Aurora Cannabis (NYSE:ACB) isn’t having a great run. ACB stock continues to fade, dropping nearly 40% from March highs. Aurora stock admittedly still is up 25% for the year — hardly a terrible performance — but the more-recent trend has been sharply negative.
To be sure, Aurora isn’t alone. Cannabis stocks across the board are struggling. Canopy Growth (NYSE:CGC) and Cronos Group (NASDAQ:CRON), too, are down almost 40% from March highs. And those companies both have fortress balance sheets, thanks to billion-dollar investments from Constellation Brands (NYSE:STZ) and Altria (NYSE:MO), respectively.
Aurora, on the other hand, has a potential balance sheet problem. That might seem like an exaggeration. The company closed its third quarter (ending March 31) with 390 million CAD ($296 million) in cash. The company is not going bankrupt any time soon.
But there is a large debt maturing in a little over seven months. And that debt is likely to maintain the pressure on ACB stock.
How Aurora Cannabis Has Grown
On March 9, 2018, Aurora closed the offering of a convertible debenture. Including the underwriters’ allotment, Aurora Cannabis Inc. raised 230 million CAD.
The offering wasn’t the first convertible bond Aurora had issued. In fact, counting a warrant issue in late 2017, it was the sixth. The company had raised steadily higher amounts — 2.05 million CAD in May 2016, moving to 75 CAD million a year later — at incrementally higher conversion prices. In eachcase, Aurora stock kept rising beyond the conversion price, which allowed the company to force bondholders to take ACB shares, instead of a cash payment.
Those conversions wound up as a win/win. Aurora could issue stock instead of paying in cash. The investors lending cash to the company got ACB stock on the cheap.
To be sure, those conversions were a key part of the massive dilution that makes some investors nervous about ACB. But they allowed Aurora to finance its growth, including some 15 acquisitions worldwide.
The company almost certainly couldn’t have done so with a traditional long-term bond issue; the cannabis industry simply is, and remains, too chancy for risk-averse lenders to give the company money at any reasonable interest rate without an equity kicker. Given that ACB stock has risen nicely since 2016-2017, it’s difficult to argue that the company’s strategy didn’t work.
Why the Decline in Aurora Stock Matters… This Time
The sixth offering almost certainly is going to play out differently. The conversion price is 13.05 CAD — that’s 60% above the current price of Aurora stock on the Toronto Stock Exchange. (It’s the price on that exchange, not the more-recent NYSE listing, that matters.) Should ACB stock reach a daily volume-weighted average of 17 CAD for 10 trading days, the company can force its lenders to take shares instead of cash.
Right now, a forced conversion seems highly unlikely: ACB stock would have to double in less than seven months, and then stay at that level for two weeks. Even a move to somewhere above 13 CAD doesn’t necessarily mean the lenders convert their debt into shares. There are expenses involved in taking those shares — and near-term risk if ACB stock declines during the process.
In other words, unless ACB stock rises 70% in maybe six months — giving lenders time to respond, as well as confidence that the stock won’t pull back as many pot stocks have on occasion — Aurora Cannabis is going to have to pay back 230 million CAD in cash on March 9.
That doesn’t seem like that big a problem. After all, Aurora has, at least as of March 31, 390 million CAD. But repayment may not be as easy as it appears.
Why Aurora has a Convert Problem
There are several reasons why Aurora Cannabis may not be able to repay all of the converts in cash. First, of the 390 million CAD, some 43 million CAD is restricted. But that figure actually may rise.
The cash is considered restricted because Aurora Cannabis is required to hold it under its credit facility with Bank of Montreal (NYSE:BMO). According to its Q3 filing, the company has to “reserve cash equal to two years of principal and interest payments.” The problem is that the facility matures on Aug. 29, 2021.
Come early 2020, Aurora Cannabis is going to have to restrict more cash to account for the looming principal repayment: the company currently has drawn 148 million CAD. It could extend the credit agreement, but BMO is likely to want some level of pay-down before doing so.
Yet, even with an extension, Aurora still has a problem: It’s still burning cash, some 430 million CAD in the first nine months. That figure will come down over the next nine months, to be sure. But unless Aurora wants to pull back on its capacity-building efforts — and it doesn’t — free cash flow is going to stay negative.
On top of all of that, Aurora needs cash on hand to run the business. It can’t take cash down to zero, or even CAD 10 million — particularly given that cash burn could continue into calendar year 2020.
And so, as of right now, it does not appear like Aurora can pay the debt off in cash. And unless Aurora stock soars quickly, it’s going to have to.
Near-Term Risk to ACB Stock
It’s worth repeating: Aurora Cannabis Inc. isn’t headed toward a March bankruptcy filing. In fact, we’ve recently heard a similar story from skeptics toward another growth stock: Tesla (NASDAQ:TSLA). Tesla had $920 million in convertible debt that came due on March 1. TSLA stock had traded below the conversion price, and so observers worried that the company wouldn’t have the cash.
The worry for ACB stock is that the story will be similar — and that it already is. Aurora probably will need to raise capital at some point, either to repay the convertible or to extend, or pay back, its credit facility. To do so, it’s going to need to either sell stock or convertible bonds at a lower conversion price. Both suggest more dilution for Aurora shareholders.
Indeed, Aurora already has positioned itself to do so. It filed a shelf offering in April, allowing it to raise up to $750 million.
The problem, if the market knows a capital raise is required, is that selling becomes a bit of a vicious cycle. A lower ACB stock price means any offering of equity and/or convertible bonds will have to be priced even lower. (Such large chunks of stock almost always have to be sold at a below-market price.) Institutional investors may hold off, figuring they can buy Aurora stock cheaper in an offering than on the open market. Traders then front-run the stock, shorting ACB on the assumption that an offering is coming.
Certainly, sector weakness hasn’t helped ACB stock of late. But the convertible maturity is becoming a factor as well. Bank of America Merrill Lynch (NYSE:BAC) highlighted the debenture in downgrading Aurora stock this month. And I doubt they’re alone. The lower ACB stock price means a higher likelihood of Aurora issuing even more shares at an even-lower price. And that could prove to be an overhang on ACB until the company makes clear how it plans to proceed.
As of this writing, Vince Martin has no positions in any securities mentioned.