There isn't much middle ground with Sundial Growers (NASDAQ:SNDL). You pretty much either love or hate the stock. So far this year, Sundial has given investors a lot to love: Its shares have skyrocketed 140% and were up a lot more than that a couple of months ago.
Now the Canadian cannabis producer has made another move that's likely to be a polarizing one. Sundial recently filed a prospectus with the U.S. Securities and Exchange Commission (SEC) to sell up to $800 million worth of its stock. The company appears to be preparing to make a major wager on the global cannabis industry. But will Sundial's big bet pay off?
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Follow the money
Sundial reported unrestricted cash totaling 719 million in Canadian dollars (around US$575 million) on hand as of March 15, 2021. Why does the company think it needs another $800 million?
In its SEC filing, Sundial stated that it intends to use the net proceeds from the stock offering for financing potential acquisitions or investments in "equipment, facilities, assets, equity or debt of other businesses, products or technologies." The company also said that it could use some of the proceeds "for working capital and general corporate purposes."
It's the first proposed use of cash that investors should really focus on. Sundial specifically noted in its fourth-quarter update that it's exploring opportunities to acquire or merge with other businesses in Canada, the U.S., and/or other countries. The company formed a joint venture with the SAF Group to invest in cannabis-related verticals with the potential for debt, equity, and hybrid deals.
Sundial won't really be able to bet all of the $800 million on potential acquisitions or other cannabis investments. Its sales agents for the stock offering will receive their cut of the gross proceeds. And it's possible that the company will need some of the cash to fund ongoing operations. However, most of the money will likely be used to invest in business development deals.
Risks
There are some significant risks involved with Sundial's strategy. The most tangible one is that selling $800 million worth of new shares will dramatically dilute the value of existing shares. That total amounts to nearly one-third of Sundial's current market cap.
Another key risk is that the company's investments simply don't generate very good returns. Sure, there are several cannabis companies that be candidates for Sundial to buy with a huge cash stockpile. However, any Canadian companies on the list face what Sundial referred to in its SEC filing as "continued weakness in the overall Canadian cannabis market."
Sundial can't acquire U.S. cannabis businesses as long as marijuana remains illegal at the federal level. At least, it can't do so without forfeiting its listing on the Nasdaq stock exchange, something the company wouldn't want to do. It could perhaps expand into the U.S. hemp CBD market, but that probably wouldn't be a wise decision at this point because of uncertainty about the U.S. Food and Drug Administration's final CBD regulations.
The company could look to make deals in other markets such as Europe or Latin America. However, bigger rivals such as Canopy Growth and Aphria, which will soon merge with Tilray, already have headstarts in those markets. Sundial could also find the valuations of attractive businesses in these emerging cannabis markets quite expensive.
A smart move?
I'm not going to slam Sundial's strategy to generate $800 million in gross proceeds through a stock offering as a dumb move. Yes, there are multiple risks that shouldn't be overlooked. However, I think it would be premature to call this move a mistake at this point.
Sundial stated in its SEC filing that it hasn't "identified any single material use for which we intend to use the net proceeds" from the stock offering. Until the company actually announces one or more targets, my view is that it's best to refrain from making any assumptions about whether or not its investments will pay off.
It's important to note that Sundial will almost certainly sell smaller blocks of newly issued shares over time rather than all of it in one fell swoop. The company could announce stock sales in tandem with specific investments that it seeks to make.
I've been consistent in my view that there are more attractive marijuana stocks to buy than Sundial Growers. However, I think it's best to take a wait-and-see approach with the company's business development strategy. The odds aren't necessarily favorable, but it's still possible that Sundial's big $800 million bet could pay off over the long run.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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