Cannabis Musings - December 18, 2024

Vireo is both a buyer and a seller.

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We were going to talk about a very interesting chart posted to LinkedIn by Gail Rand of grand consulting, looking at gross margins of some of the largest MSOs, and how it’s illustrative of the highly-fragmented nature of the cannabis marketplace nationally (the post is still worth your time), but Vireo Growth threw a wrench into those plans this morning when it announced a whopper of a deal in which it’s selling itself. I know that’s a backwards way of looking at the transaction, so let’s dig into this.

The very short version of what’s happening, which is explained in more detail in their Wednesday morning press release and investor presentation, is that Vireo is acquiring four different cannabis operators across a number of states, plus a software company, for Vireo stock. They’re also going to sell $75 million of stock at $0.625 per share (Vireo closed at $0.25 per share the day before). All of this is subject to a lot of approvals, particularly Vireo’s shareholders and state regulatory authorities (that have to approve the license transfers). If it closes in full, it’ll transform Vireo into one of the larger multistate operators in the U.S.

Oh, and they’ve appointed a new CEO (a co-founder of Chicago Atlantic) and CFO.

What’s really interesting to me about this deal is that, assuming everything closes, Vireo’s existing shareholders will end up with 21% of the resulting company, with totally new leadership at the helm. In other words, Vireo is giving away 79% of the company in the form of stock, plus executive control, to other investors, in exchange for a giant pile of assets. Don’t get me wrong – that’s not necessarily a bad thing. But this deal is more than a roll-up (a typical private equity strategy where you take a midsized company as a platform, and then strategically acquire smaller business to roll into the mothership, gaining scale and efficiency, in theory) – it’s a transformation into something that isn’t very much Vireo anymore. I respect the fact that Vireo doesn’t see the deal this way, but this is not your everyday M&A deal.

A few other things worth noting:

• We learn some interesting data points about deal valuation (which are typically based on a multiple of EBITDA or revenues). They’re reportedly buying three of the cannabis companies at 4.175x “Reference EBITDA” (which they don’t define in the press release, but explain in the presentation that it’s “pro-forma for pending acquisitions as well as new retail openings and grow expansion in near-term,” which basically means they’re taking into account future transactions of the targets that are already in place), and the Florida company for 5.4x Reference EBITDA. Some quick math from page 11 of the presentation implies revenue multiples around 1.10x to 1.25x (1.50x for Florida).

• The sellers of the four cannabis operations can earn more Vireo stock if they outperform EBITDA targets (known as an “earnout” in M&A parlance), but, interestingly, are also subject to a “clawback”, meaning that they’ll have to forfeit shares if the companies don’t meet targets. You don’t see a clawback as often as an earnout, which I think reflects some of the uncertainty inherent in this industry.

• The earnout shares will be issued at the greater of “Vireo’s 20-day VWAP as of December 31, 2026 or $1.05 per share” (“VWAP” being “volume-weighted average price”, where you average out the share price over a period of time, adjusted for trading volume, so you get something that, in theory, isn’t as affected by short-term volatility and better reflects the true price). It’s interesting to me that they agreed to a floor price (the lowest price at which the shares will be issued, namely $1.05), rather than just agreeing that earnout shares would be issued at the VWAP on December 31, 2026. This helps the existing Vireo shareholders because it reduces their overall dilution if the stock hasn’t fully performed by that time.

• You may ask how Vireo would issue stock at $1.05 per share if it’s trading at, say, $1.00 per share on December 31, 2026. Good question! I think they can do that by simply issuing fewer shares because the denominator is larger (the numerator being the total $ value of the earnout.

• Vireo’s stock price shot up to $0.69 shortly after the announcement, but quickly came down below the $0.625 per share price at which the $75 million of stock is being sold, trading closer to the $0.52 implied price per share for the acquisitions. In other words, the market is taking into account the dilution that’ll occur by the additional shares that will be issued.

• The deal is backed by cannabis finance company and friends of Cannabis Musings, Chicago Atlantic. According to its own press release, Chicago Atlantic is Vireo’s largest shareholder and is backing the $75 million stock financing. It’s an interesting move after the combination with Silver Spike earlier this year, probably giving Vireo even more access to capital going forward, and, with Chicago Atlantic’s co-founder now running Vireo, makes them look even more like the current flavor of institutional asset managers (i.e., managing credit and private equity investments).

• Soldering together the operations of five cannabis companies, plus a software platform, simultaneously is going to keep the Chief Operating Officer busy for a long time.

• We’re back to all-stock deals, baby! Back in the 2016-19 heyday, M&A deals were mostly, if not all, stock. That was cool while stock prices were only going up, but after they crashed in 2019, we generally saw a shift to a relatively higher percentage of cash being paid to sellers, because those stocks didn’t look as attractive anymore. This Vireo deal is all stock, which I think more reflects the fact that there simply isn’t that much cash to spread around.

So, why is Vireo selling itself? I think it’s Vireo (before and after going through the transmogrifier) reading the future of this industry that there isn’t going to be much of a middle. We’ve speculated before that, over time, the cannabis industry will be hourglass-shaped like the beer industry – a handful of large operators providing highly-branded products with little typicity, a mish mosh of small local, hyperlocal, and regional operators generally focused on higher-end products catering to the connoisseur, with precious little in-between. For the record, I don’t think this is a bad thing – I’ve always thought that there’s room in the marketplace for big and small.

I think this transformation doesn’t fully take root until cannabis is federally legal, because it really requires interstate commerce, but this transaction is, to me, a sign that this future reality is already on the horizon. Now that state-legal cannabis is past its infancy (although some might argue that it’s still there), operators need to start thinking about what they want to be when they grow up. Where do they fit into a national marketplace where the large players satisfy the vast majority of the volume and the small players satisfy the niche? Particularly if the alcohol distributors have their way and are gifted a mandatory three-tier interstate distribution system (cf. the Federal Trade Commission, in its recently-filed complaint against Southern Glazer’s, the largest national wine and spirits distributor, alleges that Southern sells one out of every three bottles of wine and spirits nationally).

“Az s'iz nito in top, iz nito in teller.” (“If there's nothing in the pot, there's nothing on the plate.”)

We’ve talked before about why M&A is and will remain hard in this industry. But challenging times call for creative and extra-ordinary measures.

© 2024 Marc Hauser. 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. The foregoing represents my own views and not those of Jardín.