HEXO Corp (TSX: HEXO; NYSE: HEXO) announced last week that it is acquiring private grower Redecan, Canada’s largest privately-owned licensed producer, for $925 million CAD in cash and stock.
The $925 million purchase price will be paid to Redecan shareholders ($400 million cash on closing, $525 million paid on closing through the issuance of HEXO common shares).
This transaction puts HEXO in the position as a Canadian leader in dried flower (in premium, mainstream, and value price points), and cannabis-infused beverages through Truss Beverages.
Redecan has products in the flower, vape, oil and capsule categories.
Prior to the acquisition, HEXO’s top sellers were oils and capsules.
Hexo has gained a major asset by picking up Redecan’s “Redee” pre-rolled cigarette-like product.
Redecan Redees lead in market share in British Columbia, Alberta, Saskatchewan, and Ontario.
Overall, this acquisition is a bold move; Redecan had a long-term goal of becoming a top 3 Canadian cannabis company, and now has the aim of becoming the undisputed market leader within their sights.
So far this year, HEXO has purchased:
- Zenabis Global (TSX: ZENA), a low-cost greenhouse grower
- 48 North (TSX.V: NRTH) a pevious outdoor grower and owner of a house of brands including cannabis-derived beauty products.
- Redecan, the best value brand in Canada
We Have a Problem: Debt, Debt and More Debt
To pay for this deal, HEXO added $500M CAD in debt, for a total of $600M CAD on the balance sheet.
The problem is, they haven’t made a cent of profit yet – losing a total of $130M CAD last year alone.
According to analyst estimates for EBITDA (a measure of cashflow) over the next 3 years, HEXO will have very little chance of paying off the debt off when it comes due in May of 2023 – even with additional cashflow from the Redecan acquisition.
Therefore, the most likely outcome will be another flood of stock (share dilution).
HEXO had 127M shares as of March, up 100% from a year ago. Between Redecan, 48 North, the convertible debt and a recent filing to issue even more stock, HEXO will eventually have 300M+ shares, up 130% from today.
Let’s discuss why share dilution will hurt HEXO shareholders:
It looks like the two most likely outcomes for HEXO are:
Scenario 1: HEXO defaults on its debt in May 2023 and goes bankrupt
Scenario 2: HEXO wins Canada, but dilutes investor ownership by 56%
This puts HEXO Corp shareholders in a bind as the stock price will be lower than today in both scenarios.
If HEXO lets Redecan do what they do best, they may be able to gobble up more market share, but at the end of the day, HEXO’s huge pile of debt, will take nothing less than explosive growth from Redecan to pay off.
Even if laws in the US change allowing HEXO to enter, this will require even more capital and you guessed it more stock issuance.
Over the next two years, the path for a positive outcome is very narrow for HEXO indeed.
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