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Evolving As Your Environment Changes
Recently O’Keefe held a panel discussion around investing in cannabis, dos and don’ts and what to do when considering a reorganization or turnaround. However, conversation started long before our September event. The Michigan cannabis market was experiencing some of the most substantial price decreases in flower in the United States. From a consumer standpoint this sounds like great news. Investors on the other hand were starting to assess their investments, return profiles and more importantly, when do I get to see a return?
Since our discussion M&A activity has slowed, ongoing partnership discussions between competitors and brands looking to vertically integrate all the while watching their cashflow tighten. Many companies have looked to refinance debt for better terms and lower interest rates. Some MSOs have sold off assets in the form of sale lease backs in an effort to de risk and shore up capital. This shift in the market has also begged the question to many operators, is now the time to exit?
We have seen some large transaction announcements for the first part of 2022. Many of these transactions have been in the works since 2021. Publicly traded companies are still on the sidelines patiently waiting until federal legislation changes and will be well positioned to unify geographical fragment businesses that have been restricted to only selling statewide. Unfortunately, the time horizon keeps getting further away. I have spoken with many companies wanting to sell but understand now is not the time. We have seen an uptick in reorganization and restructuring measures across multiple states. Both voluntary and lender forced. This is alarming for most investors as lenders have the most recourse when it comes to getting capital back all while being personally guaranteed by shareholders. Oh, and bankruptcy is not an option.
Being proactive is imperative at this crossroad in the cannabis industry. Getting your arms around operations, financial reporting, accounts receivable and finally, 280e taxes might be the difference between surviving and thriving. Each state, depending on where they are in their lifecycle, will experience the same problems. Canadian cannabis companies have been a bellwether for what we are witnessing here in the United States. Many Canadian businesses have stopped focusing on market share expansion and have turned their attention to profit margin. How acquirers approach valuations have shifted. Many buyers value off a relative EV-to-Sales while we have recently seen multiple LOI’s base value off adjusted EBTIDA and take into consideration how much debt is on the balance sheet. While most of the cannabis businesses are experiencing common growing pains there are secondary and non-flower touching businesses that have been able to stabilize and show double digit growth YOY while bringing on senior style debt facilities allowing for the lowest cost of capital in the industry.
While hindsight is always 20/20, when approaching pre-revenue investments you must consider their business plan, tech enabled platforms, proforma growth and profit margin, and where they play in the food chain. Cannabis is an emerging industry and is subject to regulatory headwinds. Don’t veer away from best practices from other industries when considering the merit of an investment in cannabis. While it has been doom and gloom lately when public companies miss earnings, there is still plenty of upside to be had.