Special purpose acquisition vehicles (SPACs) struggle to find suitable buys as valuations fall
By Dane Hamilton
The cannabis stock selloff over the last year which caused investments to go up in smoke also threatens to upend plans for cannabis special purpose acquisition companies (SPACs) that were formed in the last year to buy cannabis assets when values were high, industry experts say.
Over a dozen SPACs have collectively raised over $3 billion from June 2019 through the present with mandates to buy cannabis and cannabis-related companies, according to cannabis-focused investment bank ELLO Capital. The companies typically have 18-to-24 months to buy private companies or give the money back to investors.
But with valuations across the industry in a continuing slump from highs in early 2019, these SPACs are scrambling to find viable acquisition candidates that fit their revenue and valuation mandates, raising pressure on these managers and their investors, advisors said.
“They are starting to come up against their termination dates and they will start getting desperate,” said Hershel Gerson, CEO of ELLO, who advises on cannabis mergers and acquisitions, capital raises and other deals.
The North American cannabis industry, once viewed as having virtually unlimited growth potential, has fallen to earth in the last 18 months due to a variety of factors, including continued national and state regulatory restrictions, inexperienced operators and a lack of solid institutional investor bases that support companies longer-term. The MJ Alternative Harvest, a proxy for the industry, has fallen over 75% from early 2019 to March 2020, although it has rebounded slightly in recent months.
Many of the current crop of active SPACs were formed in early to mid-2019 when valuations were much higher, including Subversive Capital, which raised $575 million in June 2019; Mercer Park Brand, which raised $402 million in May 2019 and Tuscan Holdings, which raised $200 million in March 2019, according to ELLO data.
The valuation surge in late 2018 and early 2019, a period when Canada legalized recreational use of cannabis, along with a number of U.S. states, prompted many cannabis companies to list shares on Canadian and U.S. exchanges, often through reverse mergers with shell companies, leaving them off the table for SPAC transactions.
And now, with the industry still struggling with growing pains, fewer companies are available for SPAC transactions at last year’s valuations, leaving many SPACs struggling to find acquisition candidates with substantial revenue and profitability metrics.
“You saw a lot of SPACs coming in at the same time looking for assets,” said Tahira Rehmatullah, president of T3 Ventures and board member of Akerna, formerly MJ Freeway, which went public through a merger with MTech, a SPAC, in 2019. “But valuations declined and the pool of acquisitions is much more limited than it was a year ago.”
SPACs may seek to combine multiple companies
Under fund mandates, SPACs must put 80% of their capital to work on a single company, and they typically look for companies that are cash flow and EBITDA positive. But with industry travails, fewer private companies meet those criteria. Now some SPACs are looking to merge multiple companies to make the numbers work, presenting a litany of issues over valuations of individual companies, their share structures in the merged company and managerial control, ELLO’s Gerson said.
“It’s hard to get them to agree, and if they do agree, they are worried about relative valuations of their companies, which is a real challenge,” said Gerson.
There have been only a handful of cannabis SPAC deals in recent years, with the most recent being Clever Leaves pending merger with a Schultz Asset Management SPAC last month, and Cannabis Strategies Acquisition’s 2018 merger of five U.S. and Canadian companies with combined 2019 expected revenue of up to C$270 million. Gerson said he expects several more SPAC deals before year end.
Some substantial companies that could be viable SPAC candidates include Verano Holdings, which terminated an $850 million deal this year to be acquired by Harvest Health this year; Canndescent, Ascent Wellness, Gage Cannabis, Connected Cannabis and NorCal Cannabis, industry watchers said.
But some industry players say the amount of money raised for cannabis SPACs outweighs the number of viable candidates, forcing them to look to other parts of the industry for potential acquisitions.
Bruce Linton, the former CEO and co-founder of industry leader Canopy Growth, this year raised $150 million for a SPAC called Collective Growth, but the vehicle is focused only on hemp, a cannabis plant derivative that is legal in the U.S. and Canada, and related sectors.
A lack of potential pure-play cannabis companies is “part of the reason Collective Growth is not into cannabis,” Linton told Mergermarket. “How many kick-ass private cannabis companies are out there?”
“There’s a mismatch” for the amount of capital in SPACs looking for deals and the numbers of viable acquisition candidates, he said, adding that he has looked at over 100 companies since founding the SPAC this year, an indication of the extent of work SPAC operators must conduct to find appropriate assets. “So many companies went public in recent years that it really does limit the field,” he added.
Still, industry watchers said the challenges in raising investor capital is likely to tempt a number of companies to look to do SPAC deals, a move which can bring immediate capital, an investor roster of institutional investors and skilled managers to guide the companies, all key SPAC selling points.
SPACs gain popularity
SPAC deals, once viewed as an alternative for companies that couldn’t go public for various reasons, are enjoying a renaissance this year. High profile investor Bill Ackman in July launched Pershing Square Tontine Holdings, a $4 billion SPAC billed as the largest to date. And healthcare services provider MultiPlan, a portfolio company of Hellman & Friedman, agreed in July agreed to a $3.7 billion investment from a Churchill Capital SPAC to go public on the NYSE. As of July 22, 47 SPACs across all industries have held IPOs in 2020, up from 59 for all of 2019 and 46 in 2018, according to lawfirm Debevoise & Plimpton.
“Anyone with money is being approached by those that don’t have money,” said David Traylor, senior managing director of Golden Eagle Partners, an investment bank focused on cannabis and life sciences companies. “Still, some SPACs want companies with at least $150 million in revenue that they can bring to $300 million (in deal size) with leverage. There’s very few companies that have that kind of revenue.”
Dane Hamilton is U.S. Healthcare Editor for Acuris, a subscription news and data provider for finance and M&A executives.