The most interesting part of the fiscal Q2 financial report from Aurora Cannabis earlier this month had nothing to do with its operations or even anything that took place during the quarter ending 12/31. Instead, it was its aggressive use of its at-the-market (ATM) facility subsequent to the end of the quarter that stood out to us. The company sold 19.6 million shares at an average price of US$4.58, raising US$89.7 million. This increased its shares outstanding by 10% in a single month. At quarter-end, the company had over C$332 million unrestricted cash, but it also had C$432 million of convertible debt that is due in three years. During the quarter, it repurchased C$7.1 million at a discount, and the company used the proceeds from its ATM to get more aggressive, disclosing that after the quarter it purchased another C$13.4 million of debt at a steep discount.
Given that the company is experiencing a decline in revenue as it continues to generate large operating losses, we think that Aurora is prudent to sell shares in the market above tangible book value, especially in light of the situation at HEXO Corp. Some other large LPs face similar challenges but have been slow to address what appears to be substantial debt rollover risk. Specifically, we believe that investors should expect Canopy Growth and Tilray to sell shares in 2022 to shore up their respective balance sheets ahead of large debt maturities.
Canopy Growth
We recently discussed the challenges at Canopy Growth and its deteriorating financial position. Indeed, the company's recent financial report revealed, as we had expected, that debt (C$1.5 billion) now exceeds cash (C$1.4 billion). C$600 million debt due in June 2023 could represent a challenge to the company, as it used C$419 million in the first three quarters of the year to fund operations. The recent sale of its German subsidiary will offset the likely continued drain of its operations on its cash balances, but the dwindling cash and limited prospects for achieving substantial cash generation would leave the company in a very vulnerable position ahead of the 2026 maturity of its C$900 million credit facility (which requires a minimum liquidity of US$250 million).
If analysts are correct in their outlook that Canopy Growth won't reach positive adjusted EBITDA until three years from now, the ability to refinance the debt will be increasingly questioned. While its stock is trading near a 5-year low, we think it makes sense for the company to sell stock, as it currently trades at 2X tangible book value despite projected losses ahead and looming debt maturities.
Tilray
Similarly, Tilray has a substantial amount of debt relative to cash. The company ended its fiscal Q2 ending in November with $332 million, but it reported total debt of $738 million. This debt includes two convertible notes: $278 million due in 2023 and $260 million due in 2024 (with a conversion price of $11.20). The company's cash balance declined by $150 million in the first half of its fiscal year, with $110 million consumed by its operations, net capital expenditures of $16 million and the balance mainly from the repayment of debt. The circumstances aren't as challenging for Tilray, in our view, as they are for Canopy Growth, but the company is very dependent on an increasing stock price to cover the 2023 debt maturity (i.e. conversion at $11.20) unless they are able to borrow more. Analysts expect the company to generate adjusted EBITDA of $97 million in fiscal 2023.
Tilray's stock is currently valued at 13.8X its tangible book value. Combining the market cap with its net debt, the enterprise value of $3.3 billion is 34X projected adjusted EBITDA for its fiscal year ending in May 2023. For a company with aggressive expansion plans, improving the balance sheet seems imperative, as acquisition targets are likely to be concerned with near-term debt maturities. When we interviewed its CEO, Irwin Simon, last August, he expressed hope that the company would see its 2024 debt converted into stock, but its stock has declined from $14 to $6 since then. Simon suggested that the company could use an ATM, but this would likely be to help fund its M&A. Both Tilray and Aphria historically have exchanged debt at a discount for equity in the past, and this could be how the company handles the current situation as well.
Conclusion
The aggressive selling of its stock by Aurora Cannabis in January may be a precursor to stock sales by other large LPs, especially Canopy Growth and Tilray. Quite simply, the businesses haven't scaled as expected and don't support the current levels of debt, especially for Canopy Growth. We expect that the pending debt maturities next year will weigh heavily on investor sentiment. While the stocks of all three companies are down substantially from where they have been historically, biting the bullet to strengthen the balance sheet may be necessary to restore investor confidence.
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