Couche-Tard goes deep(er); Green Acre bags a homer
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A news release last week announced a ‘planned’ debt to equity conversion. It’s a cute turn of phrase. Good word-smithing in corporate communications can do a lot of things.
Great corporate communications can make credit defaults sound like an orderly move to ‘strengthen the balance sheet’. Or poorer than expected overall sales can be de-emphasized by focusing on a specific SKU that’s ‘grown by over 1000%!’
It’s all about context. In the first example, working capital covenants might have been breached, or in the latter, that the specific SKU referred to was a product platform just launched and simply reflects initial orders. One won’t ever hear about product returns though.
A favorite phrase of mine is: “It’s not what something is, it’s what it’s seen to be‘.
It’s also never in what’s being said, the core is mostly in what’s not said. We see that in virtually every single corporate communication that’s ever been issued. Some accentuate a positive; some minimize a negative; some deflect potential criticism; some walk a fine line on being deceptive; some simply frame an action/activity. Fire & Flower’s ($FAF) announcement of a planned debt to equity conversion falls into a couple of these categories.
Today – March 10th, 2021 – is the day that Couche Tard’s ($ADT.B) $23.8MM of $0.75/share debentures will be converted into $FAF equity, which, is currently residing around $1.25. $FAF’s stock has been averaging well above that (~=$1.40) for the past month. Thus, $FAF forced the debenture holder’s hand, and swapped the debt obligation into stock.
$FAF happily attaches the phrase ‘de-leveraging the balance sheet’ in referring to this. And that’s the upside that convertible debentures provides lenders: an ability to make much more than simply the interest on a loan. And pretty orderly stuff all around.
There is a little bit more word-smithing attached. See, ‘debentures’ are debt instruments: they aren’t typically ‘bonds’. The distinction is that bonds are usually tied to a specific asset or business unit – debentures aren’t typically secured by any asset. The result is that debentures typically carry a much higher interest rate to compensate lenders for the risk of default.
The reader will note my gratuitous use of italics and the word typically above. That’s because the legal cannabis sector has played very fast and very loose with the typical definitions around debentures. I’ve seen assets tied to debentures all over the place, even seniorities ascribed across multiple issues. For the more staid and starched industries out there, that happens infrequently. $ADT.B’s debentures were fully secured.
A second tranche of debentures was forced as well – another $28.5MM at 8%. This one (called April 2020) – was packing a $1.00 forced conversion share price ($0.25 less than $ADT.B’s). They had been created by a loan made by Green Acre Capital several months earlier than Couche-Tard’s – when Fencott was short liquidity – and at an initial issuance of $0.50/share.
So, $FAF’s shipped out 91.1MM shares today at an average price of $0.57.
It was about a year ago that $FAF ‘forced’ another tranche of ACT’s debentures. Thus, an orderly conversion of secured debt into equity at established forward prices (if hit), sees $ADT.B accumulate an interest in $FAF far beyond what had been contemplated by the initial
purchase ‘investment’ by Couche-Tard. When that ‘investment’ wasn’t performing, Couche-Tard simply changed the deal.
The net result is that $ADT.B will own a very large and very pre-determined amount of $FAF for cheaper than what was originally contemplated; with conversions ensuring that $ADT.B will get the lower of price between the options and debt issues per share; that they’ll maintain relative ownership positions contingent upon the initial option document – which means that Green Acre Capital’s conversion will induce further equity issuance to Couche-Tard (to keep ownership provisions whole). And all of this is subsidized by existing shareholders, who will be diluted by every option strike and every conversion that’s made. Unless $ADT.B alters their deal – which they have and could do again (Fencott will do what he’s told, it’s not his company anymore), I thumbnail $ADT.B’s ownership to be pushing 70% if/when they crystallize the options.
I mentioned up top that ‘it’s never in what’s being said, the core is mostly in what’s not said’. I sincerely doubt you’ll ever see the preceding paragraph included in a $FAF press release. You also won’t see it mentioned that CEO Trevor Fencott just bagged $1.275MM in unrealized gains off of the conversion, because he had also put $850k into the Green Acre tranche. His 1.7MM shares are currently $0.75 in the money (I’m genuinely curious if it’ll be reported as share based compensation – my bet that because it originated from a debt instrument, it won’t).
As I’ve said before, I don’t think $FAF is a good investment in legal cannabis. It’s because 70% of returns will accrue to the owners, and not $FAF ‘shareholders’ per se. A $FAF shareholder isn’t strictly holding exposure to a weed retailer. They’re largely holding a very (very) small piece of a multi-national retailers’ structured asset base. That’s a different exposure.
I hope this illustrates the distinction.
<An aside – Green Acre, a capital corporation – has 60MM shares at $0.50 to do with what they like. I lay this out so the reader might have a better understanding of corporate finance, and how equity options can be used to create returns for creditors based upon the market price for shares. Instead of a planned $4MM in interest plus the return of principal from the initial debentures, Green Acre is sitting on $43MM in unrealized gains ((58MM x ($1.25-$0.50)). Quite the upside.>
Please note – this isn’t a screed about executive compensation – nor about how and what capital firms make by deploying capital. This is simply to give you insight to the ‘behind the ropes’ of corporate finance 😊 The recent ‘re-interest’ in legal cannabis has brought around a lot of things that weren’t possible a few months ago.
The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds position in $ATD.B.
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