*Alexa* play Public Service Announcement by Jay Z
My name is G to the Ross to the Man Capital
Scouring the markets for assets so valuable
Ok, let’s get back to my day job
What if I told you US cannabis provides one of the best risk/reward opportunities
US Cannabis is the most compelling investment opportunity I’ve come across because
1. Robinhooders/Institutions are unable to buy OTC stocks
2. TAM will 3x in the next 10 years (14% CAGR)
3. Hypergrowth companies trading at value multiples
Let’s walk through each of those reasons
#1) Robinhooders/Institutions are unable to buy OTC stocks
Since cannabis is federally illegal in the US, any US plant-touching company can not list on the NYSE, they have to trade OTC
Robinhood only allows trading of companies on the NYSE
This means all of our favorite YOLO degens can’t invest right now
Not only can’t Robinhooders invest but many of the deep-pocketed suits can’t either
Many hedge funds can’t buy cannabis stocks because
Some banks/prime brokers won’t custody shares
OTC stocks are highly illiquid
Compliance/reputational risk
Wasatch’s compliance department forced the firm to sell after it acquired $100mil worth of cannabis stock
With all of these hoops to jump through, hedge funds only own ~4% of all US cannabis companies
When Robinhooders & Hedge Funds both have easy access to US cannabis stocks we should expect to see a tidal wave of demand leading to a significant re-rating of multiples
A ~5x return sounds
to me
With tons of capital unable to invest, this is our opportunity to acquire positions BEFORE the tidal wave of capital floods the space
#2) TAM will 3x in the next 10 years (14% CAGR)
In an uber bullish scenario, Jeffries sees the cannabis TAM hitting $172bil
“On possible support from wider disruption, the current national adult cannabis penetration is 11.2%, while the national annual legal spend per cannabis user is $469. This compares to alcohol at 55% and $1,378, respectively, painkillers at 40% and $229, and anti-depressants at 15% and $122. If we were to assume cannabis national penetration at 30% (we believe prevalence is underreported anyway), and annual spend per user at $1,750 (note Colorado is at $2,683), this would equate to a market of $172bn.”
Unlike any other industry, the demand already exists it’s just a function of more states flipping the switch, (flipped, flipped)
Catalysts galore are on the horizon
In the next 12-24 months we will be onboarding new recreational markets in
NY
NJ
VA
CT
NM
With a backlog of other big markets in discussions to legalize recreational (FL/PA/OH)
We haven’t even started talking about international growth yet…
#3) Hypergrowth companies trading at value multiples
Cannabis is the fastest growing industry, yet trades in the bottom 15% of all industries
Sometimes when I look at the margin of safety these companies have
But I’m not, these companies are really that cheap!
Show me another industry growing >40% CAGR over the next 3 years trading @ 9x ‘22 EV/EBITDA and
I will quit my job and work for you!
Yet, stock prices are declining
While business is
Not only are these companies executing, but profit expectations also keep on rising yet the share prices keep diving - peep the orange line
It is unusual to see such a disconnect but sometimes markets can be irrational
“Companies are not the stock and stocks are not the companies’” - Jeff Bezos (click the link)
Let’s do some back-of-the-envelope math to ballpark what our returns could be...
US legal market sales are projected to be $70 billion
25% EBITDA margins (top players now are ~35%)
25x EV/EBITDA multiple (Alcohol & Soft Beverages trade @ ~20x)
$440bil of total cannabis market cap
Today, the largest player is ~$8bil
10% Market Share → $44bil
~5x upside potential
There are only 2 ways to make money in stocks
Multiple Expansion
Earnings Growth
One of these engines can yield strong results but having both is where exponential returns are made
US Cannabis has both multiple expansion and long term earnings growth
Multiple Expansion
Before the custody issues and even without Robinhooders, US cannabis stocks were trading at 22x EV / EBITDA
Today, they are trading at 8.3x (175% increase to get back to Feb levels)
Imagine what multiples these stocks will be trading at in a federal legal world with full investor participation
Earnings Growth
The industry is expected to grow @ a 14% CAGR over the next decade with most of that growth hitting the bottom line as these companies further achieve operating leverage via economies of scale
It is clear cannabis has the hallmarks of a compounding machine over the next decade
What is the path towards uplisting to a major exchange & unlocking this giant pool of capital?
There are 2 pieces of legislation that will pave the road for cannabis companies to graduate from the OTC to the NYSE
Cannabis Administration and Opportunity Act (CAOA)
Deschedule cannabis
Remove 280E
Expunge prior convictions, allow for the petition for resentencing
Preserve states rights to set their own policies
Allow for transportation of cannabis into states that are legal
FDA would be in charge of regulating the manufacturing and marketing of cannabis products
10% federal tax in year 1 → 25% by year 5
This comprehensive bill is a hail mary from Chuck Schumer with little to no chance of passing
SAFE Banking
It [is] SAFE, It [is] SAFE
Protect banks that service the legal cannabis industry
Cannabis companies are forced to work with local credit unions since it is money laundering for a bank to move funds across state lines
Allow dispensaries to accept debit & credit cards
Lower cost of capital
Doesn’t explicitly permit uplisting but would cause FINCEN to update its rules regarding AML laws which could provide enough safe harbor for US exchanges to permit uplisting
The good news is SAFE can finally pass congress today
SAFE has passed the House 5 times but has been stonewalled in the Senate by the former Republican majority leader Mitch McConnell
The bad news is Chuck Schumer can pass the bill with a now democratic senate majority but is holding it hostage in favor of his bill
We see Schumer standing firm on his bill and ultimately conceding once he realizes he doesn’t have the votes
At that point, we see a hybrid bill combining SAFE with some social equity language and passing some time in the next ~6 months
If business is boomin, then why are share prices…
A stock is a story and each day is a page
Let’s review the story of MSOS (ETF), a basket of cannabis stocks
1-year chart below
From October 2020 to February 2021, MSOS ran 116%
What happened during that time frame?
Small-Cap stocks, in general, were running heavy with the Russell 2000 (IWM) increasing 43% over the same time frame
On January 5th, the Georgia runoff went blue
Democrats have been a party that has embraced cannabis and now with the House, Senate, and President all blue investors were excited about the prospects of the acceleration of cannabis legalization
Even publications like CNN were mentioning the following day “Cannabis stocks soar, Big Tech sinks following Georgia elections”
From the Georgia runoff (1/5) to the following week, MSOS rallied 22%
Since February 10th, MSOS has fallen ~50%
What caused the peak in February and why are we still bleeding?
Capital Raises
In mid-January/February, companies took advantage of their higher stock prices to go raise more money
Terrascend - $180mil
80% of the raise was from 4 institutional investors
Green Thumb Industries - $156mil total ($100mil + $56mil)
$100mil raise was from 1 investor
Curaleaf - $250mil
Trulieve - $200mil
Cresco Labs - $125mil
100% of raise was bought by 7 institutional investors
Even though these companies are gearing up for a fully legalized world, the market needed to digest >$1bil of newly issued stock
#MSOGang
On 2/12, #MSOGang started trending on twitter.
If anyone is aware, when an investment starts trending, it’s usually the sign of a top (remember GameStop/AMC/laser eyes to $100k the first time Bitcoin hit $50k)
While attention to the space is good, we attracted many short term traders looking to ride the wave
Custodian Issues
Shortly after all those capital raises, Bank of America/UBS/Credit Suisse and other banks dropped custody
Now add JP Morgan to the list
Said another way the banks told anyone who owned shares to
Nearly $1bil of stock that institutions just bought had to be sold in an illiquid market by April 31st!
In the chart above you can see the increase in volume in early 2021, followed by many large red bars into the end of April coinciding with funds having to sell out of their positions
With institutions gone and retail fully invested, short-sellers have pillaged this space as there are no large buyers to stop the bleeding causing further downward pressure on these stocks
Look at the pick up in % of Total Value shorted after April 16th for Curaleaf
Remember that time there was a dying video game store that had a large number of short-sellers
History doesn't repeat itself, but it does rhyme…
Political Blue Balls
On March 2nd, Chuck Schumer announced federal legalization was a priority in the senate and that he, Corey Booker, and Ron Wyden would draft a comprehensive bill in the coming months
With the market excited about the prospects of SAFE finally being able to pass in now a democratic controlled senate, the market was beginning to wonder if Schumer was reaching for too much with a new bill when SAFE, a passable bill, is already on the table
Schumer is essentially splitting a winning hand
From March till July, Chuck Schumer kept saying the draft of the bill would be coming soon so often that the running joke on Twitter was Chuck “Sooner”
Not only was this new cannabis bill delaying the passage of SAFE, Corey Booker adamantly stated at the draft release of the CAOC that he would vote against SAFE
Following those statements by Corey Booker, MSOS fell 10% over the next 4 trading days
With each passing day getting closer to midterms and no progress being made on the legislative front, investors are getting concerned that nothing will pass by next November
Let me tell you a secret
The longer it takes for legalization the better it is for the top players
The top players in the space are the only ones able to access debt, albeit at ~8% interest rates
However, the smaller players are unable to access the capital markets and if they do, they might be able to get lending @ 16%, maybe even higher if they have to tack on warrants
This means each day that passes the large leaders can outgrow the smaller competitors and achieve economies of scale allowing them to become more profitable and get access to even cheaper debt
Smaller companies are unable to operate in this environment and are being forced to sell to top players for pennies on the dollar
The COO of AYR Wellness stated in an interview that they are able to buy smaller competitors trading @ <6x EV/EBITDA
The flywheel keeps spinning for the Tier 1 players and quietly they don’t mind if SAFE gets passed or not because they can win and operate profitably in the current environment
Jason Wild, the CEO of JW Asset Management, who has allocated 80% of $2.2bil fund into the space in regards to legislation said “you can pay me now or you can pay me MORE later”
The longer it takes for federal legalization to happen, the bigger the moat these companies can develop and big alcohol/tobacco won’t be able to compete and will be forced to buy
Investors who think federal legislation is the only catalyst for this industry are wildly mistaken
What are the risks?
#1) Federal Illegality
Although unlikely, it is possible for the federal government to enforce the law
#2) Timing on Legislation
Although we believe our thesis will work with or without legislation immediately getting enacted, we could face delays in the market realizing the true value
#3) Unfavorable Rules/Taxes
It is possible the government may overregulate the industry and impose rules/taxes that can allow the black market to thrive
#4) Interstate Commerce
It is possible if a post legalized world were to happen soon, more capitalized companies can potentially outspend & outgrow our portfolio company’s existing footprints
#5) FDA Involvement
FDA can be given extensive jurisdiction over the cannabis industry which could result in cultivation standards that could cause substantial write-downs
How do we plan on allocating capital?
We will be taking a 2 prong approach
Individual Names (50%-66%)
Although the space is full of compelling names, we’ve identified a handful that is poised to outperform the peer group
OTM LEAPs (25%-50%)
There are 2 rules when it comes to options trading
#1) You have to pick the right direction (up/down/sideways)
#2) You have to pick the right time frame for your predicted move
Given the low valuations + our ability to front-run other hedge funds and Robinhooders when we see movement on the legislative front, we will acquire long term OTM options
In closing,
investors put some respeck on US cannabis!
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