Aurora Cannabis Inc (ACB)

[FUNMAN]

Aurora Cannabis: Reverse Stock Split Incoming
Mar. 4, 2020 7:30 AM ET|

https://seekingalpha.com/article/4329193-aurora-cannabis-reverse-stock-split-incoming


Summary

* Aurora Cannabis may be proposing a reverse stock split in the near future.

* It'll make Aurora Cannabis compliant with NYSE's listing norms and prevent it from falling into the penny stock category.

* However, it won't alter Aurora's state of decline and its deteriorating financial and operational results.

Shareholders of Aurora Cannabis (ACB) have had a woeful past year. The company's growth momentum has slowed down to a crawl and it's now arguably experiencing a severe cash crunch. With its shares down by over 75% in the last 6 months, and hovering around the $1.3-mark at the time of this writing, there is reason to believe that Aurora Cannabis' board would move to undergo a reverse stock split in the coming few weeks.

Reason for a Reverse Split
Let me start by saying that stock exchanges internationally have their own respective listing and delisting criteria. Aurora Cannabis, for instance, is listed on NYSE and the exchange finds companies with shares trading below the $1-mark, for an extended period of time, as non-compliant. I dug into NYSE's rule book, which says:

A company will be considered to be below compliance standards if the average closing price of a security as reported on the consolidated tape is less than $1.00 over a consecutive 30 trading-day period... Once notified, the company must bring its share price and average share price back above $1.00 by six months following receipt of the notification.

These notifications aren't uncommon. In fact, another popular cannabis firm, CannTrust, received a non-compliance notice only last week. Its press-release read:

CannTrust is no longer in compliance with the NYSE's continued listing standard rules because the per share trading price of the Company's common shares has fallen below the NYSE's share price rule. The NYSE requires the average closing price of a listed company's common shares to be at least US $1.00 per share over a consecutive 30 trading-day period.

Needless to say that if companies can't regain compliance with NYSE over a period of time, they're eventually delisted from the exchanges. But there are ways to fix this messy situation. One common method to quickly regain this compliance is to implement a reverse stock split, which essentially means merging multiple shares into one, to inflate the value per share. While I don't think Aurora Cannabis is on the verge of being delisted, I do believe that it's headed for a reverse stock split in the near future.

I say this because conducting a reverse stock split is a lengthy process. It involves getting approval from the board. Once this is done, notices are drafted and issued to regulators and the shareholders. This is followed by a waiting time which involves giving enough time to shareholders to read, understand and grant approval. Once shareholders approve, a financial firm eventually implements a reverse split. All this can take several weeks and sometimes even several months.

One may argue that Aurora's shares aren't below the $1-mark yet, so it's not a cause of concern yet. But here's the thing, reverse stock splits take a long time to unfold. Prudent managements initiate proceedings for conducting a reverse split beforehand, if their non-compliance with the exchange is imminent, so that they're able to proactively focus on the business rather than being caught up with regulatory hurdles later on.

One may also argue that Aurora Cannabis' shares can potentially rebound and negate the need for a reverse split. While that's a plausible argument, we'll be essentially leaving Aurora's future to hope and faith this way - akin to gambling at a casino. Besides, things, as they stand, seem bleak for Aurora and its shares might as well continue to tumble over the coming weeks.

What Lies Ahead?

The ground reality is that Aurora Cannabis is in a precarious operating and financial position. It posted a significant revenue decline in two of the three end-markets that it caters to. Its management sounded very optimistic about the growth prospects of its wholesale and adult use cannabis in prior earnings calls, but forget about growth, the company is currently struggling to regain its prior levels of sales. The question at hand now is - How far will Aurora's revenues fall before they eventually plateau and stabilize?

One might expect that with fewer opportunities, Aurora's management would be smartly allocating its supplies to lucrative and high-margin avenues. But that doesn't seem to be the case. Aurora Cannabis posted a major drop in its realized gross margins across all three end-markets. This really casts doubt on its growth prospects and highlights that Aurora is facing pricing pressures.

Not to mention, Aurora Cannabis also seems to be experiencing a severe cash crunch. It has already slashed its capital expenditures and it also listed one of its greenhouse facilities up for sale earlier this year. But the company disclosed in one of its documents that it diluted its shareholders once again - it raised C$267.7 million in gross proceeds by issuing 69.949 million shares in Q2 FY20. From the document:

During the three and six months ended December 31, 2019, the Company issued 69,949,434 and 77,507,893 common shares, respectively, under its At-the-Market ("ATM") program (Note 24(NYSE:B)) for gross proceeds of $267.7 million and $325.2 million (US$202.0 million and US$245.3 million) at an average price of $3.83 and $4.20 per share (US$2.89 and US$3.16 per share), respectively.

So we have a company that's posting shrinking revenues, deteriorating margins and its diluting shareholders to keep up with expenses and yet, its shares are trading at a lofty forward sales multiple of 7.5x. This doesn't look very encouraging for long-side investors. I believe this is inefficient market pricing which will correct over the coming weeks with the stock falling further. This, in turn, suggests that the company would have to undertake a reverse stock split to remain compliant with NYSE.

One might argue that reverse stock splits aren't a big deal, as we're only artificially inflating a stock's value. While that's a reasonable argument, doing so signals to the Street that the concerned company isn't capable of organically growing its market capitalization and unlocking value for its shareholders. Besides, artificially achieving listing compliance also takes the pressure off of managements to stage turnarounds for the time being. So, I view reverse stock splits as a quick way to lose shareholders' confidence.

Besides, I conducted a study on over 550 companies that undertook reverse stock splits between 1998 and 2017. Unsurprisingly, a majority of these companies (~60%) saw their share price decline within one year of their reverse splits coming into effect.

Concluding Remarks

Given how quickly Aurora Cannabis' shares have been losing value and reaching close to the $1-mark, I believe the company's board will propose to carry out a reverse stock split in the coming few months. It'll prevent Aurora from falling into the penny stock category and keep any listing-related problems at bay. But it won't solve any of Aurora's financial and operational core issues - such as deteriorating margins or falling revenue. So, I also believe its shares could fall further over the coming weeks.