Cannabis Musings - August 3, 2023

A sort of state of the industry, with apologies to F. Scott Fitzgerald.

Aug 04, 2023

Friends, earlier this week, I recommended an article by Chris Roberts about California-based Flow Kana. It reminded me of a mid-2020 long-form piece about MedMen published in Politico by Ben Schreckinger and Mona Zhang. Both stories detail the overexuberance of Blitzscaling executives, and the giddy investors throwing cheap cash at them, during that 2017-19 wave. Az men hot gelt, iz men i klug, i sheyn, i men kan gut zingen (“If you have money, you’re smart, you’re handsome, and you can sing well”). Those were good times.

I still remember the salad days of 2018, chatting at a Hall of Flowers afterparty with an operator with little in the way of revenues, history of operations, or, well, business experience, learning they were talking to a Canadian investment bank about going public to raise capital. Still a practicing lawyer at that point, I asked them if they realized the mishegas of being a public company, knowing the answer to my question but still trying to be helpful. Needless to say, those practical aspects were obscured by millions of dollars of easy growth capital and a farkakteh valuation.

Stock market valuations validated both the promise of legalized cannabis and the expectation of glory. Trading prices skyrocketed, which was driven by trader speculation in stocks that had little liquidity (increasing price volatility) because they were traded on the Canadian Securities Exchange, and many shares were still in the hands of founders. In addition, some of the larger companies pursued an aggressive acquisition (roll-up) strategy, issuing press releases announcing non-binding letters of intent (the kind of move that gives securities lawyers agita), which would push up the stock price, allowing the company to raise more money at higher prices. What could go wrong?

Those public trading multiples, which were based (loosely) on multiyear revenue projections (at that point, there wasn’t even positive adjusted EBITDA to flout), supercharged private company fundraising. Winning a license was like winning the lottery (figuratively), and investors, including public companies flush with recently-raised cash, were funding pre-revenue business plans with little thought as to the long-term challenges to building a cannabis business. Later fundraising rounds were closed with eye-popping multiples, similarly based on multiyear revenue projections.

Flow Kana wasn’t the only company to take advantage of the excitement. Delivery service-turned-licensed operator Eaze raised $225 million over the years, with a peak valuation of $700 million. Software provider Dutchie raised $350 million as late as 2021 (after that first cannabis wave, but still during the peak of the last venture capital boom) based on a $3.75 billion valuation. In my experience, both in the deals I did and the deals I worked on, the easy money was available to companies large and small. It mostly didn’t matter where or how – it just mattered that it was cannabis.

We all know how this ended up. Cannabis stock prices fell back down to earth in 2019. The realities of almost certain operating losses in running a cannabis business came to light. Cash dried up as billions of dollars of value was destroyed and investors felt burned. Prices rebounded a bit in early 2021, right after the Democrats took the Senate and a brief moment of hope for legalization came and passed (shortly after speculators read the filibuster rules). Companies that held such promise in the eyes of investors like Flow Kana, Herbl, and Green Growth Brands simply closed up shop, while many more were unable to dig out of the toxic capital structures they had built. The graveyard is filling up and lawsuits are flying.

And yet, for all of its excesses, the money binge from that first wave fueled the construction of the state-licensed commercial cannabis, from infrastructure to supply chain to lobbying for expansion. Consider how the first dotcom bubble funded the tech industry. Tech has done pretty well in the long run. Granted, that industry didn’t have one arm tied behind its back while being repeatedly punched in the gut and poked in the eyes by regulators, but one needs to remain somewhat optimistic to survive in the cannabis business. I recommend Bloomberg’s Odd Lots podcast from July 7, 2022 with Stephan Paternot, founder of TheGlobe.com, for some perspective on how the two bubbles are similar.

The state of the industry is not good, and we’ve talked recently about how there really isn’t much on the horizon that could fundamentally improve things from a capital perspective (although rescheduling, if it actually were to happen, and in a way that actually benefited the entire industry, well, that would be nice). Short of federal legalization, I’m not sure how the problem is solved. At best, it’s mitigated.

At the same time, this industry is only going in one direction. Even in legacy states where revenues remain flat, there’s still consumer growth. Public attitudes towards cannabis continue to improve. For some reason, the federal government still hasn’t shut the whole thing down. There are some profitable companies out there (on a net income basis, not just on a creative adjusted EBITDA basis), and some of the large companies still have access to debt capital (even on an extend-and-pretend basis). The industry continues to transform and improve.

It’s going to take a long time to recover from the capital binge hangover and convince investors to start trusting the industry again. Nonetheless, we beat on, boats against the current, yada yada yada.

Be seeing you!

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.

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