Cannabis Chart Of The Week: Why Has Financing Activity Dropped So Steeply?

Total Cannabis capital raises are down 67% YTD compared to 2021. The decline has been particularly steep in equity raises (U.S. down 73% and Canada down 94%), but debt financing has also suffered (U.S. up 72%, Canada down 86% for a total decline of 33%).

• The reason for the equity decline is apparent. The MSOS ETF, a widely used cannabis stock indicator, is down 40.0% YTD, and valuation multiples have declined accordingly. Last week’s Viridian Capital Chart of the Week showed that cannabis MSOs are now trading well below intrinsic value. No CFO wants to sell stock at such low prices, particularly if there is still any glimmer of hope that a positive legislative result could produce an upside catalyst.

• This week’s chart shows another reason why capital raises have fallen so steeply and why debt raises have not filled the gap from the decline in equity deals. The graph points out that capital raises are off because the MSOs do not need the additional capital. 

• The graph takes the top 10 MSOs for which we have analyst cash flow estimates and looks at the need for additional financing. The green bars in the graph show year-end 2021 cash levels. The brown bars show consensus estimates of 2022 free cash flow, calculated as cash flow from operations minus investing uses of cash. The yellow bars show 2023 free cash flow estimates. The black line sums up all of these values.  

• The blue line (measured on the right axis) shows incremental debt capacity assuming a 1.5x free cash flow interest coverage, a 10% cost of debt, and subtracting existing debt balances. This calculation is conservative for several reasons: 1) 1.5x free cash flow coverage is ample given that cash flows for these companies are growing, 2) 10% is a reasonable rate for the leading MSOs, and 3) we are giving no effect to collateral values or cash flow generation of any assets purchased with the incremental debt.

• If the analysts’ consensus is correct, the companies on this chart can internally fund their needs for 2022 and 2023, particularly given their healthy current cash balances.

• If the analysts’ consensus is wrong, the blue line shows that most of the companies on the list should have no trouble plugging a modest shortfall, particularly given the conservatism involved in the calculation. We continue to expect to see modest debt raises to refinance existing debt. More significant debt issuance may correspond with new state legalizations or unplanned expansion opportunities.  

• We do not see significant equity raises becoming necessary or advantageous for the companies in the chart. However, we believe we will see modest PIPE issuance as companies embrace new investors and finance unique opportunities. Smaller, faster-growing tier 2 or 3 companies may continue to have more extensive capital needs, and we expect continued private company convertible issuance where the pricing mechanism allows the valuation to be pushed to the next liquidity event, presumably in a more favorable climate.

The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.

The Viridian Cannabis Deal Tracker provides the market intelligence that cannabis companies, investors, and acquirers utilize to make informed decisions regarding capital allocation and M&A strategy. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis, CBD, and psychedelics industries. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• 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) Status of the company announcing the transaction (Public vs. Private)

• Principals to the Transaction (Issuer/Investor/Lender/Acquirer) Key deal terms (Pricing and Valuation)

• 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)

Since its inception in 2015, the Viridian Cannabis Deal Tracker has tracked and analyzed more than 2,500 capital raises and 1,000 M&A transactions totaling over $50 billion in aggregate value.

Photo by Javier Hasse.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.