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.