Green Versus Green

More insolvencies and consolidations are seen for the cannabis sector in 2020; in agribusiness, food security may become more important in the wake of covid-19

LIKE many sectors, the agricultural sector has experienced disruptions to business due to the novel coronavirus pandemic. Bars, lounges and other providers of recreational substances — including cannabis producers — have also been hit hard.

Help for agribusiness — and for the cannabis sector — is now coming from government by way of aid programs. More broadly, however, the two sectors continue to be treated differently in funding their growth by both the government and private lenders. And agribusiness could ultimately benefit as a public policy focus on food security may mean prioritizing Canadian-grown food.

For now, though, “none of us know what this will look like” after the COVID-19 pandemic ends, says Stewart Sutcliffe, head of the private equity and private mergers & acquisitions groups for Stikeman Elliott LLP in Toronto. How growth develops in agribusiness and cannabis alike “depends on how the exit from COVID goes,” he says.

“Will other governments be more protectionist in the wake of this? It’s wait and see for now.”

In May, Agriculture and Agri-Food Canada, on behalf of Farm Credit Canada, announced a $100-million Agriculture and Food Business Solutions Fund to support companies through unexpected business disruptions such as the COVID-19 pandemic. Launched in partnership with Calgary-based Forage Capital Inc., the fund will support a range of enterprises in the agribusiness and agri-food sector, including companies involved in primary production, agri-tech, manufacturing, packaging and distribution. The fund is expected to help companies by offering convertible debt investments and other flexible financing solutions, with successful applications being supported to a maximum of $10 million.

And, in April, the Business Development Bank of Canada and Export Development Canada announced that bars, lounges and the cannabis sector would all have access to the $40 billion in new credit during the COVID-19 crisis. Like much of the retail sector, cannabis stores, too, have been forced to close due to the pandemic’s physical distancing requirements and restrictions against congregating.

That the government included cannabis businesses in its economic response plan “is interesting,” says Paul Davis, national chairman of the Capital Markets and M&A Group for McMillan LLP, based in Toronto.

“On the farming side, the Farm Credit Canada has made a full suite of lending products available to legal cannabis producers and others in Canada.”

Primarily, though, the cannabis sector is relying on other forms of financing. In 2018-2019, equity capital raised in the sector was down 31 per cent and debt was up 28 per cent, Davis says.

“The trend was becoming clear based on changing fundamentals. When you look at companies raising money now, there are companies that are profitable with a strong balance sheet, that are funding growth from their own operations. Many others that are not profitable, they’re using every tool in their respective toolboxes to raise capital.”

Those tools include:

  • Base shelf prospectus, where certain dealers/issuers can offer and sell securities to the public without a separate prospectus for each act of offering and without the issue of further prospectus;
  • Bought-deal financing, in which brokers purchase securities from an issuer before a preliminary prospectus is filed “and then place it with their clients”;
  • Private placement of equity, in some cases from the companies’ key shareholders;
  • Convertible debt financing, “one of the key drivers of growth in this industry,” when a company borrows money from an investor or group of investors with the intention of converting the debt to equity at some later date;
  • Sale of non-core assets; and
  • Restructuring capital to buy more time.

Leilani Kagan, a corporate lawyer at Thompson Dorfman Sweatman LLP in Winnipeg, sees cannabis companies as “funding growth in different ways” to agribusiness because the legalization of cannabis production and retail sale for recreational use is still very new from a legal/regulatory perspective.

“So, traditional lenders are not yet all in the cannabis lending space,” says Kagan. “It’s still a very new industry to lend to from a traditional lender perspective, and the traditional chartered banks . . . are not necessarily able to lend into the cannabis space.”

Canadian banks that have U.S. branches and regulatory and compliance requirements are not able to lend into the cannabis industry, she says, which precludes a lot of producers in that industry to access lending. “Once we see federal legalization in the U.S., I believe that will then open up the market here for cannabis producers to access more traditional forms of lending.

“Until that happens, there will always be [a] disconnect between [agribusiness and cannabis],” she says.

A trend toward consolidation is also expected to continue in the cannabis market.

“I think that the consolidation and rationalization [of the past year or so] has led to more confidence in producers that are currently active,” Kagan says. “This will eventually open up the market to more access to capital — bank lending and private equity — because producers that are still active have withstood [buyout etc.], have shown they have a good business model, a business plan, which will turn into better access to lending for those that are currently active.”

At the same time, Davis predicts that insolvencies will increase in the cannabis space, which saw their glory days dim in 2019.

“Cannabis has been the high-profile, significant-growth new industry,” he says. “And it’s gone. It’s going through what I call the normal cycle, which is financing, M&A, restructuring/consolidation, continuing.”

There were three insolvencies in the cannabis sector before December 2019, two in December and six in the first quarter of 2020, he says — “and more to come. This bodes well for those with strong balance sheets, and there’ll be opportunities. It will be clearly easier for regulated cannabis companies because of the way regulations work with Health Canada licences.”

After the 2008 financial crisis, there was also an increase in contested transactions, Davis notes, adding that he believes it more likely that cannabis will come under attack than other sectors. In contested transactions, with valuations falling, investors may see an opportunity to make a hostile takeover bid or to change the board of directors or take other business steps without a proxy fight.

“We see those trends as likely.”

Davis also foresees short-selling campaigns for those companies with weakened balance sheets. Short-selling is speculation on the decline in a stock or other securities price, where an investor sells a security on the open market, planning to buy it back later at a lower price.

“When you look at the M&A trend [in the cannabis sector], it’s down worldwide. The frothy M&A is over; it fell short of expectations, with falling valuations.” But M&A is not dead, he says. “We’re now in a buyers’ market and expect consolidation to continue. Opportunities will be created . . . for issuers that have [a] strong balance sheet in cash; there’ll be real opportunities.” Distress M&A will grow for cannabis companies in trouble and who must sell. “There will be opportunities.”

On the agribusiness side, the more successful companies are expanding into artificial intelligence and data collection, says Kagan. Farming is becoming high-tech, “and that data is valuable. . . . So, we’re seeing a number of people become interested in the industry because of the data it produces.”

And in light of the pandemic, and going forward, “it will be more important for Canadian players to be well funded and well capitalized, to produce, manage and supply food all within our own national ecosystem,” she says, so that Canadians won’t have to look outside their own country for food.

“I can see agribusiness getting a boost from capital projects, infrastructure and produce, manufacture and process all within Canada.”

The challenges will be greatest for smaller or more local businesses, says Stikeman’s Sutcliffe. For those businesses especially, “cash preservation is paramount right now.”

“And whether it’s strategic partners, whether it’s joint ventures or trying to access public markets or, frankly, rely on their relationships with their existing bank, I think each of those businesses that aren’t already well capitalized are going to have to take that as it comes.”

And with no immediate end in sight to the economic downturn caused by the coronavirus pandemic, Sutcliffe says, “it’s a tough time to talk about trends because, in the short term, it’s just such a unique situation. Is it a medium-term or a long-term issue? I guess we’re all going to find out.”