First quarter 2022 capital markets review: Debt financing remains the main source of funding

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For the first quarter of 2022, there were 70 capital increases totaling $1.2 billion. Compare that with the first quarter of 2021, which saw 163 capital-raising deals totaling $4.6 billion. This represents a decrease in transactions of 57% and a decrease in total capital raised of approximately 74%.

So what’s going on here?

To be fair, the first quarter of 2022 followed a strong first quarter when the number of capital raising transactions and the total capital invested reached historic levels.

Nonetheless, the quarter reflected a sharp decline in investor interest in the cannabis sector due to:

1) any legislative progress regarding the legalization of cannabis;

2) the decline in the market valuation of public cannabis companies, which made stock offerings dilutive and costly;

3) and the general decline in general market sentiment. The S&P 500 fell more than 5% in the first quarter and has continued to decline ever since. Cannabis stocks are not immune to general market trends, and given their more speculative nature compared to larger, more established companies, it could be argued that cannabis stocks tend to fall more than the market in his outfit. Additionally, the appetite for M&A deals and other types of financing tends to wane during periods of market turmoil. No one likes to do business with uncertainty.

Change in the distribution of capital by industrial sector

Cannabis deals (capital raises and mergers and acquisitions) are broken down into one of 12 industry sectors to track the flow of deals by sector. Over the past year, there has been a rotation of capital invested in different sectors of the cannabis industry. The chart below and accompanying story detail this sector rotation.

Culture & Retail, historically the most important sector for equity financing, represents only $14 million (1.6%) of equity raised since the start of 2022, compared to $1.9 billion ( 52%) in 2021. This downward trend is expected to continue for several reasons:

  • MSOs have been able to use their equity in acquisitions, one of their main needs for new capital.
  • Tier 1 MSOs have strong cash positions and are expected to be free cash flow positive in 2022 and 2023, eliminating any urgent need to issue equity in a bear market.
  • Greater availability and better pricing of debt is another limiting factor.

Investments/mergers and acquisitions, which is mostly comprised of SPAC IPOs, has also fallen out of favor as an industry sector for capital inflows. This category accounted for only 9.9% of year-to-date increases in 2022, compared to 16.1% in 2021, and is expected to represent a lower percentage in future periods due to increased SEC scrutiny and the poor performance of de-SPAC shares.

The real estate sector, which is made up of cannabis lenders and sale-leaseback providers, has benefited from sector rotation in 2022. Riding the trend of greater use of debt capital, this sector has accounted for 47.3% of 2022 equity issuance year-to-date. , compared to just 7.6% for the comparable period in 2021. Given that we expect significant legalization to remain elusive and stock prices to struggle to rebound in the general market downturn, we believe this sector will continue to benefit from it.

Software/media companies also took a bigger slice of the financial pie, accounting for 22% of year-to-date increases versus 7.1% the previous year. This trend is expected to continue as MSOs seek to improve the efficiency and compliance of newly built and acquired operations.

Farm technology has been down since the start of the year, a resurgence in demand as MSOs expand operations in newly opened adult recreational states.

Increase in debt as a percentage of total capital raised

For all of 2021, debt financings reached their highest percentage since our tracking began, reaching 44% of total dollars raised in 2021, compared to 38% in 2020. the year were debt transactions.

This trend is likely to continue in the current environment, as cannabis companies remain eager for growth capital, but cautious about issuing stock due to low public market values.

M&A activity

There were 319 M&A deals in 2021, the highest number since 2018 and up 235.8% from the 95 M&A deals recorded in 2020. The total deal value of 25.2 billion in 2021 increased by almost 573% compared to 2020.

For the first quarter of 2022, there were a total of 58 M&A deals, down 21.6% from the first quarter of 2021. Despite this drop, M&A activity fared much better held up than in previous cannabis stock price slumps. And against the backdrop of a 73.9% decline in capital raising by cannabis companies in the second quarter of 2022, the pace of M&A activity remains robust.

M&A activity is poised to remain strong as the industry as a whole continues to be among licensed operators and cannabis companies in general. Consolidation is necessary in the current state of the market and is a healthy dynamic for the industry.

Evolution of mergers and acquisitions by sector of activity

Since 2015, companies in the culture and retail sector have been the top acquirers as they consolidate within markets and expand into new states. This trend continued in the first quarter of 2022. However, two sectors that saw a real increase in M&A activity in the first quarter of 2022 were biotechnology/pharmaceuticals and software/media.

The Biotech/Pharma sector accounted for 4.7% of all M&A deals in Q1 2022, compared to just 0.5% in Q1 2021. This reflects the emergence of the psychedelics sector, which is experiencing faster development FDA drugs and clinical trials. the way of trials than medical cannabis.

The software/media sector accounted for 14.7% of all M&A deals in Q1 2022, compared to 5.5% in Q1 2021. This reflects demand for ERP, inventory management, point of sales and other more sophisticated business systems to better manage operations as cannabis businesses evolve.

Sale-Leaseback

So far, the story of sale-leaseback in the cannabis industry has been a story of rate cap compression largely due to long-term confidence in legalization at the federal level – despite little progress. immediate – as well as the growing strength of credits in space. Sector cap rates, which are the implied multiple of the operating profit of the underlying property, have fallen from 17% over the past two years to a range of 11-15% today.

These rates, while high relative to the overall sale-leaseback universe, still offer attractive levels of financing for cannabis operators due to industry-specific capital constraints. However, the volatile interest rate environment in the first quarter leading up to the second quarter wrinkles this narrative.

In the traditional sale-leaseback universe, the cap rate environment in Q4 2021 and early Q1 2022 was one of the strongest seen across the board. The growing number of investors, combined with the low interest rate environment, created a very attractive selling momentum with compressed cap rates and outsized valuations.

We started to see a different story at the end of the first quarter.

Despite the cannabis industry-specific squeeze and credits getting stronger every month as smaller entities go through their early growth cycles, the interest rate environment has started to provide some headwinds. The 10-year treasury bill climbed around 70 basis points throughout the quarter and has since risen around 50 basis points since the end of the quarter, which has had an impact on the cost of capital of the sale-leaseback investors.

Over $50 million in cannabis sale-leaseback transactions were priced in the first quarter of 2022, spanning Massachusetts, New Jersey and Pennsylvania.

Specialized players such as cannabis real estate investment trusts (REITs) have so far filled the need for funding in the space, and we have yet to see traditional sale-leaseback investors feel the need. comfortable with the area. This year will be a very interesting time as we see stories of rising interest rates and an inflationary environment collide with positive growth drivers from multinational operators and increased legalization initiatives.

Scott Greiper is the current and founder of Viridian Capital Advisors a financial and strategic advisory firm to cannabis businesses.

David Rosenberg, CFA is a director of SLB Capital Advisorswho advises companies and private equity investors on a wide range of sale-leaseback transactions.


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