Cannabis company Tilray Brands Inc. has signed a deal to take a stake in beleaguered rival Hexo Corp. and launch a strategic partnership with the company.
Under the agreement announced Thursday, Leamington, Ont.-based Tilray will acquire up to US$211 million of senior secured convertible notes that were issued by Hexo and are held by funds affiliated with HT Investments MA LLC.
The notes will be amended to allow Tilray to exercise conversion rights at a price of 90 cents Canadian per Hexo share, and the conversion price implies that Tilray would have the right to convert the notes into a 37 per cent stake in Hexo.
Gatineau, Que.-based Hexo positioned the deal as a key piece of its turnaround plan.
Hexo has been at work on the plan since Hexo co-founder and chief executive Sebastien St-Louis left the company in October, as it struggled to quell losses and PricewaterhouseCoopers LLP raised "substantial doubt about its ability to continue as a going concern."
Roughly a month ago, the company became non-compliant with minimum bid price requirements set out by the Nasdaq market, which could delist Hexo if the situation does not improve.
"Fixing Hexo's balance sheet has been the biggest strategic priority for the company over the past several months," said Hexo CEO and president Scott Cooper, who previously ran Hexo's joint venture with Molson-Coors Canada, Truss Beverage Co.
"Today's announcement provides a line of sight to achieving that goal and means that management can now direct its full attention towards executing on and achieving the Path Forward."
The terms of the notes, Hexo said, are "significantly more favourable" to the company and will strengthen its balance sheet and accelerate its transformation into a cash flow positive business within the next four quarters.
The deal pushed Hexo's stock up by about four per cent to 73 cents in Thursday morning trading, while Tilray's fell about one per cent to $7.35.
For Tilray, the deal is a gateway to a stake in Hexo and way to grow its empire, which already includes Aphria Inc. and the Broken Coast, Chowie Wowie, Riff and Solei brands.
But there are risks to the deal Jefferies LLC analyst Owen Bennett pointed out on a call both companies made Thursday to announce the deal. He said that if Tilray does not convert the notes, it "arguably helped make a major competitor stronger whose share could have been up for grabs anyway near-term."
"If you convert just to keep an equity stake, you've arguably still made a competitor stronger and that stake does not help you hit your target of 30 per cent market share in Canada," he said.
Tilray CEO Irwin Simon said he sees the move is key to the growth of the Canadian cannabis market and added that there is "enough around for strong companies."
"If we want to convert, we've bought in today at a really good price," he said.
"If we don't want to convert in the stock, every dollar goes up. It's worth $200 million to Tilray. There is tremendous savings that will bring our cost structure down for both companies."
The savings will be delivered through a joint venture they will form to provide shared services to both companies. They estimate total savings, which will be shared equally, are expected to be up to C$50 million within two years.
Cost savings have been key for cannabis companies, which faced sales challenges when the COVID-19 pandemic temporarily shutdown many stores and limited the ability to market to and educate consumers.
Some of those impacts have lingered even as shutdowns have eased, BMO Capital Market's cannabis analyst Tamy Chen said in a note to investors Thursday.
She reviewed figures from data firm Hifyre and found a "flat" daily sales rate in February, when compared with January.
She also detected Tilray's sell-through rate — the percentage of inventory sent to stores that sells — fell 23 per cent quarter over quarter in its third quarter as the company implemented price markdowns.