A Strategic Investor’s Guide to Cannabis 2021

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State of the Cannabis industry

For industry revenue and growth potential you can just about pick your number.  Grand View Research predicts a U.S. market size of some $33 billion this year, reaching as high as $84 billion by 2028.  The Motley Fool reposts the prediction by cannabis industry research source BDSA that the U.S. market will reach $34.5 billion in 2025 achieving a CAGR of 18% yearly from now until then. 420 Intel projects an even higher CAGR grow rate for the U.S. industry of 26.7% from now through 2028. And New Frontier Data projects a $31.1 billion U.S. market by the end of 2024. Any way you cut it, the U.S. cannabis market continues on a path of explosive growth.

Capital Flowing into the Cannabis Industry

As we reported in a recent EDGE Briefing, 2021 is becoming the most lucrative year in the history of legal cannabis in the U.S. With public support for legalization and states coming out of the pandemic in their own panic for increased tax revenues, funding is again flowing into this capital-constrained industry.  Marijuana Business Daily reports on Viridian Research findings that the amount of capital raised as of September 10 is already up 118% over full year 2020. In four of the top five industry sectors YTD investments have surpassed, or at least equaled 2019 investment totals.

A Strategic Investor’s Guide to Cannabis 2021

And all this is happening even before Big Tobacco and Big Pharma get more deeply into the industry to bring their level of professional management to cannabis operations.

Capital Flow Sources

Recent Equity Transactions

A Strategic Investor’s Guide to Cannabis 2021

Although the majority of the capital flowing into the cannabis industry via private equity and IPOs has been through large MSOs, this increase in capital is significant for smaller operators for the potential of being acquired. Key equity transactions have included TerraAscend Corp’s private placement of C$224 million, Ascend Wellness Holdings $80 million IPO in May, and Aurora Cannabis closing a public offering last month of US$137.9 million.

Cannabis Industry Maturing to the Point of Turning to Debt

As more debt providers come online, recent multimillion-dollar debt funding among cannabis industry leaders shows that debt as a capital source for cannabis companies is a rational use of capital – potentially cleaning up balance sheets and enabling access to funding for expansion and/or the purchase of distressed assets coming out of the pandemic – to use debt financing for competitive advantage in the marketplace.

While the industry has been capital-constrained, borrowing against assets has been a key source available for many cannabis companies to pursue. Vertically integrated cannabis companies often have significant real estate and other assets that can be leveraged. What has changed now, though, is that more debt providers have come online over the past couple of years addressing a range of needs.  This means that cannabis companies can now refinance at more attractive rates.

SPACs in Cannabis

With many VC and PE investors, as well as virtually all institutional investors, staying away from the industry, this puts the use of Special Purpose Acquisition Companies (SPACs) in the limelight – for cannabis companies in the U.S. and in Canada to access capital over traditional sources and in order to pursue the path of going public. In fact, SPACs are bringing substantial liquidity to maintain sales growth and provide cannabis companies with the competitive advantage of more quickly getting to market.  In many cases the SPAC merger process with a target company, termed to “de-SPAC,” can take place in a substantially shorter period of time than the traditional IPO timeline.  This, though, must be accomplished in a relative short period of time – the two-year requirement for all funds to be invested or, if not, returned to investors.

Capital Creation from M&A Transactions

Of Course, these SPAC transactions do not happen without an acquisition and Mergers and Acquisitions have set the tone for industry capital transactions in 2021. Leadership to market dominance typically does not happen by slow, steady organic growth. Trulieve just recently acquiring Harvest in a $2.1 billion deal to form the world’s most profitable MSO substantiates that premise. YTD 2021, over 144 transactions have been announced or closed, compared to 32 in the same period last year. The ever-increasing volume of Mergers & Acquisitions began to surge in Q4 last year when over $600 million in M&A transactions were announced. Consolidation and mega-deals have already set the tone for 2021. MSOs are leading the charge in the U.S. by having achieved scale, cleaned up their balance sheets and stockpiling dry powder for roll-up acquisitions. These MSOs are now acting more like CPG companies in the maturing cannabis market.

In Canada, investors want strategic ways to gain greater access to the U.S. cannabis market. M&A transactions, as exemplified by the pending Aphria-Tilray reverse acquisition, are expected to play greater role.

Why this matters is well expressed by Regrow.io :

As these mergers and acquisitions in the cannabis industry continue to find their way into mainstream business conversations, the closer we come to public acceptance. This acceptance represents countless jobs and validation for those who have believed in this industry’s potential from day one.  While cannabis remains illegal on the federal level, companies are forced to find new avenues for growth due to legal limitations, such as the inability for cannabis to cross state lines. This is why the industry is seeing multi-state operators joining forces to expand its operations more efficiently.

Action in the Current Marketplace 

In March, U.S. News reported that the U.S. cannabis industry had already raised $2 billion in equity capital in 2021. That total was dwarfed on May 10 when in one transaction alone Trulieve acquired Harvest for over $2 billion.  Recent major transactions activity:

In that transaction Trulieve (CSE:TRUL ) (OTC: TCNNF) acquired Harvest Health and Recreation (CSE:HARV , OTCQX: HRVSF) in a $2.1 billion deal that forms in the U.S. what is reported to be the “world’s most profitable multi-state operator.” This is based on the combined adjusted EBITDA of $461 million that Trulieve projects for 2021. Trulieve will now have a retail network of 126 dispensaries across 11 states which they state gives them “an unparalleled platform for continued growth.” Trulieve’s acquisition of all of the issued and outstanding Harvest shares will be filed on SEDAR and made available under Harvest’s issuer profile at www.sedar.com.

Some of the most recent transactions of note:

  • Marijuana Business Daily reported that two weeks ago TerrAscend acquired Gage Growth in $545 million all-stock deal being the first of the major multistate operators (MSOs) to begin consolidating the Michigan market – a market on track to become the second-largest legal cannabis state in the U.S.
  • Another large-scale consolidation last week was Hydrofarm Holdings Group Inc. (NASDAQ: HYFM) acquired House & Garden Inc., Humboldt Wholesale, Allied Imports & Logistics, and South Coast Horticultural Supply Inc. (collectively to become “House & Garden”).

Ganjapreneur reports on Ayr Wellness Inc., Curaleaf Holdings Inc., and The Parent Company each announced acquisition deals last week for $80 million, $67 million, and $65.2 million, respectively.

  • Miami-based multistate operator Ayr announced the close of its purchase of PA Natural Medicine, LLC, which operates three dispensaries in Bloomsburg, State College, and Selinsgrove, Pennsylvania. The terms of the deal include upfront consideration of $80 million, including $35 million in cash $25 million in seller notes, and $20 million in stock. An earn-out based on 2021 Adjusted EBITDA, is payable in the first quarter of next year.
  • Massachusetts’ Curaleaf also last week said it had completed its acquisition of Los Sueños Farms, which at 66 acres is the largest outdoor grow in Colorado.  Boris Jordan, executive chairman of Curaleaf, said the “deal provides Curaleaf with a high-quality, efficient, and low-cost supply of biomass to support our wholesale and retail customers in Colorado.” The $67 million deal includes land, equipment, a 1,800 plant indoor grow, and two retail cannabis dispensaries.
  • The $62.5 million deal announced also last week by California-based The Parent Company (TPCO Holding Corp) is for 100% equity of the retail dispensary and delivery operator Coastal Holding Company, LLC, for $16.2 million in cash with considerations of up to $40 million in equity of The Parent Company upon the completion of milestone events.
  • Motley Fool, though thinks there is an M&A that has a greater potential for return on investment than that Trulieve/Harvest merger. That is, the Greenlane (NASDAQ:GNLN) and KushCo (OTC:KSHB) merger.  For one thing they are not strictly marijuana producers, but market non-plant touching products as well. The main reason, though, is that based on the smaller market cap of the merger, there is more potential upside from the deal.

That Trulieve/Harvest Health acquisition as seen by the industry is having more far reaching affect than merely the size of the deal.  This M&A between two of the largest cannabis MSO’s that are publicly-owned puts literally all cannabis companies potentially in play for an M&A transaction. Green Growth CPAs sees the dramatic impact this transaction has on the industry as follows:

Ultimately, what does this mean? It means that suddenly, all cannabis companies are potentially in play for M&A deals. While the number of public and well-capitalized cannabis MSOs is growing, there is a clear leading class with: Trulieve, Curaleaf, Verano, Cresco Labs, and Green Thumb Industries. In the wake of the Trulieve/Harvest deal, anyone not in the aforementioned top of the class becomes a potential target for those on top.  

Avoiding the Potential Pitfalls in this Rosey Picture

With this fiercely rapid pace of M&A deals comes the danger of pitfalls in a successful deal in such a complicated industry; an industry subjected to state-by-state regulations while still being illegal federally. The latest figures we can find on the impact of M&A miscues in the cannabis industry come from SP Global Market Intelligence from research done by cannabis research firm New Frontier Data.  In 2019 it was found that companies/investors backed out of 95 M&A deals valued at $2.46 billion.

A Strategic Investor’s Guide to Cannabis 2021

The basic aspects of M&A transactions that need scrutiny according to Marijuana Business Daily are:

  • The Purchase Price – With deals being primarily cash and stock, sellers need to perform due diligence on the stock they are getting.

If the buyer is public, the sellers should know when (under securities laws) and how the stock may be sold (will the broker execute a trade in a cannabis stock?).

If the buyer is private, the sellers should consider doing due diligence on the buyer.

  • Change of Control – In cannabis this means that most state and municipal regulatory agencies will require some sort of vetting and approval for the change in control.
  • Legacy Liabilities – In an M&A transaction, unlike in a simple asset acquisition, a buyer does not have the luxury of picking and choosing assets. In cannabis the acquirer needs to conduct due diligence into the true nature of the seller’s finances, which can often be unaudited.
  • Handling Debt – In the case of the cannabis industry a distressed company cannot file for bankruptcy protection in order to restructure its debts to become an acquisition target. The puts additional pressure on the buyer to avoid creditor lawsuit entanglements

What Can Investors Use as a Guide Through M&A Deals for the Right Investment to Meet A Portfolio Strategy

For our clients, here is the advice we provide as they assess M&A opportunities in the cannabis industry:

  • Know what the organization is getting into – Detailed due diligence and proper integration planning are crucial to identifying potential issues. What is the long term plan? This is particularly significant in the cannabis industry because, as we mentioned, bankruptcy is not allowed for cannabis businesses.
  • Get the right people involved– Determine essential stakeholders early and get them involved. By doing so, retention and change issues will be minimized.
  • Know what the organization wants out of the deal– Determine objective business decision criteria to minimize political issues and the impact of personal preferences.
  • Get it done right – Devote the necessary resources even if the company is “running lean.” Transaction execution and integration are together a full-time job.
  • Know what success means– Establish a measurement process for performance milestones in order to determine the success of integration activities.
  • Don’t underestimate the infrastructure– The IT function must be an integral part of both the due diligence and integration planning efforts. IT is a critical enabler of all integration efforts.
  • Time Kills Deals – That being the case, your advisors, lawyers, accountants and other stakeholders must realize that the price and terms of a deal don’t get better over time, and “negotiation exhaustion” kills deals.
  • The Only Thing Constant is Change – Target markets and target consumers change rapidly over time. Fingers must be kept on the pulse of the marketplace for the intended goods and services of the merger so that expectations from the beginning of the process remain attainable at close.
  • Over-communicate– Personnel will be forgiving at first and will not expect all the answers. They will, however, expect strong leadership that has a vision and a plan for how to get there; how to blend the cultures of the merging organizations into a compatible, inclusive growth-oriented environment.

What’s It Really Worth?

Once it is confirmed that legal/compliance requirements are met then the next major step is conducting a realistic valuation of the business.  Your investment banking intermediary will develop financial models to include the most important fixed and variable financial factors that will be the most important components in determining the value of a company. There are, of course, significantly different financial factors to consider for different companies, particularly complex in highly regulated industries such as cannabis. In the cannabis industry your advisors must positively understand the idiosyncrasies in this marketplace in order to identify a valuation range that ensures the buyer is not overpaying and that the seller’s proformas are verifiable.

What It Takes to Make It Over the Finish Line 

  • The Vision of the Parties
    • All stakeholders to the M&A transaction must have a clear vision as to the direction toward profitability the marriage of the parties will take. This requires good advice about the fundamental legal and business issues that will arise and the judgement calls that will have to be made during the process to keep a clear vision for the post-closing entity.
  • Commitment
    • Once the decision is made that a buyer’s objectives are better served by acquiring rather than taking the path of organic growth, all key management team members must fully buy into that direction regardless of hurdles that will arise along the way.
  • Culture Comprehending ESG – The Critical Role it Plays in Realizing the Value in an M&A Deal
    • A critical component of the very essence of the deal is the shared values and behaviors in Environmental, Social, and Governance (ESG) that shape employee experience, interaction and morale within an organization. Understanding the Culture Equation avoids differences that are likely to become too hard to manage after the transactions is completed.

Investor Takeaway 

2021 is becoming the most lucrative year in the history of legal cannabis in the U.S. The majority of states now have medical and, in many cases, adult use legalization in place and sources like Grand View Research project a US industry size of $33 billion this year, $84 billion by 2028. Along with this market growth is the ever-increasing volume of  M&A transactions in the industry. YTD 2021, over 144 transactions have been announced or closed, compared to 32 in the same period last year. The recent Trulieve/Harvest Health acquisition is seen by the industry as having more far-reaching affect than merely the size of the deal. This deal between two of the largest most profitable publicly-owned MSO’s proves that any cannabis operator is in play.  And along with this potential and the fierce pace of M&A sweeping through the industry – the pace happening now and projected to be the industry’s future – comes the danger of pitfalls in a successful deal in such a complicated industry; an industry subjected to state-by-state regulations while still being illegal federally. In the final analysis after all the nuances in the cannabis industry, processing a cannabis M&A transaction across the finish line involves the vision of the parties, the commitment of all stakeholders involved, and the successful blending of the cultures of the merged companies. A guideline for investors is provided above.  But in this complicated, nuanced industry an experienced team with specific industry experience is required to provide the value added of managing the M&A process and strategy.

How We Can Help

Let’s Talk

We will be at the Salon Suite at the Wynn in Las Vegas during the MJBizCon, October 20 – 22. Please let us know if we can talk about your strategic investment strategy one-on-one.  Click here and we’ll set up a time to meet. Click Here>>>

We excel at structuring deals to provide access to capital while meeting client investment strategies in emerging 2021 opportunities with our core expertise in Cannabis along with other highly regulated markets in the fields of Pharma, Biotech, Healthcare, Agtech, Clean/ClimateTech, and CBD/hemp companies. We specialize in thoroughly vetted companies looking to drive growth and enterprise valuations through M&A, non-dilutive debt financing and/or capital investments ranging from $5M to $100M+.

Let’s talk about putting the power of this expertise to work for you as a Sell-side or Buy-side client.