This is our second structure on Terrascend ($TER), our first laid out an MSO in acquisition mode with operations in a couple of places where $GTII’s and $CURA’s aren’t.

No time to waste.

To the financials!

___________________________________________________________________________

• Canadian sales largely flat, running around $5MM/quarter. Still sporting a negative gross margin, but it is improving. $TER’s only losing 16 cents for every dollar of revenue generated in Canada. Last quarter, it was $0.45 per dollar. I’ll defer to GoBlue regarding operational nuts and bolts.
• I’ll mention G&A is down relative to higher sales. That’ll be more important next financials.
• Share Capital (Note 13) at 5 pages. It’s expensive.
• 39MM of long dated warrants. 20MM options. More below.
• Share based compensation is going to get lit up next quarter. Look for fantastic Christmas bonus’ for management in most MSO’s. Optionality is going to get lit up this year. Some will be austere, some will be shamelessly greedy. These guys have the potential to go big.

Ok. Not much more here incrementally.

An interesting guarantee was built into a ~=$35MM raise they did back in May. The paper says that if $TER raises again at a lower share price, it’ll adjust pricing of the initial raise for unit holders. This ‘price protection guarantee’ is a good example of creativity in corporate finance. It’s also a good example of why one should go to filings for information. The core of the raise was issued in preferred shares, which pack a 1000:1 exchange ratio. The raise was incredibly expensive for shareholders, but a bullish share price can be a strong salve. I value the warrants at about $1,500CAD (out of a total ~=$2,600 CAD raised per unit), with overhang from them alone coming in about $178MM (at current share price). It’s double that if one includes the actual shares from the offer.

Regarding other warrants they list, something popped out at the bottom of a table detailing prices and expiries. The last 2 grants were part of a debt transaction in early March. What I noticed was their 10 year tenor (!) and the $1.40 difference in strike:

Something that long dated is anomalous. Turns out these warrants were the ones granted to Canopy Growth ($WEED) in partial exchange for an $80MM loan (mentioned last time). They’ll only be able to be struck in the case of US legalization, which, also explains the tenor. Pricy money for $TER, macro positioning for $CGC.

And yesterday, $TER announced yet another loan from Canopy (for $20MM) that has the same interest rate and ratio of warrants going out the door as the prior loan did. This one is targeted solely for $TER’s hemp subsidiary (Arise). Same 10 year tenor, the big difference is in the warrant strike, now at $15 & $17 (!).

It’s worth mentioning at this point that $WEED had spent about $130MM (that I can find) in both building up and tearing down their hemp business over the past couple of years, only to spend ~=$240MM in the past 8 months buying hemp businesses via options into $ACRG & $TER. A charitable take is that they’re moving the duration of the exposure to better mirror ‘real-world’ evolution. An uncharitable take is that $WEED did it all horribly wrong the first time, and gaining US exposure this way is simply a pivot.

There’s two things that strike me about $TER – one is about their US capacity, and one is around Canadian operations. Let’s look at Canada first.

We noted last time that a supply deal $TER had with Pharmhouse appeared fallow. We’ve since discovered that Pharmhouse has some pressing issues to tend to, and fallow is how the deal will likely remain. As we’ve several times in other outfits, supply deals have frequently been an issue. Not that they exist – heck no. Supply deals exist everywhere across almost every product and good that’s ever been traded. The ‘issue’ supply deals have been creating in legal cannabis is when one party realizes they’ve obligated themselves to pay more than prevailing market price for a commodity. Sometimes for months. Or years.

The relative decline in wholesale market pricing has been reflected in retail prices in Canada (a ‘chicken/egg’ analogy fits here). A company without sufficient levels of <desired> production will be sourcing product months ahead of sales. The existence of a backwardated price curve – present for the past year in legal Canadian cannabis – will see revenue decline relative to cost over time. I strongly suspect $TER (like others) has been trying to sort out the Canadian supply chain in this context. They’re showing ok throughput: but locking down desirable supply at a consistent price is where many mid-tiers in Canada have been struggling. $TER’s showing improvement, but the difference in margin between the US and Canadian operating segments remains stark. From a distance, I’d guess a switch to positive margin in Canada is a must if the northern division is to survive ‘as is’.

Just after I wrote that, I spotted a line in their MD&A , and we don’t have to guess about Canadian ops anymore. $TER made the decision to shutter it’s Canadian cultivation business (a 67k ft² GMP certified facility. Remember when ‘GMP’ was all the rage?). There’s a suggestion that they’ll keep sleeving product & continue with brand fulfillment, we’ll likely get a look next quarter into how much money it’s gonna cost them to walk away from a $43MM facility. It looks like the decision was made during this quarter, and that the decision was made abruptly….no wind-down required:

The Canadian market gave a final kick in $TER’s pants – seeing a $2.4MM write-down on purchased supply-deal inventory:

How/if the Pharmhouse deal and their ‘GMP’ facility are linked is not mentioned. Since Canadian cultivation is being nixed, we’ll leave it at that. The US is going to be $TER’s core business now, not being able to make a go of it in Canada speaks volumes.

As to capacity, they’ve gotten more descriptive in Note 17 (Revenue). They used to split the numbers by ‘wholesale’ and ‘retail’….. ‘wholesale’ has now has been upgraded to ‘Branded Manufacturing’. For anyone with any interest at all in these guys should want to know: do they have an ability to increase sales with their current footprint ? If so, what is the dollar value of that ‘ability’?

The Apothecarium is a retail brand they appear to be making their core. Their retail cannabis properties in northern California cost $TER about $30MM each……from a deal done in mid-2019 to acquire three dispensaries in the Bay area. Looking chic in style, $TER touts that one of them won an award from Architectural Digest for ‘Best Dispensary’ in the US. For $30MM, one would hope a shop is tight, and that there’s no water leaks. I note this not to rip on the design, honestly, I like upscale. The best I’ve ever seen it executed is in Borenjongens, which channels a 19th century apothecary setting….and specializes in exotic hash. Yes, the Netherlands is that good. Here’s hoping that one day, North America will see a similar normalization/segmentation within retail cannabis markets.

No, I mention it because $30MM is a big dollar amount to put into a retail store in a wide open state with a relatively mature consumer base. Where we have visibility, we’ve seen good numbers reported from some others (specifically thinking about MedMen here in terms of single store sales). But we’ve also seen tension in California across permitting, taxes, county regulations, and even in false starts made by companies entering it ($HARV).

Where I’m going with this is to wonder how much $TER actually has left on the gas pedal right now. They have a couple more storefronts in build, they’ve got Maryland to digest (cultivation only), NJ to open, and presumeably, more business development in the pipeline.

Their asset array underlaps other MSOs in several ways. GoBlue’s begun divining what we can from specific physical state-level exposure MSO’s present. In $TER’s case, interest and taxes make up 41% of total sales – by far the highest percentage we’ve seen in the MSO’s – reflecting the operational environments that $TER operates within (readers might recognize the impact of good ol’ 280e here).

It’s a good example of the realities confronting MSOs, and we’ll continue to develop our MSO analysis out over time.

Regarding $TER, I’ve spent a fair amount of time on them. Despite that, the only impression I have is that their capital cost is higher relative to peers (I see it in the high 20’s), and openly wonder if they’ve got enough horsepower within their existing/contemplated asset base to ‘keep up with the Jones’. Given current valuation of MSO’s, sales and asset growth needs to keep motoring.

I really want to know if $TER has to capability to keep pace. These financial statements don’t tell me that, other than to say expansion will be occurring over the first 2 quarters of 2021. Woot. Next quarter, if there’s a sales increase……combined with a deceleration in the percentage of growth…..I’d take that as a negative. If one accepts $TER might be capacity constrained, a potential trap exists here as well. If sales increases are tied to harvest timing, an investor could get a false front should a quarter line up well operationally.

I have a hard time getting a line of sight on this outfit. They’re growing in smaller markets, and have a couple of winners in the bigger ones. Cost of capital is very high. All I can say at this point.

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 $TER.