Whale Watching: Will Institutions Migrate To Cannabis Stocks?

Toward the end of summer, a few friends and I would gather at our local spot on the water to watch the sunset. Most would drink, I would enjoy some kind bud, and we talked or didn’t talk depending on the mood.

The night of August 30th, I was pulsing. The HHS news had just leaked and while I was physically there, I was mentally checked out, going through the math in my mind and mumbling something about 280E to anyone who happened to enter my orbit.

The following Thursday a group of us gathered to celebrate our pal Sammy’s birthday and kick off the NFL season. At the end of the night, a buddy of mine needed a ride and as I wasn’t drinking, I was happy to oblige and pay it forward.

The conversation turned to—what else—cannabis and the seismic shifts that we had just witnessed. “If you’re looking at this space for the first time,” I said, “you have no idea how fortunate you are because this is what we’ve been waiting for.”

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I hosted a few of that crew to watch my Raiders that Sunday and our friend—who has a huge role at one of the world’s largest asset managers—bee-lined to me and began to pepper me with questions on 280E, swap mechanisms and importantly, the potential to generate meaningful alpha.

I saw the light switch flip so I made him an offer: “come spend a few days with me at ATB next week. You may never speak to me again by the time it’s done but there’s no better way to educate yourself on the space than to just dive right in.

We Jilt this City

To understand where we are, you have to appreciate how we got here. I’ve been trying to make introductions between Wall Street types and U.S cannabis operators for many moons with varying degrees of success, some of which have proven bittersweet.

In 2020, in an effort to co-join these universes, we introduced a respected west coast small-cap fund manager to several U.S. cannabis operators. Lo-and-behold, when the next 13-F filings crossed the wires, they were splashed all over the space. It felt like genuine progress; until it didn’t.

A few months later, after participating in a deal for a U.S plant-touching operator, the PM is said to have gotten a tap on his shoulder from compliance. I don’t profess to know the particulars of that conversation but suffice to say they were nowhere to be found when the next 13-F’s hit in the Spring of 2021.

Then there’s that time a few years ago when a tier one U.S. operator did a $300M bought deal and Blackrock is reported to have been the lead investor. The only problem was that several days later, after not being able to custody the stock, they were forced to DK the trade and scurry back to the sidelines.

[institutional investors + large CPG avoid this space like a plague lest they be tainted with the very same 280E blame-brush that is now in the process of being repealed]

Layer in multiple false starts on SAFE banking, the COVID-induced canna glut that expedited the price curve normalization, maddening state level delays, a persistent illicit market, custody fuckery, pernicious algorithms and the structural/ naked short base and well, any semblance of optimism has been a weapon of mass destruction.

Moby’s Dick

Our local whale wasn’t the only big hitter attending the event.

Another, who is likely a top-three holder in the space, took I-90 West into town and met us for a few Arnold Palmer’s Tuesday night before the ATB cocktail hour.

My hope/ intention was to connect them with each other—whales of a feather—as well as with some of the better people/ opportunities in the space, a sequence that started with Ziad Ghanem/ Keith Stauffer at TerrAscend (with a nod to JW, a late scratch).

From there we went to the ATB cocktail hour where every conversation with an old friend or familiar face, started with, “It’s great to see you—so happy you’re… alive.” It has been a harrowing journey these last seven or eight years; the hugs were genuine.

There were active conversations on a number of topics, from the implications of the HHS recommendation to the specter of the DEA affirmation being coupled with the Garland Memo and timing thereof; and the senate mark-up of SAFE banking and the likelihood/ timing of potential passage in the House.

It was great to catch up with several peers in the investment community, haggard as we/they are, all sharing what one of the whales called “a thousand-yard stare.”

The discussion veered to the source of recent flows, as well as the process/ mechanism that’s being used to transact (routing through Europe; rotating brokers to cover/ re-short before delivery) and the whispers of enforcement that seem to be getting louder.

One fund manager shared that, as far as locating borrows for short-sales, a broker (not ATB) told him, ‘we know who the good accounts that locate the shares are, and others who do so much business that there’s an implicit ‘don’t ask, don’t tell’ policy. Swell.

There were several stories about one particular Canadian bank that is aggressively calling U.S operators advising them to raise money—and when the companies send their deck to set a process in motion, their stocks suddenly get hammered.

^ certain clients are said to get the call to short stock + look to cover on the offering, which printed money for a cadre of Canadian criminals hedge funds for a long time.

As sunlight is the best disinfectant, I share these stories; those motherfuckers are real.

All-in-all, it was timely and classy kick-off that set the stage for the main event.

By the time the whales and I got to the venue, we had a set agenda in an effort to put the best industry foot forward. I won’t delve too deep into the one-on-one’s but I will share that the lineup included Glass House GLASF, TerrAscend TSNDF, Verano VRNOF, Village Farms VFF and AdvisorShares'MSOS MSOS, with a healthy dose of 4Front FFNTF sprinkled in.

As I said, best feet.

In terms of the main stage—Colin to the main stage; COLIN, the main stage—ATB did a bang-up job of summarizing the content in real-time, which was another nice touch.

Gonna leave this one in front of the firewall because after all, it’s their content; our regular format with a deeper dive into all this and more will continue tomorrow.

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Thank you ATB for such a well-run event, which we foreshadowed here:

True Colors

We like to say, you can learn a lot just by watching; that’s even more apt when navigating a prolonged shit storm. We saw select operators step up and do amazing things, and we saw certain people devolve into the worst versions of themselves.

And we saw that with the banks; custody fuckery that began w/ Pershing and metastasized through JP Morgan, Credit Suisse, UBS and others, continued this year as Cowen, BTIG, Cantor shit-canned their canna research because there was no way to know when, or if, banking revenues would emerge to justify that expense.

One bank that didn’t blink was ATB, who will be hosting the first post-HHS industry conference next week in New York. Their analyst, Freddy Benson Gomes, has been, as they say, tip-top, shit-hot and second-to-none in his coverage.

Firehose, On

Kim Rivers, CEO, Trulieve TCNNF

Smart & Safe Florida – The self-enacting clause was strategic given witnessing the challenges of starting adult-use in other markets.

Supreme court reviews all ballot initiatives for:

(1) Single Subject – can only address a single subject to ensure clarity and make sure voters are not being mislead, and

(2) Alignment – ensures the ballot summary is not misleading when compared to the actual text of the ballot amendment.

Believe at some point there will be a ruling.

Threshold to pass is 60%.

Once it passes, believes there is little implementation risk given the language and stage of development of the medical market.

Liquidity position – still have dry powder.

Will exit this year in a leaner and more optimized position.

Winding down inventory position when 280E happens (there was a bit of an inventory build by design)

Industry is a little too short-ranged focused (focusing on the shiny objects)

Kyle Kazan, CEO, Glass House & Bearded Brett Novey, CEO, PharmaCann

At the end of the day, cannabis is a commodity.

Thesis is that over time, all markets will look like California and Colorado, so if you can win in these markets you can win anywhere.

Many California retailers aren’t paying their taxes; 65% of cities and counties in California still have no stores.

New York – uncertain on the timing is when the ROs can begin participating in the adult-use wholesale market. That’s the big long-term opportunity for the MSOs.

Potential reframing of the New York market as being a largely illicit market to being a largely unlicensed market.

The demand is there, the retail footprint and infrastructure is there – its now about turning it on and having a mechanism to ensure that participants follow the rules.

Hope that the market will really ramp within the next 12 months

There’s a huge fee ($20mm, paid in tranches) for the privilege of being vertical in the NY market; this might not be worth it for various operators.

Creating markets that are fully functioning + regulating the market effectively would be easier if the states would implement learnings from each other.

Comes down to the state’s willingness to level the playing field and support local state licensed operators.

For NY the cautionary tale should be the city of LA.

Issued a lot of social equity licenses, but they also didn’t snuff out the illicit market.

Glass House’s prices in their central LA store are cheapest of all their stores because surrounded by ~10 unlicensed retail stores.

It’s hard to compete with a food truck when you’re paying rent.

Glass House has 10 stores, and their own brand penetration in their stores is ~25%.

·Although the margin benefit of owned brand penetration is good, at the end of the day – menus drive traffic. Customers value having selection.

What are they excited about?

PharmaCann

Excited about Ohio – should go adult-use mid next year

Excited about Pennsylvania (should go rec mid-2025)

Looking at 7 states they would like to expand into long-term.

There’s nothing more important to PharmaCann than this state right here (New York)

Balance sheet reflects a company that has been shepherding their number one asset.

Have been fully costed in eight markets for a decade.

Think the next 18 months will be big

Glass House

Expecting rescheduling next year, think there will be pacts between legal states for cannabis trade between states.

Not looking to become an MSO

Have been very focused on being quick, but not hurrying.

How are different from other companies in the industry?

PharmaCann

Standardized across all 8 states (lot of companies can’t say that, everything is different in every single state)

Its easy to overpay in a limited license state, but what happens to that premium paid when that state issues more licenses?

Glass House

MSOs are playing a game against each other, Glass house looks at it in more of a Money Ball perspective; well positioned for when the walls come down.

Cost advantage in California.

Boris Jordan, Chairman, Curaleaf CURLF

People have been more focused on SAFE banking than rescheduling.

HSS recommendation for rescheduling was a pleasant event for the industry.

Waiting to see the political process

Violating international treaty is an issue à Canada has done it, Uruguay has done it.

[me: IDK on the Uruguay part; I believe they were carved out of the treaty from the go]

Believes the US is waiting to see what Germany does

Controlled Substances Act à said that no other country had a controlled substances act, the US actually forced other countries to adopt a CSA (or similar)

Whatever the rescheduling issue, this 100% will be challenged in court

BUT from what he hears from congress, in the mean time companies can stop paying 280E taxes (but will need to accrue the expenses) which will help improve cash flow in the short term

Doesn’t believe a legal challenge would be successful

Will be interesting to see how this develops

A lot of the capex is done in the markets they are in.

A lot of the short term spend will likely go to New York given the catalysts and growth they’re seeing there.

Additional spend would likely be in Ohio and Pennsylvania depending on what happens with the potential for adult-use legalization there.

Ohio is probably ~ 60%, would add another 3 stores to get to the cap of 5 (and allowed to add another 3, due to being a Level 1 cultivator)

Pennsylvania – thinks it will have to go soon since sandwiched b/w recreational states, so the real question on that one is timing of when it will happen

Thinking it would be more of a 2025/2026

Florida – they’re all rooting for Kim (Trulieve), knows the political process there very well, would refer to her for any of the specifics.

Will be interesting to see how tourism plays into the game

Looking at a historic perspective of other states that have flipped the switch à lower penetration yields 3x-5x growth of market when rec sales are rolled out, higher penetration yields more of a 2x growth

Don’t see any dramatic change to their capex

Virginia is the one market they aren’t in that they might look to get into at some point

New York – retail is not the game play here, it’s wholesale.

Think the next 2-3 years will be very profitable in NY

Curaleaf’s view is there is a lot of potential in the suburban areas

Europe – Think it should be around 60mm international revenue for this year, think they can probably 2x next year and then taper off from there.

UK is one of the greatest markets he’s seen, only vertical player there

Only market he’s ever seen where the illicit market is priced higher than legal market

No secret that he wasn’t happy with the Q2 results, has gotten very involved since then

Doesn’t necessarily want to have large cash balance, rather put that cash to work

SAFE banking – Schumer put this thing through committee, on the structure of the current bill they (believe they) have the votes for the Senate BUT now they don’t know if they will have the votes in the House.

This is the big difference from last time, McConnel will not support it.

Has a much better chance of getting this done.

Feel much more comfortable that this time the work has been done and the work has been done properly.

Depending on how the markets roll out, there’s the opportunity for Curaleaf to see substantial growth.

Germany (largest operator, 23% share), New York

Ohio – sounds like its likely to pass in November, but thinks it probably won’t be until end of 2024 for the market to actually get rolling

Florida and Pennsylvania are two other big catalysts

Darren Weiss, President & Aaron Miles, CIO, Verano

Underpinned by higher margins.

Very focused on premium positioning.

Have always been focused on being lean and mean and doing more with less, optimizing headcount, increase efficiencies.

Vertical mix represents a larger % of shelf space across 

Florida – as a result of hopes of adult use and an oversupply of product in the market, there has been substantial pricing pressure

Verano has largely been able to stay out of this game, sells products at higher price points due to premium focus

Have had to increase portfolio to provide value products, both in Florida and across their national footprint

Single stores do less now than they did a year ago as the market gets closer to the a saturation point

Will be opening four additional stores in CT, one more in PA, a number of other stores in the works

Trying to stick as many flags in the right places with the right products

Pennsylvania – Verano is seeing stabilization in Pennsylvania, not seeing a free fall and doesn’t think there will be much more

Likely seeing a retrenchment with relation to capacity in the state

Happy with what they have, will be happy to see adult-use, likely to see legislation with some real legs next year with the potential to turn on in 2025.

Cost per gram is a very important part of their story – continuing to see gains on these measures

Also seeing improvement in dollars per labor hour in retail, tremendous amount of innovation that can and will take place at retail to improve these metrics

There’s a host of other KPIs where they can improve efficiencies

Retail in this space is undifferentiated

“Who does retail the best in cannabis” à thinks they’re all pretty much the same

All creating techniques and implementing business models to create stickier customer interactions

Web 3.0 technology, AI, will be able to help them differentiate their retail business

M&A learnings – don’t do 19 transactions in a very short period of time 

Were off to races now pulling back, evaluating what different opportunities look like.

Have been positioned ahead of adult use in multiple markets and will continue to be.

Have gotten better at understanding the demand trajectory along the course of a launch, maturation process of the market

The past mentality of market enthusiasm and growth increasing in perpetuity upon the conversion to adult use is not accurate.

Using data analytics has been game changing.

Potential of SAFE or rescheduling.

View is if you couldn’t run a business without those infusions, you wont be able to run a business after

Rescheduling – theoretically there would be no more 280E, could be $80mm-$100mm of cash now flowing to the bottom line

Excited about the prospect, but are not relying on 280E going away.

Can sustain the business despite any changes to 280E. 

Also have small wins at the state level with states decoupling from 280E (such as Illinois and New Jersey)

Once states go from medical to adult-use, after a certain period of time there’s a plateau – can leverage R&D and other to create a more holistic approach

Drivers behind FCF guidance of 65-75mm

That’s without the potential of 280E

Margins matter, but free cash flow is much more important

Look at everything through the lens of cost of capital

Florida – starting to build out but if they see the market starting to stagnate, they will pull back (similar to what they did in Pennsylvania)

Have seen the business and the people grow in a way that has been admirable, particularly on a strategic level and the holistic view of creating long term value for shareholders.

Looking forward to developing more category disruption and innovation.

The stops and starts at a federal level have been frustrating, but the point is that its still being discussed at the federal level.

People are more interested in learning the Company’s story now.

Excitement is the conversation has continued.

Can feel the energy picked up behind the space again.

They don’t run the business based on any assumptions.

Charlie Bachtell, CEO, Cresco Labs CRLBF

SAFE Banking Act:

Controlling the things they can, educating decision makers and legislators is showing results.

In a good spot from a Senate perspective, when it goes to the floor still no specific timeline.

Customer’s ability to use credit cards would be big.

Even the extension to the impact on cannabis industry employees – Charlie applied for a mortgage and got denied

The idea of securities exchange language getting into the current SAFE act on the table is not likely.

Rescheduling independently has the potential to have a lot of benefits and doesn’t require the politicking of something like SAFE

Its still a Show Me story – can’t develop strategy on the potential of this happening, strategic positioning of Cresco remains the same.

Want to have a strong balance sheet going into 2024 so they can go into new markets or deeper in existing markets

The mindset of continuing to focus on the core and cutting things that don’t move the needle.

SKU and product rationalizations.

Where are we at in the cycle of building the brands compared to other CPG industries?

Already seeing that brands matter, third party analytics help track velocity

Show you if you’re connected to the consumer

Drivers of free cash flow are creating efficiencies, reducing costs throughout footprint

Have less capex planned in H2/23

In 2024 have more stores to build out in FL PA and OH (when adult use passes)

Need to be very diligent with your capital allocation

Past is not always indicative of future – one state rolling out a certain way doesn’t mean another state will also roll out in a similar way

Cresco has more catalysts in front of them in the near to mid-term than ever.

Seeing boxes get checked more than ever before.

Doesn’t think investors are missing much about this, its about achieving what they’ve all known should happen.

Enjoy your night and please remember to enjoy responsibly.

/end

CB1 has positions in / advises some of the companies mentioned and nothing contained herein should be considered advice.

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Photo by Swanson Chan on Unsplash

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