Cannabis Musings - March 4, 2025

Read past the headlines.

Friends – if you’ve paid attention to the cannabis industry for long enough, you know that it loves press releases. It’s not quite as bad as it was during the 2016-19 heyday, when no event was too insignificant to announce to the world. Non-binding letter of intent to acquire another company? Sure! Who cares if it gives the securities lawyers agita. Marketing devised a new logo for your edibles line? Why not! Your dispensary just made a sale to its 10,000^th customer? Let everyone know!

Perhaps that last one is a little made up, but why let truth get in the way of hyperbole? The industry really likes to toot its own horn. Not that there’s anything wrong with that – press releases are part of the game of being a public-facing company, particularly when you’re trying to get attention in a space that doesn’t draw many eyeballs. There’s something of an art to writing a press release, making sure that you’re disclosing what you want and what you need to (what’s required by securities laws), but sometimes it requires you to look past the headlines and dig into the details to understand the nuance. Sure, that company you follow proudly touted its new loan, but did you read deeply enough into the press release to see that it was borrowed with a large original issuance discount or that it’s 20% cash collateralized?

This happens a lot when companies report earnings. In an industry where profits (in terms of positive net income) are elusive at best, companies love to tout their “adjusted EBITDA” results, and understandably so – it’s always better to announce positive results than negative. The risk for observers is that adjusted EBITDA can be a little bit of shticklach (“trickery”), using tolerated subjectivity to improve the optics. Bloomberg had a long article last week about a large private equity deal that went bad, primarily due to a dispute over whether the reported adjusted EBITDA was truthful. To understand the problem, you need to understand the metric.

Generally, US companies prepare their financial statements based on certain standards known as Generally Accepted Accounting Principles (GAAP), issued and maintained by the Financial Accounting Standards Board, a private group that everyone (including the SEC) lets set the rules. Small companies generally won’t bother with this, because compliance is complicated, but as companies grow and attract capital, borrow money, etc., there’s an expectation that they play along. And for good reason – a prospective investor wants to know that they understand how the financials are compiled, rather than doing it themselves.

One of the simplest ways to determine whether a company is making money is to look at the literal bottom line of the income statement – basically, revenue minus costs, expenses, taxes, and interest (I’ve simplified that for convenience). Net income for tax purposes is different, because tax is its own beast, but for now, we’re just talking about net income in accounting. The problem with looking at net income is that it may not totally reflect the company’s performance. For example, accounting rules have you depreciate the value of certain assets and amortize (write down) the costs of other assets over time, which aren’t really cash transactions. And there’s sometimes extraordinary, one-time costs that hit net income but hide the longer-term trend.

So, finance folks developed the concept of EBITDA – earnings before interest, taxes, depreciation, and amortization. The idea of this metric is to show how profitable a company is by focusing on its operations, taking out exogenous concepts like the cost of debt, what’s paid to government agencies, and non-cash reductions in asset value. It’s particularly useful when looking at leverage on a business, because it’s tied to cash generation. Additional nuance is added when you get into more specific metrics like EBITDAR (backing out rental costs for companies that do a lot of property leasing) and EBITDAX (used by oil and gas companies to back out exploration costs, and is also fun to say out loud).

One of the challenges of EBITDA is that it’s not part of GAAP – it’s a metric that’s totally separate from what accounting firms will sign off on or audit. That makes it more prone to finagling. It also buries certain aspects of a company’s financial health because it ignores material cash outflows that the company is actually making. Particularly in cannabis, where taxes are, well, really high, EBITDA obscures the fact that a substantial amount of cash is being paid to the government, exacerbating the risk of only looking at a cannabis company’s EBITDA results.

If that weren’t confusing enough, financial analysts then got the idea of adjusting EBITDA further. Why not also back out other one-time, extraordinary (in terms of something being “extra-ordinary”, not “awesome”), and irregular items? Certainly, that makes sense – if you’re trying to analyze the performance of the core operation, you want to smooth out as much distortion as is reasonable. So, you’ll frequently see items adjusting EBITDA for litigation costs, one-time gains or losses, and donations (for example, used by Trulieve to reflect “Legislative campaign contributions”, which was presumably its spending on the 2024 Florida adult-use ballot initiative). One of the more controversial adjustments is for share-based compensation – incentive equity that’s issued to employees and directors instead of cash bonuses.

In cannabis, we also sometimes see adjustment for “change in fair value of biological assets”, which is an accounting requirement under International Financial Reporting Standards (like GAAP, but non-US), but not required under GAAP (so you’re not likely to see it on a US operator’s financial statement, unless they’re only filing up in Canada). This requires the plants to be valued at fair market value minus the cost to sell, which is an inherently subjective measurement. Companies like to back this out of EBTIDA, understandably, because it’s a non-cash concept, but it can sometimes really sway the final adjusted EBITDA number.

None of this rises to the level of the egregious behavior that we saw with the ne plus ultra of EBITDA adjustments – “community-adjusted EBITDA” as made up by WeWork. That silliness didn’t last very long, after appropriate ridicule by the finance community, but it’s illustrative of the use and misuse of the metric. Adjusted EBITDA can be used to distract from the actual cash performance of a company, particularly if it has, say, an expensive preferred stock dividend that its required to pay in cash every quarter (which won’t even be disclosed in net income).

This isn’t to say that EBITDA or adjusted EBITDA should be ignored. The metric has its uses. The point is to always look beyond the press release headlines, and, even more so, the talking points posted on social media. Just because a company is enjoying positive adjusted EBITDA doesn’t mean that it’s not burning cash to fund bottom line losses (which, in this industry, is more of the norm). Trust, but verify.

Be seeing you.

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© 2025 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.