Coming into 2019, marijuana stock investors had a lot to look forward to. Canada had become the first industrialized country in the modern era to legalize recreational cannabis in Oct. 2018, derivative pot products were expected to hit Canadian dispensaries later in 2019, and a number of U.S. states appeared to be on the verge of adult-use legalization. This was supposed to be the year that cannabis stocks turned the corner to profitability and really matured.
Unfortunately, this vision hasn’t been anywhere close to reality for the weed industry in 2019.
To our north, Canadian growers have been pummeled by supply concerns. Regulatory agency Health Canada has struggled to work through a large backlog of licensing applications, while the country’s most populous province, Ontario, has slow-stepped the rollout of dispensaries. Meanwhile, high tax rates in select U.S. states have made it veritably impossible for legal-channel cannabis to be competitive with illicit producers. All in all, this has led to sales and profit projections plummeting across the board.
More importantly, though, it’s raised serious cash concerns throughout the industry.
HEXO’s latest cash raise is heightening investor concern
For example, yesterday, Dec. 26, Quebec-based grower HEXO (NYSE:HEXO) announced a registered direct offering to sell 14,970,062 shares of its common stock to institutional investors for gross proceeds of $25 million. This stock offering also includes nearly 7.5 million purchase warrants that have a five-year term and an exercise price of $2.45.
What’s truly notable about this capital raise is that the offering price of $1.67 was 15% below where HEXO’s stock closed on the previous trading day. While selling stock isn’t uncommon for cannabis stocks, the magnitude of the discount to this direct offering is eye-opening.
For those who may recall, HEXO is one of a number of Canadian growers to have walked back sales projections and cut production estimates. Throughout much of the year, HEXO had been touting its intention to deliver 400 million Canadian dollars (about $305 million U.S.) in 2020 sales, as well as 150,000 kilos in peak marijuana production. But following Canada’s ongoing supply concerns, HEXO pulled its sales projection for 2020 and announced that it would idle its Niagara grow farm (acquired via the Newstrike acquisition) and 200,000 square feet of cultivation space at its flagship Gatineau facility. Essentially, this could reduce HEXO’s peak annual run rate by a third, or 50,000 kilos.
Furthermore, HEXO is one of the few cannabis stocks to have also announced job cuts. HEXO plans to reduce 200 jobs in an effort to conserve cash. CannTrust is the only other major Canadian grower to announce layoffs thus far, but it’s doing so on a temporary basis, due to the fact that Health Canada has suspended the company’s cultivation and sales licenses.
The scary thing is, HEXO’s not alone.
Discounted share offerings and sale-leaseback agreements abound
For instance, in late September, ancillary player KushCo Holdings (OTC:KSHB) announced a direct offering of nearly 17.2 million shares that also came with roughly 8.6 million warrants. The cash-raising move, which was priced at $1.75 per share for the direct offering, raised about $30.2 million in gross proceeds.
The thing is, KushCo had closed the previous session at $2.69, meaning that the direct offering was priced at a 35% discount. Understandably, this offering came during the height of the vaping health scare in the U.S., and KushCo generates most of its revenue from selling vaporizers. Nevertheless, the discount to this offering was jaw-dropping.
We’ve also seen a marked increase in sale-leaseback agreements in the U.S., with cannabis-focused real estate investment trust Innovative Industrial Properties (NYSE:IIPR) being the prime beneficiary. In a sale-leaseback agreement, a cash-needy company sells one or more of their cultivation or processing assets to a property management company (in this case, Innovative Industrial Properties) in return for cash. Innovative Industrial then leases the property back to the seller for an extended period of time (usually 10 to 20 years), thereby reaping the rewards of rental income and passing along annual rental increases that outpace the inflation rate.
A number of vertically integrated multistate operators (MSOs) in the U.S. have been turning to sale-leaseback agreements in recent months to bolster their cash pile. Remember, marijuana is an illicit drug at the federal level in the U.S., which therefore makes it difficult for cannabis stocks to gain access to traditional forms of financing.
One such MSO that’s utilized sale-leasebacks to boost its balance sheet is Cresco Labs (OTC:CRLBF). In October, Cresco sold two of its Illinois properties to Innovative Industrial for $32.8 million. This cash is very much needed, as Cresco Labs is trying to establish a 10-store presence in Illinois (the maximum allowable), which is set to commence adult-use weed sales on Jan. 1, 2020. Additionally, Cresco Labs is in the process of acquiring Origin House, which could prove to be costly on a post-merger basis.
Cash is tough to come by for most marijuana companies throughout North America. That’s just another concern that could further weigh down cannabis-stock valuations in the near term.
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Authored By: The Motley FoolArticle category: Marijuana Business NewsRegional Marijuana News: United StatesCanada
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