Cannabis company facing challenges

Opinion

Hey there, time traveller!
This article was published 15/08/2024 (413 days ago), so information in it may no longer be current.

It’s hard not to try to figure out what should have happened or what could have happened that might have prevented an enterprise from being forced to seek creditor protection.

If it’s happened all that’s left is to manage the winding up process in as responsible a manner as possible.

The ownership of Delta 9 Cannabis is deploying such responsibility and thoroughness — it’s the same way it’s conducted itself since its founding in 2014 — in its current court-appointed creditor protection process.

It has not yet filed an official Plan of Arrangement as part of the court-appointed Companies’ Creditors Arrangement Act process — which would lay out a payment process for its unsecured creditors — but it does have a path forward with its plan sponsor, Ontario based The FIKA Company, to pay off its $40 million of secured debt. FIKA will also take over ownership and operation of Delta 9’s 41 cannabis stores in Manitoba, Alberta and Saskatchewan, all of which have remained open since the creditor protection process began last month.

(There’s likely not much hope that Delta 9 shareholders will be able to reap any value.)

It has now started the process of seeking offers for its cannabis production operation, which consists of 297 production pods (custom-designed shipping containers) in a 100,000-square-foot building along with all sorts of intellectual property including genetics.

Those production operations also include $68.4 million of tax loss carry-forwards to shelter future operating income in what was always one of the lowest cost producers in the country.

Although just a couple of years ago it was able to make the claim that it was one of the few Canadian cannabis companies that was generating a profit it fell into default on its banking covenants such that its creditors were within their legal rights to make a demand payment.

In a recent interview Delta 9 founder and CEO, John Arbuthnot, did not try to suggest that somehow his company was unfairly treated or that Delta 9 was impacted more than others by industry trends that are making it hard for any cannabis company in the country to thrive.

Since it signed a $32 million lending agreement with First Calgary Financial, a division of Connect First Credit Union Ltd. two and a half years ago, Arbuthnot said it had maintained a “great relationship” with that credit union.

Companies have often breached lending covenants and not been forced into creditor protection. Typically, that are ways to negotiate terms between parties, especially if relations are good, until the debtor is able to get back on-side.

Two months after closing the Connect First loan in Feb. 2022, Delta 9 borrowed another $10 million from Sundial Growers Inc. (now called SNDL Inc.).

In May of this year Connect First merged with Servus Credit Union, then in July SNDL acquired the indebtedness of Delta 9 that had been held by Connect First.

That last transaction “came out of left field” as far as Arbuthnot was concerned.

At the beginning of 2023 Delta 9 reduced its cannabis production by 40 per cent and laid off 40 employees in a cost cutting maneuver that many others in the industry were engaged in to address what had become an imbalance in the market with supply outstripping demand.

Throughout the course of the last two years many of the largest players in the industry — including SNDL itself — have reduced production.

The move was starting to have an impact on the bottom line at Delta 9 and it was very close to getting back into compliance on its covenants with Connect First.

“What we did not anticipate,” Arbuthnot said, “Was escalation of hostilities from our senior lenders at Sundial.”

In making the demand payment SNDL knew full well that Delta 9 would not be able to come up with the cash to pay down the $40 million in total debt. It’s conventional wisdom that SNDL’s move was designed to acquire Delta 9’s assets.

But perhaps it should not have come as such a surprise. SNDL has used this strategy in the past on other licensed producers and it’s been part of the play book of vulture capitalists for decades.

The irony is that after cutting production at the beginning of 2023 Delta 9’s production facilities are now operating at full capacity.

And while the industry as whole has been suffering mightily, investor sentiment is starting to turn around. After so much Canadian production was shuttered over the past 18 months, the supply-demand imbalance is starting to correct itself.

As well, with increasing numbers of U.S. states passing legalization legislation and demand picking up in international markets both for recreational and medical cannabis there are signs that the Canadian market may be emerging from the depths.

None of that will be of any solace to Arbuthnot and Delta 9 shareholders who built an innovative, economically impactful enterprise taking calculated risks along the way as every business must only to run into an unexpected drop from a crafty opponent that it just could not return.

martin.cash@freepress.mb.ca