Description

Greenspace Brands Inc. (JTR)

Recommendation

Buy JTR equity.  If you have some beer money lying around to bet on a lottery ticket, JTR might be of interest. JTR is distressed because it has a major liquidity problem and successfully turning around a mess like this is usually a low probability endeavor and therefore the likelihood of a total wipeout is high.  Having said that, JTR's brand portfolio has significant value and sized properly, I believe an investment in the equity at current levels has the potential to be a homerun – IF(!) a few things end up going right.

Based in Canada, the Company is a busted roll-up of emerging organic/natural food companies where the top line and market cap have been going in opposite directions.  The ugly stock chart is easy to explain – the business has been managed for hyper top line growth at the expense of profits and well, bad things happened as they often do to aggressive rollups.  JTR’s market cap has shrunk to a miniscule $15mm while its enterprise value is now $37mm. In early 2018, the Company sported a market cap of $120mm and so the value destruction that has taken place here in a very short period of time is shocking.  

What’s interesting is that while the valuation has collapsed, the Company’s key brands continue to grow (with an occasional hiccup) and show good progress at the retail level – Y/Y organic growth rate has reached ~20% in recent quarters for some of the key brands.  LTM revenues are $81mm and as of a couple of months ago, the business was on track to get close to $100mm by the end of 2019. This suggests that JTR is trading at 0.46x LTM revenues, an undemanding multiple for an emerging natural foods company. In an ideal world where JTR wasn’t a forced seller and put itself up for sale, I believe it would fetch considerably more than $37mm.  In fact, I believe that the Company owns a brand, maybe even two, that could sell for over $30mm on its own. Without making heroic assumptions, I estimate the brands today are worth $90 – 130mm in total which results in JTR equity valuation of $0.90 – 1.40/sh versus the current share price of $0.21. Yes, you read that right and no, I haven’t written this up after consuming one of the Company’s cannabis products (yes, they will soon have them but I’ve ignored this free option in the report). But will this value be realized in full? Realistically, the odds are against it.      

As you might expect, there’s always a catch, or in this case a few.  There are no profits to be found here, or for that matter even positive EBITDA, at the moment.  If that wasn’t scary enough, the Company has maxed out its ABL credit facility, which also happens to be in technical default (though the lender has provided a waiver).  The facility matures later this year and will have to be extended. JTR is currently surviving on a high interest rate loan from a vulture lender. Additionally, the Company doesn’t have a CFO right now and even when it does, they tend to leave after a short period of time – but I believe that probably has more to do with not being able to work with the difficult CEO/Founder than anything else.  Could there be fraud? It’s possible but I haven’t seen any evidence of this. Finally, there’s a $7.7mm seller note due in January 2020 that the Company obviously can’t pay off given its liquidity situation today. All together sounds very compelling, no?! Clearly not to the large holders who have been selling their stock to dumpster divers like me in recent weeks.

Insiders, who collectively own ~12% of the Company, also believe that the market is undervaluing the assets as they’ve recently purchased $355k worth of stock within the last year at much higher prices.  Management is openly frustrated with the stock price but they have nobody to blame but themselves. While not a bad guy, the CEO/Founder, Matthew von Teichman, has demonstrated to be highly arrogant and stubborn in his pursuit of rapid top line growth even as investors pushed back on the strategy.  But he’s finally had his ‘Come-to-Jesus’ moment and recognizes that the Company is destined for bankruptcy unless he reverses course from his failed strategy and takes aggressive action immediately. With ownership of 6.2mm shares, or 8.3% of the Company, he has personally seen ~$8.4mm of his net worth vanish in about 12 months and he can’t possibly be too happy about that.  

While the CEO has no intention to sell the Company given the long runway he sees for further growth, the ugly balance sheet leaves him no choice but to engage in strategic transactions in the coming months/quarters. I believe that he will either sell a major brand or bring in a partner(s) to invest in one or more of their brands.  The benefits of this will be twofold: one, it raises much needed liquidity and strengthens the balance sheet, and two, it will highlight the disconnect between JTR’s public market valuation and the private market values for its brands. I believe the stock could rerate higher on these developments.

The way I see it, there are two ways to win here.  The first is a near-term breakup scenario where one or more brands are sold to pay off debt leaving JTR a much smaller company.  While I think the stock will work in this scenario, this is not my preferred outcome as I doubt a distressed forced seller gets anywhere near full value for its assets.  A much more interesting scenario is one where the key brands remain within JTR control, the balance sheet is right-sized, and the business is turned around and managed for profitability with a much slower top line growth.  The tricky part will be the balance sheet but one way to raise liquidity is by doing brand level deals – for example, selling a minority interest in Love Child for $10 – 12mm. While its painful to give up ownership in the crown jewels, it’s a small price to pay to address the mistakes of the past and still preserve the optionality to grow the business into a $100 – 150mm top line business over the next several years.  In this scenario, it wouldn’t be a stretch to think that the equity value of JTR could exceed $150mm in 2 – 3 years.

The ways to lose here should be obvious.  Either they raise liquidity in the next two or three quarters or this Company restructures and investors lose money, perhaps all of it.  And between now and then, there will likely be more bad news reported and some of it may be completely out of left field.

Company / Business Overview

JTR is a Canadian company with a business strategy to develop, market and acquire and sell high-quality natural and organic food brands within the North American marketplace. It was formed in April 2015, when Life Choices (founded by current CEO, Matthew von Teichman, in 1999) completed a reverse take-over transaction with Amuento Capital (a shell corporation).  Following the completion of the reverse take-over transaction, JTR quickly commenced on its consolidation strategy. Today, JTR has six distinct brands that are distributed primarily through grocery stores such as Loblaws, Metro, Safeway and others. The Company’s current brand portfolio includes: Love Child Organics, Central Roast, Kiju Organic, CEDAR, GO VEGGIE, and Meatbar.  A seventh brand called Riot Eats will be rolled out sometime mid-year. Of these brands, four move the needle from a revenue and valuation perspective – Love Child, Central Roast, Kiju and GO VEGGIE. The other two are still very early in their life cycle and its unclear whether they take off or fail.

It’s no secret that organic and natural is a fast growing segment within the global and N.A. food industries.  The Canadian organic sector, just like the US organic sector, is on fire. The Canadian organic market share has reached 2.6% of grocery market sales for food and beverage – this is a up from 1.7% in 2012, suggesting that this is no longer just a small and niche industry.  Consumer demand for organics is growing at an unprecedented pace, now allowing organic to hold the title of the fastest growing sector in Canadian agriculture. While produce is the largest category in the organic food and beverage market by value, demand for ready-to-go and value-added organic products (a manufactured product that adds value beyond the primary ingredient) is growing rapidly.  Industry research shows that the organic food processing sector in Canada has been growing by 10%+ per year.  Baby food and other foods for infants and young children have strong market share in the Canadian organic market. Adults tend to begin purchasing organic products once they have children. Millennials are also contributing to the growth of the organic market in Canada. They’re significantly more likely to purchase organics, with 83% of millennial respondents identifying as organic consumers.  These trends position JTR’s brands nicely for further growth in the coming years.

A core focus of JTR’s growth strategy has been the acquisition of smaller natural and organic food brands (with less than $25mm in revenues), which offer innovative products and have attractive growth potential, but lack the necessary financial resources or relationships to take it to the next level.  The thinking was that JTR’s established platform, deep industry relationships and access to the equity capital markets would position the company as a consolidator in the highly fragmented organic foods industry. While this playbook worked for a while, the most recent acquisition in 2018 has put the Company’s future in jeopardy.

Current Situation

How did we get here?  Let’s first take a listen to the CEO’s mindset before the wheels started to come off the bus:

“So I'd like to talk to you about the great debate that rages between management and some of our shareholders around how we view decision-making surrounding top line growth versus growing EBITDA.  As an overarching thought, we believe that the long-term interests of shareholders are best served by growing the top line as quickly as we can. We feel that investing in the launch of new products within our main brands, although very costly, keeps the blood pumping through those brands and makes sure that we are always considered the innovation leaders. We're also focused on winning new distribution and driving more people to stores, which are also costly exercises but are critical in growing the overall profile of the brands as well as the revenue attached to each one.

At the end of the day, we are certain that the long-term value of the company is not influenced by whether we generate $1 million or $3 million in EBITDA in a given quarter, but rather how meaningful the brands have become to consumers, which is represented best by revenue. Given that we take as many opportunities as we can to focus on top line growth, as that's where the value in the business lies, 20% growth in listings and revenue will add significantly more value to our business long-term than 20% growth in EBITDA.”

While this wonky strategy to forgo profits didn’t harm JTR much as long as EBITDA hovered around breakeven, the flaws in the business model started to show after JTR acquired the GO VEGGIE brand.  When the transaction was announced, investors condemned it calling it risky and outside the Company’s comfort zone. This transaction of $23mm was double the size of its largest previous acquisition and partly financed with seller financing that has now become a big balance sheet problem.  Before this transaction, JTR was almost exclusively a Canadian business with no presence in the U.S. market. GO VEGGIE was exclusively a U.S. brand and so this acquisition made very little strategic sense for a small company like JTR. Furthermore, the brand was in decline which meant that it would require a lot of management attention in order for it to reach full potential.  So why make this acquisition? Again, let’s listen to the CEO’s rationale:

“The acquisition of GO VEGGIE is a massive acquisition for us and it is a critical step in our path to being a billion dollar business, which is one of our long term goals. Over the last year we’ve realized that to fulfill our goal of getting meaningful scale, we need to be in new markets, not just Canada, and the U.S. will be a key.”

“We want to be a very large company and you can't be a big player in the natural food world without a big U.S. business. So we're investing to make sure that we're able to build a big U.S. business properly from the beginning. The additional expenditures in the U.S. will be money very well spent as we start to see momentum in that business over the coming 6 months.”

Unfortunately, six months later, there was no momentum to be found.  Management quickly found out that running a new U.S. business from Canada was not a simple exercise.  The costs in the U.S. were much higher than their Canadian equivalent and they were even more so as management invested to reinvigorate the declining GO VEGGIE brand with new product launches.  On account of these elevated expenses at GO VEGGIE, JTR’s EBITDA went from marginally positive to negative causing the liquidity crunch that the Company is currently experiencing.

As often is the case in situations like this, the lack of liquidity on account of the botched GO VEGGIE acquisition has led to operating problems at some of the other brands.  The hardest hit so far has been Central Roast. In the most recent quarter, the Company was unable to purchase sufficient inventory in Central Roast to satisfy orders leading to a substantial decline in sales, both Y/Y and sequentially. The rest of the brands have so far been spared and continue to grow but without a fix to the cash problems, it’s safe to assume that they too will be hurt in the future.  

So how is management responding to these challenges?  First, they eliminated or sold smaller brands (Rolling Meadow and Kiwi Pure) that didn’t offer a lot of future upside.  They finally realized that it’s better to invest in a small number of brands that have real potential to be disruptive than spreading around resources they don’t really have across too many brands.  Second, they restructured the business to cut costs in an effort to get back to positive EBITDA. The U.S. administrative office was closed and operations and finance functions were moved up to the Canadian platform.  Finally, all M&A and strategic options are now on the table in an effort to generate liquidity and reduce debt, in particular the Galaxy note due next year. I imagine this includes outright sales of brands or taking on brand level equity partners.  

Brand Overview

Love Child Organics

In October 2015, JTR acquired Love Child, a producer of 100% organic food for infants and toddlers. Love Child’s mission is to bring to market only the purest, most natural and nutritionally-rich food, boosted by superfoods such as Quinoa, Acerola and Chia and without the addition of any synthetic preservatives, refined sugars or other additives. Love Child’s products include organic purees in BPA-free squeezable pouches and an extensive infant and toddler organic snack range, available at Canadian retailers including Whole Foods, Loblaw, Shoppers Drug Mart, Overwaitea Food Group and Walmart Canada.  Love Child has benefited from some innovation that has been very well received by the market generally, including some new pouches featuring prunes or avocados that have jumped to the top of the list in terms of sales velocity at store level after just a shot amount of time on shelf.

All in, this acquisition ended up costing the Company $8.0mm, or 1.5x sales.  I estimate the current run rate revenues for Love Child is ~$24mm, up more than 4x from the time of the acquisition, and is growing at 15 – 20% per annum.

Central Roast

In February 2016, JTR acquired 70% of the outstanding common shares of Central Roast.  In October 2016, the Company purchased the remaining 30%. Central Roast is a leading, all-natural functional snack company that manufactures, markets, and distributes healthy snacks through the major retail channels in Canada. Central Roast’s products include raw and roasted nuts, trail mixes, and for special occasions, sweet treats, available at a wide range of significant grocery retailers across Canada.  In total, this acquisition ended up costing the Company $16.5mm, or approximately 1.5x sales.

I estimate the current run rate revenues for Central Roast is ~$20mm, up 60% from the time of the acquisition, and was growing double digits prior to the recent inventory shortage issue arising from the Company’s lack of liquidity.

Kiju

In January 2017, JTR acquired Kiju, an organic juices and drinks company. Kiju is a brand leader in the Canadian shelf stable organic juice segment and markets and distributes a variety of juices through major consumer retail channels in Canada and to a number of select customers in the U.S.  The Company paid ~$9.2mm in total for this acquisition, or 1.2x sales.

I estimate the current run rate revenues for Kiju is ~$11mm, up 30% from the time of the acquisition, and growing at 15 – 20% per annum.  

GO VEGGIE

In January 2018, JTR acquired Galaxy Nutritional Foods, which owns the GO VEGGIE brand.  Over 40 years ago, Galaxy created the cheese alternative category for health conscious consumers and remains a leading provider of cheese-free products.  Across its product portfolio – Vegan, Lactose Free, and Lactose & Soy Free – GO VEGGIE offers more than 55 products in a wide variety of formats. GO VEGGIE is one of the leading cheese alternative brands in the U.S. with distribution in over 12,000 locations through most major grocery retailers and natural food chains, along with a growing food service business. The plant based dairy alternative market is one of the fastest growing subsets of the natural food market, but has very few established players.  Total consideration paid was US$17.8mm, comprised of US$4.5mm in cash, US$7.62mm in stock and a two-year vendor take back loan of US$5.72mm, carrying an 8.5% coupon. The Company issued 7.16 million Common shares at $1.37/sh as part of the transaction.

I estimate the current run rate revenues for GO VEGGIE is ~$US$15mm, down from US$18mm at the time of the acquisition.  Much of this decline was as a result of eliminating unprofitable lines of products within the brand. Having said that, I don’t get the sense that there’s been any organic growth here yet.  

CEDAR

In August 2017, JTR acquired CEDAR, a brand in the cold pressed juice category.  The brand was launched in 2014 with a unique line of super food based, high pressure processed, cold pressed juices. An extended shelf-life and smaller package size allowed CEDAR to gain national distribution in the grocery and natural channels, capitalizing on the growth and popularity of cold pressed juice at independent juice bars. Wide spread consumption among millennial females, young Mom's and health seekers has established CEDAR as the go to brand for plant-based products among this customer segment. From this base, CEDAR launched a line of plant-based spreads, Kombucha and probiotic enhanced beverages, coast to coast.  This acquisition cost the Company ~$5.8mm, or 1.3x sales.

I estimate the current run rate revenues for CEDAR is ~$6mm, up more than 50% from the time of the acquisition, and is growing at double digits per annum.

Meatbar

Meatbar was internally developed by the Company and launched in April 2018, and is trying to win distribution nationwide. Meatbar features grass fed meats with assorted spices, nuts and seeds in a convenient and familiar ‘bar’ format, feeding very well into the macro trends of high protein, simple ingredients and convenience snacking. Early indications appear to be for a favorable response from the industry, particularly in the Gas and Convenience channel. The current flavours include Sriracha which features grass fed beef, antibiotic free pork and nitrate free bacon; Sweet and Savory which features grass fed beef, cranberries and pumpkin seeds; and Original, simply featuring grass fed beef and assorted spices.  So far, this brand has not met management expectations as it hasn’t seen the sell through velocity in the food, drug and grocery channels. Sales within the C-store in the gas and convenience channel has been quite good but it hasn’t gotten the kind of distribution management had hoped.

Revenues from this brand are currently insignificant to the Company.

Riot Eats

Riot Eats, also internally developed, is now the second plant-based food brand that JTR owns after it acquired GO VEGGIE. Riot Eats is entering the market with several new products across multiple categories including plant-based cheese alternatives, butter substitutes, and spreads.  The Company decided to invest in more vegan food brands because of the impressive numbers that plant-based products have hit. According to Nielsen and the Plant Based Foods Association, sales in the category are rising 20% annually, topping $3.3bn. The Riot launch, which was due to be launched in May, was pushed back to mid-year to align with a major customer reset.  Management is very excited about Riot Eats and believe that it could end up being a big success as the product and brand positioning has been well received by buyers in the U.S.

Capitalization

JTR has $23.2mm in total debt which could increase by another $2.0mm should it draw the balance on the Primary Capital loan.

At the secured level, the Company has an ABL facility with $13.2mm drawn on it.  The facility is secured by substantially all of the assets of the Company and contains a standard fixed charge coverage covenant of 1.1:1.  The Company is not in compliance with this financial covenant, however the bank has provided a waiver for the default. The facility has to be rolled over in October 2019 and while the lender has been very supportive during the Company’s difficulties, there’s no guarantee that they will want to stay in the loan come maturity.  

Additionally, the Company has recently entered into an expensive loan agreement with Primary Capital providing for a $4.0mm facility comprised of an initial principal amount of $2.0mm and an additional $2.0mm available on standby which may be drawn at any time within the first six months. The loan matures in one year and carries an interest rate of 1.0% per month, increasing to 1.5% per month after six months or if the first $1.0mm on standby is advanced. If the second $1.0mm on standby is advanced, the Loan will bear interest at a rate of 2.0% per month.  The Loan is guaranteed by The Cold Press Corp., a wholly owned subsidiary of the Company which distributes the Company's CEDAR brand, and is secured by a second lien on some of intellectual property. Obviously, this toxic loan needs to get paid off ASAP.

At the unsecured level, the Company has a $7.7mm seller note obligation due in January 2020 relating to the GO VEGGIE acquisition.  It’s not clear what rights the creditor here has and what action they might take should this note go unpaid at maturity. Given that the creditor is Mill Road Capital, a sophisticated investment firm, it’s likely they will look to take a pound of flesh if asked to restructure the paper.  For this reason, it is imperative that JTR raise liquidity to pay off this obligation in cash.

Summary Financials

JTR has grown revenues from $4mm to $81mm in a very short period of time but it came at the expense of cash flow.  The cash shortfall was bridged with additional debt and equity capital raises when brands were acquired. But now that the capital markets are pretty much closed to the Company, it has no choice but to live within its means and cut expenses and get back to cash flow breakeven.  

SG&A as a percentage of revenue has exploded since the Company acquired GO VEGGIE.  Much of this incremental cost is coming from the cost associated with creating the new Riot Eats brand, but much is also due to a general operating structure in the U.S. that is much more expensive than the Canadian operating structure. However, now that the U.S. administrative office has been closed and relocated to Canada, SG&A will decline over the course of the year.  There’s now a clear path to getting to 2 – 3% EBITDA margins assuming that revenues hold up and don’t contract the way they did in the most recent quarter.

Valuation Thoughts

Honestly, nobody really knows with any certainty what a large CPG company or PE fund will pay for the types of emerging brands that JTR owns.  In recent years, natural and organic companies have been acquired at multiples below 1.0x revenues to in excess of 6.0x revenues. The table below shows some recent transactions that could be relevant data points for valuing JTR assets.

In the table below, I’ve taken a stab at a SOTP for JTR.  Obviously, take it with a grain of salt. I acknowledge that the Company may not realize these numbers, either in M&A transactions or in its public valuation, given its distressed situation and the need for immediate liquidity. Love Child is the most valuable asset and given its growth rate and reach, I think its reasonable to assume that it could sell for 1.5 – 2.5x revenues.  The CEO is very confident that it would fetch even more than this. Even though Central Roast and Kiju are very attractive assets for potential buyers, for the purposes of this analysis, I’ve assumed that the rest of the brands are less valuable and therefore would trade for 0.8 – 1.5x revenues.  Admittedly, I have the least confidence in what GO VEGGIE is worth. Given the strong underlying growth in the market for plant-based products, there’s enormous upside in this brand if management can successfully reposition it. A growing brand with good distribution in this segment would surely be worth 2.0 – 3.0x revenues.  Having said that, it’s not clear if the brand continues to be in decline and whether it’s been further damaged under the short ownership of JTR.

Based on these simplistic assumptions, I value the brand portfolio at $90 – 130mm in total.  Assuming these brands continue to grow as they have been, I believe their values increase by double digits per annum for the foreseeable future.  

Based on this SOTP, I get to a value of $0.90 – 1.40/sh for JTR equity, which compares very favorably to the current stock price.  Note that this valuation assumes that the Company burns through all of its cash and draws on the remaining $2.0mm available on the Primary Capital facility.  

In summary, there's definitely asset value here to pay off obligations and for equity to make out well. It's just a matter of execution and probably some element of luck. The tough decisions the Company makes, or does not make, in the coming months will dictate what happens to equityholders. If they immediately start shopping the assets, then there's time to maximize the value of the brands. If they wait till the end or only shop the less attractive assets, its possible that they will fail in their efforts to get out of this mess. There needs to be urgency and realistic expectations and I hope the CEO and the board realize this.

So maybe skip the trip to Vegas this year and instead consider placing a bet on Green……space Brands!

Catalyst

* Liquidity raise from some type of a brand level transaction

* Refinancing of the ABL

* Redemption of the Galaxy seller note and Primary Capital loan

* Operate business for profitability rather than just for revenue growth