Toxic financings

When interest rates are no longer zero and there is actually an appreciably large cost of capital, corporations with negative cash flows and heavy debtloads are finding terms like these three examples.

First example

Goodfood (TSX: FOOD), a previous Covid-darling (to-your-door delivery would clearly replace regular grocery shopping when a trip to Superstore would kill you with viral pathogens!) has been losing money since day one, and now they have exhausted their cash balances to the following point where they have to issue this debt:

MONTREAL, Feb. 06, 2023 (GLOBE NEWSWIRE) — Goodfood Market Corp. (“Goodfood” or the “Company”) (TSX: FOOD) is pleased to announce that it has closed an offering (the “Offering”) of $12,675,000 aggregate principal amount of 12.5% convertible unsecured subordinated debentures of the Company (the “Debentures”) due February 6, 2028 …

The Debentures will be convertible at the holder’s option into Goodfood common shares (the “Common Shares”) at a conversion price of $0.75 per Common Share. The Debentures will bear interest at a rate of 12.5% per annum. The interest portion for the period commencing on the issuance date and ending in February 2025 will be capitalized semi-annually and convertible at a price equal to the volume weighted average trading price of the Common Shares on the TSX for the five (5) consecutive trading days ending on the date on which such interest portion becomes due, plus a premium of 50%. As of February 6 2025 and until the Maturity Date, the interest portion will be payable semi-annually in cash. As of February 6 2026, Goodfood may repurchase the non-converted portion of a Debenture at an amount of the principal and accrued interest plus an amount providing the holder with an internal rate of return (IRR) equal to 18% for the period during which such Debenture will have been outstanding. The holders may require a repurchase on the same terms upon a change of control of the Company.

This second paragraph is a terrible clause for common equity holders in that there will be a share issuance in February 2025 that will be quite expensive. In addition, the entire issue, if converted at 75 cents per share, would constitute about 18% of the shares outstanding, not counting any dilution before-hand with the interest capitalization.

While Goodfood has stemmed some of the cash bleed, it’s cash position on December 3, 2022 sits at $28.5 million and it has a $9.5 million credit facility due November 2023, $47 million $35 million in convertible debt (TSX: FOOD.DB, FOOD.DB.A) due 2025 and 2027, and now this debt above. There are also the customary IFRS 16 lease obligations. The cash burn got down to $6 million in the first fiscal quarter (3 months ended December 3, 2022).

I am always very wary when companies have to obtain debt financing at double-digit returns. In rare instances, when a company’s back is pressed against the wall, the equity will be trading like such utter trash that it is a reasonable risk-reward ratio better than a casino to take a small position, but such situations are extremely risky in nature. Usually for the company to bail themselves out of the situation, equity holders have to take some sort of bath (either through Chapter 11/CCAA or a highly dilutive transaction) which makes an investment in a more senior part of the capital structure more lucrative.

Second example

Greenbrook TMS (TSX: GTMS), a company that operates trans-cranial magnetic stimulation clinics across the USA, has a corporate strategy of “We will lose money on every acquisition, but we will make it up on volume”. Suffice to say, such strategies will require capital.

On July 14, 2022 they made an agreement with an asset manager for a US$75 million credit facility and the material term was:

The Credit Facility provides Greenbrook with a US$55 million term loan, which was funded on closing. In addition, the Credit Facility permits Greenbrook to incur up to an additional US$20 million in a single draw at any time on or prior to December 31, 2024 for purposes of funding future M&A activity. All amounts borrowed under the Credit Facility will bear interest at a rate equal to the three-month LIBOR rate plus 9.0%, subject to a minimum three-month LIBOR floor of 1.5%. The Credit Facility matures over 63 months and provides for four years of interest-only payments.

Three-month LIBOR plus 9% these days is around 13.8%.

On February 7, 2023 they announced:

The Company announces that it has entered into an amendment to its previously-announced credit facility with Madryn (the “Credit Facility”), whereby Madryn and its affiliated entities have extended an additional tranche of debt financing to the Company in an aggregate principal amount of US$2.0 million, which was fully-funded at closing (the “New Loan”). The terms and conditions of the New Loan are consistent with the terms and conditions of the Company’s existing aggregate US$55.0 million loan under the Credit Facility (the “Existing Loan”) in all material respects.

The New Loan also provides Madryn with the option to convert up to approximately US$182,000 of the outstanding principal amount of the New Loan into common shares of the Company at a conversion price per share equal to US$1.90 (the “Conversion Price”), subject to customary anti-dilution adjustments and approval of the Toronto Stock Exchange (“TSX”). This conversion feature corresponds to the conversion provisions for its Existing Loan, which provide Madryn with the option to convert the outstanding principal amount of the Existing Loan into common shares of the Company at the Conversion Price.

Sweet deal.

Third example

Bed Bath and Beyond (Nasdaq: BBBY) fights away Chapter 11 with a really toxic financing:

UNION, N.J. , Feb. 7, 2023 /PRNewswire/ — Bed Bath & Beyond Inc. (the “Company”) (Nasdaq: BBBY) today announced the pricing of an underwritten public offering (the “Offering”) of (i) shares of the Company’s Series A convertible preferred stock (the “Series A Convertible Preferred Stock”), (ii) warrants to purchase shares of Series A Convertible Preferred Stock and (iii) warrants to purchase the Company’s common stock. The Company expects to receive gross proceeds of approximately $225 million in the Offering together with an additional approximately $800 million of gross proceeds through the issuance of securities requiring the holder thereof to exercise warrants to purchase shares of Series A Preferred Stock in future installments assuming certain condition are met. The Company cannot give any assurances that it will receive all of the installment proceeds of the Offering.

At the initial closing, the Company will issue (i) 23,685 shares of Series A Convertible Preferred Stock, (ii) warrants to purchase 84,216 shares of Series A Convertible Preferred Stock and (iii) warrants to purchase 95,387,533 shares of the Company’s common stock.

While I haven’t read the terms and conditions of the S-3 filing that references the preferred securities and warrants as above (off the top of my head it is not clear what the strike price of both sets of warrants are), I can guarantee there’s huge dilution. What’s even more impressive is that the Reddit WallStreetBets and pretty much the whole financial universe is treating BBBY as the Gamestop of 2021:

This is simply insane trading. Multiple opportunities to make and lose money on a very liquid market (and option implied volatility is sky-high, especially on yesterday’s 100% spike up to ~$7/share). This casino-like trading is one reason why I think central banks are quite intent still to keep sucking liquidity out of the marketplace (QT), until this sort of thing ends.

Take-home message

Tightening financial conditions are triggering marginal companies (ones that have negative cash flows and debts) to engage in toxic financings. At what tier will the debt contagion persist? If you own shares in companies that are going to face financing crunches in the upcoming year or two, you may wish to brace yourself.