The global cannabis industry is shaken by the current economic crisis

Following the declaration of cannabis as an “essential product” in the many jurisdictions of both Canada and the United States in the midst of the COVID-19 pandemic, CEOs and press spokespersons throughout this fledgling industry are scrambling to spread the word about “a crisis-resistant industry.” However, the investment market does not seem convinced.

In an environment where current earnings are only a small percentage of what is projected for the medium term, and with few companies having achieved positive EBITDA and cash flow status, external capital is more than a coveted resource: it is a vital one.

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The cannabis industry is looking for new ways to raise capital during the market crisis

The investment windfall that saw the cannabis market “boom” during 2018 and early 2019 had already entered a shrinking process several months before COVID-19 put all markets on hold. According to the Viridian Capital Advisors Deal Tracker, during 2019, the number of financing rounds decreased by 12.8%, while total capital raised fell by 20.3% from the previous year.

So far in 2020, the decline has been even more significant. During the first five months of the year, the number of financing rounds decreased by 51.2% and the total dollars raised fell by 65.7%.

As a result, cannabis companies are looking for new ways to raise capital, including a strategy called sale-leaseback. It involves selling a property to another company and then leasing it back out and continuing to operate while freeing up capital for use or reinvestment.

“Today’s survivors are going to be tomorrow’s leaders,” said Roderick Stephan of cannabis-focused investment fund Altitude Investment Partners at the latest Benzinga Cannabis and Capital Conference.

For the investor, companies with less than three or four months of cash “cushion” are now in red alert or what others call “crisis mode”. In this line, sale-leaseback transactions provide a quick cash solution.

Cannabis companies currently facing hard times

In 2018, the cannabis industry was very interesting for investors. But by mid-2019, the ground had become muddy for large producers in Canada and the US.

The shares of Canopy Growth (CGC), one of the leading companies in the industry, lost 46% of their value between September 2018 and September 2019.

Aurora (ACB), Aphria (APHA), Tilray (TLRY), MedMen (MMNFF) and other cannabis giants faced similar or, in some cases, even worse fates. Huge capitalization losses were accompanied by corporate scandals, massive changes in executive teams, and layoffs, in some cases, of hundreds of employees at a time.

The main theory today points to the over-extension and exuberance of companies, which seemed to act as if the capital well would never run dry.

“Many companies went through hypergrowth processes seeking to capitalize on a market opportunity that later contracted both in demand and in the stock market valuation of public companies,” said Lucas Nosiglia, president of Avicanna Latam.

“This forced many companies to restructure, work on reducing costs and generate operational efficiencies to minimize the need for financing in a context where the potential demand is still far from being reached,” added Nosiglia.

Scott Greiper of Viridian Capital Advisors added some other factors. For Greiper, the disappointing financial results in U.S. and Canadian companies led analysts to revise their forecasts negatively.

In turn, the public cannabis companies were weakened by falling share prices and declining cash balances, forcing them to raise capital at increasingly dilutive levels. Management cracks began to appear when inexperienced traders first faced a challenging capital market environment.

Sale-Leasebacks in the cannabis industry as an option to survive

Raising money through real estate is not news. However, for cannabis companies in the US, traditional real estate loans are not very viable.

Most US banks do not want to be associated with cannabis companies, even though cannabis is legal (for medical or recreational use) in more than half of the states in the country. This resistance is due to the fact that the plant remains illegal at the federal level; which creates an unjustified level of risk, the banks argue.

A few small banks offer loans to cannabis companies. But they do so at rates of 10-15%, explained Fernando Russo, an Argentine working for a cannabis investment firm in Washington D.C.

“If you talk to 100 banks, maybe two will be interested and one will complete the management,” continued Joe Caltabiano, co-founder of the giant Cresco Labs, valued at nearly $1 billion. All this has led many cannabis companies to opt for less traditional mechanisms. Among them, the sale-leaseback.

“Sale-leasebacks are very real,” said Caltabiano. “There are a multitude of operators who are willing to participate, have the capital ready and are looking for tenants from whom to buy goods.”

Cannabis has become a game of resistance. Giving up an asset is good business if it provides the possibility to extend the life of the company long enough to be the one who stays on after the recession. However, strategy is not a universal solution for all cannabis companies.

“Sale-leaseback is available to a few companies that operate large facilities (cultivation, distribution and manufacturing). These properties, in most cases, are stabilized and sellers have projected cash flows to meet rent payments for at least 10 to 15 years,” added Fernando Russo.

Multiple noticeable transactions in the cannabis market during the past months

Over the past nine months, the cannabis industry saw a number of high-profile transactions that illustrate this trend.

In March, the operator Green Thumb Industries (GTII) sold an Illinois growing and processing facility to Innovative Industrial Properties (IIPR) in a $50 million sale-leaseback.

In February, Grassroots Cannabis signed a $19.7 million agreement with NewLake Capital Partners.

In October 2019, Innovative Industrial Properties, the real estate investment trust (REIT), completed an agreement with PharmaCann for about $18 million for an industrial property in Illinois.

In the same month, Acreage Holdings (ACRGF) and GreenAcreage Real Estate Corp closed a series of sale-leaseback transactions for property owned in Massachusetts, Florida and Pennsylvania totaling approximately $18 million.

In August 2019, Curaleaf Holdings (CURLF) completed a sale-leaseback with Freehold Properties valued at approximately $28.3 million for six of its properties in Florida, Massachusetts and New Jersey.

Capital is the fuel for any company in an emerging industry. Therefore, we are likely to continue to see a diverse range of financing options for cannabis companies, which will expand as legal and legislative initiatives emerge and companies mature.

“For now, sale-leaseback transactions have become an attractive option for unlocking cash on the balance sheet by eliminating ownership of real estate assets,” concluded Greiper.

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(Featured image by StockSnap via Pixabay)

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