- A $10 million loan for four months.
- Investors pay approximately 17% in fees and dilution, or 60% annualized.
- Acreage trades at a huge discount to Canopy Growth due to risks of insolvency.
- I will steer well clear of this company.
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Source: Acreage Holdings.
On Monday, Acreage Holdings (OTCQX:ACRGF) announced an odd funding transaction: Selling $11 million of convertible debt at below par value with a conversion price well below market rates. This isn't Acreage's first unusual funding transaction, as their February $100 million funding round also was difficult to understand.
To make sense of this transaction, I break down what occurs in a reasonable scenario where the investor cashes in their convertible debt for shares and Acreage repays the loan before it all becomes an extremely cheap stock offering. In that scenario, Acreage ends up paying an effective 17% fee to borrow money for four months. This is a "payday loan"-like fee that works out to 59% interest annually.
Acreage trades at a steep 68% discount to its value in Canopy Growth (CGC) shares if that deal was ever to be consummated. Wall Street is pricing in very substantial risk that Acreage follows iAnthus into default and perhaps follows Sunniva into insolvency. It's a difficult time to be a money-burning cannabis company.
Acreage is raising $60 million through two financing actions: A standby equity sale agreement and issuing secured convertible debt. Basically, Acreage secured the option to sell equity at a 5% discount to market prices and is taking out a payday loan.
First, Acreage will raise up to $50 million selling equity to an institutional investor in a Standby Equity Distribution Agreement ("SEDA"). Under the agreement, the investor will purchase Acreage shares for the greater of (1) 95% of their five-day weighted average price and (2) the lowest price allowed by the Canadian Securities Exchange. There also are limits on immediate resale of these shares -no more than $5 million worth can be sold in June. The press release notes that both Acreage and the investor will have some control over when these sales take place, although it does not provide full details.
Second, Acreage is issuing secured convertible debt which, in my opinion, looks a lot like a payday loan: Short-term funding at a high cost.
Among other traits, Acreage's secured convertible debt is:
- Being sold below face value: $11 million of secured convertible debt is being sold for $10 million in proceeds.
- At a high interest rate: Acreage's convertible debt carries 15% interest, which is quite high when compared to other convertible debt. Even iAnthus, which has now defaulted on its debt, was able to get convertible debt with "only" 13% interest in December.
- Sold with a conversion price substantially below market prices: Acreage's convertible debt converts at $1.68 per share while shares closed on Friday at $3.30 per share. This conversion price is a 49% discount to market prices prior to the debt being issued. Convertible debt typically converts at a premium to market prices: The aforementioned iAnthus debt converted at a 25% premium to market prices.
- Secured against some of Acreage's best assets: This debt is secured against Acreage's three dispensaries in Connecticut. These are likely some of Acreage's best assets as two of these three dispensaries were profitable in 2016 and 2017, before their acquisition, based on each of EBITDA, net income, and operating cash flow. (Acreage did not publish financial results for their third dispensary at the time of acquisition, but it was likely also profitable.)
- Of an unknown duration: Curiously, Acreage's press release did not let us know the duration of their convertible debt. Generally, higher interest rates would be more appropriate for longer-term loans as those would entail greater risk of insolvency.
In sum, this is an unusual funding deal. However, the convertible debt also comes with a very unusual clause:
"The Convertible Debenture is convertible by the holder in whole or in part after September 30, 2020. Prior to September 30, 2020, the holder may convert only $550,000 of principal amount. The Convertible Debenture is convertible into Class A Subordinate Voting Shares of the Company at $1.68 per share, subject to the conversion limitations described above. The Company has the right to redeem up to 95% of the principal amount on or prior to September 29, 2020 without penalty."
Basically, Acreage can repay 95% of this debt on Sept. 29, 2020, without suffering the costly dilution of letting debt convert at only $1.68 per share. The remaining 5% of the debt may be converted at any time or may be held to collect 15% interest before conversion. It's unclear how long this debt may be held, since we don't know the duration of the loan.
In short, this deal looks like a payday loan: Paying very high fees to borrow money for less than four months.
To estimate how expensive this loan is, I will make a few assumptions about the repayment schedule for the loan. Let's assume:
- Acreage receives $10,000,000 on May 29, 2020,
- Acreage repays 95% of the loan, and accumulated interest, on September 29, 2020,
- The investor converts 5% of the principal of the loan to shares on September 29, 2020, and
- We value shares at their closing price on May 29, which was $3.30 per share.
Given this scenario, Acreage shareholders will suffer $1.1 million of dilution immediately (based on diluted share counts) and Acreage will receive $10 million immediately. Then, in four months, Acreage will pay back $11 million ($10.45 million plus 15% interest for four months) but will receive $550,000 (the conversion price for 327,381 Acreage shares).
Working out the cash flows, Acreage shareholders effectively pay 17% fees for a four-month loan when including the value of dilution. This works out to Acreage investors are paying 59% interest on an annualized basis for a four-month loan. That's terrible - akin to investors running to a payday loan shop to make ends meet until their next paycheck. If we exclude the value of shares entirely, Acreage is still paying 4% fees and 13% annualized interest for this transaction -and that's completely ignoring the dilution entailed in this transaction.
Source: Acreage Holdings Investor Relations.
The bull case for Acreage Holdings centers around their deal with Canopy Growth. Under the terms of their agreement with Canopy, Acreage shareholders will receive 0.5818 Canopy Growth shares for each Acreage share they own. As of June 1, that exchange would more than triple Acreage investors' money.
However, the market pricing on this deal should tell investors something: Wall Street is not banking on that deal happening soon or at all. There's significant risk that either (1) Acreage Holdings goes out of business prior to Canopy Growth consummating the deal, or (2) Canopy Growth finds a way out of purchasing a company that is hemorrhaging money and forced to take out payday loans.
Acreage Holdings is behind on its financial reporting: Their first quarter results are delayed and their full fourth quarter results were only released on Friday. First quarter results are due out June 26. Both delayed releases are using leniency created due to the COVID-19 crisis and which was taken advantage of by the weakest cannabis companies like Acreage and iAnthus.
Acreage Holdings is far from profitability. Source: Author based on company filings.
Acreage's past financial results were not pretty. In 2019, Acreage reported a GAAP net loss of $195 million on sales of $74 million. The company burned through $118 million of free cash flow on the year, with OCF margins of -96%. They ended the year with $27 million in cash and $43 million in debt, thus necessitating these dreadful loans to keep the lights on. Meanwhile, management amply rewarded itself with $103 million of share-based compensation during 2019.
Simply put, Acreage is not a shareholder-friendly company. They are a management-friendly company. While the Canopy Growth overlay may look enticing, Wall Street is pricing Acreage at a steep discount for a reason: They may not survive long enough for shareholders to enjoy that overhang.
I will steer well clear of this company.
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