Bankruptcy is a word no investor wants to hear, with shareholders generally wiped out in the restructuring process. No public company is really looking to go down the bankruptcy path, which is why it is so important for investors to pay attention when one warns that bankruptcy is a very real possibility. That's exactly what Canoo (GOEV 2.59%) has had to do in its Securities and Exchange Commission (SEC) filings. The outlook doesn't look good.
By the book
The SEC requires the leaders of public companies to realistically examine their businesses and make an assessment about their potential future. More often than not, these reviews are positive and a company doesn't have to say anything about them. However, by law, a company must disclose if management believes there is a very real risk that it cannot continue operating. These are known as going concern notices.
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Canoo has issued just such a notice. It can be found in multiple places in the company's first-quarter 2023 10-Q, including on page 3 (the first page with any content) in the "Cautionary Note Regarding Forward-Looking Statements" section. It reads:
Our management has performed an analysis of our ability to continue as a going concern and has identified substantial doubt about our ability to continue as a going concern. If we are unable to obtain sufficient additional funding or do not have access to additional capital, we will be unable to execute our business plans and could be required to terminate or significantly curtail our operations.
Read that statement twice. It is terrible and should worry even the most aggressive investor. Management is blatantly stating that, as the situation stands now, it will run out of cash very soon. The cash balance confirms this. The company ended the first quarter with $6.7 million on the balance sheet, down dramatically from the nearly $36.6 million it had at the end of last year. With a cash burn like that, the company may not have much time left without some outside help.
Costly capital
There are big headwinds on that front. For starters, Canoo stock has fallen dramatically and is now down over 95% from its 2021 high. In fact, in addition to the going concern notice, the company also had to disclose that it had been warned by Nasdaq that it wasn't in compliance with listing requirements and could be delisted. These facts will make it much harder for Canoo to raise equity capital. And if it does, the move will likely be highly dilutive to current shareholders.
So if selling stock is going to be hard, what about debt? That's not likely to be any easier. For starters, interest rates have risen dramatically over the past year. Thus, debt financing is generally more expensive today than it was not too long ago. Add in the company's weak financial state, including little cash and ongoing red ink, and lenders are likely to demand extra covenant protections and lofty interest rates. Which brings up a recent convertible debt sale, in which Canoo raised around $45 million via a convertible debt offering.
While this debt deal solves the short-term liquidity problem, it comes at a high cost. The interest rate is 1% unless there's a default event, when the rate jumps to 15% (that is just one of several onerous protective covenants). That would be a very heavy burden for Canoo and would leave it in an even weaker state as it tries to build out its business for the long term. Plus, the company generated no revenue in the first quarter, so how exactly is it going to pay even the 1% interest rate related to the new convertible?
Meanwhile, if the company does manage to muddle through without default, the conversion of this note would likely end up leading to material shareholder dilution. And given the cash burn here (around $30 million in the first quarter), the company will likely have to raise additional money again in fairly short order. Even the best case scenario isn't a great one for shareholders.
Not worth the risk
Even if Canoo manages to solve its near-term financing problem -- which is not a given -- investors need to consider the long-term future here. Canoo is a tiny electric vehicle maker looking to enter what is an increasingly competitive field filled with giant, well-established competitors. In other words, if it gets the helping hand it needs and raises some much-needed cash, it still faces an uphill climb as a business. Most investors would be better off avoiding this high-risk auto stock that is blatantly stating that it could soon go bankrupt.
