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Debenture Conversion Isn’t Enough to Offset Cash Struggles, Says Hexo Bear


It has been a tough year for the Canadian cannabis industry. Not long ago, the industry was the darling of Wall Street, but it has encountered multiple growing pains. Hampered by regulatory issues as well as difficult supply and demand dynamics, valuations have tumbled as companies failed to deliver on promises and turn a profit.

This is exemplified by Hexo (HEXO). Following share price depreciation of 64% in 2019, 2020 hasn’t been much better, with the stock down by 69% year-to-date.

Recently, Hexo disclosed it planned to raise much needed cash through an equity sale. The company plans to convert C$30 million principal of its C$70 million debenture into shares/warrants, offered at a 20% discount to the trading price – C$0.80 per unit (at the time of the offer) – with an exercise price of C$1 for a period of three years. Originally issued in October 2019, the debentures are set to be paid by December 2022, and all in all, indicate total dilution, including warrants, of 12%.

“While the decision is ultimately a move we agree with, we do think it suggests the ongoing cash struggles for the company, while eyebrows may be raised around insiders who subscribed to the initial offering just seven month ago now receiving heavily discounted shares,” said Jefferies analyst Owen Bennett.

Since early December 2019, the company has enacted three equity raises, and Bennett believes the latest dilution won’t come as much of a surprise to anyone following the company’s progress. The terms of the deal suggest “that cash needs may continue to be an issue plaguing the company near term,” with the goal of turning both EBITDA and cash flow positive hampered by the “not insignificant” interest payments.

Despite bullish comments concerning the reception of the company’s Original Stash value brand, and considering the fact that these debentures were handed out less than seven months ago, it could be that recent performance has not been as strong as anticipated.

Moreover, questions are likely to come up regarding “insider involvement.” Bennett explained, “One of the more bullish reads from the initial debenture offering was that insiders, including the CEO, were to subscribe to c.12% of the C$70 million offering, signaling conviction in the longer-term story. The fact today that close to 30% of the C$30 million converting are the same insiders may not sit well with current shareholders.”

To this end, Bennett reiterated an Underperform call on Hexo alongside a C$0.50 ($0.72) price target, implying 42% upside potential. (To watch Bennett’s track record, click here)

To find good ideas for cannabis stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.

 

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