Maybe Not SAFE, But Maybe Not Sorry Either
The Bengal Bite
The SAFE Act was re-introduced by Rep. Earl Perlmutter (D-CO) this week, sparking a wave of cannabis news, and buzz about the effect of the reintroduction on U.S. cannabis company valuations. The Act explicitly allows banks and other financial institutions to accept proceeds sourced directly from state-legal cannabis businesses, an area right now which is murky.
Many were hopeful that this version of the SAFE Act would include a safe harbor for stock exchanges as well as banks to allow U.S. MSOs to uplist to NYSE and NASDAQ, but it did not (yet, it may work its way in). Investors now set to work trying to read the tea leaves of current political developments to see what it means for U.S. MSO stocks - but a little bit of nuance is important here.
To vastly oversimplify, all stocks’ long term performance depends on two factors: operations (i.e., how much profit the business actually produces), and perception (i.e., what multiple investors are willing to value these earnings - basically a proxy that combines a perception of how “safe” and repeatable these earnings are with a view on how quickly they will grow in the future).
Operationally, SAFE Doesn’t Make Much Difference For Public Companies: The cannabis industry is often perceived, even now, as being almost totally unbanked. Historically, misclassifying cannabis businesses as other types of businesses to get an account was common, and the problem still exists today - especially with smaller cannabis businesses and states that are earlier in their development.
But, plenty of banks and credit unions nowadays explicitly take cannabis accounts. Washington, Colorado, Massachusetts, and other states have banks that have set up large cannabis practices. The services provided are basic depository banking (business checking account, cash pickup, etc.) without business loans (although a few do mortgages on cannabis real estate), but those services largely address the biggest concern of public cannabis businesses: large amounts of cash floating around and creating safety and internal control issues.
The graph below compares the estimated average Colorado cannabis store sales per square foot in January 2021 with other types of stores. Given that nearly all cannabis stores lack credit card processing, so almost all of their sales are in cash, the cash-heaviness of the business is significant, to say the least.
SAFE would likely drive some meaningful, but not an earth-shattering improvement in smaller players by way of lower costs on things like insurance premiums and would certainly help the industry as a whole given the high-sales, cash-heavy nature of cannabis by significantly improving the safety and security of cannabis operations. But, it alone likely won’t drive significant profitability improvement for large public MSOs.
But It Makes a Difference For Perception, and Therefore Multiple Expansion: SAFE is seen as the next step in, and a bellwether to, eventual legalization. Passing it could increase investors’ perception of the “safety” of earnings, and thus improve U.S. MSO earnings multiples. But, the converse could also be true: failure or delay in passing SAFE could have the opposite effect and depress multiples because investors' perceptions change for the worse.
Perception is Not Reality, and Politics is Not Linear: Cowen & Co. research analyst Jaret Seiberg takes a frank view of SAFE’s reintroduction in his March 18 policy note: “Everyone should have been expecting it.” Some other points of his commentary are important as well:
- “[Cowen & Co.] expect[s] an avalanche of cannabis bills to be introduced in the weeks leading up to April 20...Almost all of these bills never get a hearing much less a vote.”
- “Much has been made of whether the bill will include capital markets access. This strikes us as unlikely as it would then be a materially different measure . . . [and] it does not really matter. This bill is symbolic. The actual text will be negotiated as it gets closer to a vote. This is when it will matter if capital markets access gets included.” (emphasis added)
Seiberg’s last point is key: the negotiation will drive the outcome. The word “negotiations” conjures up images of bargaining with Republicans, which was largely the case before the Democrats took the House and the Senate. Now, the negotiations could look a bit different because, as Seiberg notes, SAFE is likely a “backup plan if Democrats cannot enact legalization legislation.”
So, whereas before a Senate Democrat may have been pro-SAFE, now they could potentially try to hold out for a more substantial legalization solution - trying to shoot the moon but lowering the chance of incremental progress. Republican support will certainly be important (this Twitter thread gives an excellent rundown of likely Republican senator positions), but it may be that holdout Democrats are the keystone to a political bargain. While the SAFE Act would be an undoubted benefit to the industry as a whole, perception of its actual operational effects has outrun the likely reality, but that perception may drive continued volatility in stock prices based on day-to-day political bartering.
If SAFE does end up including the safe harbor, then we could (and very likely would) see rapid uplists by MSOs (many of which are already or just about to become full-fledged SEC reporting companies with U.S. GAAP financials audited to PCAOB standards), better trading accessibility and perception benefits imparted by trading on major exchanges typically translate to higher multiples. Also, it typically translates into a lower cost of capital for company expansion - effectively the institutional analog to perception improving, as institutions demand smaller risk premiums to give you capital.
But, it likely won’t translate into meaningful day-to-day profitability improvements.
This Week's Bite:
- Right on Cue, Eaze Expands: Eaze announced that it was entering the relatively new Michigan cannabis market with its delivery service and platform, and a partnership with future NFL Hall of Famer Calvin Johnson, one of the consensus best wide receivers of all time and a fantasy football player that saved a season from being a complete embarrassment for this humble writer. Johnson, with his old teammate and business partner Ron Simms, is the owner of a dispensary and multiple other cannabis facilities in Michigan. (Forbes)
- And the SPACs don’t stop coming: Unlike many other SPACs, which seek one main acquisition target for their qualifying transaction (QT), Greenrose Capital is seeking to cobble together a QT from a basket of smaller ones. Greenrose has announced its intent to purchase Shango Holdings Inc., Theraplant LLC, True Harvest LLC, and Futureworks LLC. The acquisitions will give Greenrose legal-weed operations in seven states – Arizona, California, Colorado, Connecticut, Michigan, Nevada, and Oregon. Plans call for Greenrose to pay $170M in cash, $15M in stock, and $25M in debt for the firms. Simultaneously, Greenrose announced that it was seeking to raise $150M by way of a private placement to close simultaneously with the QT. This kind of raise is commonly done by SPACs to replenish cash which is anticipated to be redeemed by SPAC shareholders prior to the QT (We’ve previously covered SPACs' structure, the incentives of the players, financial performance, and where there may be opportunities for investing in SPACs).
Not to be left out of the action, Silver Spike has launched its second SPAC on the NASDAQ raising a total of $250M. (Seeking Alpha | Dai Troung | Marijuana Business Daily)
- SAFE revived and filibuster reform on Biden’s mind: The filibuster has inspired much debate over the years. To end debate on the vast majority of legislation (generally the largest exception is budget legislation) in the Senate requires 60 votes. So as long as you have 41 votes and a willingness to continue debating, you can prevent the majority from passing anything - essentially, if you talk long enough, you can win or at least draw.
Most of Biden’s agenda (including cannabis reform) falls within the filibuster and so it is D.O.A. without 10 republican members’ support. That is unless the Democrats decide to change the filibuster rules. While initially an unthinkable step because of the long-ingrained cultural norms of the Senate, President Biden is warming up to the idea of some sort of reform that goes short of eliminating the filibuster entirely, potentially a positive development for cannabis-friendly legislation like the SAFE Act. (Marijuana Moment)
- dutchie raises a monster round: This week dutchie announced that they had closed a $200M round lead by Tiger Global, and also had completed acquisitions of Greenbits and LeafLogix. Dutchie now seems styled as a one-stop solution for cannabis retailer and grower needs - from enterprise resource planning and traceability to wholesale sales platform and finally to retail point-of-sale.
The round values dutchie at $1.7 billion, making it the largest cannabis e-commerce platform around. To put that in context, just 7 months ago, dutchie had raised $35M in its series B round valuing it at $200M. Only time (and maybe some fundamental financial analysis) will tell if this transaction presents a steep surcharge when compared to other SaaS platforms. (TechCrunch)
- Going Global? With Curaleaf acquiring Emmac Life Sciences (Europe’s largest cannabis company by license footprint) for $285M and Mexico opening up its recreational cannabis market, the global cannabis opportunity and supply chain are back at the front of investors' minds. (Bloomberg | Yahoo Finance)
- A Metric SNAFU: In an effort to make sure companies are being compliant with regulations, many states have mandated “seed-to-sale” tracking technology, of which Metric is the most widely adopted. However, repeated issues and outages have plagued customers in California, forcing some cannabis companies to do all their invoicing and track-and-trace paperwork by hand (costing thousands of dollars and man-hours). It will be interesting to see if any states decide to move to another competitor. (Marijuana Business Daily)
- Potential for Alzheimer’s as a cannabis medical use-case: A study published in the Journal of Alzheimer’s Disease found that a two-week, high-dose CBD regiment restores the function of two proteins which are key in the reduction of plaques in the brain, improving cognition in mice models. With over 6 million Americans and 50 million people worldwide suffering from Alzheimer’s, this new study has huge implications for medical marijuana. From a financial angle, it will be interesting to see if more companies begin to invest in FDA-ready-cannabis pharmaceuticals given the recent purchase of GW Pharmaceuticals by Jazz Pharmaceuticals. (Ganjapreneur)
A SPACtacular Investment Opportunity? Depends
from the bengal bite
Last week and the week before, Parts I and II, we discussed the growth of SPACs, the incentives of the various parties, and some historical financial results. This week we write on where and when investors might want to keep an eye on SPACs for opportunities:SPACs Trading Below $10: This should go without saying, but if a SPAC share is trading below $10 (the standard redemption value of a share), an investor could buy the share and just wait to redeem it for $10 to earn a relatively riskless profit. SPACs don’t often trade for much under $10, but when the market is disrupted significantly, there may be more opportunities to pick up free dollars in SPACs than in other sectors because of a factor many investors may not appreciate: how hedge funds employ leverage.