TILT Holdings Inc (TLLTF)

[FUNMAN]

TILT Holdings: The Baby Has Been Thrown Out With The Bathwater

Feb. 3, 2020 11:45 AM ET

By: Winds Research

https://seekingalpha.com/article/4320973-tilt-holdings-baby-thrown-out-bathwater?utm_medium=email&utm_source=seeking_alpha

Summary

* TILT is down 94% from its 52-week high.

* A strong and growing revenue base set against its low market capitalization opens up the company as a value play.

* While its liquidity position is weak, the continued generation of cash from its operations will allow it to survive the sector cash crunch.

* The expression "Don't throw the baby out of with the bathwater" describes an avoidable error in which something good is eliminated in the process of getting rid of something bad. TILT holdings (OTCQB:TLLTF) is that baby.

The company, down 94% from its 52-week high, trades at a market capitalization of $138 million with a value of $0.25 per common share. The central thesis of my bullishness is that TILT is an under the radar cannabis stock which saw its stock price get crushed after it went public at an unfortunate time. This company found itself amidst a tapering of investor sentiment towards the sector and could do little to differentiate itself from an investment standpoint.

Further, it was losing money, and the complexity of its holding structure meant it has been difficult to value. Against this torrid backdrop, the divergence between the company's market value and its intrinsic value has reached a level where one would be excused for concluding that it is tiptoeing at the precipe of bankruptcy. TILT, currently trading at a forward price-to-sales of 0.57, represents deep value, possibly the deepest in the industry.

TILT's Financial Strength And Valuation

TILT realized revenue of $46.10 million during the third quarter of its 2019 financial year, net income, while positive at $26.10 million, was converted very poorly to operational cash flow due to a negative adjustment for stock-based compensation. This meant that for every $1 in net income generated by TILT, only $0.11 was converted to operational cash flow.

While this is clearly sub-optimal, the company, operating in a fledgeling market, faced the aggregated headwinds of a vaping health crisis, sector-wide cash crunch, and management turnover. These would have negatively impacted the operational scalability of the firm, created inefficiencies, softened revenue, and increasing the cost of capital.

Hence, the bull case assumes that the cash generated from operations, while small, will not be a one-time result. If TILT is able to build on this positive base in its future quarters, then the threat posed by the currently weak liquidity position of the company will be somewhat mitigated. Total cash and short term investments at the end of the quarter was $3.6 million, with a further $35 million raised through the sale of 8.0% per annum senior secured notes post period end. The proceeds will help TILT retire short term bridging finance which bore interest at 18.75% per annum. This will mean a cut to interest expense of $5.8 million realized during the quarter, raising the prospect of a further strengthening of future operational cash generation.

Assuming TILT grows revenue 11% to $51.2 million in Q4 2019, total revenue for the year would be $170 million. Taking a two-year view, and assuming a compound annual growth rate of 20% across this period, revenue for FY 2022 would be around $244 million with a forecasted net operational cash flow margin of $20.80 million. This would place forward (2-year) price-to-cash flow of 6.63, an incredibly constrained figure.

However, the spectre of future toxic dilutive rounds and below market value assets sales to raise capital provides an ample rebuff for any potential TILT bulls. The company might prove to be a value trap, indeed its current cheapness is for a reason; a precarious cash position set against a dried up capital market. This presents bankruptcy risk, the worst risk of all. Further, if actual results are not in line with my bullish assumptions, then the long case for TILT crumbles.

And while the company, in an openly published letter to its shareholders, described a continued generation of cash flow from their plant-touching assets, it is not clear whether total aggregate cash flow will be positive during the fourth quarter. But bulls would be pleased to have heard the comments from Mark Scatterday, TILT's interim CEO, on his belief in "disciplined financial management and fiscal accountability". TILT now more than ever needs to be tethered at the hip to prudent financial management.

The Baby, The Bathwater, And The Throwers

Fundamentally, TILT is a company with an impressive and growing revenue base, generating positive operating cash flow. At its current market capitalization, its earnings potential is being severely discounted by the market. The baby has been thrown out with the bathwater, and the throwers seem to be remiss to this.

If TILT maintains and improves on the fiscal discipline displayed during its last reported quarter, it will survive the cash crunch. This opens up the possibility of a company likely to generate operating cash flows at a margin of at least 8.5% on revenue which could exceed $200 million during its next financial year. Hence, it is hard not to conclude that the company has strong upside potential with relatively limited downside risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.