Due to their inability to access traditional loans, cannabis companies operating in the U.S. have had to resort to selling equity (shares) in large volume to fund their ambitious expansion efforts.
However, institutional investors are skeptical and want a good deal, so they’ll usually pay just under the market price for their shares. Discounted shares are not the only way companies sweeten the deal; companies will often include stock warrants in the deal as well.
Stock Warrants function in much the same way that stock options do. They give the owner the right to buy or sell shares of a company at a specific price. Where options and warrants defer is where the money goes when the contract is exercised. While options trade on exchanges and all the money is going between investors, shares associated with warrants will be newly issued by the company.
So warrants provide the company with additional funding sources when exercised, while investors reap the reward of buying additional discounted shares. If the warrants are being exercised, it’s usually a win-win situation, as the company’s share price has usually risen a significant amount (and they get the cash). The investor makes a nice gain on their investment.
Whether an investor is going to invest in warrants depends on several factors. The most important factors to consider are the strike price (the price to buy/sell the shares at), the date of expiration (the date the warrant will expire if not exercised), the current share price of the company and, finally, the price of the warrant itself. One can find the intrinsic value (the profits made if exercised today) of a warrant by subtracting the strike price from the current share price. Break-even share price (the price the shares would need to trade at to break even based on the current price of the warrants) can be determined by adding the strike price and the price of the warrants.
An additional consideration for investors is whether or not the warrants have an acceleration clause attached to them. An acceleration clause allows the company to move up the expiration date, should certain conditions be met. Usually, companies use acceleration clauses to protect themselves from issuing shares at massive discounts in the event of a run-up in the share price.
Finally, investors should consider the implied volatility of the warrants. Implied Volatility (IV) measures the market’s opinion of how large movements in the stock will be. A higher IV means the market anticipates large swings in price, while a lower IV shows anticipation of smaller price changes. There are many free implied volatility calculators available online.
Cannabis Multi-State Operators (MSOs) trade on the Canadian Securities Exchange (CSE), so prospective investors outside of Canada need to trade internationally in their brokerage to access these warrants. Below is a breakdown of outstanding warrants from some top MSO’s. Share prices are based on closing prices on 4/4/2021, and all amounts are in Canadian dollars.
- Ticker: AYR.WT
- Strike Price: $11.50
- Expiration: 5/24/2024
- Current Share Price $35.08
- Warrant Price: $23
- Intrinsic Value: $23.58
- Break-Even Price: $34.50
With the current share price roughly 3 times the strike price, current owners of Ayr Wellness warrants have made out quite nicely thus far. A positive sign for prospective investors is that the warrants are priced below their intrinsic value, so they’re guaranteed a profit just by buying and exercising the warrants. Of course, with an expiration date still over 3 years away, investors are hoping for even greater returns.
- Ticker: CL.WT
- Strike Price: $12.50
- Expiration: 9/24/2022
- Current Share Price: $15.25
- Warrant Price: $6.50
- Intrinsic Value: $2.75
- Break-Even Price: $19
Unlike Ayr’s warrants, Cresco’s warrants trade at more than their intrinsic value. In fact, they trade at more than double their intrinsic value. Owners (and traders) of the warrants are banking on the share price rising significantly in the year and a half leading up to expiration. While investors might still realize gains by going long on these warrants, they are quite expensive relative to other warrants and even Cresco’s own common shares.
- Ticker: RWB.WT
- Strike Price: $1
- Expiration: 9/24/2022
- Current Share Price: $1.47
- Warrant Price: $0.61
- Intrinsic Value: $0.47
- Break-Even Price: $1.61
While the warrants are well in the money, they’re trading substantially over their intrinsic value. While not near the premium being afforded Cresco’s warrants, RWB’s warrants are still quite expensive relative to other investment opportunities. Like Cresco, RWB’s warrants are due to expire in about 18 months, so there is a fair bit of risk associated with them as well.
- Ticker: TRUL.WT
- Strike Price: $17.25
- Expiration: 6/18/2022
- Current Share Price: $51.71
- Warrant Price: $33.20
- Intrinsic Value: $34.46
- Break-Even Price: $50.45
Trulieve’s warrants appear to be attractively priced. Like Ayr, they’re trading below their intrinsic value. The warrants have the shortest term to the expiry of the group, so perhaps investors are discounting the warrants to account for that extra risk. Regardless, based on an intrinsic value to price ratio, Trulieve appears to have the most promising warrants of the bunch.
After a significant run-up over the last year and peaking in mid-February, Cannabis has been correcting. When the bottom comes, warrants present an attractive rebound play for cannabis investors. Not all warrants are created equal, though. The warrants for Red White & Bloom (CSE: RWB) (OTCQX: RWBYF) and Cresco Labs (CSE: CL) (OTCQX: CRLBF) appear to be quite expensive relative to those from Ayr Strategies (CSE: AYR.A) (OTCQX: AYRSF) and Trulieve (CSE: TRUL) (OTCQX: TCNNF). Investors might consider picking up these warrants instead of the common stock in anticipation of the coming cannabis rally.
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Red White & Bloom is a paid client of The Cannabis Investor. The Cannabis Investor holds a position in RWB.
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