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TILTed

Originally posted on June 17th, 2019 by Mollytime

 

A guy walks into his doctor’s office, he says: “Doctor, Doctor! My arm hurts when I do this.”

Doctor says: “Then don’t do that.”

The joke’s older than me, but what made the patient decide to go see a doctor in the first place is a good analogy here.

Over the past 6 months, I’ve been asked by some Reddit subscribers to have a look at TILT, which, I also foolishly semi-committed to having a go at. I’d recently run the financials of 5 companies a couple of weeks back, and TILT were to be the sixth. By the time I got to them, I just wanted to read something that didn’t make me nauseous. And by all accounts, TILT was one that would not only make me nauseous, but also dizzy and feverish as well – all at the same time.

So, I took a hard pass.

After all, we here at TheCannalysts seek to provide value, not simply point out where none lays. The time I did spend on them has helped me out though with all of the following.

Regarding TILT (if you haven’t caught up to the news), a $500,000,000 impairment of goodwill and signs of significant cash burn were reported (May 1st financials), as well as a restatement of financials (June 5th). And….a resignation of a chairman (May). And….. a 75% decline in share price since January.

So, almost inevitably, shareholder’s pitchforks began being sharpened and stakeholder torches were lit – and an inevitable mob began heading to the castle.

You could also say that this was the moment when the patient ’knew to call the doctor’.

An article came out in the Globe and Mail last Friday Cannabis Company Chairman Steps Down Following Half-Billion Dollar Writedown. The title intimates that the write down and resignation is linked. I don’t have access to the article, so if you do, the following would be a good place of comparison in reportage.

What I can see is from an excerpt from BNN, where we are told that the G&M report says: “weeks after Tilt wrote down the outsized charge based on goodwill impairments, the company paid “key management personnel” US$59.3-million in stock compensation in a single quarter, as well as US$0.9-million in cash compensation” , and that “Tilt has just US$12 million in cash remaining and in April, secured a US$20-million credit facility that charges an effective interest rate of 18.75 per cent.”

This last line adds impact by suggesting they’re now doing daily trips to Money Mart for cash, and thus, even darker clouds lay ahead. Cue ominous music.

It’s taken me awhile to build a pseudo-chronology around the TILT-tilt. I’m not going to go full on CSI on it though: blood spray pattern analysis isn’t my strongest point (I aspire to look forward, not back). Here, I’ll just point out that a guy’s been shot, his breathing is shallow, and there’s not much of a pulse. And that the family is now looking for some sort of justice.


Last November, with pitch decks in full force, TILT raised $120MM cash. From then until February, they went shopping.

May 1st, TILT puts out its’ initial audited annual statements, and, yeah, it’s went over with shareholders like hitting a large animal on the highway. Bones, blood, and carnage.

Despite adding $504MM in goodwill over the year, $496MM of that goodwill never saw (or lived) until the year end statements – it was written off. An ‘impairment’ in formal terms. And that seems to really have pissed investors off.

It all comes down to several acquisitions they made to buy (not build) the business, and initial capital structure design. As is somewhat becoming typical (especially among MSO’s), the share structure is multi-layered. TILT issued 100MM ‘Common Shares’; 2MM ‘Compressed Shares’, each with a 100:1 conversion rate to common shares; as well as 55MM ‘LP Units’ which convert 1:1 for common shares as well.

Thus, the 100MM share float they present actually becomes 350MM common shares fully diluted. Holy fuck.

The acquisitions? They used alot of those Compressed Shares buying them.

Sea Hunter: 154k Compressed shares were issued for this outfit, which translates to 15MM common shares. Issued when the stock was around $4, the asset likely went on the balance sheet for some $60MM. I say ‘likely’, because it’s a complex transaction, and I don’t need to spend 5 hours unwinding it.

BriteSide: $206MM added to Goodwill. By year end written off.

Sante Veritas: $133MM added to Goodwill, written off.

Baker Technologies: $158MM added to Goodwill, written off.

So. How does $500,000,000 in cash and shares become worthless in less than 6 months? The simple explanation is that there were no justifiable assets there in the first place.

According to the financials, the business valuation they performed initially had some <ahem> assumptions in the models that didn’t exactly hold. Typically, it takes a year or two to figure that out, but it’s obvious that these lemons weren’t even able to last that long (Note 10).

And, TILT really pooched it by keeping Note 10 to the length of a cocktail napkin – it explains virtually nothing. Which, a vacuum of detail also likely inflamed shareholders more.

Underlying this is the accusation that management enriched themselves through all of it. Recall from the G&M article above, it suggests that executives gave themselves $60MM in stock compensation (SBC) in a single quarter! no less. Allegations of self enrichment and nefarious shenanigans by management abound.

True?

Well, let’s check trusty ‘ol Note 12 – which is often where Share Capital is explained in listed financials for many outfits. Kind of a default spot really. This one is 6 pages, which is also about 3 times longer than the ’typical’ Note 12’s out there. It’s also the first full rundown of warrants, options, units, and compressed share deployment.

There’s only a reported $29MM in SBC on the financials though. What gives? I thought it was $60MM, no?

Let’s look at what the new guy CEO/Chair (who replaced the old guy CEO/Chair) had to say about SBC in a special press release from June 6th“The options’ $5.25 exercise price means that at today’s current stock price these options are deeply out of the money. There should be no confusion on this point—these options will only have value as TILT keeps growing and focuses on taking the stock price up past $5.25 CAD.”

Well, kinda.

I’d encourage the interested reader to read the release in full. If you’re not interested in losing 20 minutes of your life – the short form is that financials report optionality in accounting terms – not on economic valuation. This is why people may struggle with my valuation of optionality versus financial statement presentation. The statements can sound compelling, but really, accountants don’t care about cash per se – they care about recording and reporting the ‘economic essence’ of a transaction. Which, can be wildly disparate with the actual financial impact to the equity box that optionality can bring.

The other bit that’s unsaid is that when the business combinations occur – with exotics used like ‘Compressed Shares’ or ‘Founder Compensation Units’ – these can sometimes get rolled into acquisition costs. This can occasionally surface as Goodwill. I didn’t do the full run on this thing, so I can’t opine on this component of the transactions.

But reporting an evaporation of a half-billion shekels: cue the pitchforks and torches. And while Joe Retail is probably steamed too – they aren’t likely driving this outrage.

Yes, their ‘investment’ has gotten smoked over the past 6 months. But change at the top is rarely driven by retail. Any institutional and initial underwriters know exactly the valuation all around – and most likely they were the ones handing out the pitchforks and torches and gasoline to anyone with a hand.

I don’t know the actual case here: it’d take me another full day to work that out, and it’s out of scope for the point of this piece.

The preceding? That’s just the juicy stuff.

There’s mouldy breadcrumbs littered all over the balance sheet as well. At December 31st, they wrote down their inventory by 30% (Note 6). Of $50MM in PP&E booked over the year – half of that was simply ‘Leasehold Improvements’. Which, are not always a good thing1.

Ok, so what’s the point of this? Ah, finally! He mentions a ‘point’ to this. Finally.

There’s 2 things the retail investor should take away from this shmozzle.

  1. Complex share structures induce leverage.
  2. ‘Buy’ versus ‘Build’ is a riskier investment for emerging industries than in mature industries with established history.

That ‘buy versus build’ may sound familiar as a business model to some. C21 Investments is another business that has tracked into a similar model. iAnthus as well. Among many, many others.

I am certainly not suggesting these ones are heading for the same rocks that TILT ran aground upon – but. They have a higher risk profile than an organic buildout in an emergent business.

And maybe think about companies with ornate capital structures, complex & contingent deals/optionality within their financials, or those that do paper deals on a fast build.

There you have it.

And if you’re an investor – I’d spend some time looking for information in TheCannalysts.ca for exactly where we illustrate the 2 points I’ve mentioned above.

Despite the name-calling and opprobrium I’ve received over the past 3 years from folks telling me that goodwill doesn’t matter – or that non-cash charges don’t impact business valuation – TILT is the best real-life cannabis-company example that’s landed on my desk in awhile.

While our crime victim’s family is looking for justice – once the money is gone – it’s usually long gone. Despite how many villagers storm the castle.

Do checkups often on your health, and read solid analysis of the financial statements of companies you own.

If you’re on top of things, you’ll disarm that smarmy doctor by never needing to have gone to see them in the first place.

1 – See, if I’m a business, and I lease a building for $500 – but need to spend $10,000 to get it operational – it goes onto my books as $10,500 (Debit cash for $10.5k, Credit PP&E for same, entry split between building ($500) & Leasehold Improvements ($10,000). The reality is that I don’t own the building, and I’ll have to amortize the capitalized repair/repurposing costs over the life of the asset. The bottom of it: the only thing you spent on was repairs: not actual assets that can be crystallized if needed in the future. Anyone who’s bought an old car, hot rodded it, and tried to recover the amount ‘invested’ in it will know full well what I mean. Leasehold Improvements are much like that on liquidation/distress.

(The interested reader will find a motherlode of information in Note 2 (page 9 of the May 1st set annual financial statements)

The preceding is the sole opinion of the author, and in no way constitutes a recommendation to buy or sell any security or derivative. The author holds no position in TILT.