Your Comps Are Wrong: Why and How to Use Comp Tables

by | Jan 14, 2021 | Comp Table & Market Commentary, Free

Why do we think comp tables are so important?

They are the key tool in understanding investment opportunities and risks in an industry. 

  • provide a menu of available public investment choices for purchase or sale
  • show the range of valuations of the choices, showing discrepancies that may or may not converge in the future. Public valuations also inform private company valuations and acquisition pricing
  • show the size and leverage of the public options
  • show the range of operating margins and opportunities for margin expansion or compression
  • show the cost of capital for companies and the industry, which can be applied to similar companies in the private market either raising new capital or deciding whether to sell to another company
  • on the second page, the stock price performance shows what is moving up and down, helps isolate specific performance vs peers and the broader market

And how can you manage a portfolio with wrong data?

Tracking the multiples over time shows trends in a company’s cost of capital and shows the potential upside and downside based on the company’s and the sector’s historical high and low valuation.

 

MJResearchCo provides a list of historical comp tables here

 

 The Complexities of Cannabis

 Most industries’ valuations can be automatically calculated with publicly available information by financial tools such as Factset, Bloomberg, Sentieo, or YCharts.

 For cannabis, however, these automatically generated tables are almost always wrong because:

 

 

 

 

  • These downloads often do not include the warrants and options in the most cannabis company equity stacks

  • Convertible debt is often split into the “Debt” portion and the “equity” portion on the balance sheet, but in real life the security will either be debt below the strike or equity above the strike.

  • Downloads do not include equity and debt offerings subsequent to quarter end, and never include the associated warrants.

  • they also do not adjust for acquisitions, nor future earn outs of closed acquisitions

  • Sometimes “fully diluted” shares actually include warrants that are so far out of the money that they have little chance of being exercised, and thus should NOT be included in the capital structure (unless you expect a repricing which has happened in cannabis). An example is TGOD’s 14.5 million warrants striking a C$9.00 and $9.50 vs the current price of C$0.31.

 

 

Why do we think comp tables are so important?

They are the key tool in understanding investment opportunities and risks in an industry.

  • provide a menu of available public investment choices for purchase or sale
  • show the range of valuations of the choices, showing discrepancies that may or may not converge in the future. Public valuations also inform private company valuations and acquisition pricing
  • show the size and leverage of the public options
  • show the range of operating margins and opportunities for margin expansion or compression
  • show the cost of capital for companies and the industry, which can be applied to similar companies in the private market either raising new capital or deciding whether to sell to another company
  • on the second page, the stock price performance shows what is moving up and down, helps isolate specific performance vs peers and the broader market

Cashless Exercises Make Share Counts More Dynamic vis a vis Stock Price

We have switched our comp table share calculation to cashless exercise of options and warrants from cash exercise in the past.

The net effect is that share counts now change with every move in the stock price, while with cash exercises they only changed at the strike prices of warrants and options (convertible debt is still exercised at cash, which we will detail in a future article). 

Why does this matter? Because no active fundamental investor invests for the current price; they invest for a future price, yet the dilution increases with every increase in the stock price.

After you’ve done all your fundamental analysis to determine a company’s enterprise value, how many shares will there be? How is that future value split up?

If you use the current share count at the current stock price (or worse, the shares outstanding 2 months ago with no warrants at all), you will be overstating your return and understating you dilution.

Let’s use Aurora Cannabis as an example. In the chart below, the black line is the share count using cash exercise, the purple line is the share count using cashless exercises, and the green line is the enterprise value using cashless exercise shares and ignoring net cash. To use this, you look up your target valuation on the green line and then look at the share count implied on the purple line and the share price below.

Using our dynamic share counts, the target is $46.79, or a 432% return from the current price. Yet if you use the share count downloaded from software, you will overestimate your return by calculating $59.52 and expecting 566% return – you will be disappointed by 22%. Even if you use the point in time shares from our comp table at $8.94, you will still over estimate the target at $50.33.

 

How can you manage a portfolio with wrong data?

How can an active investor properly weight their positions if they expect Aurora to rise 22% more than it truly would with the correct math? How can a portfolio manager properly weight positions when ALL of them have such dynamics? How can a portfolio manager intuitively understand how value accrues to the equity holders vs the warrant holders under different scenarios?

What if you are an M&A team looking to acquire a company for a 50% premium, yet there are 20% more shares at your target valuation?

What if you are a private investor who thinks they are buying 19.9% of a company but you only buy 18.5% (like British American Tobacco did with Organigram)?

This is an issue endemic to nearly all companies in the cannabis industry because of the significant use of warrants and options to complicate the capital structures; it is not a commentary on Aurora specifically.

At the end of the day, the warrants shift incremental value to the warrant holder vs the common shareholder. This is fine to align incentives, but the common shareholder must be aware of the shell game where they expect to capture an equal share of the company’s upside. In the Aurora example, the shareholder using the downloaded shares would expect a 566% increase in the enterprise to result in a 566% increase in the stock price, when actually the enterprise increases 463% and the common captures only 423% of the return and the warrants gain the rest.

We at MJResarchCo have these shares vs. price charts for most cannabis names and are working on publishing them to Premium Members soon.