Cannabis Chart Of The Week: Debt Raises Decline As Effective Cost Of Capital Increases

This week's chart explores the relationship between U.S. Cultivation & Retail sector debt issuance and effective costs of debt.

Cannabis companies issued a record amount of debt in 2021, including six of the ten largest debt deals in U.S. cannabis history. The pace declined in 2022, but low debt costs and strong access to debt capital kept the spigot open. The first half of 2023, however, has seen a sharp reduction, with sequential quarter issuance down 78%.

There are several reasons for the downturn in debt issuance:

MSOs have reduced capital spending and cash used in acquisitions in response to challenged capital markets.  

Many MSOs have essentially maxed out their debt-carrying capacity. Ten of the nineteen MSOs, with market caps over $5M and sell-side analyst coverage, now have more than 3x debt/ 2024 consensus EBITDA. Viridian estimates debt higher than 3x EBITDA is difficult to sustain in a 280e world.  

Also, as the orange line on the graph indicates, the effective cost of debt has risen significantly since the first half of 2022, making debt less attractive to issuers.

Viridian calculates the effective cost of debt issues in a manner that puts all debt structures on an even basis. We explicitly value the embedded options in convertible debt and debt with attached warrants. We subtract that value and any OID from the debt's principal before calculating a new yield, which we term the effective cost.

The obvious reason for the rise in effective cost is the underlying rise in market interest rates. Another less recognized component is the rise in the percentage of debt with equity-linked features. Nearly 52% of the debt issued in the first half of 2023 had equity links compared to 5.5% and 5.7% for the first and second halves of 2022, respectively.

The cannabis industry needs a re-equitization to maintain its growth rates. However, the delay in any meaningful reform in Washington is putting a freeze on this activity. Investors have become skeptical that SAFE is anything besides political football, and they are afraid of getting bagged again. Meanwhile, no CFO wants to be the guy that sold stock at the absolute bottom of the market only to have some catalyst like SAFE run his stock up by 50% or more. That reasoning led to a lot of debt issuance, but only a few companies currently have significant excess debt capacity.

A few brave companies, including TerrAscend TSNDF and Ascend Wellness AAWH have tiptoed into the equity market in the last couple of weeks, and both have excellent reasons to raise equity. Otherwise, only the liquidity starved or those with very high IRR projects will likely enter the capital market soon.

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.

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