The last time we covered Canopy Growth Corporation (NASDAQ: CGC) we summarized the best case for investors assuming there was a a few miracles along the way.

If CGC miraculously turned its gross margins negative to 3.63% and somehow erased most of its debt, a 0.1X sales multiple would be fine with them. That brings us to about 10 cents per share.

Source: Bankruptcy risks grow like a weed

The stock dropped quite sharply right after this article when news of the debt swap hit. What is debt swap and how does it impact you, the common shareholder? We’re looking at that and giving our opinion on where it’s headed.

The exchange

CGC announced that it had reached an agreement with some noteholders and that it would issue common shares for these notes.

Canopy Growth has agreed to acquire the Notes from the Noteholders for an aggregate purchase price (excluding accrued and unpaid interest which will be paid in cash as part of the Cash Payment) of approximately C$252.8 million (approximately US$196 million) (the “Purchase Price”), which will be payable in a number of shares of Canopy (the “Share Consideration”) equal to the purchase price divided by the weighted average based on the volume (the “VWAP”) of Canopy’s shares on the Nasdaq Global Select Market (the “Nasdaq”) for the 10 consecutive trading days beginning June 30, 2022 inclusive (the “Average Price” and such period being the ” Average Period”), subject to a floor price of USD 2.50 (the “Floor Price”) and a maximum price equal to USD 3.50.

Source: Alpha Research

It was a win for the bearish thesis, as CGC also viewed these notes as a direct risk of bankruptcy in 12 months and was desperately trying to fix the problem.

Extremely Distressed Award

CGC ticket holders paid little heed to the price drop and the swap will occur at the extreme low end of the range. This will add approximately 80 million odd shares to the total, diluting shareholders by 20%.

On the other side of the equation, it only saves the company about $8.5 million in annual interest costs.

A maturity of $600 million seems addressable

There was a second small tranche that negotiated the same terms for the tickets. Cumulatively however, only a third of the total ratings have been processed. The $400 million outstanding is now reaching a point where it is more likely to be repaid when the time comes. If investors will recall, we said the terms of the credit facility limited debt repayment. These conditions required more than $200 million in cash to be met at all times. We thought it would be a tough hurdle to jump, but now that the requirement has dropped by $200 million, it seems doable.

In an ideal world, however, CGC would repay all of its $600 million through the issuance of stock. We know investors might disagree and think this would destroy the bullish case. We think that would actually give CGC the best chance of avoiding bankruptcy. A 50% stock dilution is better than a 99.99% dilution in bankruptcy.

Asset sales could help more

While the July 2023 note maturity is less threatening, credit facility banks will likely need a pound of flesh. What we mean is that these banks would likely ask CGC to conserve cash and increase the buffer on secured debt. It should also be noted that convertible notes have actually fallen since the announcement of the debt exchange.

They are now yielding around 22% until maturity, again suggesting that the market does not think they can be redeemed or refinanced. CGC will probably have to contribute its stakes in Wana and TerrAscend.

Verdict

Bankruptcy remains a risk in 12 months, but there is no doubt that the risk has diminished with this distressed debt exchange. Constellation Brands, Inc. (STZ) owns an overwhelming share of the shares and, prior to this exchange, held 142.25 million shares at a cost basis of C$5.49 billion (approximately US$4.25 billion). ) or C$38.59 per share (approximately US$30 per share). They also held the convertible debt and participated in this exchange subject to the remaining debt being repaid in cash. Obviously, they don’t want to lose effective control here, which could happen if CGC repaid the debt with shares issued below $1.00.

In the egg and bacon breakfast, the chicken is involved but the pig is engaged. STZ is clearly committed here and probably wants to avoid acknowledging the giant mistake of investing in CGC. It also makes a buyback possible, although we assume it would come at a zero premium and likely at a lower price from here. This risk, however, makes us retrace the downtrend here and we reluctantly upgrade it to a hold/neutral note. We would look to move to the bearish side if we get a strong rally above $4.00.

Please note that this is not financial advice. It may seem, seem, but surprisingly, it is not. Investors are required to do their own due diligence and consult a professional who knows their objectives and constraints.