February 1, 2023 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
Eight capital raise transactions totaling $54.8M closed this week. Seven more transactions closed than last week, and the volume was up by $51.1M. Two more transactions closed than the previous year, but the volume decreased by $36.0M. This week’s average deal size was $6.8M compared to $15.1M last year.
Cannabis capital raises are off to a multi-year low. Only $5.9M has closed through the first four weeks of the year compared to $248.0M last year.
Public companies have raised 56.7% of total capital YTD.
This week’s MariMed (MRMD: CSE) debt deal is a bellwether transaction for 2023. It shows that creditworthy companies can still find debt financing, albeit at much higher costs than last year. The 30% warrant coverage increased the returns to eye-catching levels, but debt is the only game in town, given the moribund equity market. It is a win/win deal for both MariMed and Chicago Atlantic and is optimistic for the market. High-return projects can find capital even in today’s market.
We are hearing more talk of groups assembling pockets of capital to pursue the acquisition of distressed assets. Much of this is focused on California, but opportunities abound in other developed markets that have been the chief victims of price compression.
California appears to be finally catching a break. Decreased licensed capacity of around 15%, horrific weather, and an increased number of stores seem to be firming wholesale prices. Now we will see how much of the gains are given back at retail to compete with the legacy market. We are hopeful but mindful that significant overcapacity still exists in the market, a situation unlikely to be corrected before interstate commerce. Interstate commerce hit the news this week, but we still find it hard to take seriously. After all, which state wants to be the counterparty and allow cheap California weed to decimate its local industry?
The 3-month vs. 10-year treasury spread is still close to the most inverted since 1981, at negative 117bp (126bp last week). This inversion has successfully predicted the previous five recessions, and we don’t think it will miss this time either. The degree to which the premium end of cannabis holds up in the face of a recession is the big unknown. We don’t doubt that people will continue to smoke weed in the recession, but to what degree do they downscale into more affordable SKUs?
YTD Returns by Public Company Category
Tier 1 MSOs continue to be the only category with negative YTD returns. The sector was weighed down this week by abysmal performances by Cresco (CL: CSE), Columbia Care (CCHWF: OTC), and TerrAscend (TER: CSE), all down between 8.5-10% on the week.
Best and Worst Performers of the last week and YTD
Several of this week’s top gainers, including Auxly (XLY: CSE), Slang (SLNG: CSE), Fire & Flower (FAF: CSE), and Tilt (TILT: CSE), were bounce-backs from the loser list last week. The volatility is extreme, with several of these names up 10-20% this week after being down similar amounts last week.
Lowell Farms (LOWL: CSE) repeats on the loser list, down 14.4% this week after a decline of 28% last week. The longer things go on without any news on the company, the more negative the market assumes the outcome will be. The reasoning is that everyone knows the company is for sale, and if there was buy-side interest, wouldn’t we have heard something by now? The argument is a bit too simplistic, but we have heard it from several respected sources this week.
We are happy to report that our fears of contagion in the cannabis lender sector have proved unfounded. IIPR, AFC Gamma, NewLake Capital, and Chicago Atlantic all performed in the context of the market this week. The ability to book transactions like this week’s Chicago Atlantic/ MariMed deal is undoubtedly positive for the sector’s ability to raise funds.
The Week’s Largest Closed Equity Transaction:
On January 24, 2023, Journey Clinical (Private), a psychedelic medicine infrastructure company, completed an $8.5M Series A funding.
Union Square Ventures was the lead investor, with participation by AlleyCorp, Able Partners, Colibri, Coalition Partners, Gaingels, Fifty Years, Palo Santo, PsyMed Ventures, Satori Capital, and individual investors.
Journey’s telehealth platform allows therapists to verify patient eligibility, track outcomes, and monitor for adverse effects.
The company’s offering center on Ketamine therapy but will be broadened to psilocybin and MDMA after regulatory approval.
The psychedelic sector has raised nearly $400M in the LTM that ended 1/27/23, up over 900% from the previous year. Viridian Capital divides the cannabis/CBD/psychedelics world into 12 subsectors, and psychedelics is the only one that has raised more capital in the current LTM period compared to the prior year’s LTM.
Another Interesting Equity Raise: the rise of the distressed asset consolidators:
On January 23, 2023, Talarya Brands, a company formed by PE firm D4 in January 2022 through the merger of California brands Cream of the Crop and West Coast Trading, raised $6M in equity funding.
D4 and Talarya are now funded to acquire distressed assets, including cultivation assets in Northern California or opportunities in other more established markets, including Colorado and Washington.
Talarya looks to employ best practices and new technologies from other industries to improve the profitability of acquired assets.
The group is an early mover in what we believe will be 2023’s key theme – the consolidation of distressed assets.
Public vs. Private Raises:
Four of this week’s eight capital-raising companies are public. Two trade in Canada on the CSE, and three trade in the U.S. (two on OTC and one on Nasdaq).
Equity vs. Debt Cap Raises:
Equity accounted for seven of this week’s eight capital raises and 45% of the funds raised.
Debt accounted for 47% of trailing 4-week capital raises. We expect this ratio to be volatile because of the limited capital raise activity. Debt should average over 50% of capital raised, especially since many companies are trading at or close to their 52-week lows. As exemplified by this week’s MariMed raise, we expect more equity-linked transactions in the current capital-constrained climate.
The Week’s Largest Debt Raise:
On January 24, 2023, MariMed (MRMD: CSE)(MRMD: OTC), the 13th largest MSO by market cap, closed a $30M secured credit facility from lenders led by Chicago Atlantic Credit and including Silver Spike Investment Corp.
An additional $5M of proceeds is available at the Company’s option for six months after the initial closing. According to the agreement, the aggregate commitment may be increased to $65M under certain conditions; however, we could not access the relevant exhibit that appears not to have been filed.
Proceeds from the Credit Agreement will be used to complete the build-out of a new cultivation and processing facility in Illinois, complete the build-out of a new processing kitchen in Missouri, expand existing cultivation and processing facilities in Massachusetts and Maryland, fund certain capital expenditures, and to repay in full the Kind Therapeutics seller notes incurred in connection with the Kind acquisition in April 2022. The remaining balance, if any, will be used to fund acquisitions.
The cash interest rate is floating at prime + 5.75% with a prime floor of 6.25%. Prime is now 7.5% producing a total cash interest rate of 13.25%.
An additional 1.4% of PIK interest will also be charged, and this PIK interest rate goes up to 1.75% if the agreement’s maturity is extended.
The agreement provides for 30% warrant coverage at a 20% premium to the 20-day VWAP. At the initial closing, 19.15M warrants were issued at $0.47 per share exercise price with a five-year expiry.
The facility requires principal amortization of 1% of the principal outstanding per month beginning in May 2023 and has a final maturity of January 24, 2026, subject to an additional two-year extension under certain circumstances.
Prepayments under the loan are subject to a “make-whole” for the first 20 months of the term, and subsequently, the company can prepay the facility with a 3% prepayment premium. The 20-month make-whole provision essentially makes the loan uneconomic to prepay for at least the first year, but the 3% premium after month 20 is quite reasonable.
The loan is secured by substantially all of the company’s assets, with some exclusions for parcels of real estate already collateralized by existing mortgage debt and certain other customary exclusions
We calculate the effective cost of this facility at 19.7%. To arrive at this figure, we explicitly valued the warrants in the transaction at approximately $2.0M. We use 30% volatility in these calculations because the market is unwilling to ascribe full volatility to cannabis warrants due to the high cost of borrow on the stocks. Importantly, our estimates do not include any fees customary for a facility of this type, such as collateral monitoring fees, success fees on exit, etc. These could add several points of additional effective cost.
The pricing of this loan is evidence of the recent tightening of credit conditions in the cannabis market. Debt is becoming more expensive and more challenging to access. At the same time, MariMed and other companies have attractive IRR projects to fund that warrant paying the higher cost.
The cash interest expense of 13.25% is only 2/3 of the total cost, but it represents a spread over treasuries of 938 bp. That puts this loan close to the classic definition of distressed at 1000bp over treasuries.
We consider MariMed to be an excellent credit. The table below shows the Viridian Credit Tracker model rankings for the 19 MSOs with market caps over $50M. MariMed ranks as the 7th best credit, ahead of several much larger companies like Cresco (CL: CSE), Ascend (AAWH: OTC), Columbia Care (CCWH: CSE), and AYR (AYR.A: CSE). MariMed’s ranking would be higher still, but the Virdian model penalizes it for its relatively small size.
The Viridian Credit Tracker model uses 11 variables to estimate four main credit factors: liquidity, leverage, profitability, and size. The graphs below use our most highly weighted liquidity and leverage ratios to demonstrate the strength of the MariMed credit. The free cash flow adjusted current ratio takes the standard current ratio and adds annualized free cash flow to the numerator, accounting for cash burn and short-term debt maturities. The total liabilities/market cap ratio is our favorite measure of leverage, giving a market-based estimate of the value of assets above liabilities.
MERGERS & ACQUISITIONS
One M&A transaction closed this week, for $0.65M, compared to three transactions for $30.0M in the prior year.
Fourteen transactions totaling $131.1M have closed YTD, compared to fourteen transactions for $506.5M last year.
The 2023 average transaction size of $9.4M is the lowest in recent years, and unlike most of the previous years (except 2020), the U.S. has accounted for less than 10% of the total.
We believe the likelihood of relatively sizeable public/public M&A transactions has increased significantly based on the low trading multiples of tier 2 and 3 MSOs and SSOs, particularly those perceived to be cash flow pressured.
Major Pending Deals Risk Arb
The Cresco/Columbia deal spread widened by 760bp to 53.6% on 1/27/23. This spread signals considerable market doubt about closing this transaction despite both companies continuing to say that they are committed to the deal. Market rumors regarding the closing of the Diddy transaction have not helped. The crash of equity prices has also reduced the likely proceeds from other planned asset sales in Ohio and Florida and probably extended the timeline into the 2nd quarter. The deal has made significant progress towards closing, but an unannualized rate of return of 54% for a 3-6 month investment seems too good to be true. Will this transaction fall apart or be recut somehow? What are we missing here?
The valuation gap narrowed to 1.49 on 1/27/23, a new low since we began tracking this measure and 189 bps lower than its 52-week average. The valuation gap is the difference between the EV/NTM EBITDA multiple for the largest MSOs and the multiple for the less than $300M market cap group, which are their primary targets.
This measure has been a significant driver of M&A activity since a larger gap creates an opportunity for more accretive transactions. The gap tends to increase in improving markets while declining in retreating markets to the greater trading liquidity of the larger companies.
The gap has plunged primarily because the Tier one stocks are significantly more liquid and have accordingly traded down more sharply. In a chaotic market, the small company trading multiples may not be a good guide to the prices at which these companies would sell in an M&A setting.
The Largest Closed M&A Deal of the Week:
On January 24, 2023, 22nd Century Group inc. (XXII: Nasdaq), a leading competitor in the reduced nicotine tobacco, hemp/cannabis, and advanced plant technology sectors, announced the acquisition of privately held Pharmatech Ltd., a leading UK distributor of cannabinoids.
The total upfront consideration of $.65M was paid in cash. An additional three-year earnout provision is tied to revenue milestones.
Pharmatech’s products include CBD isolate and finished products like gummies, oils, and tinctures.
XXII intends to utilize its newly opened distribution facility in the Netherlands and the Pharmatech acquisition to scale its operations in the European consumer products sector.
VIEW DEAL TRACKERS
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.
Launched in January 2015, and having analyzed more than $60B in deals, the Viridian Cannabis Deal Tracker is a proprietary data service that monitors and analyzes capital raise and M&A activity in the legal cannabis and CBD industries. Each week the Deal Tracker provides proprietary data and market intelligence on transactions, including:
Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors – from Cultivation to Brands to Software)
Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A)
Principals to the Transaction (Issuer/Investor/Lender/Acquirer)
Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)
Deals by Location of Issuer/Buyer/Seller ( To Track the Flow of Capital and M&A Deals by State and Country)
Credit Ratings (Leverage and Liquidity Ratios)
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