Investor Intelligence - MJBizDaily

Road to Legalization - Key Investor Considerations Ahead of U.S. Federal Cannabis Reform

• Top cannabis fund managers, investors and operators offer insight on how they’re focusing their strategies ahead of U.S. federal reforms.

• Leading analysts offer key considerations for public and soon-to-be public U.S. multistate operators.

• Weighing the upside and risks of getting in ahead of the big institutions that are still sitting on the sidelines.

From K Street to Wall Street, support for federal U.S. cannabis reform is building rapidly. Advancement of key legislative measures in recent weeks and signals of support for reform from U.S. Attorney General William Barr are boosting investor sentiment and fueling interest from Wall Street banks and major institutions that—until recently—have watched the industry from the sidelines.

“As the federal government inches toward full legalization, we are already seeing non-cannabis-focused institutional capital coming into the market as (investors) get more comfortable with the positive regulatory momentum,” Jeff Howard, managing partner at Illinois-based, marijuana-focused private equity fund Salveo Capital, told Investor Intelligence.

For investors, federal cannabis reform ushers in a host of considerations—depending on your position. Here’s a look at the evolving landscape, the big players getting in and a deeper dive into the key considerations for investors as federal reform draws near.

TIMES THEY ARE A-CHANGING

In just the past month, two key legislative proposals advanced through Congress that industry experts believe could pave the way for cannabis reforms within the next year: The Secure And Fair Enforcement (SAFE) Banking Act, which had been shelved for more than half a decade, passed the House Financial Service Committee with a 45-15 vote. It could receive a full House vote in June. The STATES Act, which aims to give states the ability to enact their own marijuana policies and resolve banking and taxation issues, was reintroduced in both chambers with bipartisan support. Additionally, AG Barr noted that federal cannabis reform is preferable to what he called an “intolerable” landscape today.

The moves are “clearly positive for early investors,” and they signal a de-risking of the industry that’s driving up deal flow “in anticipation of positive developments at the federal level,” said Salveo’s Howard.

Among the most recent activity:

• In mid-April, cannabis industry giant Canopy Growth Corp. announced it had struck a $3.4 billion deal to buy New York-based Acreage Holdings. The move would be the first major Canada-U.S. cannabis deal—but the purchase won’t be executed until the U.S. government removes federal prohibition.

• Just last week, San Francisco vaporizer maker Pax Labs drew in big-name institutional investors to its massive $420 million raise, led by New York-based Tiger Global Management, San Francisco-based Tao Capital Partners and Prescott General Partners of Boca Raton, Florida.

• BlackRock, one of the world’s largest money managers, disclosed in regulatory filings that its funds have an $11 million stake in Curaleaf Holdings, a Massachusetts-based medical cannabis company. While the investment is small for BlackRock, which has nearly $6 trillion of assets under management, the stake is one of the first publicly disclosed investments by a major institutional investor into U.S. cannabis.

PREPPING FOR COMPETITION AND CONSOLIDATION

For investors, the recent deals underscore the flood of institutional capital cued up for cannabis and the consolidation that is expected to accelerate rapidly in the U.S. once federal reform lands. “On the investment side, we expect capital to flow to every sector of the market,” said Karan Wadhera, managing partner at Casa Verde, a cannabis-focused venture fund. “We continue to expect strategics to enter the space in a way that aligns with their current knowledge base— agriculture businesses toward cultivation, CPG toward brands, retailers toward dispensaries.”

New York-based Tuatara Capital is working on a $375 million cannabis investment fund—the second to date for the firm—that will focus on investments in cannabis sectors the company believes will have the most “relevance” after federal reform, according to Al Forman, managing partner at the private equity firm. Those sectors include social consumption, cannabinoid health and wellness, cannabinoid pharmaceutical, and hemp. “When you think of the signals the industry has started to receive … it gives the indication that there is a broader corporate strategic entrance coming as regulations and policy in the U.S. firm up,” Forman said. “Within that framework as we evaluate investments, it really becomes incumbent upon us to be able to identify the types of teams, business models and intellectual property that will both have relevance in those future end markets and will be attractive to one of these entering strategics to either acquire or partner.” For investors currently in the space, the anticipated consolidation should provide strong exit opportunities.

Valuations may run up in the short-term post federal reform, but over time they likely will level out as more institutional money moves in, said John Wagner, managing director at Colorado-based 1stWest Mergers & Acquisitions. “Old-school firms use old-school traditional valuations when buying companies, and they will stay in those swim lanes no matter what they are buying, whether it’s a door lock company or a cannabis company,” he said. “Look for more valuation discipline by larger and increasingly professionalized cannabis investment practices.”

At Casa Verde, the fund said it is focusing investments on ancillary companies that solve “long-term structural industry problems,” Wadhera said. The firm has led a series high-profile funding rounds for growing cannabis firms—luring co-investments from mainstream multibillion-dollar hedge funds and corporations. In October, the firm co-led a $50 million raise for seed-to-sale tracking firm Metrc with Tiger Global Management. Casa Verde also led an undisclosed investment with Big Tobacco’s Imperial Brands Ventures in United Kingdom-based medical cannabis startup Oxford Cannabinoid Technologies. “From our seat, we’ve tried to prepare (for federal reform) by making investments in businesses that should perform well regardless of regulatory climate,” Wadhera said. “We have intentionally avoided businesses that are solving short-term, regulatory pain points to avoid this deregulation risk.”

UPSIDES, DOWNSIDES

Federal reform will also usher in more traditional bank-backed financing—giving cannabis companies cheaper access to capital. Larger U.S. cannabis companies that have turned to Canadian capital markets to list and raise capital could uplist to the major U.S. indexes. “You’ll see a huge pop across the board on all of the stocks, and with better access to capital, these companies could grow faster,” said Andrew Kessner, an analyst with New York-based William O’Neil. But reform also opens the doors for larger players such as Big Alcohol or Tobacco firms to compete, which could shut out some multistate operators if they’re not takeover targets. “If a firm came in with $2 billion and major corporate infrastructure, it could buy up some existing assets and become a pretty formidable player,” he said. “If you’re a company like Curaleaf or Harvest, right now they have this window to build up their business without threat of competition from Canadian LPs or a CPG industry leader.”

Brett Hundley, an equity analyst at New York-based Seaport Global Securities, added that multistate operators, both public and private, have been the “sought-after investments” at this point in U.S. cannabis. “The risk for today’s cannabis companies is this: if legalization happens too soon, Big CPG will come into the cannabis space and simply take technological know-how—either through partnership or some other mechanism—and input this into their own brands,” he said. “Investors will, in turn, put their money into these big CPG equities, and a lot of the expected valuation wave for U.S. cannabis operators will disappear. In a perverse way, full federal legalization is probably bad for the marijuana industry right now.”

Another consideration: Returns and generous terms on private investments may also come down as the price-to-risk ratios on cannabis deals fall, said Danny Moses, investor and member of the investment committee at cannabis equity fund Merida Capital. “The terms that you’re receiving to deploy money right now are very generous,” he said. “You’re getting warrant coverage, options, board seats. That will go away when the institutional money comes in. Right now, you also have the chance to see outsized returns, but if you’re waiting to pull the trigger until federal reform, you’re waiting to compete against institutional money and that won’t be easy.”

Earnings Roundup - Sizing Up the U.S. Cannabis Leaderboard

Earnings season is in full swing with a host of public U.S. cannabis companies reporting quarterly revenues well above their year-ago performance. The 10 leading U.S. firms by Q4 revenue includes a mix of:

• Multistate operators (MSOs), including Cresco Labs, Curaleaf Holdings, Green Thumb Industries, Harvest Health & Recreation, MedMen and Trulieve.

• CBD producers Charlotte’s Web and CV Sciences.

• Ancillary cannabis firm KushCo Holdings, a maker and supplier of cannabis packaging, supplies and accessories.

It’s a leaderboard well worth watching as these firms embark on massive expansions in 2019 that will require serious spending and expert execution to gain market share and create a dominant national footprint.

PATH TO PROFITABILITY

As M&A activity continues to ramp up, analysts and investors are closely tracking capital expenses, which vary widely across multistate operators in various stages of accelerated growth. While anticipated, intense capital outlays continue to be a drag on earnings and fuel losses. Trulieve and Cresco maintain their positions as the most profitable MSOs, posting full-year net income of $43 million and $3.9 million, respectively. Comparatively:

• Los Angeles-based MedMen reported revenue of $29.9 million and a net loss of $64.6 million for the quarter ended Dec. 29.

• Green Thumb Industries, a Chicago-based firm with operations in 12 states, reported a Q4 loss of $20.8 million on revenue of $3.1 million.

• Harvest of Phoenix reported a net loss for the quarter of $71.1 million—which included a noncash fair-value charge of $50.7 million tied to convertible debt that was converted into equity during the year.

• Wakefield, Massachusetts-based Curaleaf, which operates in 12 states, posted Q4 revenue of $32 million and a quarterly loss of $16.5 million.

Those firms that can keep tight rein on cap ex while investing in organic and acquisitive growth will be able to chart the straightest and likely fastest path to profitability.

A GLANCE AT GUIDANCE: POISED TO SURPASS CANNABIS GIANT CANOPY GROWTH?

For those cannabis firms offering guidance on their full-year revenues, some enormous numbers are hitting the charts—fueled in large part by recent activity and their M&A pipelines. Here’s a quick overview:

• Curaleaf is forecasting a $400 million revenue figure for 2019, based on its plans to open 67 dispensaries in 12 states by the end of the year.

• Harvest Health & Recreation boosted its 2019 revenue guidance to $350 million-$400 million. The estimate is a big leap from its previous prediction of $223 million and driven largely by its recent acquisitions of Verano Holdings, CannaPharmacy and Devine Holdings. While the company has just 13 dispensaries currently open, it’s on pace to have more than 120 stores in operation by the end of 2020. While the CannaPharmacy and Devine deals have not closed yet, Harvest is including revenues (specific amounts not disclosed) in its guidance.

• Trulieve reaffirmed its fiscal 2019 guidance of $214 million in revenue and gross profit of $145 million—which would be a 68% spike year-over-year. That forecast doesn’t factor in sales from recently announced acquisitions in California and Massachusetts or the anticipated opening of 14 new recreational dispensaries in Florida. Trulieve has said it expects to update the outlook as the company gains more insight on the timing of those new additions.

Across the board, these estimates all exceed the 2019 revenue forecast of $184.8 million for Canadian cannabis giant Canopy Growth—which boasts a nearly $15 billion market cap. Whether these forecasts pan out, only time will tell. But the projections underscore just how quickly U.S. operators could leap frog in sales—and value—past their Canadian cohorts that continue trade at bubble-like multiples. As the year unfolds, we’ll continue to track this leaderboard, highlighting the key metrics that investors should consider as industry growth accelerates.

By Lisa Bernard-Kuhn

Viridian Insights - Assessing the Investment Opportunity in Consumption Devices: Deal Flow, Valuations & Trends

The cannabis consumption devices sector has expanded dramatically as consumers seek healthier and more convenient ingestion options alongside the progression of cannabis legalization. In the illicit sector, product suppliers had no incentive to offer varied consumption options as consumers were forced to purchase whatever was brought to market. In the legal market, however, competition and innovation have rapidly expanded the ways in which cannabis can be consumed.

Vaporizers have become a leading method by which cannabis is consumed due to portability, convenience and health implications. Rather than having to light a joint, glass pipe or other old-school device and inhale combusted cannabis as smoke while simultaneously putting off strong cannabis odors, vaporizer users can simply press a button and inhale nonsmoke vapor with less cannabis smell. Additionally, the act of vaporization limits the amount of nonactive ingredients and combustion byproducts inhaled by the user, leading to a relatively healthier experience. Eaze, a leading cannabis delivery application based in San Francisco, reported that users of its platform increasingly ordered vaporizers through 2018. This trend was further supported by cannabis market intelligence firm BDS Analytics, which reported that the market share for marijuana concentrates increased from 10% of all products sold in 2014 to 27% in 2018, with most of those sales being prefilled vaporizers.

BEYOND DISTRIBUTION: PRODUCT CREATION, SOPHISTICATION GAINING GROUND

Many of the early vaporizers in the cannabis industry were simply purchased wholesale from factories in China, most of which had been developed for inputs such as nicotine e-liquids—not cannabis. However, as competition has increased between hardware providers and users seek more advanced offerings from vaporizer providers, firms in the consumption devices industry must find ways to differentiate themselves from their peers. The implementation of advanced materials and technologies has been utilized by several providers. For example:

• Ceramics resist the stresses of high temperatures and are relatively nonreactive with the compounds in the vaporizer.

• Manufacturers are also experimenting with various types and designs of heating apparatuses that use different materials to provide consumers with greater choice in experience.

• Various technologies that provide additional functionality.

More recently, companies have begun offering full enterprise solutions around vaporization hardware, assisting licensed operators in navigating the engineering, design, procurement and marketing of their various offerings.

Capital raises in the consumption devices space have remained much lower than in other sectors, though we have seen a small number of companies successfully raising funds because of differentiation from e-commerce or rollup strategies. Consumption device companies focusing on developing novel technologies have been more successful. Several publicly traded consumption device companies focusing on e-commerce sales and distribution raised much of the capital through the middle of 2018. Private companies in this sector have focused on developing novel technologies, included metered-dose inhalers, tech-enabled vaporization devices and new methods for temperature and airflow controls.

Capital-raise activity in this sector increased dramatically in Q2 2019 with Greenlane Holdings of Boca Raton, Florida, completing a $102 million IPO onto the Nasdaq (after a $48 million convertible note financing closed in January 2019) and Pax Labs of San Francisco closing a $420 million private round.

MERGERS & ACQUISITIONS

Most of the M&A activity we have tracked in the consumption devices sector has been related to product creation and intellectual property or reach. Additionally, cannabis companies buy into this sector for advanced technologies. Canopy Growth Corp. acquired Storz & Bickel, the manufacturer of Volcano brand vaporizers, for up to CA$220 million in cash, specifically citing the desire to use Storz & Bickel’s expertise to enhance Canopy’s product development capabilities.

Cannabis companies, both inside and outside this sector, have purchased consumption device companies to gain access to their customer base and bolster their scale. Cambridge, Massachusetts-based Tilt Holdings, for example, acquired Jupiter Research, a vaporizer manufacturer and distributor, for $210 million. We expect these types of deals to continue as consumers demand more advanced hardware options.

VALUATIONS

There are few publicly traded pure-play cannabis consumption device companies, limiting the availability of valuation metrics. However, as these companies are essentially hardware manufacturers and distributors, they tend to trade at lower valuations than cannabis companies that are “touching the plant.” We have seen deals done at low-singledigit multiples related to trailing revenues. However, that is not to say firms in this sector will not be able to command premiums for their technologies, intellectual property or more profitable niches. Many operators in this sector face substantial competition, putting pressure on margins and, subsequently, valuation multiples.

LOW GROSS MARGINS

Before I take a meeting, I always ask a few questions:

• What are your financials? Here, I am looking for annual and monthly recurring revenue for as far back as they have them, runway left/ cash on hand, and cost of goods sold or unit economics on their products.

• What is your current funding structure and what does your cap table look like?

• What are you raising? At what valuation? And how did you get to that amount?

The first question is one of the most overlooked in this space. Much of the industry looks at grow capacity as the gauge for value, but as quality, production output and premiumization happens, capacity is no longer the only factor. Companies that explain away low margins will struggle to get funding as investors know that margin compression is not an if but a when. Is a company’s gross margin less than 50% in its projections? If so, you are in trouble. Low margins in this business will kill you. As will margins that do not fully include all aspects of this labor-intensive, capital-intensive business where unique regulations and taxation can have you selling millions and making pennies. For instance, assume in your investor pitch that those on the other side of the table are going to question you on the tax assumptions you have, which can range from as low as 10% to as much as 37% for growers. The unicorns in the space are largely vertically integrated companies, due to the ability to cut out costs throughout their supply chain and thus increase their margins and capacity as well as the belief they will control this space. The largest Canadian cannabis companies average a gross profit margin around 50%—and you can be sure since their founding those numbers have compressed.

IF THEY BUILD IT, THEY WON’T COME

About 20% of the decks I see are automatically discarded because there is no clear path to profitability, which means no breakdown of cost of customer acquisition (CAC), lifetime value (LTV), conversion rate, etc. Investors have a responsibility to our limited partners to provide a return on investment. Thus, we need to see how founders are going to get their idea into users’ hands and how much it will cost to do it. This needs to be broken down into excruciating detail. While their potential revenue numbers may be sky high, the devil is in the details of achieving those numbers. For instance, there are widely varying predictions on the median spend of a customer, anywhere from $33 to $250—depending on the reports you cite—which is a critical consideration for cannabis dispensaries. If we assume that each customer will spend $33 per visit and that your gross margin is 50%, you better spend less than $16.50 per customer.

Here’s one of my favorite lessons learned from one of my founders, who sold two very successful consumer packaged goods companies: “If a founder won’t get their hands dirty old-school selling, they won’t win in CPG.” That’s why I will go in depth with founders on how they sell. I’ll ask them:

• If I were a customer, how would you pitch this to me?

• What was the biggest account/sale/sales day you’ve had, and how did that happen?

• When was the last time you tried to sell this idea and failed? What happened?

• What are your sales and distribution strategies?

Often, decks are heavy on ideas and hockeystick-like returns, and founders forget that once you build your game-changing business, users can buy it only if they know about it. It is the founder’s job to go spread the gospel, and I love nothing more than seeing those who do it just like breathing. Remember, each year more than 627,000 new businesses open, according to Small Business Administration estimates. Industry consensus is that a few thousand get funded each year. We have to use our “nos” to find the few “yeses” in the 627,000 haystack.

By Harrison Phillips, vice president, Viridian Capital Partners

Investor Watch - MedMen fumbles are putting investors on fence

When California-based cannabis company MedMen released its most recent financial results Feb.28, CEO Adam Bierman acknowledged the group had not done enough to “own our own narrative.” Unfortunately, the wish to boost such a narrative went sour quickly. With a combination of a number of public relations missteps and expansion decisions that many are questioning, the headline-friendly company has seen its share price falter and remain in the doldrums.

The jury is still out, however, on any future opportunities for the company. “I think the stock performance makes it clear that investors are taking a wait-and-see approach as to whether the company will be able to work through its challenges,” Jesse Pytlak, a research analyst at Torontobased Cormark Securities, told Investor Intelligence. The challenges seem to include both MenMen’s public image as well as some of its execution plans as the company contends with others to gain market share in the increasingly competitive space that is the fastconsolidating cannabis industry.

PR STUMBLES

A few days after its February results were released, MedMen got into hot water with U.S. authorities after a public relations firm the company had hired, Winning Media, published a story on marijuanastox.com urging readers to buy MedMen stock. The story, which MedMen distanced itself from by saying it hadn’t been approved according to internal company procedure, may have fallen outside the scope of what Winning Media was hired to do, namely, promote the company through online ads, authorities noted. Better news followed when private equity group Gotham Green Partners said March 22 it will pump $250 million into MedMen in the largest single investment in a publicly traded marijuana company with U.S. operations. But MedMen’s pattern of one step forward and one step backward continued April 19 when major executives and board members said they were leaving the company. MedMen said chief operating officer Ben Cook and general counsel and board member Lisa Sergi resigned. According to CNBC, Daniel Yi, senior vice president of communications also left, but MedMen did not confirm his departure in its official media release. Yi could not be reached for comment.

EXECUTION PROBLEMS

On April 15, the company released unaudited sales figures that some observers have noted were not exactly stellar. While strong growth was reported in Nevada and Arizona, where MedMen recently expanded, the 5% reported quarterly revenue growth in Southern California retail locations was described as “anemic” by Motley Fool commentator Sean Williams. In addition, sales from recent acquisitions fell, suggesting MedMen may be overpaying for such targets, Williams said.

The investor community will be anxious to hear quarterly results May 29 just to see where MedMen is on its trajectory. For now, Pytlak at Cormark is maintaining a target share price of 7.50 Canadian dollars, upgrading the stock from Market Perform to Speculative Buy on March 25, just days after the Gotham Green investment. “We think that the financing with Gotham Green is a meaningful first step to rebuilding investor confidence in the company’s longer-term outlook,” Pytlak wrote in a research report in which he also cautioned that concerns remain over the company’s cost structure.

As for recent share-price performance? On March 1, after results were released, MedMen (MMEN) closed on the Canadian Securities Exchange at CA$3.92 and received a boost after the Gotham Green investment to close at CA$4.49 March 25. More recently, the stock has been on a largely downward trajectory, dipping to a close of CA$3.80 on April 22 after the senior executives resigned. As of April 29, the stock was at CA$3.71, down from March 1.

By Nick Thomas