HEXO Corporation ($HEXO) announced last week that they’re acquiring Zenabis Global ($ZENA) in an all paper deal for some $235MM.
The move to sell $ZENA had begun long before the announcement. I’d guess back to last June when bridge financing took a powder – unwilling to continue wearing the risk of non-payment. Perhaps the writing was already on the wall after ex-CEO Andrew Grieve made a blast crater of the company’s share price with one of the dumbest capital structure stunts I’ve ever seen pulled.
Either or, proof that they were mortally wounded came at the beginning of the year when Sundial ($SNDL) pulled a debt stunt to end run dealing with management. If there’s one thing I can’t blame $SNDL for – it’s for not wanting to deal with $ZENA’s management. Why talk to a bunch who drove their company into this state of affairs?
<Hey, $ZENA still had Grieve listed as being on the Board of $ZENA and as a director of the company until September 2020. And what does that say about $ZENA’s management? The same thing as 25% of shareholders wanting their asses gone. Any percentage north of 10 isn’t a ‘good’ thing>
Better for an acquirer to simply walk around management…..and have security escort them out of the building when its’ time. Lucky for $ZENA, there was enough sales to make an acquisition attractive to somebody (anybody). Which, brings us to $HEXO.
GoBlue’s covered the nuts and bolts of $HEXO much more than I, although I’ve commented on a couple of their raises. What’s really notable about $HEXO is their ability to get cash from the market. It’s exceptional – and shows a depth of support that far exceeds other companies in the space. Sales have been increasing (if modestly). From a capital structure standpoint, it has the feel of a loot-box for management to myself, with optionality flunk far and wide. they actually issued themselves RSUs that were $3 in-the-money – which is a heck of a thing to come with free stock. $HEXO is packing a decent sized cash balance (~=$150MM) after raising long and hard. And on the face of it, the sales that $ZENA brings with them makes it look like a real-live cannabis company with pro-forma sales being north of $40MM/Q (we’ll come back to this shortly).
That’s the face of it anyway. Let’s have a look at the deal itself:
- $ZENA will end up with 12.5% of the combined entity (a hard discount on existing shareholders, despite the ‘premium’ offered. Absent cash, it’s only an equity swap.
- $ZENA’s issuing a $20MM debenture to pay for themselves to be bought. I read it as a protection for $HEXO – that along with a $6MM termination fee – sees any other potential bids for $ZENA become more expensive
- The deal hinges on whether the BEVO sale will get done (a high probability given $ZENA’s the tenant that built the asset)
- A ‘special committee’ comprised of $ZENA’s 2 independent directors was struck to examine strategic alternatives. It had recommended the sale to $HEXO, although I can’t find anything about it being constituted. It probably came together sometime in December when $ZENA realized they could lose control of the company. Perhaps after the hostile run by $SNDL.
- Anyhow, the Amateur Hour that’s been going on for two years at $ZENA is coming to a close. $HEXO is going to create a single board seat for a single person from $ZENA. Must’ve been someone they wanted, or perhaps a throw in as part of the deal.
- Speaking of which, the deal’s terms weren’t exactly dictated by $ZENA
For $HEXO……they tout some benefits:
- Domestic sales increase – potentially taking them up to $53MM/Q. O say ‘potentially’ – because its’ already known that $HEXO bought some $7MM wholesale from them in January. If that’s been consistent buying, inter-company eliminations will reduce promised ‘gains’ in sales
- European exposure via $ZENA’s GMP certification. Aside from the glacial regulatory progress there, this is a genuine benefit to $HEXO.
The 8 year/32 quarter royalty scheme demanded of $ZENA by a previous lender is still up in the air, with $SNDL asking for some $13.7MM. It’s heading to litigation. An initial read looks like it will still apply. The impact will probably be a reduction in notional purchase price.
Another potential hitch is the $WMD/$TLRY supply agreements, where $ZENA was provided with a whack of cash ($40MM) in exchange for long term biomass provision. Those deals will likely need to be crystallized, which, could mean a demand for cash by the buyers.
I’m not a fan of ‘could’ or ‘likely’ or ‘may’. Contingencies isn’t an analyst’s happy place around litigation.
$HEXO doesn’t seem to have an issue those words though, at least in detailing ‘accretive synergies’ from the deal. Their statements about cost savings are caveated on both sides – by ‘may’ realize savings of $20MM/yr, and ‘should’ allow them a path towards cash-flow positivity. Not much meat on this bone:
A main takeaway for myself is in the nod to ‘capacity utilization’ by $HEXO. I mean, they closed the sale of their Niagara facility just last summer, citing excess production capacity in the market. They evaluated that in March 2020, which means they took a dump on the sale of the facility, and yet within a year, are citing a lack of capacity as a reason to buy $ZENA.
Was it because they couldn’t grow? Or is there an outsized emphasis on EU/GMP status driving this?
In talking with GoBlue, his largest reticence about $HEXO has been in execution – that CEO Sebastian St. Louis has missed too many self-made deadlines during build. Good management sets realistic and achievable markers for themselves. Hitting them is all about establishing credibility. It’s one of the best ways one has to measure existing and future performance.
And that’s really where I land here. There are some points on paper where this makes sense, but, $ZENA also brings a mess of a capital structure along with it layered onto the assets. At least they aren’t valued in the billions now. But, there’s another $50MM in potential cash payouts to be made and a less than declarative statement around operational run rates go-forward.
I get the sense that this remains a promise about the future, rather than providing a vision of it. $HEXO declares there’s some $53MM in quarterly revenue in the combined entities. Should inter-company sales prove to be persistent, that combined value will have been double counted on both income statements. And regarding those potential liabilities, a rather large cash component will come along with the deal. Integrating 2 shops won’t be cheap, and I wonder if $HEXO will be back soon enough looking for more cash.
After all – that $150MM they’re currently sporting would be needed to gird against the next two years – as market share becomes a hard needle to move. The only strong moves $HEXO’s made ex-Quebec has been in value brands, and Quebec itself isn’t a sufficient market to drive this vehicle. I get the feeling – that like $ACB – international market growth will really need to come around to make this deal anywhere near ‘successful’.
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.