My 2 ¢ on the Announced LDS Secured Credit Facility On November 21, 2017, LDS announced the following after market close:
The Company has arranged a US$500,000 secured credit facility (the "Credit Facility") with an unrelated third party creditor. The Credit Facility will allow the Company to purchase additional raw material without drawing on its development funds and will allow saving more than five hundred thousand dollars in raw material acquisition costs.
Outstanding principal under the Credit Facility accrues interest at a rate of 3% per month, compounded monthly and payable on maturity on May 16, 2018. The Company may prepay the Credit Facility at any time, subject to the payment of $50,000 in minimum interest. The Credit Facility is secured by a general security agreement covering all of the Company's personal property, and first deeds of trust on three parcels of unimproved real property totaling 20.5 acres owned by the Company in the City of Adelanto, San Bernardino County, California.
There was a Form 10 filed with the CSE (here) that provides the following piece of information:
On November 13, 2017, the Issuer entered into a US$500,000 secured credit facility (the “Credit Facility”) with Acamar Investments, Inc., an unrelated third party lender (the “Lender”), which closed on November 16, 2017.
What appears to be the issue for some are the following:
- The high interest rate of 3% per month; and
- The General Security Agreement (GSA) over all assets.
Let me offer an alternate interpretation. It is true that LDS is subject to pesticide-free biomass from external parties and given their stringent “no pesticide” requirement as well as the recent California wildfires, they may be forced to pay higher market prices for this raw material input. This may get expensive - true. But the cost will get passed down to the chain to the customer.
In the world of corporate finance, you take money when it is offered to you. Acting in a prudent and fiscally responsible manner, a company ought to take measures to arrange for a facility as a backup plan in case the unforeseen happens (i.e. some delay occurs on say selling inventory or input prices rise beyond what is expected). Doing so is not unlike buying life insurance. You don’t buy life insurance expecting to have to use it. You buy it for when the unexpected happens. I believe this is what LDS has done as a contingency measure to obtain this facility.
As far as the high cost of the facility, keep in mind that this is a bridge facility that is temporary with a May 16, 2018 expiry. We know from the above that the facility closed on November 16, 2017. Let’s assume for argument’s sake that it was fully drawn on that date, an aggressive assumption. Now assume it stays fully drawn until May 16, 2018. What is the total cost? Well in very rough numbers the interest accrued is 6 months x 3% x $500K = $90K. Is that a lot? It doesn’t seem like the kind of rate I would want long term but bridge facilities are usually more expensive - think about the rate on a bridge loan when you are carrying two houses because you bought a new house and can’t sell your old one. This is especially true when the loan is made to a business that partakes in federally illegal activity. Everything about running a cannabis operation in the US, where it is federally illegal, is a little bit more expensive. That’s why the margins are what they are. That is why there is a viable black market. The risk takers dealing with said businesses need to be rewarded for the risk they are taking.
It is interesting that the facility matures ~15 days before the expiry of the one year, 75 cent warrants that were issued earlier this summer as part of the 50 cent financing.
The company will have two sources of cash inflow between now and the maturity of the facility. First, they are ramping up operations which will hopefully see month-over-month growth in revenue and, second, if their shares manage to get high enough above $0.75/sh, the warrant holders will start to exercise and this will bring in ~C$16M assuming full warrant exercise and assuming my math is correct. Given today’s price action and imminent announcement of sales, it does not appear that this bridge facility will be needed for long, if at all. But it is a very very good plan B in case things don’t go exactly as planned.
On the subject of the GSA, this can be explained by the fact that we are dealing with a lender making a loan to a company running a federally illegal operation as well as the fact that this is a short term bridge facility, not likely to be drawn as it is really a Plan B contingency scenario. If you are arranging a short term, plan B credit facility, the simplest and fastest way to get it done is to offer a GSA (not the case for a long term facility where you would want to sit with the lenders and really haggle over what security you were willing to provide). It is super quick to execute and gives the lender the greatest comfort because the borrower pledges all assets of the business to the lender. If you are the borrower and don’t expect to draw under the facility, you don’t really care about giving a GSA because you receive a “get out of jail free” card knowing you don’t expect to use it. The facility provides a double fail safe.
But what happens if you a are wrong and you do need to draw on the facility? It’s not a big deal. You draw on the facility to bridge the time you pay for biomass, to the time it takes you to transport it to your facility, convert the biomass into oil, strips, vape cartridges, all the way through to when you sell the products and collect cash. Recall this is a cash business. So the cash collection cycles are short assuming you can move product.
But what happens if you draw on the facility and can’t move product? How does the GSA work? It’s easy. The lender triggers the GSA to try to recover their loan principal plus interest. Most times lenders don’t want to step into the lender’s shoes to run their operations to recover the funds. They will often offer cure periods to make good on repayment. LDS will have a first option to raise capital to repay the loan. They can do this in any number of ways by selling an asset (i.e. previously purchased land package), doing an equity issue, doing some other refinancing like granting a royalty rights on CannaStrips in Colorado to someone else in exchange for a capital infusion, etc. If this fails, it then the lender would push LDS into receivership but this is so far down the remote path of not going to happen it didn’t even warrant this paragraph.
To sum this all up, I don’t think the credit facility is worth the time that has been spent debating it.
I think the bigger question we need to have addressed is when will we start seeing buildout of the grow side of the business to reduce reliance on third party biomass sources? When will we start building out the grow operations and dispensary on the 24.75 acres of land zoned for cannabis grow/manufacturing operations? I’ll try to address this in a separate post.
~S