The Looming Issue of Convertible Debt in the Canadian Cannabis Sector

The Canadian cannabis sector has a looming problem that few people want to address. No, we’re not talking about the massive goodwill issue as identified by Marketwatch last night. Nor are we talking about the price suppression expected to be seen in the near term for the sector as whole. Rather, we’re focused on a much more looming issue: convertible debt.

The issue of convertible debt has been alluded to many time previously. The Deep Dive itself has reported on the issue a number of times as of late, with the issue being prevalent at issuers such as GTEC Holdings and Zenabis Global. However, convertible debt, and debt in general, has largely been the elephant in the room that no one truly wants to address on a grand scale. It’s mentioned on a case by case basis, but largely, it appears that investors in the sector would rather not address the issue head on, for the consequences of such debt can be drastic.

Zenabis’ current outstanding liabilities

Convertible debt first started showing up in the cannabis sector in late 2017, as retail funding was drying up for licensed producers within the space. One of the most notable of which, was Cannabis Wheaton, now Auxly Cannabis’, raise for $100 million via unsecured convertible debenture units. The massive raise conducted by Auxly set off numerous further debenture raises across the sector.

While the first phase of the cannabis sector largely squeaked by on small private placements from a dedicated investor base and a few select funds, with a growing sector these funds were simply not enough. When these high risk cannabis entities turned to more seasoned and risk-adverse investors and firms they found that there was little interest for the standard private placement.

Rather, these firms and investors wanted to buy debt. The reasoning behind which is simple – they received a nice little semi annual check as a result of the interest rate, and if the equity did not perform as expected, at the end of the allotted time period investors could get their initial investment back and walk away with a decent return on their money. Even if unsecured, this could net a gain of anywhere between 6% – 18% on average for the investor.

So, the cannabis sector began the next phase of growth and started entering into convertible debentures deals. Seasoned investors were happy with the terms they had secured, retail investors were happy with the funding to continue operations at their favourite sector player, and operators were happy that they were able to continue to keep the lights on and fund further growth.

What’s more, is that many naively assumed that the debt would convert at the end of the term and not be an issue. Many worked under the assumption that equity prices would continue to rise, despite the ability of many entities to actually perform or meet their own targets within the sector. With the realization once recreational legalization hit that many company projections were far, far out of reach, equity prices began to slide. Enough so, that conversion prices for all this issued debt are far above current equity prices in many instances.

Compounding the problem is the nearing due dates for the repayment of debt. Short sellers have identified the market opportunity, and the need for issuers to raise funds to cover the debt. Capitalizing on the issue, they frequently short troubled firms, with the knowledge that they will have to raise further funds to cover debt obligations. Once the firm finally elects to raise funds, short sellers will buy into the financing as a means to close their position, often profiting not only on their short, but by also essentially getting a free half or full warrant to cover their open position. Many short sellers view it as a low risk play given the need for firms to raise capital.

With many of these convertible debentures being issued in 2018, the cannabis sector is nearing a period where many of these debt obligations are about to come due. The vast majority of these financings were conducted on two year terms, thus the pending urgency for issuers to raise funds. As a result, the current environment has seen suppressed share prices as few large investors wish to get into high-risk investments, wherein a number of firms are essentially ticking time bombs.

To highlight how dire the current situation is, we’ve compiled a list of several issuers that are currently in precarious situations as a result of their current debt load and the likely inability to currently pay off the debt under current cash reserves. Note that the data is based on the latest financials filed by the issuer, and subsequent raises or financings may have occurred.

Outstanding Convertible Debentures

IssuerOutstandingInterest RateConversion PriceDue DateCash Reserve ($M)
Aleafia Health $19,486,968.00 8.0%$2.39Feb 2 2021$57.97
Aleafia Health $40,250,000.00 8.5%$1.55Jun 22 2022$57.97
Aurora Cannabis $209,474,000.00 5.0%$13.05Mar 9 2020$346.66
Aurora Cannabis $285,733,000.00 5.5%US$7.23Feb 24 2024$346.66
Auxly Cannabis $94,620,000.00 6.0%$1.55Jan 17 2020$165.02
GTEC Holdings $4,395,000.00 8.0%$1.50Jun 10 2020$2.23
GTEC Holdings $1,782,000.00 8.0%$1.50Oct 17 2020$2.23
GTEC Holdings $444,000.00 8.0%$1.50Oct 17 2020$2.23
Indiva $4,577,285.00 10.0%$0.75Dec 13 2019$8.15
National Access Cannabis $16,509,147.00 8.0%$1.08Nov 30 2021$8.17
RavenQuest BioMed $480,883.00 10.0%$1.45Feb 28 2020$1.30
RavenQuest BioMed $1,923,532.00 10.0%$1.45Feb 28 2020$1.30
RavenQuest BioMed $11,602,373.00 10.0%$1.45Feb 28 2020$1.30
Supreme Cannabis $75,496,095.00 6.0%$2.45Oct 19 2021$75.02
Vivo Cannabis $2,907,005.00 7.0%$1.50Dec 21 2020$17.57
Vivo Cannabis $27,161,749.00 6.0%$4.00Feb 28 2021$17.57
Zenabis Global $10,797,319.00 6.0%$2.52Oct 1 2020$8.67
Zenabis Global $11,232,097.00 6.0%$3.62Sep 27 2021$8.67
Zenabis Global* $24,146,674.00 6.0%$2.75Apr 1 2022$8.67
Zenabis Global* $3,918,235.00 0.0%$4.04Demand$8.67

As seen above, many of these firms will be forced to find additional funding before their debt comes due. Otherwise, they risk having to sell off assets as a means to cover their current obligations. While only a handful is secured (asterisks denote secured debt), those who fail to fulfill obligations will have limited resources in the future for funding should they elect to not meet their obligations.

While time exists in all cases before repayment is required, issuers will have to begin the process of raising funds now to satisfy shareholder concerns with regards to said debt. And until that time occurs, its likely that equity pricing will continue to deteriorate as time draws near.

The author has no affiliations related to the above listed organizations. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.