Is the Cresco Tryke enterprise liable to change as a result of its agency greenback share construction?
March 25, 2020
We suspect that the fixed-dollar structure of Cresco Labs’ acquisition of Tryke is likely to lead to the demise of the business – either through a change or an outright termination.
Due to the current structured rate of return of 60% at Cresco, Tryke, based in Las Vegas, has 16% to 21% of the new company for only 7 to 10% of pro forma sales.
Chicago-based Cresco has shown its willingness to change business after changing its merger with Origin House and ending its acquisition of VidaCann.
To be clear, our conclusion is based solely on our analysis of this business structure with a fixed consideration in US dollars paid in equity. This increases the risk of the deal if the stock price changes dramatically from the price when the deal is announced.
We didn’t hear anything specific and the company didn’t comment on questions.
Trades structured on fixed stock exchanges have less execution risk when stock prices are volatile because each party’s stake in the new company does not change with stock prices.
Given the bullish long-term investment outlook for the cannabis industry, but the recent short-term volatility in stock prices, we would encourage buyers and sellers structuring mergers or acquisitions with an equity component to focus on the percentage of the new company they own in a deal will be completion.
Tryke will receive 32 million shares at $ 7.14 or 75 million at $ 2.80
As shown in the Tryke Deal presentation, the company will receive consideration of a minimum of $ 209 million and a maximum of $ 242 million payable in Cresco shares.
The number of shares issued to Tryke has more than doubled since the deal was announced, as Cresco’s share price fell 61% – from $ 7.14 to $ 2.80 on March 23. That leaves Tryke with 16% of the pro forma company compared to 8% at the time of the announcement.
If the deal had been closed at Cresco’s March 18 low of $ 2.05, Tryke would own 21% of the pro forma Cresco. If Cresco shares were to hypothetically drop to $ 1.50, Tryke would get 139 million shares, or 26% of the company, and at $ 1.00 Tryke would get 209 million shares, or 35% of the company.
When the deal was announced on September 16, 2019, the equity stake was reported as $ 227.5 million. However, we assume that Tryke will only get the guaranteed minimum of $ 209 million, with the stock down 61%. Dilution is 9% worse at $ 227.5 million.
|date||Consideration of equity
|CL share price||CL shares in Tryke||CL shares Ex Tryke||Total Pro Forma CL shares||Tryke possession||% Price change since deal|
|16.09.2019||$ 227.5||$ 7.14||31.9||389.6||421.5||7.6%|
|December 09, 2019||$ 209.0||$ 5.30||39.5||391.1||430.6||9.2%||-26%|
|03/18/2020||$ 209.0||$ 2.05||102.0||393.4||495.4||20.6%||-71%|
|03/23/2020||$ 209.0||$ 2.80||74.6||393.4||468.0||15.9%||-61%|
Although the structure is referred to as “collar” by Cresco management, when they hear “collar”, finance professionals typically don’t think of it – a structure that uses options to hedge the consideration and share price within a certain price range.
Instead, it is a collar for the entire amount of equity in US dollars made available to the seller, which does not protect shareholders from downward dilution.
Tryke offers 7% -10% of sales for 16-21% ownership?
The presentation notes that Tryke had sales of $ 70 million in 2018 (70% of which in Las Vegas). Assuming Tryke merely maintained its market share when the Nevada market grew 28% in 2019, Tryke would have sales of approximately $ 90 million in 2019.
That’s a big assumption, however, given that competitor’s flagship Planet 13 didn’t open across the street until late 2018, meaning the reported $ 70 million in 2018 revenue was before a significant change in the competitive landscape.
The number reported for Tryke implies revenue may decline.
Cresco reported that Tryke had sales of $ 17 million in the third quarter of 2019, representing 25.4% of total Nevada sales in 2019. Assuming similar seasonality for Tryke, the 2019 revenue estimate is $ 67 million ($ 17 / 25.4%) – or a 4% decrease from last year – and a decrease in Nevada market share of 12 % in 2018 to 9% in 2019.
Consensus estimates put Cresco in sales of $ 908 million in 2021. This means that Tryke’s potential sales of $ 67 to $ 90 million would represent about 7 to 10 percent of the company’s total sales.
Even so, Tryke will own 15% to 20% of the equity if the acquisition is completed as the first structure at Cresco’s current share price – and Tryke may experience declining sales.
To match ownership of revenue, Cresco’s share price would have to rise to $ 4.80 to give Tryke 10% of the pro forma company, and 155% off the deal price of $ 7.14 to give Tryke 7 % to give.
MGM’s temporary closure of casinos due to COVID-19 will not help either Tryke or Planet 13 in the near future, although the coronavirus is (hopefully) temporary and should probably not affect a long-term merger decision.
Fixed stock deals are more likely to close
A fixed consideration in US dollars paid in equity is riskier in the case of volatile stock prices, since this structure is effectively an offer of stocks at a future price unknown. Given the recent major changes in the share prices of cannabis companies, we believe that such deals are at greater risk of being renegotiated or failing entirely.
Sellers have an interest in the combined company’s success if they accept equity in return. In these cases, the most important number is the percentage of ownership of the future unit. The headline deal value isn’t really relevant and changes with the share price of the underlying equity.
Stock swaps with a fixed number of shares or a fixed exchange ratio, such as Cresco’s acquisition of Origin House and Charlotte’s Web’s proposed acquisition of Abacus Health, have a greater chance of closing out on volatile stock prices.
Sellers who wish to continue owning part of the new company should ignore the total value and instead focus on the number of stocks they will own in the new company. Sellers who only want to cash out should ask for cash. They can do this by hedging the stocks that they will soon acquire (when the market is deep enough).
While we highlighted the risk of the Cresco-Tryke transaction, there are other outstanding deals that include a fixed consideration that is paid in equity:
- Columbia Care’s acquisition of The Green Solution has 79%, or $ 110 million, of consideration to be paid in CCHW equity, although the company has not disclosed the exact structure. It could be a fixed amount of $ 110 million, which would mean the number of shares increased from 35 million to $ 3.15 at the announcement to 81 million at $ 1.36, or it could just be 35 million stocks or something in between. The deal sounded on track in the last profit call.
- Curaleaf’s acquisition of Grassroots will close with $ 40 million in consideration and a potential earnout of $ 200 million in 2021 to be paid in CURA equity. At the close of $ 3.09 on March 23, which is 60% less than when the deal was announced, the $ 40 million equals 12.9 million shares and the potentially $ 200 million earnout $ 64.7 million. However, given that most of the consideration is a fixed amount of 103 million shares and $ 75 million in cash (which haven’t changed), we believe this deal is likely to close.
Mike Regan can be reached at [email protected].