MedMen: Upping The Ante

|
About: MedMen Enterprises Inc. (MMNFF), Includes: CRON
by: Jonathan Cooper
Summary

Gotham Green has strengthened its commitment to MedMen with an additional $30 million in funding and the removal of price-based obstacles to an existing $250 million commitment.

In the amended deal, MedMen lowers the conversion prices for its existing and its future convertible notes and agrees to an $18.75 million fee.

MedMen continues its "march toward profitability" and will continue to be a leveraged bet on management's ability to turn revenue into profits and cash flow.

MedMen remains a risky, leveraged, and unprofitable cannabis company with higher costs than any of its U.S. peers.

On July 10th, Gotham Green Partners ("GGP") and MedMen (OTCQB:MMNFF) announced amendments to GGP's previously announced $250 million investment in MedMen.

MedMen is growing rapidly but has poor cash flow. In its most recent quarter, MedMen generated $37 million of revenue (+22% QoQ; +155% YoY) but suffered an operating cash flow deficit of $59 million and spent another $45 million on acquisitions and investments in infrastructure. MedMen ended their March quarter with $22 million in cash after having spent $105 million in the first quarter of calendar 2019.

Shortly after that quarter ended, MedMen entered into a relatively complex funding agreement with Gotham Green Partners, a private equity group co-founded by Cronos CEO Mike Gorenstein (CRON). That deal strengthened ties between Cronos and MedMen, which already had a 50/50 joint venture together in MedMen Canada. The MedMen Canada joint venture appears to be dead/dormant due to Canadian retail cannabis restrictions, but Cronos still has ties with MedMen. During their most recent earnings call in May, Cronos CEO Mike Gorenstein described a relationship with MedMen as something that would "start in Canada and expand globally" and that Cronos was banking on the value of the MedMen brand and didn't feel pressure to start its own brand.

Original $250 Million Funding Deal

Under the original terms of the agreement, GGP agreed to purchase $250 million of convertible senior secured notes from MedMen. This debt offers GGP advantages over other creditors in the event MedMen is successful or unsuccessful: If MedMen is successful and their stock price appreciates, the convertible nature of this debt would allow GGP to realize gains beyond interest payments. Conversely, the senior secured notes would give GGP preferred status in the event MedMen became insolvent. GGP also receives stock warrants in the deal (approximately 50% warrant coverage), which provide GGP another avenue to gain if MedMen is successful.

GGP's notes were to be released to MedMen in three tranches of $100 million, $75 million, and $75 million. Each tranche has a three-year term with an interest rate of LIBOR + 6% per annum, or a bit over 8%. The first tranche has already been released, but two-thirds of Tranche 2 and all of Tranche 3 were only available if MedMen's stock price hit certain price thresholds:

"[I]n order for the Company to access

  1. Required Tranche 2, the 20 trading day VWAP of the Subordinate Voting Shares as of the trading day immediately preceding the date notice is given to the lenders (as reported on the CSE and converted to US dollars) must be at least US$3.75; and
  2. Tranche 3, the 20 trading day VWAP of the Subordinate Voting Shares as of the trading day immediately preceding the date notice is given to the lenders (as reported on the CSE and converted to US dollars) must be at least US$4.50."

MedMen Press Release, April 23, 2019 (formatting changed)

The first $25 million of Tranche 2 did not have price targets attached to it, but the remaining $50 million of Tranche 2 ("Required Tranche 2") required a share price of at least $3.75/share while the $75 million of Tranche 3 required a share price of $4.50/share.

Source: TMX Money.

When GGP's funding was announced, MedMen shares traded at $2.84/share. Since then, shares have fallen to $2.50/share, well short of the targets for GGP's second and third tranches although outperforming many of MedMen's peers.

Note that even if MedMen's share price was higher, Required Tranche 2 and Tranche 3 would not yet be available to MedMen. Required Tranche 2 becomes available to MedMen six months after May 23rd (the closing of Tranche 1-B) and Tranche 3 becomes available six months after that.

Amendment Increases Deal to $280 Million

“Both Gotham Green and Wicklow have shown continued confidence in our strategy and recognize the potential ahead,” said Adam Bierman, MedMen co-founder and CEO.

MedMen Press Release, July 10, 2019

On July 10, GGP and MedMen agreed to amend this $250 million funding agreement, which includes $100 million that has already been paid out and $150 million to come.

The changes to the agreement were expansive. These changes include:

  • An additional $30 million equity investment: GGP and Wicklow Partners have agreed to purchase $30 million worth of shares at a price of $2.37/share. This adds 12.7 million shares to MedMen's share count, or approximately 2% dilution for existing holders.
  • Eliminate trading price thresholds: The trading price thresholds for both Required Tranche 2 and Tranche 3 have been eliminated. Provided the other conditions are met (e.g., timing), MedMen will have access to this capital regardless of their stock price.
  • Lower conversion price for existing Tranche 1 convertible notes: Under the amended agreement, the initial $100 million of Tranche 1 notes (already issued in April and May) now converts to equity at a price of $2.55/share. Prior to the amendment, it converted at $3.29/share.
  • Lower conversion price for Tranche 2 and 3 convertible notes: Under the amended agreement, Tranches 2 and 3 convertible debt will convert at the lower of: $2.55/share, the 20-day average price of shares when MedMen request the Tranche, or the 20-day average price of shares when the Tranche is issued. Prior to this amendment, these Tranches converted at the lower of $7.00/share or 15% higher than the 20-day average price of shares when the Tranche is issued.
  • An $18.75 million fee (maybe): To amend these terms, MedMen will add 15% to their debt to GGP on the effective date of the amended deal. Given that the debt is expected to be $125 million when the deal is amended, this works out to an $18.75 million fee. This fee will be canceled, however, if GGP eventually converts any of the debt to equity while shares are above $2.95/share.

Effectively, this deal will ensure that MedMen has access to the full $250 million of the original deal regardless of its share price. It also gives MedMen $30 million of capital through an equity raise, plus another $25 million from the first third of Tranche 2, which is expected to be issued soon.

In return, GGP and Wicklow Capital receive better terms for their existing $100 million in senior secured convertible notes, their future $150 million in senior secured convertible notes, and a possible $18.75 million fee depending on whether MedMen's shares rise past $2.95/share.

MedMen's Plans For The Funds

Under the amended agreement, GGP will increase the size of its funding to $280 million in total, with about $55 million coming imminently (through Tranche 2-A and the equity raise), $50 million coming in approximately four months, and $75 million coming in approximately ten months.

Funds will be used to help MedMen build out its retail footprint past its existing 37 pro forma retail stores, to focus on strategic markets like Illinois, and to continue expanding in Florida.

Illinois Gov. Pritzker signed a bill to legalize recreational cannabis on Jan. 1, 2020. Today, Illinois has 55 dispensary licenses issued and each company is permitted to operating five dispensaries. Under the recreational legalization, each company will receive an additional dispensary license for each license it has, and the store cap will be increased to ten dispensaries per company. Today, MedMen operates one dispensary in Illinois while Pharmacann operates four Illinois dispensaries. MedMen is in the process of acquiring Pharmacann in a $682 million deal announced in October 2018.

MedMen also is expanding in the Sunshine State's growing cannabis market. In Florida, each licensee has the right to open 35 medical cannabis dispensaries. MedMen purchased a Florida license-holder in June 2018 for $53 million and opened its first Florida dispensary on June 14, 2019. MedMen has seen modest sales from its first location, selling 165 grams of THC on the week of July 5, putting it in ninth of 12 Florida companies for sales/store. It's likely their sales/store will increase as they establish a customer base, since the store is only three weeks old.

Thoughts

Overall, MedMen and its creditors both stand to gain from this deal.

Under the agreement, MedMen gets an extra $30 million imminently and has assurance of being able to access the $125 million of Required Tranche 2 and Tranche 3 regardless of stock price movements. However, MedMen also agreed to pay a potential $18.75 million fee and has lowered the conversion price of both $100 million of existing debt and $150 million of future debt.

In my view, MedMen is a leveraged, risky investment due to its cash flow. Over the past four quarters, MedMen has accumulated a free cash flow deficit (including net acquisitions) of $380 million.

“We continue to march onward towards profitability.”

Adam Bierman, MedMen co-founder and CEO, May 29, 2019.

MedMen's new CFO Michael Kramer has been vocal about reducing MedMen's costs and moving towards profitability. Kramer has promised to cut SG&A costs by 20% from December 2018 levels and MedMen founders Bierman and Modlin have agreed to salary reductions to $50,000/year. MedMen has a strong brand name, significant ties to Cronos, and should have access to capital through this $280 million funding deal and a C$60 million at-the-market equity offering.

MedMen is saying the right things and now has access to capital that should help them continue to grow for the next several quarters. Now, they just need to deliver stronger profitability and cash flow. If they do, investors should prosper. That said, this investment looks too speculative for me, and I will remain on the sidelines until I see more signs of improving profitability.

Happy investing!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.