Boy, is Hexo Corporation CEO Sebastien St-Louis making moves.
Redecan is a private outfit that’s been persistent in generating sales (from what we can see). They’ve been an early mover in mass market pre-rolls. I asked our friends over at ‘What’s My Pot’ about Redecan(they provide cannabis reviews and data aggregation services), and they had this to say about the company:
“The prerolls are very, very low quality but also $2 each so the value proposition works – most weed at that price point from the big pubco is inconsumable. They had the same cultivar lineup since 2018 up until recently that was dialed in well enough and priced cheap enough and available widely enough to become a default for a lot of folks.”
It certainly doesn’t sound like a Supreme that’s for sure. But Redecan does come with some $58MM in quarterly sales (according to this from BNNBloomberg). That’s a good size of a number. And as ‘good’ numbers remain only ‘revenue’ at this stage of the sector’s maturation, they won’t come cheap. <See, ‘normal’ commerce does asset valuations on income and earnings, not typically revenue. Despite being 3. years in, Canadian legal cannabis isn’t yet ‘normal’ just yet, and it remains very much in formation>. Hexo even made a video touting the transaction.
Let’s look at the deal:
The notes are secured by a ‘first lien’ against all assets, but what caught my eye was the 9% discount to the principal, which is really expensive. The entire amount was sourced from the US as well (an unnamed institutional), and is to be repaid at 110% of the stated principal on maturity if the conversion feature hasn’t been struck. I don’t have any numbers on this outside of a relatively vague press release, but I get an implied interest rate of 21% in USD (and that’s without the optionality). Boy howdy.
The idea behind buying revenue is simple enough – get enough heft and scale (‘ala Constellation/Couche-Tard), and one can settle into making returns on assets that independents simply can’t. So, if companies are buying ‘revenue’, how do recent transactions price out?
Having a large component of cash involved is more expensive due to relative scarcity. One can impute that cost of by adding financing charges required (like that 21% effective interest rate plus optionality). And one can estimate upside by applying a margin number to the revenues to impute ‘income’. In the case of Redecan, we won’t be able to see their contribution to $HEXO until the end of this year (or beyond), so there’s a good leap of faith in this. Assuming all is as stated, a 40% GM on $140MM annual sales would bring about $56MM in free cash flow annually, which, is about $15MM less than the interest cost for the financing, let alone the cost of the paper. So, this deal has ~=30%+ forward discount rate attached to Redecan’s assets.
No cheaper than most in the sector (whose cost of capital hover in the high 20’s). But I’m not sure how well this table will inform at this point: the deals (like the quality of the underlying companies) are all over the map. I have confidence that Redecan’s the best mark we have for the cost of forward sales.
When I saw $HEXO’s announcement, I couldn’t help but think of Canopy ($WEED) and their $700MM war-chest and what they’re up to. They’ve been beaten to the punch by Tilray/Aphria and $HEXO in being the biggest kid on the block. If the $FIRE acquisition signals anything, they’re making a move to quality and branding. And I am more convinced than ever that $WEED’s going to be announcing something big, and something soon. That may not be terribly insightful (as analysis goes), but the theme that’s always been present with them in my eyes has been ego. And I’m certain $WEED CEO David Klein isn’t going to follow 48North’s CEO Charles Vennat – who watched his cash evaporate while apparently being stuck in a freeze ray for a year.
Nope. No sir. No how.
And what about Sundial ($SNDL), an absolute x-factor in the market right now. Cashed up, holding disparate but not-really-profitable operations across the value chain….what’s their next move? I see them in the same position as Canopy right now – having signalled a business strategy….one’s gotta believe they’re planning to execute on it.
The other takeaway for me is that Redecan’s folding up shop. It’s a family business, and two of the folks in charge are heading onto $HEXO’s Board, which, has now swollen to 10 people. Their shares are locked up for 24 months, so maybe they want to keep an eye on their baby until then. But, if you own a profitable company bringing in a quarter billion a year in sales: what’s the motivation to eat stale danishes every quarter?
Did they see this as the moment where Redecan is worth the most it’ll ever be? Are they convinced that – even given a strong market share and solid sales numbers – there is no real future in anything that isn’t Godzilla sized? Perhaps they’re old and want to take a victory lap, I honestly don’t know.
On its’ face though, it’s not a ‘good’ signal for remaining mid-Tiers. Nor is it a good signal for middling outfits with middling capital structures that’ve been passed over by the judges in the beauty pageant so far. There’s absolutely no way that we get a raft of 4 acquisitions with a value of more than $1.6B in 4 months without a ton of outfits having been looked at hard. $SNDL, $HEXO, $WEED….for pot companies looking for a buyer…..it must look like backstage in a makeup room just prior to a curtain rising.
That implies there’s going to be many out there without dates for the prom. I’ll put myself out there with a couple of predictions. Just some blue skying, but its’ where my instincts are right now:
- Auxly is going to be bought by $WEED.
- $WMD is going to align/partner/merge/buy Aleafia. The union/medical angle these 2 sport is too complimentary to ignore.
- More (large) consolidation in the US: look for a $HARV level move to be made by either $CURA or $GTII.
The thing I do have confidence in is predicting is more M&A activity is coming, and coming fast (yeah, we’ve said that for a few months now, but things are really starting to motor). 2020 was a hell of a year for raising capital, and now that capital is <relatively> coming back in, I think it’s going to be spent much more focused than in the early days of build, and on going ‘big’.
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 any of the companies mentioned.