Sundial Growers (NASDAQ:SNDL), the Canadian cannabis grower, has decided to become a hard money lender even though it can’t afford to lose any money. Amazingly, SNDL stock has been inching higher as a result, even though this is a fairly risky move by the company.
Here’s what happened. On Dec. 30., Sundial lent 58.9 million CAD to a division of a public Canadian company, Zenabis Global (OTCMKTS:ZBISF). Zenabis was supposed to repay 7 million CAD the very next day. So the net investment would be 51.9 million CAD.
Apparently, that repayment happened on time. However, for some reason, Sundial says that there was a default, even though the $7 million was repaid. Zenabis is disputing the default.
The Hard Money Part
But here is the interesting part. Even though the terms of the loan were for four years at a 14% interest rate, the land also includes another very steep provision. This is what makes the loan a “hard” money loan, as the term is known in the lending industry for any high-interest loan.
For example, on top of interest payments, the loan requires the Zenabis’s subsidiary to pay a 2.5% to 3.5% quarterly royalty to Sundial for 32 quarters, or eight years. The royalty rises from 3.5% on the first 25 million CAD of quarterly revenue to 2% for revenue above 37.5 million CAD.
And on top of all of this, SNDL stock gets complete collateral on all of the cannabis assets at Zenabis Global, the parent.
Now it turns out we can look up the financials for Zenabis on the Canadian version of the SEC database, called Sedar.
It turns out that as of Sept. 30, Zenabis had just 4.5 million CAD in cash and 85 million CAD in current liabilities, including 13.2 million CAD in current debt. It also had 100 million CAD in long-term debt, and had just lost 17 million CAD that quarter on 28.5 million CAD in sales.
Therefore, Zenabis is essentially insolvent without the 51.9 million CAD loan from Sundial. In fact, even though Zenabis’s sales are growing quickly, I suspect it is highly unlikely that the company can repay this loan within four years.
That is probably why the royalty provision is for 32 quarters, or eight years. In most Western countries, royalties cannot be part of a bankruptcy protection process — they have to still be paid no matter what as long as the company is making sales.
Money It Can’t Afford to Lose
I highly suspect that Zenabis is going to need more money, which Sundial can’t afford to lose. For example, Sunday said that after the loan it made it had just 51 million CAD in cash.
But, as I pointed out in my last article on Sundial on Dec. 22, it is still losing money on a cash flow basis. It made negative 20 million CAD cash flow from operations (CFFO) during Q3.
We will know how much CFFO was negative during Q4 once the company releases its Q4 results. But having just 51 million CAD in cash as of Jan. 6 means that it can only last two more quarters of negative cash flow.
That is, unless it sells more equity. That is what the company has been doing. For example, its share count has risen from 504 million shares outstanding as of Sept. 30 to 919 million as of Dec. 30.
What to Do With SNDL Stock
So the company is selling shares to make risky loans that might not pay off. It’s almost like a new line of business of the company. And it is an indication of an opportunistic, rather than focused, management style.
I estimate that the royalties will pay close to one million CAD quarterly, or four million CAD annually. Over eight years that works out to 32 million CAD, or just 61.6% of the 51.9 million CAD million lent out.
I estimate Zenabis will be in bankruptcy well before the end of the four-year term of the loan. Sundial will be just another creditor trying to get its money back. The royalties will prevent a total loss and limit it to a downside of 39.4% of the 51.9 million CAD loan.
But any way you look at it, this is a very risky hard money loan that has a high degree of risk. SNDL stock has been rising, but it looks like it is taking on a good deal of risk and a new line of business.
Investors in the stock may want to consider this before going all in. They may want to see if the hard money lending operation, funded by selling shares, is worth the risk.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.