Full Circle Capital: A Case Study of a Backdoor Cannabis Play
Always on the lookout for ways investors are participating the cannabis space, today we are taking a look at a publicly traded company that, on the surface, offers a unique access point. Rather than a recommendation for or against the companies mentioned here, consider this a case study on the intricacies and pitfalls of small cap stock investing in general, especially in areas like cannabis where “alternative financing” is often the only kind a company can obtain.
Full Circle Capital (NASDAQ: FULL) is an $80 million cap publicly-traded company that owns senior financing rights in Advanced Cannabis Solutions (OTCBB: CANN). Full Circle also owns debt and equity in many other companies across a wide array of industries, and is what is known as a Business Development Company, a special designation of a closed-end fund that primarily invests in higher risk and/or troubled companies. BDCs do not have to register as investment companies with the SEC, but they do have to register their securities with the regulator. As such, BDCs often take a more proactive role in affecting business strategy and management changes than would a typical, passive lender.
Lottery Ticket Holdings
As it relates to its stake in CANN, Full Circle held warrants, which are much like stock options, to buy 1 million shares of CANN stock. The warrants were obtained as part of a deal to extend up to $30 million in credit to Advanced Cannabis, a loan which CANN has yet to tap. So when cannabis stock mania gripped the equity markets last spring, CANN shares rose with the tide, briefly crossing $30/share before a slow and steady decline to the low single digits of today.
This created a major problem for Full Circle and the investors who were seeking a “safer” way to access cannabis opportunities, because the exercise price of those warrants is more than twice what shares of CANN currently trade for. Currently trading for around $2.20 per share, in January CANN briefly traded above the exercise price for about a week, before plummeting about 75% in the months since.
Full Circle’s Core Business: Smart Lending
Full Circle, per its filings, states that it makes investments “primarily in asset-based senior secured loans and, to a lesser extent, mezzanine loans and equity securities issued by smaller and lower middle-market companies that operate in a diverse range of industries. Our investments generally range in size from $3 million to $10 million or more … .”
Here is where it can get a little tricky. The majority of you without advanced financial credentials may start to glaze over when we say “rights offering,” “exercise price,” warrants, and the like, but these terms are vital in being able to understand how a company like Full Circle Capital can make money.
In addition to lending out money at very high rates, typically 10% or more, a company like Full Circle can often obtain rights to buy shares of the underlying company. This can come about during an initial lending deal, or as a squeeze play when the company it is lending to would otherwise have to seek bankruptcy protection. Overall, it is a model that many BDCs have used to great success, provided they create a diversified portfolio of strong, growing companies that can pay back their loans.
Portfolio Management Not Yielding Good Results
Full Circle is one of dozens of publicly-traded BDCs; they are a popular instrument for many fixed income investors because of the high income levels they throw off—they are mandated to deliver almost all of their net profits back to shareholders. Most offer yields above 7%, while FULL shows a current yield of over 11.5%.
In a low income world, this should be enough to make the securities very attractive to investors. But a company like Full Circle can only remain an attractive investment if it can show a steadily rising net asset value, or essentially the book value of all the various holdings the BDC owns and manages.
Despite an environment the past few years where almost every asset class and industry has performed well, Full Circle has shown a declining NAV every year since 2010. The dividend amount has been nearly cut in half since then, and in recent quarters the net investment income Full Circle uses to pay the dividend is not enough to even cover it.
The company has had to scramble to reduce its own internal management fees, while also highly diluting shareholders with a massive rights offering. As a result, FULL shares that traded consistently above $7 for years are now trading for half that price.
At the same time, the massive windfall that some investors believed would come from the CANN warrants has evaporated. Maybe CANN will turn things around, but it is a long road ahead given that the company has over $2 in liabilities for every $1 in assets. In the meantime, investors considering approaching cannabis opportunities from unique angles must commit to doing the necessary “extra homework.”
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