Cannabis Musings - May 22, 2023
Canopy's Complex Construct Crafting Constellation Comity
Friends – once again, I’ve read Canopy Growth’s filings about its internal restructuring so you don’t have to. We first talked about Canopy’s efforts back in October, as part of what is now apparently becoming an ongoing series about uplisting (listing stock for trading on a “better” exchange).
Seven months ago, Canadian licensed cannabis producer, Canopy Growth, filed a hefty press release outlining a plan to get its Toronto Stock Exchange-listed stock also listed for trading on the US-based Nasdaq. Among other things, listing on a US stock exchange not only offers a certain perception of legitimacy, it also comes with better trading volume, more participants, potential index listing, and theoretically easier access to delicious institutional capital. It’s that last one that’s really the golden goose for cannabis companies trying to list on the Nasdaq, although we’ve discussed before why that benefit would nonetheless likely remain out-of-reach.
On Monday, Canopy filed a preliminary proxy statement (a public disclosure filing soliciting a shareholder vote) updating us on its efforts. They’ve apparently been keeping their lawyers and accounts very busy over the past half year.
As hinted at back in October, the plan (assuming Canopy’s shareholders approve it) is for Canopy to consolidate all of its US-based plan-touching assets – Wana, Jetty, and Acreage – into a single company, Canopy USA. Canopy (the public company) would own non-voting stock of Canopy USA, retaining nearly all of its economics, and have the right to exchange that non-voting stock into voting stock of Canopy USA (which it presumably won’t do until the US legalizes cannabis).
As I noted back in October, this is sort of like “tracking stock”, which is stock of a company that’s issued to the public, but only has economic rights by contract, without any voting or liquidation rights. It’s certainly built with more protections to the investor than, say, the China-based companies floated stock on US exchanges that simply provided “exposure” to the economic value without any future rights to the assets, something the US Securities and Exchange Commission didn’t particularly like.
It's also very similar to what TerrAscend is trying to do with its own restructuring, which we discussed a few weeks ago. That being said, there are a number of things that make this proxy, and this structure, very differnt.
First, the proxy statement says that “Based on the advice of our legal advisors, the transaction structure was intended to” allow Canopy to not violate US federal law by owning the non-voting stock of Canopy USA (the plant-touching assets), laws such as the Controlled Substances Act, money-laundering rules, and, possibly the most misunderstood law around, RICO.
Note that Canopy’s lawyers provided “advice”. I could be wrong (always possible!), but I read that to mean that its lawyers did not issue a legal opinion. That’s a very important difference. A legal opinion is sort of like a guarantee from the law firm that, say, a contract is enforceable with a certain law, subject to many, many pages of caveats and exceptions. You can sue the law firm if they get it wrong, which is why law firms don’t like to issue legal opinions, and which is why law firms charge so much money to issue legal opinions.
On the other hand, “advice” is more like guidance, and almost definitely came in the form of a memo that had about a page of disclaimers saying that the “advice” couldn’t actually be relied upon (wrap your head around that).
Why does that matter? Well, I’m guessing that Canopy’s lawyers couldn’t get comfortable issuing a “clean” opinion that the resulting structure would fully comply with federal law. One thing the proxy does make clear is that Constellation’s lawyers didn’t think so. (As a reminder, Constellation is a large investor in Canopy, and it appears that a lot of this restructuring is being done to downscale the relationship between the two.) In particular, Canopy:
“determined that it would be prudent to provide our shareholders, particularly institutional shareholders, such as [Constellation], the Company’s largest shareholder, with the ability to self-assess compliance with Applicable Federal Law.”
I read this to mean that Constellation’s lawyers very much didn’t agree with Canopy that the Canopy USA non-voting share structure would fully protect Canopy from violating US federal law. Indeed, the proxy notes that, “in the event of aggressive enforcement policy,” the structure may still subject Canopy to an argument that it “‘aided-and-abetted’ violations of U.S. federal law,” even though Canopy also says that its own lawyers advised that it’d be in compliance with law.
I’m honestly pleasantly surprised to see this level of nuanced discussion on the vagaries of US cannabis law. Aiding-and-abetting, which is basically that you helped someone else commit a crime, is a notoriously fact-intensive and squishy analysis (much more than you’d expect). An analysis that, in my experience, gets ignored in public cannabis company risk disclosures.
The proxy then goes on to explain the problem with that regulatory risk (which highlights why institutional capital won’t invest in cannabis):
“In particular, certain institutions have prescribed investment criteria that they are required to abide by or contractual covenants to third-parties contained in credit agreements or other material contracts with which they have to comply. Given the nuance and complexity associated with international laws and regulations related to cannabis, certain of these institutional investors are either prohibited or significantly restricted from investing in or owning shares of certain, or in some instances, all, cannabis companies.”
So, to placate Constellation (well, Constellation’s lawyers), as well as any other current institutional Canopy shareholders who would “self-assess” the proposed structure and still think that Canopy would be at risk of violating US federal law, Canopy is offering those shareholders the ability to swap their Canopy common shares for non-voting, non-participating (in dividends) shares of Canopy. These “Exchangeable Shares” (which may be exchanged into voting shares of Canopy at any time) are a non-voting interest in a Canadian company (Canopy) that has a non-voting interest in US plant-touching asserts (Canopy USA). On other words, aiding-and-abetting aiding-and-abetting, which is apparently enough protection to keep Constellation’s lawyers happy enough.
The tsuris here is that those Exchangeable Shares will not be listed on an exchange, making them hard to trade and hard to value (you’d likely discount this stock relative to Canopy’s publicly-traded shares because of the limited rights and liquidity). That will put institutional holders that “self-assess” the structure’s risk to be too great in an interesting situation – do they hold the stock and simply take the risk that Canopy’s assertion of legality is wrong; do they swap for non-voting shares that don’t get dividends and aren’t exchange-listed; or do they just sell their shares?
Finally, we should note that Canopy makes it very clear in this new proxy statement that the Canopy USA holdings will not consolidate (meaning they won’t be included) on Canopy’s financial statements, even though Canopy will hold nearly all of the economic value of Canopy USA. This is presumably to address the Nasdaq’s apparent distaste for Canopy’s previous plan to consolidate Canopy USA on the financials.
It's an impressively complex transaction, one that gets Canopy not just uplisting (possibly), but bundles together the US assets, allows them to close on the acquisition of Acreage, and decouples them somewhat more from Constellation. I think it’s a fair assumption that Canopy has been discussing extensively this revised structure with Nasdaq, and Nasdaq didn’t laugh them out of the room, so assuming they get the shareholder votes, this probably gets done (although, like the memo probably said, you’re not allowed to rely on that for any reason!).
I also wonder if other pending uplisting proposals will be modified now that Canopy’s proxy has openly discussed the aiding-and-abetting risk, and offered highly-regulated, risk-intolerant investors an added layer of (probable) protection.
Never underestimate the ingenuity of lawyers and accountants when it comes to structuring.
Be seeing you!
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© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.