e environment. Four companies now exceed 4x leverage, which we believe will be close to the maximum sustainable post 280e.
  • The new metrics make Curaleaf and TerrAscend valuations look significantly higher than GTI, whereas standard metrics reduce this effect.
  • Valuation metrics can be deceiving when a company is just achieving positive cash flow status. Glass House, for example, has enormous valuation multiples. Still, it is based on very small EBITDAs that are likely to expand significantly in the next several years.

• The third graph looks at leverage through the lens of total liabilities to market cap. We believe this is the single bes
• The third graph looks at leverage through the lens of total liabilities to market cap. We believe this is the single best measure of leverage because it is a direct reflection of the market’s assessment of the value of a company’s assets in excess of its liabilities and is sensitive to changes in market perception of a company’s future.
  • On the bottom left are companies with Adj E.V./2025 EBITDAR of under 7x and total liabilities to market cap under 2x. The group includes Vext, GTI, PLTH, Verano, and Cresco. Companies in this quadrant are right to consider stock repurchases or using cash in acquisitions. They can afford some additional debt and can take advantage of the ongoing dislocation in equity prices.
  • In the middle, between 2x and 5x total liabilities/market cap, we see Ascend, AYR, Jushi, and MariMed. Each of these has significant upside catalysts that could mitigate or exacerbate the excess leverage. For example, Jushi is levered to potential adult rec developments in Pennsylvania and Virginia, and AYR has significant Florida torque.
  • On the right lies Cannabist and Schwazze (not pictured). We applaud Cannabist management. They have seen the writing on the wall: too levered to issue equity or debt, its only option was asset sales. Its exit from Florida and agreements to sell out of Arizona and portions of Virginia are further ratification of this. The debt market recognized the company’s progress this week with significant credit spread tightening. We have not yet modeled the announced asset sales into Cannabist’s credit picture as we are not sure how much EBITDA will be lost in the transactions. We will await adjusted equity analyst estimates. Note that Schwazze now has total liabilities to market cap in excess of 23x, a level that generally indicates deep distress. The uncertainty is heightened by the company’s failure to file 2^nd quarter financial statements and the potential for significant revisions to prior statements.
  • 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 fourth 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 (including Schwazze, not pictured).
• The bottom left group, including Curaleaf, Verano, and Vireo, has low leverage but is below the critical 1x liquidity level. This suggests that Curaleaf and Verano should take advantage of the robust debt market to augment their liquidity. Vireo is a more challenging call. Their adjusted net debt/ EBITDAR is relatively high, which makes them an unlikely net debt issuer and suggests asset sales.
• On the top left, we find companies with adequate liquidity and low market leverage, including both GTI and TerrAscend, due to their recent refinancings.
• Companies in the lower middle-to-right generally have constrained liquidity and high leverage, a potentially dangerous combination in a capital-constrained environment. AYR has significant optionality based on the Florida vote. If things go the company’s way, they will probably have significantly lower market leverage, allowing for more financial flexibility. Cannabist’s liquidity is understated in the graph and is likely to be OK based on announced asset sales. 4Front and Schwazze, despite making moves to restructure their debt, continue to have inadequate liquidity and excess leverage and should be watched carefully. We note that FFNT has no consensus on 2025 EBITDA estimates, but a full year of Illinois cultivation will probably make leverage look significantly better.

• • MASSIVE UPSIDE STILL EXISTS FOR INVESTORS WILLING TO WITHSTAND ELECTION-YEAR VOLATILITY
    • We continue to believe that at current levels, U.S. MSOs have enormous upside potential. The graph below shows the multiples reached after a number of past legislative/regulatory events. It makes clear that a doubling of prices is a reasonable assumption. We recommend a balanced portfolio that leans toward the companies in the top half of the Viridian Credit Tracker model ranking.
    • Notably, the discussion of SAFER has begun again. We hesitate to put much stock in such debate in an election year. Still, the ongoing talks do point to another critical catalyst, one that many institutional investors believe is more important than S3.

• • CANNABIS STOCK LIQUIDITY STUCK AT ABYSMAL
    • CANNABIS STOCK LIQUIDITY STUCK AT ABYSMAL
      • The average daily dollar volume of $16M for the week ended 10/4/24 is below the $17M trailing 12-week average.
      • 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. The current DTTMC of 882, a modest improvement from last week’s reading of 934, 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 176 days to trade out of his position.
      • As the presidential election cycle accelerates, we expect more trading volume and price volatility.

• GIVING CREDIT WHERE CREDIT IS DUE
  • The chart below shows our updated 10/4/24 credit rankings for the 31 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.
  • We have made recent upgrades to our credit model to more accurately treat lease liabilities and account for non-payment of taxes as a financing source.
  • The blue squares show the offered-side trading yields for each Company. Trading yields have declined significantly since the HHS rescheduling announcement. We are expecting the round of recent refinancings to re-rate the landscape of cannabis debt.
  • We still believe that AYR has significant potential for appreciation. AYR just obtained a Virginia license and has one of the highest Florida torques.
  • The new Acreage deal at approximately 18% seems a bit rich to us, but it largely depends on the degree to which Canopy can and will support the company in the future.