One of the features of successful business is that they reduce the risk of decisions producing undesirable outcomes. How is that done?

Several ways. One is to do research. Not the scientific kind, but if you’re a consumer packaged goods (CPG) company and developing a new product or brand, you would likely look at consumer buying habits and preferences, and align marketing and products to what’s already popular. Indeed, Canopy Growth ($CGC) has outright stated their product lacks desirability in several aspects: flavour, moisture, eye appeal, and strength (in other words: all of it). To address this, $CGC stated this quarter that they are decreasing R&D spending in medical and therapeutic use – and shifting it to consumer profiling and preferences. They want to discover what the average Joe pot-head truly desires – and produce it. CEO Klein is very clear about what they think of past product offerings, saying that: “We ($CGC) are implementing a renewed corporate strategy with the appointment of a new leadership team which will focus on delivering quality products to our consumers”. They’re also doing a supply chain strip-down, as well as an end-to-end review of cultivation – including process and operations.

Another way to increase the chances of positive outcomes…….is to eliminate the possibility of anything else happening. Sounds simple? It is. Prepare the ground before you take a step on it.

This is done in annual general meetings (AGM) all the time. Major shareholders are worked prior to votes coming forward, perhaps a specific vote is put forward to mollify the concerns of some of them. I see this idea reflected in $CGC’s upcoming AGM – where a resolution on executive pay (non-binging, of course) is included for shareholders to vote on:

Some folks will view this as general governance. To myself – with CEO Klein paid $45MM CAD for the 6 months he’s been CEO, I think it signals the company is tossing a sop out in front of calls demanding it. ‘Preparing the ground by getting in front of it’ as it were.

Capital raises are very important to prepare the ground. I mean, putting out a raise and missing not only stresses the business plan, it’s analogous to throwing a party and nobody showing up. So, during raise design, a company will engage capital firms (who advise on various flavours and colours that are in-style), and let the sell side run the cycle through the high-net worth/institutional wash, and get feedback as to what kind of pricing and shape the raise should have to ensure either full uptake (or being fully underwritten).

I believe this was reflected clearly in Tilray’s last raise, which brought in an instrument I’d never heard of before: the ‘pre-funded warrant’.

As it turns out, that March raise was fully underwritten. Of course it was. It’d been designed in tandem with $TLRY and taken up by the capital firms before it was announced. $TLRY’s has also had some success with their At-The-Market program, pulling in some $30MM over this fiscal year. But second quarter demand evaporated (Q1 ATM: $27.6MM, Q2: $3.3MM) when buyers compared a ‘plain ol’ regular share’ to the optionality bait on the ‘pre-funded warrant’ hook (EDIT – and thanks to GoBlue digging into covenants, we also know there is restrictions on the ATM program, which is the main factor on uptake drying up).

$TLRY also entered into a $60MM ‘Senior’ debt facility – of which they drew down $50MM in February. They went back to the well in early May, the lender thought about it for a month, and said ‘nope’:

That amendment to the facility was quick. I’ll let the reader go into Note 13 if desired (it’s not atypical of commercial lending that I can see), but I’ll point out that every single asset (even those that haven’t been bought yet) $TLRY has is secured under the facility, and the lender has installed a direct hot-line on CEO Brendan Kennedy’s desk. When they call, I can say with some confidence that he will take each and every one:

So, despite a somewhat miserable quarter (they are retooling after all), $TLRY was able to bring in some $155MM US over the past 2 quarters. But. Working capital has decreased from $166MM at the start of the year to $126MM now as operational burn rates and restructuring costs work their way through the financials.

The totality of this to me is that their runway is shortening and options are becoming more limited as the senior facility places guard rails on both sides of the road, including cash position.

Their headcount went down by another 157 this quarter (previous: 258) as jobs were eliminated as $TLRY tries to match run rates with economic reality; they’ve got lender approval required to perform asset sales; and despite an improvement in cash burn of some $30MM (that’s the amount their quarterly cash burn went down) – overall sales are decreasing against peers.

Just like $CGC, the story is that of cost containment against revenue (while encouraging overall) aren’t accelerating fast enough. The ultimate outcome will largely be on how well they re-tool to address consumer market realities. And just like $CGC, preparing the ground for the legal cannabis market in Canada wasn’t an option for producers, who have the uncertainty of regulatory and provincial disparities to contend with. After all, how can one prepare for a meteor strike?

I see $TLRY’s cost of capital in the high 20’s, and a large gap between operational returns and asset viability. These financials are a ‘bridge’ to myself – inasmuch as investors will have to wait and see how well they actually come out the other end of the restructure.

Regarding breaks between economic reality and asset pricing, there’s few images more stark than $TLRY’s share price advance since their last raise. We know there’s money in legal cannabis, it’s a rapidly growing market, and that it can be profitable (at least in some segments). The enthusiasm of 2018 is emerging again on the effervescence of US MSO potential and improving metrics in some companies, despite still sucking in the large. Buyers of those last raise have been rewarded already, but I see a large gap between the reality of ‘now’ and expectations that the consumer market will continue to accelerate in growth.

Expect increased volatility in share prices – and increasing risk – the longer this period continues. As $TLRY shows clearly, there can be great returns to be made from short term holds. With high volatility, there will also be potential for great losses.

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 $TLRY