On our most recent podcast, we mention an obsession with a couple of cannabis companies. GoBlue’s fascination with Sundial ($SNDL) equals my own interest in Zenabis ($ZENA). They are interesting to us as business stories: $SNDL satiates GoBlue’s credit and unapplied overhead bugbears, while $ZENA strokes my capital structure fetish.

We both state that the outfits are ‘non-viable’ in the podcast. I’m going to take a moment and explain that comment. I’ve received a couple of nasty-grams from some $ZENA fans, pointing out that some of their operational metrics are actually pretty good, that they’re just fully operationalizing their product array, and that the future is bright. They also seem adamant that I should have sex with myself.

I wanted to clarify the claim of ‘non-viable’ concerning $ZENA. Poor communication can result when context is absent. With respect to $ZENA, I’m going to lay out what I meant by the claim that its’ a non-viable company. This is not prompted by the nasty-grams, but to explain why I made it.

Here’s a couple of facts about the company, as well as recent developments, presented as evidence:

• A short-term bridge loan – initially at 3 months in duration and extended to 9 – was a known and highly visible obligation.
• They have $59MM in term debt, which is fully secured against the assets of the company.
• Earnings from their horticultural division (which provided the ability to get capital to expand into cannabis) is significant to $ZENA in terms of sale and margin. These revenues are seasonal, and $ZENA went to lengths in their last financials to point it out in explaining variability in QoQ sales.

Here’s the context I see this within.

$ZENA was continuing to negotiate with the bridge-loan provider up until days before payment date, presumably in an attempt to defer re-payment yet again. I assume this came in the flavour of ‘just one more quarter, our seasonal business will take off, and we’ll have lots of cash then’.

$ZENA had concentrated indebtedness back in August of 2019 when they restructured their convertible debt. Such was the state they were in, there was obviously a limited lending pool available. What the restructure ended up being was very expensive in terms of interest rates and fees. It was also expensive in terms of relationships: they went ahead and screwed existing lenders by subordinating them to this new deal no less. Previously unsecured debt became secured at RCM’s behest, while other lenders not only got knocked down the list in terms of priority, but also got to choke on a reprice…. given a handful of magic beans in a $1.82 warrant grant in partial recompense.

By December 2020 (a whole month ago), it was apparent that $ZENA did not have a good relationship with RCM. I mean, even if RCM wasn’t actively shopping that liability around, it’s obvious that they were willing to accepted an offer to sell it. That would have taken a couple of weeks at a minimum to get done from a cold start. $SNDL would likely have approached RCM a couple of months prior to the announcement. That tells me that $ZENA’s relationship with RCM – the folks who essentially own the keys to the place – was either untended, or left to wither.

Now, to myself, there is no CEO out there that would rationally let a relationship like that founder without having a backstop. No serious CEO anyway. I suspect GoBlue would have a lot to say regarding the maintenance of good relationships with lenders.

This is what I meant about ‘non-viable’.

The repayment of a relatively nominal loan known 6 months in advance – induced a forward product sale that represents a good chunk of quarterly production….with payment directed externally. That poor relations with their primary (and fully secured) lender – led RCM to sell the debt to a competing cannabis outfit. This resulted in what can easily (only?) be described as the forced asset disposition of Bevo Farms. The horticultural arm that has been in actuality, the only thing floating $ZENA’s boat for the past 2 years.

It has created a blast radius right in the middle of the outfit. And now, $ZENA’s in a death match for their very existence. And if a company can be put at mortal peril – over a short-term loan tied to an asset sale – it is non-viable as an entity..

I go back to $ZENA often for several reasons. Unlike some others in the space, they have demonstrated sales of some $40MM/yr.

But they provide so many clear examples of how to screw it (many who have followed them will recall how much they touted their own financial acumen and adroitness around financing), they are an invaluable learning tool for the self directed investor. An outfit can look all shiny and promising, when in reality, there’s absolutely no foundation beneath it.

This illustrates the importance of capital structure, and I can’t emphasize it enough.

Revisiting what then CEO Andrew Grieve said way back in August of 2019: “…the next priority of Zenabis is the replacement of the Senior Debt and the Convertible Notes with standard bank financing….”

It was the right thing to say at the time, and gave folks what they wanted to hear. And while claimed as priority, it was as likely as unattainable as $WEED claiming they’ll have 50% market share next quarter.

$ZENA’s capital structure was already in the toilet. RCM just happened to be the one that reached for the handle.

I hope that puts some meat around my thoughts that $ZENA as a company was/is non-viable, and why I linger so much on a mutt. One can learn so much more from negative outcomes. And that it’s vital to explore how they came about, and apply the lesson to your own holdings and investments,

This leads into our next article, which examines some of the assumptions nested within pitch deck businesses ‘stories’. As with $ZENA, they can be gratuitously optimistic.

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 $ZENA or $WEED.