Brian Gaynor: Share structure reminiscent of bad old days

Mark Lucas (left), Nic Foreman and PhD student Daniel Reason in Cannasouth's Hamilton research lab. Photo / File

COMMENT:

The Cannasouth Initial Public Offering (IPO), which is the first domestic IPO in two years, has a poor capital structure.

Just when the NZX needs a clear, investor-focused offering, Cannasouth's share structure is reminiscent of the bad, old mid-1980s. In other words, I believe the Cannasouth IPO has a structure that primarily benefits existing shareholders rather than those participating in the IPO.

Cannasouth Ltd, a medical cannabis company, was incorporated on August 21, 2018, with Nic Foreman and Mark Lucas receiving 485,000 shares each and Merran Davis 30,000. According to Company Office filings, these one million shares were issued for nil consideration.

Four days later, on August 25, Cannasouth acquired Cannasouth Plant Research New Zealand Ltd (CPRNZ), which was established on May 15, 2017, and was also owned by Foreman, Lucas and Davis. The total cost of the CPRNZ acquisition was $1.

Shortly afterwards, Cannasouth issued 240,000 new shares to CMP Growth Capital Fund Ltd for $5 a share. CMP is jointly owned by Sean Joyce and Tim Preston.

In late October 2018, Cannasouth had these shares on issue:

• 1 million shares issued to Foreman, Lucas and Davis for nil consideration
• 240,000 shares issued to the Joyce/Preston-controlled fund for $1.2m.

On October 31, Cannasouth had a share split whereby the 1.24 million existing shares became 72 million shares. Under this, the million shares originally owned by Foreman, Lucas and Davis became 58.1 million and the 0.24 million acquired by CMP Growth Capital Fund became 13.9 million.

The next month Cannasouth raised an additional $2.5 million by issuing 10 million post-split shares to investors at 25 cents each. Consistent with the $1.2m fundraising from CMP and a further $2.5m from other shareholders, Cannasouth had cash and cash equivalents of $3.1m at the end of 2018.

Cannasouth now has 82 million shares and its IPO goal is to raise $5m through the issue of 10 million new shares at 50c each with an option to raise an additional $5m, also at 50c a share, depending on demand.

The four different share issues have the following value at the 50c a share IPO price:

• The original million shares, which cost nothing, have become 58.1m post-split shares worth over $29m.
• The 0.24 million shares originally issued to the CMP Growth Capital Fund, which cost $1.2m, have become 13.9 million post-split shares worth nearly $7m.
• The 10 million post-split shares, which cost $2.5m, are now worth $5m.
• All shares issued through the IPO will cost 50c and be worth 50c before the company lists.

This column has no problem with founding shareholders making a profit through the IPO process, particularly when the IPO company is generating revenue and has business momentum. However, Cannasouth was established less than 10 months ago and has no revenue.

The imbalance between the price paid by original shareholders and IPO investors could be tolerated if there were restrictions on the original shareholders selling shares when the company lists on the NZX, as there is on many other sharemarkets. However, there is no escrow or restrictions.

Companies with such share structures, and a lack of selling restrictions on founding shareholders, have usually underperformed on the NZX longer term.

- Brian Gaynor is a director of Milford Asset Management.

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