The partners at cannabis-focused Altitude Investment Management didn’t imagine that their decades of experience in distressed debt would apply to the rapidly growing pot industry, yet it’s become a key focus as they raise capital for their second fund.

Three of Altitude’s four principals came from Longacre Fund Management, a distressed-debt investor that wound down its main funds in 2011. Now they’re looking for high-yield pot debt as the industry struggles with a months-long share slump, unreceptive capital markets and a growing cash crunch.

Cannabis companies suffered a rough 2019, with shares in the BI Global Cannabis Competitive Peers index down 50 per cent compared to the 29 per cent rise in the S&P 500. Stocks came off sky-high valuations as companies slashed earnings forecasts, Canadian storefronts opened more slowly than expected, and a vaping-related illness swept the U.S.

“It seems like the ability to access capital has really shriveled,” said Michael Goldberg, who was previously a managing director at Longacre and founded Sonar Asset Management, which also specialized in distressed debt.

“Whereas a lot of our initial investments were either in common equity, preferred stock or convertible notes, I think we’re going to start to see the ability to structure secure debt deals with warrant coverage.”

Altitude’s first fund, which raised $30 million and closed in November 2018, is primarily invested in private companies like data firm BDS Analytics and retail platform Flowhub. The New York-based firm is targeting $150 million for its second fund, which will focus on growth-stage U.S. companies, both healthy and distressed, as well as the emerging European medical cannabis industry.

“We’re really excited about this next leg because it’s come right into our wheelhouse,” said partner Jon Trauben, a former managing director at Barclays and Credit Suisse.

Altitude would buy existing debt that’s trading at a significant discount to its issue price, as well as participate in the origination of new senior secured debt that can be converted into equity, Goldberg said.

“When you have a publicly listed company and there’s a distressed-debt financing, you’re looking at yields that are close to double of what they would be for a non-cannabis comparable credit,” Trauben said.

Senior secured loans are still relatively rare in the cannabis industry, although they’re not unheard of. Curaleaf Holdings Inc., for example, clinched a $275 million syndicated term loan priced at 13 per cent last month.

Altitude will draw the line at a certain level of distress, however.

“We’re not looking to save a company from the brink of disaster,” Trauben said. “There will be plenty of opportunities for companies that are under stress or distress to invest in; I don’t think we need to save a company from death.”

While the partners at Altitude are cheering for federal legalization of cannabis, they also admit that the current situation gives them an advantage because they don’t face competition from bigger players.

“It’s nice not having the Blackstones and KKRs and TPGs coming into our world at this moment,” Goldberg said. It also gives Altitude’s portfolio companies the chance to build moats around their businesses before they have to face mainstream competitors, he said.

--With assistance from Allison McNeely.

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