SNDL stock: Sundial producers lend money they can’t afford to lose

Producers of sundials (NASDAQ:SNDL), the Canadian cannabis producer, has decided to become a money lender even though he cannot afford to lose the money. Surprisingly, SNDL stock has gradually increased, even though it is a fairly risky decision on the part of the company.

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Here is what happened. On December 30, Sundial loaned CAD 58.9 million to a division of a Canadian public company, Zenabis Global (OTCMKTS:ZBISF). Zenabis was supposed to reimburse CAD 7 million the very next day. The net investment would therefore be CAD 51.9 million.

Apparently, this repayment took place on time. However, for some reason Sundial says there was a default even though the $ 7 million was repaid. Zenabis disputes the default.

The hard money part

But here’s 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 loan industry for any high interest loan.

For example, in addition to the interest payments, the loan requires the Zenabis subsidiary to pay a quarterly royalty of 2.5% to 3.5% to Sundial for 32 quarters, or eight years. The royalty is reduced from 3.5% on the first 25 million CAD of quarterly revenues to 2% for revenues over 37.5 million CAD.

And on top of all that, SNDL shares get full warranty on all cannabis assets at Zenabis Global, the parent company.

Now it turns out that we can search the financial data of Zenabis on the Canadian version of the SEC database, called Sedar.

As of September 30, Zenabis only had C $ 4.5 million in cash and C $ 85 million in current liabilities, including C $ 13.2 million in short-term debt. It also had C $ 100 million in long-term debt and had just lost C $ 17 million this quarter on $ 28.5 million in sales.

Therefore, Zenabis is essentially insolvent without Sundial’s CAD 51.9 million loan. In fact, even though sales of Zenabis are increasing rapidly, I suspect that it is highly unlikely that the company will be able to repay this loan within four years.

This is probably why the royalties are scheduled for 32 quarters, or eight years. In most Western countries, royalties cannot be part of a bankruptcy protection process – they still have to be paid regardless as long as the business is making sales.

The money he can’t afford to lose

I strongly suspect that Zenabis is going to need more money, which Sundial cannot afford to lose. For example, Sunday said after the loan she made, she only had C $ 51 million in cash.

But, as I pointed out in my last Sundial post on December 22, it is still losing money on the cash flow basis. It generated negative cash flow from operations (CFFO) of CAD 20 million in the third quarter.

We will know how negative the CFFO was in the fourth quarter once the company releases its fourth quarter results. But having only C $ 51 million in cash as of Jan. 6 means it can only last two more quarters of negative cash flow.

That is, unless he sells no more shares. This is what the company did. For example, its number of shares increased from 504 million shares outstanding as of September 30 to 919 million as of December 30.

What to do with SNDL stock

The company therefore sells shares to make risky loans that may not be profitable. It’s almost like a new line of business for the company. And that’s an indication of an opportunistic, rather than focused, management style.

I estimate the royalties will pay close to C $ 1 million per quarter, or C $ 4 million per year. Over eight years, this amounts to CAD 32 million, or only 61.6% of the CAD 51.9 million loaned.

I estimate that Zenabis will be bankrupt long before the end of the four-year loan. Sundial will be just another creditor trying to get his money back. The royalties will prevent a total loss and limit it to a 39.4% decrease in the loan of C $ 51.9 million.

But however you look at it, this is a very risky money loan that comes with a high degree of risk. SNDL stock has risen, but it looks like it is taking a lot of risk and opening up a new line of business.

Equity investors may want to consider this before going all-in. They may want to see if the hard money lending transaction, funded by the sale of stocks, is worth the risk.

As of the publication date, Mark R. Hake does not have (directly or indirectly) any position in any of the stocks mentioned in this article.

Mark Hake directs the Total Value of Return Guide that you can consult here.

Troy M. Hoffman