Cannabis’ Looming Debt Hangover
“Soon as that boat cleared the bar, pay me my money down” Pay Me My Money Down, Bruce Springsteen
Despite some banking and political jitters over the past couple of months, the Fed chose not to boost rates at yesterday’s session. Cannabis companies should not be celebrating too much. Their cost of capital has not subsided and will likely get worse before it gets better. The Fed also indicated that a couple of small rate increases may be in the cards by year end.
What should be keeping CEOs & CFOs up at night right now is an imminent debt hangover. Specifically, I am referring to the rollover from less to more expensive debt when this debt comes due, beginning in 2024. To be clear, cannabis debt is not cheap today. These loans were made back in 2021-22 when the Fed rate was about 50% lower than it is today.
This increase in the cost of borrowing will be precipitous, especially for speculative-grade loans made by direct lenders. This has important ramifications for a hurting sector now reliant on debt as its primary source of capital.
The amount of sleep executives will lose depends on many factors with different moving parts:
1. Their cash flow situation;
2. The debt’s true cost to the firm;
3. The health of their balance sheet;
4. If and when they become EBITDA positive;
5. The structure of the debt i.e. floating vs. fixed rates, maturities, convertibility to equity, principal payment optionality and covenants & conditions
A difficult market environment including slow growth, margin compression, low valuations and hyper-competition will magnify corporate vulnerability. Broader economic and regulatory forces do not offer any solace. Recessionary fears have not waned. Federal reform is unlikely in 2023, banking anxieties linger, and geo-political threats have not subsided.
Prudent companies have set up cash reserves, pruned unnecessary investments, and hedged against rising interest rates when rates were ultra-low.
If they haven’t done the above, firms should be reducing their debt obligations quickly through redirecting any excess cash, leveraging refinancing opportunities and cost cutting. And let’s not forget the heralded debt cliffs. They are on the horizon for some MSOs and LPs, beginning in the first half of 2024.
A debt hangover with even pricier borrowing costs (and possible credit crunches, see California retailers) will see many cannabis companies forced to scale back some of their growth plans and operations. Their long-suffering investors won’t get a break any time soon. Borrowing money to then fork it over to shareholders as dividends or share buybacks makes far less sense in a world of higher interest rates.
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