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.
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© 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.