Cannabis CliffsNotes: Hexo Corp (TSE:HEXO), Acreage Holdings, Earnings

Benjamin A. Smith
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Below are the companies — Hexo Corp (TSE:HEXO) (OTCMKTS:HYYDF), Acreage Holdings — and related news events we’re tracking closely in the upcoming week ahead.

Hexo Corp

Friday after market close, Hexo made quite an eye-opening announcement. The company announced that it has filed a preliminary short form base shelf prospectus, enabling them to make offerings of up to $800 million of common shares, warrants, subscription receipts and units, or a combination thereof. During the 25-month period that the shelf prospectus remains valid, Hexo may go to market—in piecemeal or in full—to raise capital to fund operations, pay down debt, or acquire other entities.

At this point, it’s a mystery what the company plans to do with this potential future war chest. However, through the power of deduction, we can paint a plausible portrait of likely scenarios.

Our first observation is that, contrary to the possible scenarios described in Hexo’s press release, the money will not be used to pay down debt; at least not initially. According to the press release:

“the net proceeds from any sale of any securities may be used by HEXO for general corporate purposes, including funding ongoing operations and/or working capital requirements, to repay indebtedness from time to time, capital projects and potential future acquisitions, including in relation to international expansion.”

Due to the company’s strong balance sheet, there is no debt to pay down. According to Hexo’s fiscal Q4 press release, “As at July 31, 2018, we held cash and short-term investments of $244,789,000 and continued to hold no debt on our balance sheet.”

We don’t believe the shelf prospectus is about working capital requirements either.

The first obvious reason is prospectus size, which is well beyond the funding capacity needed to fund operations in a post-legalization world. Sure, a small portion of the $800 million could be earmarked for such purposes, but not much else. The company has already stated in its annual report (filed on SEDAR, October 26, 2018) that, “Management believes that current working capital provides sufficient funds to fund current expansion projects and meet contractual obligations for the next 12 months.” Nothing transformative enough has appeared since to have changed that dynamic (in our estimation).

That leaves us with funding capital projects and future acquisitions as likely targets for Hexo’s Board.

Interestingly, those options doesn’t appear to be among the four scenarios implored by Riposte Capital in their public shareholder activist letter disseminated on September 6th. In an effort to unlock lagging valuations, Riposte Capital—Hexo’s second largest shareholder—urged the company to either:

1) Engage with any interested buyers of the company at a significant premium to the current share price.

2) Take the company private and pursue capital leverage via the banking sector.

3) Enact a meaningful direct investment from Molson Coors to fund growth and strengthen the company’s joint venture relationship.

4) Seek a no-premium, accretive merger with a comparably-sized LP that can add further geographic diversification, scale, international opportunities, and medical expertise.

Thus, we await Hexo’s next move. While there’s no guarantee the company will access any capital—let alone all of it—we do get the sense that something material may be on the horizon. The company is known to be interested in expanding internationally, and with its Quebec cannabis strategy locked-in (via its exclusive agreement with SAQ) and flagship greenhouse almost-ready, the timing may suit a big splash internationally.

Acreage Holdings

According to one source (warning: non-corroborated by publishing time), Acreage Holdings maintains a defensible position against a lawsuit filed against them just days before their public listing goes live on the Canadian Securities Exchange.

Last Tuesday, news broke that Acreage Holdings was among several defendants named in a $400 Million New York cannabis lawsuit. The plaintiff accuses the defendants of misappropriating its intellectual property and attempting to coerce staff “while simultaneously depriving EPMMNY of the income and benefits of being NY Canna’s Operational Manager.”

In response, Acreage Holdings Investor Relations has purportedly provided some, or all, pre-listing round investors with Talking Notes they are using to rebut concerns regarding the lawsuit. The notes are as follows:

“We have referred the matter to counsel and we don’t believe that the claims involving Acreage have any merit and we plan to vigorously defend ourselves and plan to take all necessary legal action to protect ourselves.

Specifically, the company believes:

● The plaintiff has sat on these allegations for many months and has decided to file its complaint with the apparent attempt to take advantage of the timing of the pending public transaction involving Acreage.

● The allegations of the plaintiff pre-date the involvement of Acreage and represent a dispute among sellers over proceeds of that sale

● Acreage Holdings has full indemnification from the seller and guarantees from the largest shareholders therein

● Acreage Holdings is not aware of any information or documentation which would have enabled the minority shareholder/plaintiff to block the transaction; thus Acreage’s ownership of NYCANNA is not in question

● Further, Acreage’s 100% ownership interest in NYCANNA has been fully approved by the NY regulators

● The amount of contested equity issued in connection with the transaction is immaterial to Acreage’s overall capitalization.”

Again, this information remains uncorroborated at this time, but deemed credible enough to pursue the above entry. Acreage Holdings has not confirmed authenticity of the above quotes by publishing time. We will update this entry if/when the company does provide confirmation, and any other tidbits they may offer regarding this matter.

The company is scheduled to go public on Thursday, November 15th, under the symbol ACRG.

Cannabis Earnings

Next week, several Canadian LPs are scheduled to present quarterly numbers to investors. Canopy Growth, Aurora Cannabis, Cronos Group, and Tilray are among the those slated to report.

While many retail investors insist the cannabis sector will react capriciously to the numbers, we take a decidedly opposing view. As earnings in pre-legalization times have mostly exerted muted effects in the marketplace (outside of a handful of notable beats/misses), there’s little reason to believe next week will be any different. GMP Securities has already lowered the bar for the sector, and post-legal sales have yet to affect reporting entity balance sheets.

Aurora Cannabis COO, Cam Battley, perhaps says it best via the following tweet:

Update: 9:10 pm EST

Brad Rogers appears to have departed CannTrust Holdings Inc. No press release announcing the departure has been officially disseminated. Midas Letter is attempting to parse current events together. More to come…

Update: 10:14 pm EST

Official confirmation has materialized via tweet from CannTrust CEO, Peter Aceto. The official line is that Mr. Rogers left on his own terms.

Benjamin A. Smith

Benjamin A. Smith

Ben is a research analyst and capital markets professional with nearly 20 years of experience. His areas of expertise are broad-based, and include extensive knowledge of macro economics, stock/derivative trading, commodity complexes, cryptocurrencies and technical/quant analysis. He also maintains an particular affinity for U.S. politics and the macro-regulatory environment facing...
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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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