Due to rapid expansion, Harvest Health & Recreation (HRVSF) is going the path of borrowing money from an investment fund. The asset-back financing adds risk to a growth story that is usually best fueled via equity offerings.
Need For Cash
Harvest Health is in the midst of multiple acquisitions that will transform the U.S. multi-state operator (MSO) into a company with a revenue target approaching $1 billion in 2020. As a comparison, the company only generated 2018 revenues of $47 million.
Harvest Health only had an adjusted EBITDA loss of $4.7 million in Q1 so operations aren’t burning a lot of cash. Lots of questions exist on where the financials will stand once all of the deals for Verano, Falcon, Devine and CannaPharmacy are closed. In addition, the company is in various stages of going from 15 retail locations at the end of Q1 to a plan that exceeds 120 dispensaries. All of these new facilities require cash to fund.
When the company closed Q1 in March, Harvest Health had a cash balance of only $116 million with total debt of $29 million. A company in the retail sector looking to reach $1 billion in annual sales typically needs access to more cash than a net cash balance of $87 million to fuel expansion.
The Verano deal at an initial price of $850 million is in all stock so the major acquisition doesn’t require cash. The company has several other deals in various stages of closing. Even with the stock down to $5, Harvest Health would have a market valuation approaching $3 billion once all the deals are closed.
The company could easily complete a secondary for up to $300 million that only dilutes shareholders by 10%. The timing isn’t ideal with the stock down at the lows, but costly interest expenses and added risks of having to repay debts are less ideal.
Harvest Health has taken several paths to raise money via debt. The company recently signed a deal for convertible debt of up to $500 million. On May 13, the company closed on the first tranche of the 7% unsecured convertible debt to raise gross proceeds of $100 million.
The debt has a maturity date of May 9, 2022 and a conversion price of $11.42. In addition, the debt holders received 3,502,666 warrants with an exercise price of C$18.17.
Now, the company has signed a deal with Torian Capital Partners for a secured term loan of up to $225 million via multiple tranches. The loan is an asset-backed financing plan bearing an interest rate of 8% with an additional cost of warrants.
The issue here is the complication and costs of debt versus just issuing equity whether ideal at the current price or not. Just $300 million in debt starts costing the company over $20 million in annual interest costs and the proposed amounts would more than double these interest costs.
The key investor takeaway is that Harvest Health has a plan to generate substantial growth via acquisitions and organic growth, but the timing of generating substantial profits is unknown. Such unproven business models are best funded via equity that has no additional covenants and costs.
The stock is appealing down at $5 but investors need to keep a keen eye on funding costs going forward.
Compass Point analyst Rommel Dionisio recently initiated coverage on Harvest Health stock with a Buy rating and $11.00 price target, which implies about 100% upside from current levels. (To watch Dionisio’s track record, click here)