What Makes Hexo An Acquisition Target Despite Its Cash Burn And Dilution Risk?

Canadian cannabis company HEXO (NASDAQ: HEXO) released its fiscal first-quarter results on Tuesday, reporting a wider loss and announcing a new strategic plan dubbed “The Path Forward.” 

The company recorded a net loss of CA$116.9 million ($90.08 million) compared to CA$67.9 million prior quarter and CA$4.2 million last year.

Its quarterly sales reached CA$50.2 million, an increase of 29% from Q4 FY21 and up 70% from Q1 FY21.

HEXO closed its acquisition of Redecan and 48North, which contributed net revenues of CA$13.5 million and CA$1.1 million, respectively, during the two months ended October 31.

The company forecast positive cash flow within the next four quarters based on the incremental cash flow of C$37.5 million in fiscal 2022 and an additional C$135 million in 2023.

HEXO said that new measures under the strategic plan include five priorities: reducing manufacturing & production costs, streamlining & simplifying its organizational structure, realizing cost synergies, focusing on revenue management and accelerating growth through organic market share gains.

The Analyst

Cantor Fitzgerald analyst Pablo Zuanic kept a “Neutral” rating on HEXO's stock while lowering the price target to CA$1.20 ($0.93) from CA$2.10. 

The Thesis 

HEXO's quarterly sales missed FactSet consensus estimates by 7%, pointed out Zuanic, explaining that the company’s ongoing cash burn, negative EBITDA and dilution risk from the $20 million in monthly redemption present more important concerns.

What’s more, the dilution risk could also represent a $60 million quarterly payment in cash in case that the holder does not accept equity or if the holder is at a 9.99% share ownership, which would be hard for HEXO to handle, the analyst explained.

“All this said, we recognize Redecan is the company’s crown jewel, and itself makes HEXO an acquisition target.”

Zuanic further highlighted that HEXO valued Redecan at CA$925 million (cash and stock) when the deal was announced in late May, while now Cantor estimates the current HEXO evaluation at CA$770 million (taking into account SSCN), noting that “erstwhile Redecan bidders could get that asset plus ‘the rest of HEXO’ at a lower price (true, the AdvisorShares Pure Cannabis ETF (ARCA: YOLO)is down 37% since in the interim).”

“But the landscape and B/S risk prevent us from calling this a trading opportunity, and we prefer to remain sidelined,” Zuanic concluded.

Price Action 

Hexo’s shares traded 4.89% lower at 83 cents per share. 

Photo: Courtesy of davide ragusa on Unsplash