The reverberations surrounding Elon Musk’s “$420” tweet continue to play out. The August 7th midday tweet kicked off an intense short-covering rally which provoked condemnation from detractors and the Securities & Exchange Commission alike. While Tesla’s go-private ambitions and timing continue to generate significant buzz down south, we looked into whether Musk’s plans actually make sense in the Canadian cannabis sector. Turns out, the Tesla CEO may be onto something.
Am considering taking Tesla private at $420. Funding secured.
— Elon Musk (@elonmusk) August 7, 2018
A going private transaction is one which transforms a public company into a private company, thereby eliminating the public shareholders. Typically, is is proposed for one of two reasons: (i) the management or shareholders of the target company want to buyout the other public shareholders and take the company private; or (ii) a third party proposes to acquire the target company either with or without the support of management or a group of shareholders. Each year, several hundred such transactions typically take place on North American exchanges, more uncommonly involving a high-profile deal (i.e. Dell Computer Co., TXU Energy).
While going private has its share of benefits and drawbacks, it can make sense in certain situations.
In Tesla’s case, it would alleviate enormous pressure to make short-sighted company decisions to pacify analysts in the current quarter. It would also abrogate Tesla’s need to disclose public information that has lead to volatility and short-sell raids in the stock price. Tesla is currently required to make quarterly disclosures on such things as debt levels, executive compensation, vehicle unit run rates, various lawsuits and partial competitive strategy disclosures. Such admissions have long nuisanced Musk, with the vitriol coming to a head in early May as Musk unleashed a Trump-esque tweet storm after a contentious Q1 earnings call.
While the reasons of going private are (mostly) different for Canadian cannabis companies, they make sense—in certain instances—on a multitude of levels.
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Effective decision making: Going private permits controlling stakeholders and its publicly traded subsidiary to integrate their operations more efficiently—without concern for fairness to other stockholders. With numerous junior Canadian cannabis companies grinding near 2018 lows, managements are coming under intense scrutiny to make material decisions to increase value now. This will only heighten as legalization approaches in October, and a little later on when earnings really start mattering. Those unable to maneuver will long for the day when their stock traded at today’s compressed valuations.
Unlocking shareholder value: Unfortunately, the share prices of many junior Canadian cannabis LPs may have already reached peak levels this year. For many—especially in entities without international exposure, MOU’s with the provinces, or lack of defining cost or branding advantage—the share price may never come back. In such cases, management may want to consider going private, as the lack of buying interest and/or liquidity in the public market could become a hindrance rather than net benefit.
Procuring a leveraged buyout/financing partner may also allow remaining shareholders to receive payouts above the current market value of the stock—which may not be otherwise unlocked. This may be suitable in cases where underlying biological and physical assets trade at a discount to its intrinsic worth, where future business prospects may fall below potential.
Furthermore, going private acts to squeeze short-sellers by forcing them to return borrowed stock to the original owner. Every month, several cannabis LPs are among the top shorted names on the TSX-V and CSE exchanges; occasionally, Canopy Growth Corp. and Aurora Cannabis Inc. have appeared in the Top 10 on the Toronto Stock Exchange.
While the latter two companies have every reason to remain public, smaller LPs who’ve ‘missed the boat’ may opt to cash out while they still can—if they can find a taker.
Reduced operating costs: There are considerable costs associated with maintaining a public company—some which smaller cashflow challenged LPs may not be able to afford. These re-occurring expenses include the costs of producing quarterly/annual financial statements and shareholder meeting governance; costs associated with auditors, law firms and other professional advisors; expenses associated with retaining and compensating directors; and fees payable to securities regulators and stock exchanges. These are significant and material operating expenditures which never cease.
Possible tax benefits of a more leveraged capital structure: This topic is out of my realm of expertise, therefore I provide no comment. However from my understanding, the acquirer and/or target entity may procure additional tax advantages operating in a private structure in the case of a leveraged buyout (LBO). Individual circumstance will vary.
Re-branding: Some Canadian cannabis LPs may find it beneficial to go-private and completely re-brand their operations from the top-down. They could then apply to re-list on a public exchange afterwards when individual business conditions warrant. One such benefit would be the ability to complete a total re-branding of the entity’s business structure, up & above the cosmetic (and ineffective) name changes commonly seen today.
How Would Go-Private Transactions Work In The Canadian Cannabis Space?
A plan of arrangement is a court-sanctioned procedure under the applicable Canadian corporate statute. It can be used in a leveraged buyout, as financing can be approved by the court. Shareholders must approve any arrangement, but the court sets out the terms under which the shareholders’ meeting proceeds and the threshold for approval. Usually, the latter is satisfied with 66 and 2/3% of the vote. Final approval of the court is necessary and is granted following the requisite shareholder approval and and agreement that the arrangement is “fair and reasonable”.
Generally, takeover bids must remain open for 105 days and are subject to minimum tender conditions.
With several dozen Canadian cannabis LPs and peripheral entities dotting the investment landscape, time is running out in their quest to unlock shareholder value. Like all speculative and growth industries of the past, only a handful will ultimately survive, leaving most to wither on the vine. Under these auspices, going private could be a serious consideration for some—especially for those without a signature product, cost, niche or operational advantage. Not only could this unlock dwindling shareholder value, some entities could be in stronger position to re-structure away from a demanding and bagholding investor base who bought into the hype at much higher prices.
The question is, when will that time come? When will select LPs finally come to the conclusion that they weren’t destined to become among the few thriving remaining players? It’s a conversation whose time is rapidly approaching.
Midas Letter is provided as a source of information only, and is in no way to be construed as investment advice. James West, the author and publisher of the Midas Letter, is not authorized to provide investor advice, and provides this information only to readers who are interested in knowing what he is investing in and how he reaches such decisions.
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