There are certain things that are hard to understand. Take Aurora Cannabis (NYSE:ACB) and some of their recent moves for example. Management notoriously overpays for acquisitions. That is easy to do when the price of your stock is near an all-time high. Sometimes the M&A process heats up forcing prices to ridiculous levels.
Has the same overly generous tendency been extended to financing Aurora’s growth? A closer look at the recent offering by underwriters for Aurora of $350 million in convertible debt is a good example. On January 24 they completed placement of the five-year deal at par.
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The original offering was for $300 million. Altogether this means the Aurora not only received its asking price for the converts (par value) but that it was oversubscribed by $45 million. And all that capital was raised quickly. It was just a week earlier when the deal was announced
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Hot market or hot deal
It is not surprising how quickly investors gobbled up the offering. The interest rate was a healthy 5.5 percent. That is a better rate than you can get on most seasoned convertible bond funds. In addition, the conversion premium, in my view, was set at a low 10 percent. For a white-hot deal it would not be unusual to price at a 15-20 percent premium. Here are the basic terms:
- $300 million plus $45 million for over-allotment
- Maturing in February 2024
- 5.5 percent interest (paid in cash semi-annually)
- Conversion price at $7.23 per share
- Conversion can be settled in cash, shares or both (Aurora's choice)
- Redeemable at face value starting February 2020
It may be impossible to separate a hot market from a generous deal priced to appeal to convertible buyers. These folks typically look at things like breakeven time or how long it takes for interest payments to absorb the conversion premium. In this case, the premium is less than two years.
It has been a while since I have done a thorough analysis of the convertible market but less than two years to breakeven is darn attractive. If everything goes right for Aurora the company can call the bonds and pay par value. But that cannot happen until after February 2022. That is generous call protection.
However, if things for Aurora go south (this is only a hypothesis) convertible investors, “under certain customary events” have the right to put the bonds back to Aurora at 100 percent of their purchase price of $345 million.
What is wrong with this offering
So what is wrong with this deal. For the average investor in converts, the obvious answer is: there is nothing wrong, it’s a great deal. But what about existing equity shareholders? If all of the issue is converted, it will result in less than 5% dilution and that is perfectly acceptable. But that is possible because Aurora has over 900 million shares outstanding.
The problem with the offering is that cash interest will accrue at $19 million annually. Yes, that figure is pre-tax but Aurora operations have lost over $200 million in the last 12 reported months. (Just for the record, revenues were less than $75 million.) So any tax benefits are delayed until Aurora starts earning some shekels.
Investors in Aurora common stock can take comfort in having $345 million for the company to grow its business. The argument can be made that not all growth can be financed with high priced equity. Some folks simply prefer cash or just don’t wish to take the risk of owning stock.
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While all of this is true, why didn’t underwriters recommend a straight equity deal either public or a private placement? That could have saved between $38 and $95 million in interest payments over the expected life of the bonds. This is no small detail considering Aurora had a negative cash flow of $69 million in the latest reported September quarter. Just something current shareholders are thinking about.