Description

Thesis

Tilray is a structurally unprofitable Canadian cannabis company trading at over 7x 2020 revenues despite significant a history of massively missing revenue expectations and significant negative revenue estimate revisions over the last 6 months. The company is smaller and does not have any proprietary advantages when compared to the other major Canadian licensed producers yet trades at a higher valuation multiple relative to its estimated growth rate than the other cannabis companies. Tilray has a highly promotional management team that has used a dual share structure to keep the stock’s float low allowing TLRY’s CEO to cash out over $28mm personally at highly elevated prices since the start of 2019. 

As the company continues to incinerate cash, TLRY has had to resort to increasingly toxic forms of equity financing including a large at the market equity offering and a recent stock and warrants financing. TLRY’s share count has started to explode higher and the float has become much less tight though borrow remains very expensive. Tilray will likely need to raise a couple hundred million dollars in additional equity capital before the end of the year.

Tilray’s convertible bonds trade at prices reflecting little to no enterprise value for the company even while the equity market values the company at almost  $1.6 billion. Tilray’s shares are likely to continue falling over the next 12 months as the company continues to miss revenue and earnings estimates, the company engages in another round of toxic equity financing, recently sold warrants become exercisable in September, and the remaining restricted shares become tradeable in December. I recommend selling call spreads and buying put options to profit from the continued collapse in the company’s share price. A capital structure trade long the company’s converts and short the common would also make sense. 

Overview

Founded in 2014, Tilray is a global cannabis company based in Nanaimo, British Columbia, Canada, serving global medical markets, the Canadian adult use market, as well as the hemp/CBD markets given ownership of a large hemp foods business. Tilray has also formed cross-sector partnerships in the cannabis industry, including in beverages (AB Inbev), pharmaceuticals (Sandoz, a division of Novartis) and lifestyle brands (ABG). Unlike other licensed Canadian cannabis names (or "LPs"), Tilray reports its results in US dollars. 

In 2019, TLRY derived 24% of its cannabis revenues from the medicinal market, 52% of its cannabis revenues from the adult use market and 24% of its cannabis revenues from bulk cannabis sales. 64% of TLRY’s revenues come from Cannabis with the remaining 36% coming from hemp sales. 

Tilray went public in July 2018 at $17/share in an IPO underwritten by Cowen, Roth, and Northland. TLRY shares squeezed to as high as $300/share in September 2018 and have been in steady decline since as the company has consistently missed expectations, the float opened up with the IPO lockup expiration, and the company started to raise money through equity offerings and acquire companies in all stock or mostly stock deals. 

Tilray has Cannabis operations in 15 countries and hemp operations in 20 countries. 

Capital Structure

Tilray’s convertible bonds currently trade around ~43% of par implying an enterprise value for the company of around $77MM. 

Issues with the business

1. Tilray burns significant amounts of cash which requires perpetual dilution. 

1. As Tilray has grown it’s free cash burn has gotten worse. The company continues to be on a run rate to burn almost $300MM this year. Tilray has publicly set a goal of achieving breakeven EBITDA by the end of 2020 though this seems very aggressive.

Note: On its Q1 call, Tilray guided to operating cash burn of $35-$45MM in 2020, cash interest of $40MM, and Capex of $40-$45MM for cash burn of $110 to $125MM. Given the company burned $72MM in Q1 this would imply a material improvement in the cash burn run rate over the last 3 Qs of the year. This seems very aggressive given the company’s inventory purchase commitments. 

2. Tilray has made many questionable decisions with respect to its use of cash. For example in early 2019, Tilray paid C$15mm in cash and C$55mm in stock to acquire Natura Naturals Holdings. Natura was a licensed cultivator of cannabis and the acquisition gave Tilray a 662,000 square foot greenhouse facility. Last week, Tilray announced that it was closing the facility which will result in $7.5mm in annual savings and avoid significant future capex.  

3. In recent quarters, Tilray has resorted to the use of an “at the market” equity offering facility to fund its cash burn. Tilray announced the $400MM ATM in September 2019 and raised $37MM in Q3 2019, $77MM in Q4 2019, and $27MM in Q1 2020. The company also raised $85.5MM in a registered direct equity offering at $4.76/share on March 17th to avoid a going concern qualification. This financing included 19mm warrants with a $5.95/share strike price. 

With only $174MM in cash on its balance sheet at the end of Q1 (even with $112.5MM in equity raised in Q1), at TLRY’s current cash burn rates the company would run out of cash by the end of 2020. Tilray will almost certainly have to raise additional equity this year.

4. That said, the terms of the March equity offering make it difficult for the company to issue stock in an equity offering below $5.95/share. “The pre-funded warrants and warrants contain anti-dilution price protection features, subject to stockholder approval, which adjust the exercise price of pre-funded warrants and warrants if the Company subsequently issues Class 2 common stock at a price lower than the exercise price of the pre-funded warrants and warrants. In the event additional warrants or convertible debt are issued with a lower and/or variable exercise price, the exercise price of the pre-funded warrants and warrants will be adjusted accordingly. At March 31, 2020, the anti-dilution price protection features remain subject to stockholder approval at the Company’s Annual Stockholders’ Meeting on May 28, 2020 and there are no triggering events during the three months ended March 31, 2020.”

Note: TLRY won the approval from its shareholders at its annual meeting for the anti-dilution price protection features.

5. The warrants from the March equity raise are currently in the money and can start being exercised starting in September. 

1. “ The 19,000,000 total accompanying warrants (the “warrants”) allow the holders to purchase an aggregate of 19,000,000 shares of the Company’s Class 2 common stock. The warrants have an exercise price per share of Class 2 common stock of $5.95 and are exercisable at any time after the first trading day following the six-month anniversary of the issuance and will expire on the fifth anniversary date from the date they become exercisable.”

6. The anti dilution provisions in the warrants limit Tilray’s ability to issue more equity if its share price falls 

1. “The warrants issued as part of the registered offering prohibit our ability to issue any additional Class 2 common stock prior to receipt of stockholder approval of the anti-dilution price protection feature, at any price lower than $11.90 per share (as adjusted for stock splits, stock dividends, stock combinations, recapitalizations and similar events).  Unless and until we receive stockholder approval, which will be sought at our Stockholders’ Annual Meeting on May 28, 2020, and not prior to June 30, 2020, subject to certain exceptions or warrant holder consent, we are generally prohibited from issuing securities for capital raising purposes (including under the at-the-market offering program) or in connection with mergers and acquisitions. Additionally, assuming approval by our stockholders and so long as the warrants remain outstanding, we may only issue up to $20.0 million in aggregate gross proceeds under our at-the-market offering program at prices less than the exercise price of the warrants, and in no event more than $6.0 million per quarter, at prices below the exercise price of the warrants, without triggering the warrant’s anti-dilution price protection features. If our stockholders do not approve the anti-dilution price protection features, we could be prevented from issuing additional securities altogether, which could have a materially adverse effect to our business. While we anticipate receiving approval of the anti-dilution price protection features at our Stockholders’ Annual Meeting on May 28, 2020, we cannot be assured of such approval.”

2. Gross margins in the Cannabis business keep falling since Cannabis 2.0 (edibles, vapes, beverages) was launched in Q4 2019. Based on the results of TLRY and the other Canadian cannabis companies, Cannabis 2.0 has been a major flop. Several of TLRY’s competitors have talked about how the growth in the recreational cannabis market is mostly coming on the low end in the last 6 months. Most likely this is reflective of competitors lowering prices to try to move stale inventory. The industry price war is putting further pressure on TLRY’s ASPs. 

Medical marijuana has significantly higher gross margins than recreational marijuana. As the recreational market grows, growth in the medicinal market has stalled. Incremental growth is likely to come from the lower margin recreational market putting a secular headwind on TLRY’s gross margins going forward. 

While selling prices have been falling, product costs have been relatively stable implying continued margin compression so long as average net selling prices keep falling. 

Industry wide Canadian Cannabis prices have been in steady decline for the past year.

The Canadian cannabis market is highly competitive with almost 400 licensed producers. With many of these companies now distressed (and many likely going to go bankrupt over the next 12-24 months) the current price war is likely to remain in place through the end of 2021. 

Tilray has announced a $40MM cost savings plan. Tilray has publicly stated that its goal of positive EBITDA by the end of 2020 is predicated on an assumption that gross margins improve in H2 2020. 

3. The company has extremely bloated inventories

1. Tilray has over 231 days (almost 8 months!) of inventory on hand at the end of March, after writing off over $70MM of inventory the last 2 quarters. As an agricultural commodity, cannabis does not have an infinite shelf life. According to Leafly, Cannabis starts to lose its potency and flavor after 6 months. 

2. TLRY’s bloated inventories have resulted in the company starting to have regular inventory write downs. Inventory write downs went from $0.2MM in 2017 to $0.4MM in 2018 to $68.6MM in 2019, to $4MM in Q1 2020. 

3. TLRY is saddled with $111.5MM of non-cancellable minimum inventory purchases over the remainder of 2020. Those purchase commitments alone amount to 3 quarters worth of COGS at the Q1 run rate.  

4. Industry inventory is quite bloated as well with the industry sitting on almost 10 months of unsold finished goods inventory and substantially more unfinished inventory.

Source: Health Canada

Working off the massive oversupply in the industry is likely to take years not months. Inventory liquidations by competitors (as reflected in the growth of low end “value” cannabis brands) is likely to be a material headwind for Tilray’s margins for the remainder of 2020 and makes the company’s goal of achieving EBITDA breakeven by the end of 2020 unlikely. 

4. The root cause of the inventory oversupply for TLRY and the industry is the simple reality that the Canadian recreational cannabis market is growing much slower than expectations and the assumptions that were used to finance the build out of massive Cannabis growing capacity within Canada. 

Licensed retail stores had been growing linearly until March when new store growth halted. A lack of new store growth should slow the growth in the adult use market over the coming months though COVID-19 related lockdowns likely have had a slight positive impact over the last few months on aggregate industry retail sales. 

5. Tilray is paying to use Brendan’s corporate jet

6. Insiders control the company through super voting stock. 

Holders of Class 2 common stock have limited voting rights as compared to holders of Class 1 common stock. We cannot predict the impact that our capital structure and concentrated control may have on the market price of our Class 2 common stock.

Brendan Kennedy (our Chief Executive Officer and President and a director), Michael Blue and Christian Groh, including individual and affiliated entities, beneficially own or control approximately 65.5% of the voting power of our capital stock.  Class 1

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common stock, held entirely by such individuals and affiliated entities, has 10 votes per share, resulting in such individuals and affiliated entities controlling a majority of the voting power of all outstanding shares of our capital stock and control of all matters that may be submitted to our stockholders for approval as long as they hold at least approximately 10% of all outstanding shares of our capital stock. Generally, a transfer by these individuals and entities of the Class 1 common stock they hold would cause a conversion of such shares into Class 2 common stock (including, if there is a transfer of Class 1 common stock, or entering into a binding agreement with respect to the power to vote or direct the voting of such shares). However, a transfer to certain entities controlled by such individuals, such as estate planning entities, would not result in a conversion and these individuals would continue to hold Class 1 common stock the superior voting rights of 10 votes per share. This concentrated control reduces other stockholders’ ability to influence corporate matters and, as a result, we may take actions that our stockholders other than Messrs. Kennedy, Blue and Groh do not view as beneficial. Further, the concentration of the ownership of our Class 1 common stock may prevent or delay the consummation of change of control transactions that stockholders other than or Messrs. Kennedy, Blue and Groh may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. As a result, the market price of our Class 2 common stock could be adversely affected.

Additionally, while other companies listed on United States stock exchanges have publicly traded classes of stock with limited voting rights, we cannot predict whether this structure, combined with concentrated control by Messrs. Kennedy, Blue and Groh will result in a lower trading price or greater fluctuations in the trading price of our Class 2 common stock as compared to the market price were we to have a single class of common stock, or will result in adverse publicity or other adverse consequences.

7. CEO Brendan Kennedy has been a major seller of TLRY’s stock having sold over 641k shares in the last 16 months netting over $28MM personally. 

In addition in May, one of TLRY’s directors exercized 2024 and 2025 options to sell stock at $7.38/share. 

8. 37.5mm shares unlock on December 13th unless the company comes to an agreement to early release more shares.  

Future sales or distributions of our securities could cause the market price for our Class 2 common stock to fall significantly.

Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the market perception that the holders of a large number of shares of our Class 2 common stock, or shares of our Class 1 common stock which are convertible into Class 2 common stock on a one-for-one basis, intend to sell our Class 2 common stock, could significantly reduce the market price of our Class 2 common stock.

Pursuant to the Downstream Merger, former Privateer Holdings stockholders who received shares of our common stock in the Downstream Merger entered into a lock-up agreement.  Each Privateer Holdings equity holder who received shares of our stock in the Downstream Merger is subject to a lock-up allowing for the sale of such shares only under certain circumstances over a two-year period. During the first year following the closing of the Downstream Merger, unless otherwise approved by us, shares will be released only pursuant to certain offerings or sales arranged by and at our discretion. We may also determine to release shares from the lock-up in the absence of an offering or arranged sale if we determine it to be in the Company’s best interest. At the end of the first year, to the extent not already released at our discretion as a result of the aforementioned offerings or sales or otherwise, 50 percent of the total shares subject to the lock-up will be released, or approximately 37.5 million shares. Over the course of the second year following closing, the remaining shares will be subject to a staggered release in four equal quarterly increments, which we also could choose to waive to allow earlier release in our discretion.

On April 3, 2020, we released 11 million shares of our Class 2 common stock from the restrictions under the Downstream Merger lock-up agreement.  We cannot predict the effect, if any, that sales of those released shares or any future public sales of our securities or the availability of these securities for sale will have on the market price of our Class 2 common stock. Shares held by former Privateer stockholders represent approximately 75 million shares or 73% of our currently outstanding shares and, therefore, represent a significant overhang on our stock.  If the remaining portion of the former Privateer Holdings stockholders’ shares are released on the one-year anniversary of the Downstream Merger or an additional significant portion were released earlier by us, it could put significant downward pricing pressure on our stock. If the market price of our Class 2 common stock were to drop as a

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result, this might impede our ability to raise additional capital and might cause our remaining stockholders to lose all or part of their investment.

It is worth noting that Privateer Holdings (the owner of these yet to be unlocked shares) is Brendan Kennedy’s private equity firm. 

9. Sell side revenue estimates for 2020 and 2021 have been consistently declining over the last 6 months.

Source: Sentieo

10. Tilray trades at a premium valuation relative to its growth rate versus the other Cannabis companies

TLRY currently trades at 7.3x 2020 revenues a discount to Cannopy (CGC) and Aurora (ACB) who have substantially higher revenues.  

Appendix

I’ve attached Cowen’s model for TLRY. Even with aggressive assumptions for the growth of the recreational business, the company remains solidly unprofitable through 2021.

Catalyst

Additional equity raises and acquisitions using equity.

Continued revenue/earnings misses and negative revenue/earnings revisions

Warrants become exercisable in September.

Remaining Privateer Shares unlock in December.

Continued Insider selling.