When we last covered Canopy Growth Corporation (NASDAQ: CGC) we summarized the best case for investors by assuming that there was a some miracles along the way.
If CGC miraculously turned their negative gross margins around to 3.63% and somehow wiped out most of its debt, a 0.1X sales multiple would look good to them. That brings us to about 10 cents per share.
Source: Bankruptcy risks are growing like weeds
The stock fell sharply immediately after that article as news of the debt swap hit. What is a debt swap and how does it affect you, the common shareholder? We review it and give our opinion on where this is going.
CGC announced that it had reached an agreement with certain holders of the notes and would issue common shares for those notes.
Canopy Growth has agreed to purchase the notes from the noteholders for an aggregate purchase price (excluding accrued and unpaid interest, which will be paid in cash as part of the cash payment) of approximately C$252.8 million ( approximately US$196 million) (the “Purchase Price”), which will be paid in such number of Canopy Shares (the “Share Consideration”) equal to the Purchase Price divided by the weighted average trading price (” VWAP”) of Canopy Shares on the Nasdaq Global Select Market (“Nasdaq”) for the 10 consecutive trading days beginning on, and including, June 30, 2022 (the “Average Price” and such period of time being the “Average Period “), subject to a floor price of $2.50 (the “Floor Price”) and a maximum price equal to $3.50.
Source: Seeking Alpha
This was a victory for the bearish thesis as CGC also saw those notes as a direct risk of default in 12 months and was desperately trying to address the problem.
Price extremely sad
CGC noteholders have paid little attention to the price drop and the exchange will occur at the extreme low end of the range. This will add about 80 million shares to the total, diluting shareholders by 20%.
On the other side of the equation, this only saves the company about $8.5 million in annual interest expense.
The $600 million maturity seems addressable
There was a second small tranche that negotiated the same terms for the notes. Cumulatively, however, only a third of the total notes have been addressed. This outstanding $400 million is now reaching a point where there is a higher probability of being paid when the time comes. If investors remember, we said that the terms of the loan limited the repayment of the debt. These conditions required over $200 million in liquidity to be met at all times. We thought it would be a tough hurdle to meet, but now that the requirements have been reduced by $200 million, it seems doable.
However, in an ideal world, CGC would pay all of its $600 million through a stock issue. We know investors may disagree and think this would wipe out the bull case. We think this would actually give CGC the best chance of avoiding bankruptcy. 50% stock dilution is better than 99.99% stock dilution in bankruptcy.
Asset sales can help more
While the July 2023 note maturity is less of a threat, the credit facility banks are likely to want a pound of flesh. What we mean is that those banks are likely to have CGC hold cash and increase the buffer on secured debt. We’ll also note that convertibles have actually fallen since the debt swap was announced.
They now yield around 22% to maturity, suggesting again that the market does not believe these can be repaid or refinanced. CGC will likely have to tender its equity stakes in Wana and TerrAscend.
Bankruptcy remains a risk in 12 months, but there is no doubt that the risk is reduced with this difficult debt swap. Constellation Brands, Inc. (STZ) owns the vast majority of shares and prior to this exchange owned 142.25 million shares at a cost basis of CAD$5.49 billion (about USD$4.25 billion) or CAD$38.59 per share (about $30 per share). They also held the convertible debt and participated in this exchange on the condition that the remaining debt must be settled in cash. Obviously, they don’t want to lose effective control here, which could happen if CGC were to pay off the debt with shares issued below $1.00.
At the egg and bacon breakfast, the chicken is involved, but the pork is committed. STZ is clearly committed here and surely wants to avoid making the colossal mistake of investing in CGC. That also makes a purchase possible, though we’d assume it would come at a price of zero, and likely lower from here. However, this risk has us reverting the downside here and we are reluctantly upgrading this to a stable/neutral rating. We will look to move to the bear side if we get a strong rally above $4.00.
Please note that this is not financial advice. It may look like it, it may sound like it, but surprisingly it is not. Investors are expected to do their due diligence and consult with a professional who knows their objectives and limitations.