Cannabis Musings - March 9, 2023

Friends – one of the podcasts I regularly consume to understand financial markets, economic trends, and industrial systems is Bloomberg’s Odd Lots. They exude giddy curiosity about arcane structures within our financial system and economy, deconstructing like a French philosopher, but without the political or sociological biases that bug me about economics generally.

Today’s Odd Lots podcast featured Samuel Rines, Managing Director at Corbu, LLC. I highly recommend you listen to the podcast yourself (and, if you’re a Bloomberg subscriber, there’s a related article posted as well), but the gist of it is that there’s a visible trend of large corporations using headlines about supply chain and market disruptions, as well as consumers generally enjoying higher wages as of late, to raise prices and boost margins. This, naturally, doesn’t help the Fed’s efforts to help bring down inflation.

This got me thinking about how the cannabis industry is moving in the other direction and hasn’t been able to take advantage of this situation. Indeed, we’re seeing gross margins (basically, gross profits divided by revenues) contract and prices (both wholesale and retail) declineacrosstheboard. Costs also play into margin calculations, and clearly retailers (on a macro level) haven’t been able to fully capitalize on plummeting wholesale prices to offset prevailing trends.

There’s certainly more underlying this dynamic than I’ll ever be able to understand, and I admit that I don’t have ready access to the right kinds of data to properly back up my thesis, but I suspect that there’s generally a concern that cannabis customers are more price-sensitive than other consumers, particularly when growth has slowed in legacy states and there’s an illicit market that’s already materially cheaper and somewhat readily available (which we discussed earlier this week).

I’m not smart enough to know whether it’s actually true, but I do wonder whether the average retail customer buying at licensed outlets really would be that eager to shift to illicit sources that can’t offer the same variety, testing, or safety. It also seems like a good reason for the industry to find ways to materially expand its consumer base beyond the stagnating core.

This is all another good example of how everything about cannabis is different. I counsel clients and contacts all the time about how what works in just about every other industry or market almost certainly won’t work in cannabis. Anyone who thinks or expects differently – a glick ahf dir!

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network,

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - March 6, 2023

Friends – have you been to New York City lately? It’s still a mess of unlicensed cannabis dispensaries. We talked about this a while back, and I was reminded of the problem last week when Jeremy Berke’s very excellent Cultivated newsletter (to which you should subscribe) reported on the slow rollout of dispensary licenses and openings.

To me, the whole reason we’re here is to build an industry where adult consumers are able to purchase a wide array of known, tested cannabis products in a safe environment. It’s why we put up with all of the mishigas. At the same time, there’s still a thriving unlicensed (illicit) cannabis industry competing for those same consumer dollars, and NYC is currently the epitome of that fact - you can’t swing a dead cat in Manhattan without hitting an unlicensed store or truck selling cannabis products.

Layered on top of all of this is the legacy of the War on Drugs. We talked a bit about that history a while back. Part of what drives the licensed side of the industry, particularly the push for appropriate social equity measures, is to counter the stain of that legacy. As a result, there are voices from within the licensed cannabis industry that are against criminal crackdowns on those unlicensed storefronts in NYC. (I hesitate to call out anyone in particular, hence no links.)

How does this dialectic play out, one that isn’t just limited to NYC? How do you encourage companies and entrepreneurs to spend money and time building out licensed operators, who are required to comply with regulations and only offer tested products at a material price premium, when there’s someone around the corner selling either untested or untracked product at a fraction of the price? And yet, how do you shut down the latter without considering what the War on Drugs did to so many people and acting accordingly?

I for sure don’t know the answer to that question, but I suspect that the industry ultimately won’t be able to have it both ways. At a macro level, one of the very many main reasons that the licensed industry is still so distressed is that it has a very large competitor that holds a very unfair advantage. What other product or service has that kind of problem?

I just don’t think that the licensed industry can thrive like it could or should while the illicit market is still so robust. Although lowering taxes, reducing costs, etc., would help mitigate that edge, the illicit industry would still have a major price benefit. No one needs to return to the destructiveness of the War on Drugs to solve this problem, but I don’t see it going away on its own.

I recognize that I could be completely wrong about this (hence this newsletter never being legal advice), but I think the industry can’t have its infused cake and eat it too.

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.

Cannabis Musings - February 22, 2023

Friends – a couple of updates. First, you may recall that, back in the halcyon days of January, these Cannabis Musings offered up some predictions for this year, one of which was that hemp-derived Delta-8 THC’s days were numbered:

I do expect we’ll see something interesting when the 2018 Farm Bill (which descheduled hemp) comes up for renewal this year. If the draft Hemp Advancement Act filed by Rep. Chellie Pingree (D-ME) last February has any legs, I’m guessing that the hemp-derived THC (e.g., Delta-8) “loophole” (I put that in quotes because I don’t think the law allows for these products (no loophole), but that’s not legal advice and I recognize that many disagree with this take) will be finally be fixed.

Well, MJBizDaily just reported that U.S. Rep. Earl Blumenauer (D-OR) seems to be of the same mindset:

[S]ome members of Congress as well as the public recognize that the minority leader bears responsibility for the delta-8 situation – and that the Farm Bill would be an appropriate place to fix it. “We had a breakthrough in the 2018 Farm Bill, but it didn’t provide a regulatory framework” for intoxicating hemp-derived cannabinoids, Blumenauer said. “There are real problems,” he added. “That is recognized. So I think that coming in and filling these gaps is something that shouldn’t be hopelessly controversial.”

Now, I’m not going to claim that Rep. Blumenauer is a reader of these Cannabis Musings, but I’m not not going to claim that either.

Second, I spoke with a reader about our discussion last week and whether the challenges for distressed investors and lenders also apply to acquisitions. My view is a bit contrarian, at least based on what I’ve been reading and hearing lately.

The conventional wisdom is that we will see larger companies strategically buy up small, distressed companies because they can do so cheaply (if you want to impress your private equity friends at a party, you can tell them this is known as a “tuck-in acquisition”), or a savvy investor will create a new holding company to buy up and integrate numerous distressed companies for scale (what’s referred to as a “rollup strategy”).

To quote Homer Simpson, “I agree with [this], in theory. In theory, Communism works. In theory.” In reality, this is really hard to do in cannabis. If it were easy, we’d already have seen a lot of it in 2019-20, and would be seeing more of it today. But we’re not. Why? I think there are a few key reasons:

• Regulatory Approval – getting approvals from regulatory agencies for a change of control of a licensed company takes a very long time on a good day. This certainly isn’t a barrier to getting deals done, but time equals risk, and when it may take up to a year to get all of the required approvals in order to close, things happen and valuations can materially diverge.

• Consideration – the purchase price (“consideration,” if you’re fancy or a lawyer) for cannabis acquisitions still tends to be paid mostly in stock of the acquiror, with some cash paid, maybe. Stock prices and valuations for cannabis companies remain mired in dreck. It’s not very attractive for a buyer to have to pay out a larger proportion of its ownership to get a deal closed, even if the target is being sold on the cheap. In my career, I’ve seen many deals die because the buyer and the sellers disagreed on valuation, but even that chasm can be bridged creatively.

• Liabilities – to me, the biggest problem holding back a robust M&A market in cannabis is liabilities. In nearly all US jurisdictions, a commercial cannabis license may not be transferred as a separate asset (I think Nevada is the only state that allows it, but, as you should know by now, this is not legal advice) - the entity that owns the license needs to be sold instead. The buyer can’t just cherry pick assets.

So, for the most part, buyers are stuck buying entities (known generally as stock deals as opposed to asset deals). When you buy an entity, all of the entity’s assets and liabilities go along as part of the entity - those don’t get left behind anywhere (you could try to move out liabilities before closing, but then you risk causing a “fraudulent transfer”, and anything with the word “fraudulent” in it is almost certainly bad (also not legal advice, but good advice for life generally)).

Sure, the buyer could get an indemnity from the sellers of the entity (basically, a guarantee to pay back the buyer for any losses relating to certain liabilities), but the buyer needs to get comfortable that the sellers are going to be around with cash when a claim is made (which also gets harder when the consideration is mostly stock). Based on my experience of nearly 25 years of deals, relying on individuals (which most of the sellers in cannabis still are) to be creditworthy indemnitors and unsympathetic lawsuit defendants is narishkeit.

Given all of this, buyers are going to be extremely picky before they get stuck acquiring all of the liabilities and problems that caused the distress in the first place, having to spend their very expensive resources (cash) to manage those liabilities, diluting existing owners at low valuations, and risking regulatory approval delay.

So, what’s my contrarian view? Simply that, for all of these reasons, I don’t think there really will be very much distressed M&A in the cannabis industry at all. Sure, it’ll happen, and there will be situations where the deal makes sense (and, of course, friendly neighborhood advisors such as Hauser Advisory can help figure that out), but I think those will be few-and-far-between, and not nearly as much as many other industry observers suggest.

I hope for the industry’s sake that I’m wrong.

Be seeing you!

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Hauser Advisory provides advice and strategy on business lifecycle events and cannabis industry navigation, tapping into a deep, national network

and twenty-five years of dealmaking and capital markets experience.

© 2023 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. Subscribe to Cannabis Musings at hauseradvisory.com.