Cultivation En Vogue, Thoughts on Vertical Integration & Comp Tables Priced 5/14/21 & 5/17/2021

by | May 19, 2021 | Comp Table & Market Commentary

Premium Members can download our pro forma in-the-money diluted comp tables below.

Cultivation is in vogue

At this point in the industry, most operators need to own most pieces of the supply chain because there isn’t a consistent, robust, and reliable supply chain – yet.  

In most mature consumer businesses, the companies that process, brand, and distribute the end product do not produce the raw material. Starbucks doesn’t grow coffee and Kelloggs doesn’t grow corn because there are deep and reliable supply chains for those inputs.  

Henry Ford focused on vertical integration in the 1910s-1920 to ensure supply of raw materials to produce 1 million Model Ts annually after experiencing shortages and price fluctuations from World War I. Ford Motor owned coal mines, iron mines, timberland, a sawmill (and invented Kingsford Charcoal briquettes to sell the sawdust), a railroad, a glassworks, even herds of sheep for wool.  

Like Ford’s supply chain with the Model T, the current cannabis supply chain is fragmented, costly and unreliable, and similar to the Model T the largest operators must be vertically integrated to outperform their peers.

While cultivation investment was a lower priority for these players in past years, the scarcity of new dispensary licenses in 2021 (which we highlighted in December and February) is forcing operators to grow sales and margins through branded product sales and wholesale. 

An outstanding question is if vertical integration will remain long term. Ford owns no mines or forests today, and is more of a brand, designer, financier, and assembler of parts sourced from Tier 2 suppliers:  speedometers from Visteon, seatbelts from Autoliv, axles from AAM, etc. There is a reliable and robust supply chain for every component, and competition across this OEM base has compressed margins to a point that it’s no longer advantageous to own the entire process.  

Even with proprietary genetics, the farming itself is separate. Johnson & Johnson developed an engineered “super poppy” in the 1990s, but it still bought the production from Tasmanian farmers vs actually owning the farms themselves. 

So long term, will the cannabis supply chain look more like it does today, or coffee, or autos, or opiates? It comes down to how commoditized the cannabis plant is today and in the future. 

Today there is generally more demand than supply. One day that won’t be the case, and the ones that will do well are those lower on the cost curve.

Cultivation catches a bid: CURA, TPCO, Columbia Care, and BRND invest in cultivations  

It seems that cultivation assets are catching a bid from public operators.  

Curaleaf is acquiring Los Suenos, the largest outdoor grow in Colorado with 50k lbs capacity, for $75 million in total ($67 million plus a potential $8 million earn-out). This is significantly more than the $12 million Schwazze (fka Medicine Man) was going to pay in 2019-2020. The read-through is they’ll likely use Los Suenos to boost Select extract presence in Colorado via wholesale with the distribution acquired from Blue Kudu, a CO-based edibles company acquired last year.  

The Parent Co (TPCO) announced they were investing $50M in a 5.5M square foot greenhouse operation, owned by Mercer Park Brand Acquisition Corp while simultaneously announcing the acquisition of 4 acres of land in Sonoma County for $16M, owned by Mosiac.Ag. Both deals will allow TPCO to capitalize their COGS while they build out their “house of brands” story, a strategy that hinges on proving incremental margins. 

We would note that Mosaig.Ag is a supplier to Cookies, another brand, so there is the question of what will happen to this relationship after TPCO closes the acquisition. Will TPCO just supply a competing brand or put their own brand on the product from the cultivation? Based on the 1Q21 call it sounds like the latter.

Columbia Care recently announced the acquisition of a 34-acre cultivation on Long Island for $42.5M. The company is gearing up for recreational legalization in New York by adding to its existing 253k square foot footprint in Rochester. The deeper reasoning is the current NY legislation seems to imply that the existing operators will be the only companies allowed to be vertically integrated, and as we have seen in other markets, leveraging cultivation scale to push branded products across a market is key to margin expansion.  

Finally, BRND (aka Mercer Park Acquisition Corp) is a special purpose acquisition corp (SPAC) that is planning to use their capital to buy a 5.5 million square foot greenhouse in Southern California. The company’s strategy is to leverage scale to provide consistent, affordable, quality products to the biggest market in the US, and this will be an important story to watch as California taxes force operators to battle illicit market providers with better economics.  

US multiples decline with rising estimates, Canadian Multiples increase with Declining Estimates

The broad market meanwhile is near highs with the SP500 1% off its highs and up 12% YTD – inline with US cannabis (+12% YTD) and behind Canadian Cannabis at +33%.

US operators reported generally good earnings, but stocks remain flattish and remain 28% off their highs in February.

Canadian operators traded down by an average of of 5%, led by ACB TGOD and HEXO all down 16% on the week. They are now an average of 56% off their highs.

Multiples continue to compress with declines as the stocks trade down while estimates actually increased in the US and decline in Canada.

The US trades at an average of 6.4X 21 and 4.2X 22 sales, down from 6.6X and 4.4X respectively on 5/10/21, and 21.8X 2021 and 13.5X 2022 EBITDA down from 22.4X and 13.7X last week.

Canadian operators trade at 12.7X 2021 and 8.5X 2022 sales, up from 12.5X and 8.3X, as the stock declines are offset by declining estimates.

As always, Premium Members can download the detailed comp tables priced on May 14 and May 17 below. They have been updated for new filings, earnings reports, and deals reported last week.

As of 5/19/2021, the authors have positions in Columbia Care, Cresco Labs, Curaleaf, Green Thumb, Harborside, Hydrofarm, Mercer Park Acquisition Corp, Schwazze, and Silver Spike Acquisition Corp. They make no commitment to update holdings in these positions.