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Deconstructing Couche-Tard’s Re-Price of Fire & Flower

Originally published July 27, 2020

Last July, a heavy-weight of convenience stores – Alimentation Couche-Tard ($ATD) – ponied up cash for an option to purchase cannabis retailer Fire & Flower. We examined the deal in depth at the time, and think it was pretty costly to existing $FAF shareholders. There was a ton of buzz around this deal, and the wonderment of having a powerhouse with experience in CPG caught some flattering commentary.

$ATD have announced they are re-pricing the deal. While the stagnation of $FAF’s share price was probably a factor for Couche-Tard to revisiting their offer, I believe it was in the Couche’s models of their asset that initiated this action.

A slow roll-out of storefronts in Canada’s two largest provinces, a hard cap in margin installed by State Monopolies, and a lack of homogeneity in regulatory and permitting across the country work to reduce aggregate revenue potential. It introduces risk and variability to earnings. And these factors slow the moment that revenue incites, and reduce potential returns of capital deployed. $ATD saw that math, and simply changed the deal. If this is reminiscent of when $STZ repriced it’s stake in $CGC (twice now btw), or $CGC’s alteration of their ‘investment’ in Acreage by layering on a topside synthetic position that gutted existing shareholder value. Just like heading back to that car dealership that you got that sexy ride from last year, and re-negotiating the remaining payment plan and trade in value you got at the time because depreciation was higher than you had figured on. And you’re not so sure about the colour anymore.

I said the other day I’d look at $ATD’s re-price, and for the past couple of days have been hating myself for saying so. I’ve turned this deal over a couple of times, and I’m still finding exposures tucked away in the <many> corners this thing has. An incremental injection of cash back in April by $ATD expanded their warrant position and ultimate ownership potential. That potential increased at the time to 266MM (up from ~=195MM in the original deal). I’ve included these, but what’s important to note is that the April action expanded total potential with very little incremental capital. It’s most likely a function of the anti-dilution mechanism within the original ‘strategic investment’, and it reflects the managerial leverage that optionality induces. This is where I can sound a little smarmy about CEO Fencott’s role in this: he’s not in charge anymore. He hasn’t been since July 2019. As of April, $ATD owned only 2.5MM actual shares in $FAF – the rest is in secured debt and optionality. The total I see is about $35MM in actual ‘investment’, which, is secured debt. All of the changes thus far now defines a path to 60% ownership, with as little as $ATD has actually put in in cash. It’s stark.

And hey – that’s alright. Companies do these sorts of things all the time, and in a free, regulated and transparent market, organizations and people are free to organize their affairs as they see fit. My point is that an existing $FAF shareholder – the one who owned prior to $ATD coming in – has a far different exposure and ownership position than they did the day earlier. That’s not in the press releases, but it stands there as fact regardless.

So, let’s look at the moist creamy centre of what the financial sorts at $ATD did to the deal:

Ok. I’ve gone from dreading pricing this to absolutely loathing it in 8 short bullet points. The breadth of this deal isn’t even complete – I’ve been wanting to meander through the filing on SEDAR….but it isn’t posted yet, and typically, that’s where the juicy stuff is. Sigh.

The cumulative impact I see is in the floor and ceiling of the deal. The original?

Now?

As I’ve mused, I think Fencott got into bed with Couche to stave off an uncertain capital raising future within an uncertain retail landscape. He may have ensured the survival of the outfit – at least until the future becomes a little clearer – but he didn’t pay the price. Existing shareholders sure the heck did though.

If I was a shareholder of $FAF……I’m reminded of ex-Alberta premier Ralph Klein’s infamous advice to cattle farmers who found BSE among their herd: “Shoot, shovel, and shut up.”

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 no position in $FAF