Tilray: Shares Plunge on Dilutive Convertible Notes Offering, but Magnitude Is an Overreaction

On May 25, no-moat Tilray TLRY issued $150 million of 5.2% unsecured convertible senior notes, with another $22.5 million possible for over-allotments. The proceeds will be used to partially refinance near-term maturities of the 5% convertible senior notes due 2023 and 5.25% convertible senior notes due 2024, of which $223 million and $138 million, respectively, were outstanding at the end of the fiscal third quarter.

Shares fell about 21% on the news in reaction to the new notes’ dilution to existing investors. While the conversion price is a fraction of our fair value estimate, the small size of the offering limits the dilutive impact. As such, we don’t expect a material reduction to our fair value estimates of $6.50 and CAD 9 per share. We believe the share price reaction creates even more upside opportunity in the only Canadian licensed producer under our coverage that’s reached adjusted EBITDA profitability.

Looking at the terms, the conversion price of the newly issued notes is $2.66 per share, a 13% premium over the May 25 closing price. However, this is nearly a 60% discount to our fair value estimate and a 42% discount to the one-year high price. Furthermore, the 2023 and 2024 notes being repurchased have conversion prices of $167.41 and $11.20 per share, respectively. However, these higher conversion prices largely reflect the capital market conditions at the time of their issuances. But, with the maturities nearing, the company left itself little time and could no longer wait to refinance the notes.

Despite the conversion price’s large discount to our fair value estimate, we think the market has overreacted. At the end of the third fiscal quarter, the fully diluted share count was about 616 million shares, but, fully converted, the newly issued notes would increase share count by about 65 million shares, or just over 10%. Thus, we don’t think the dilution is large enough to warrant the price drop.