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With the big run-up in stock prices over the past few months, we spent some time assessing MSO valuations for subscribers at 420 Investor recently. As we reviewed analyst forecasts for 2021 and 2022 for reasonableness and to get a sense of market expectations, we appreciated the many inputs one must consider. Future market revenue will depend upon the rate of conversion from the illicit market in each state as well as the ability to attract new consumers, the propensity to expand production capacity in existing markets that are currently limited and the rate of new markets opening. Company revenue will also depend upon pricing and market share as well as the ability to expand distribution. The analysts also have to judge profitability, assessing the cost of production and pricing for each market. Beyond EBITDA, analysts need to forecast tax-rates and interest costs, both of which are currently insanely high but will hopefully be lower down the road.
As we were doing this exercise, we realized that there is another huge driver of future growth potentially: acquisitions. In mid-December, we suggested that mergers were going to be a big theme in 2021, and this has certainly been the case so far. Many investors in this environment focus on investing in companies ahead of acquisition. Indeed, publicly-traded Bluma Wellness and Liberty Health Sciences have both agreed to be bought by other public companies recently. In Canada, Tilray, Trichome Financial and Zenabis all have pending mergers with other public companies. While we expect there could be more public company acquisitions in Canada, we continue to believe that most of the American consolidation will be public companies buying private companies, as license limits in many states would make mergers between MSOs less likely.
Circling back to our thinking about valuation analysis, it’s important to understand that the analysts don’t put future acquisitions into their models, even when the deal is announced. While analytically this is correct in our view, we believe that consolidation of the highly fragmented American cannabis industry is likely to provide substantial returns to the consolidators. The several public companies that have announced pending transactions have been able to acquire the private companies at seemingly very reasonable valuations. As an example, Columbia Care recently announced the pending acquisition of Green Leaf Medical, a private MSO. It will pay $45 million in cash and pay the balance in stock. It presented the price (before milestone earnouts) as 4.8X 2021 adjusted EBITDA, which, at the time, was a substantial discount to where its own stock traded. Ayr Strategies has been particularly active, announcing acquisitions in 5 states over the last few months. To the extent M&A continues at a rapid pace, analyst estimates may be understated.
One market that we continue to expect to see a lot of M&A activity is California. First, some large MSOs are not yet in the market in a meaningful way. We continue to expect a major move by Curaleaf. Even beyond the large MSOs, there are many small operators, and we are already seeing companies begin to pursue a roll-up strategy in California. Beyond California, we are expecting MSOs to use M&A to enter new states and to go deeper in existing markets, where permissible.
Valuations have certainly increased in the past five months as the industry outlook has improved following additional state legalizations and the change of control of the Senate. We are at a stage of the cycle where valuation, in our view, shouldn’t be the primary driver of the investment analysis. The continued aggressive buying of new issues by institutional investors certainly seems to validate the current valuations. While organic growth for the industry is likely to be very robust in the next few years, we think M&A could substantially boost the growth profile for many of the publicly traded operators as they utilize their stock, recently raised cash and even potentially debt, given that most MSOs have no net debt, to add assets.
Body and Mind, with core competencies in opportunistic acquisitions and license applications, has built an operations-focused business in several states. The company is active in California and Nevada in the west and Arkansas and Ohio in the east, investing in high quality medical and recreational cannabis cultivation, production and retail. Body & Mind recently reported Q1 revenue that increased 144% sequentially and is benefiting from steady growth, lean operations and asset consolidation.
Get up to speed by visiting the Body and Mind Investor Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.
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Alan & Joel