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Restructurings rise, IPOs stall as pot sector matures

Share prices for ventures are down an average of approximately 60% since March
McMillan LLP partner James Munro: “last year, and frankly the year before, was the year of [public] listings. It was just a crazy spin of deal after deal after deal. This year is different – it’s more of a market check on reality” | Rob Kruyt

The plunge in share prices for cannabis-sector stocks is shaking up corporate business plans and changing the nature of the legal work commissioned by executives.

Instead of needing assistance in securing loans, getting equity financing or navigating an initial public offering, cannabis ventures are increasingly seeking help to restructure.

Many licensed producers that once scrambled to produce sufficient quantities of cannabis are sitting on a heap of excess inventory – something that is driving down prices for dried cannabis and forcing producers to mark down the value of their production on corporate balance sheets.

The funk that has set in has pushed down shares in the cannabis-sector index fund Horizons Marijuana Life Sciences Index (TSX:HMMJ) by more than 60%, since it hit its year high of $23.87 on March 19. During that same time period, the Toronto Stock Exchange is up about 6%, and the S&P 500 index has risen by more than 11%.

“The financing side seems to be slowing down significantly, and what we’re preparing for is a restructuring of the industry in the sense of being ready for mergers and acquisitions and consolidation – expecting some of the bigger players who have equity on their books to make moves and try to acquire some of the juniors,” said Borden Ladner Gervais LLP partner Stephen Robertson. “That and getting ready for bankruptcies, and allowing companies to restructure.”

When debt deals get done, Robertson said, they are often in the form of convertible debentures, where the lender can convert the debt into equity in the cannabis company if the target company’s shares rise to a set threshold.

He called the possibility of getting equity a “sweetener” for the lender because companies often do not want to part with equity or to issue extra shares because that dilutes the value of each existing share.

“A lot of our activity as well right now is related to people still trying to open retail locations,” he said.

The spread of bricks-and-mortar cannabis stores in provinces such as B.C., and particularly Ontario, has been notoriously slow.

“There are hopes of taking those entities public but those are long-term plans,” Robertson said. “In the short term, we’re not seeing people push toward the initial public offering space.”

He agreed with McMillan LLP partner James Munro that although many companies will be losers, there will also be winners. Both also recognize the irony that capital-markets investors were giddy about the cannabis sector before Canada legalized the drug, when there was little revenue being made.

Now that there are established businesses with rapidly increasing sales, the markets have soured. The pessimism also comes despite countries around the world that have long been strongly opposed to cannabis, such as South Korea and Thailand, fuelling demand for cannabis exports by legalizing medical marijuana.

“Last year, and frankly the year before, was the year of [public] listings,” Munro said. “It was just a crazy spin of deal after deal after deal. This year is different – it’s more of a market check on reality.”

Munro said that the shakeup is revealing which businesses have solid business plans, because those are the ones that have been able to prosper and continue to obtain loans or equity financing.

One recent point of optimism for the sector was the U.S. House Judiciary Committee’s November 20 vote in favour of a cannabis reform bill that would legalize marijuana. This was the first time a House committee has done such a thing.

Munro believes that cannabis legalization south of the border will eventually happen, but is now a politically risky move that will likely succeed only under a president who is in his or her second term.

“It’s a tough bridge to jump for any president’s first term,” Munro said of legalizing cannabis federally in the U.S.

“It’s definitely a bold move to take in your first term.” •

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