VIRIDIAN INSIGHTS

• THE EXTENSION OF OUR OPTIONS VALUATION FRAMEWORK TO THE DEBT SHOWS THAT “AMEND, EXTEND, AND PRETEND” IS A RATIONAL STRATEGY.
  • In our equity analysis, we presented what to some is a counterintuitive, though theoretically sound viewpoint: if you are an equity holder in a distressed business, where the value of the assets is perhaps only slightly over or under the amount of debt, you should want high risk and high volatility. In essence, you are behind, and there are only a few innings left in the game (until your debt matures). Most of the upside accrues to you and your debtholders take most of the hit on the downside. After all, the worst your equity can be worth is zero, So swing for the fences, try to steal bases, etc.
  • That is, of course, why restrictive debt covenants exist. They give the debtholders the right to call the game early, preventing the equity from gambling away all of the value.
  • The framework has some interesting ramifications. What if the value of the assets is less than the face value of the debt? What should a rational debt holder do? It turns out that “amend, pretend, and extend” is not irrational. Allowing for a little extra risk may not be unreasonable either because, in this situation, the upside will be captured by the debt. So, we see the behavior of lenders like Gotham Green, who were faced with a situation like MedMen. It might not have turned out as desired, but the strategy was rational. Provide minimum liquidity, allow growth even if it entails risk, but keep a tight rein through covenants. Eat more and more of the equity through more warrants and reduced exercise prices so that if the risk really pays off, you get more than debt returns. It’s all quite rational. The more challenging decision is when do you actually throw in the towel and call a hard default?
  • We are starting to see more of that, as in Pelorus/StateHouse. Whether it becomes a trend depends on the direction of asset values. We never thought we would be looking at market caps where they are, nearing the end of 2024. We know there is a massive upside, but have we hit bottom yet?
• WHAT WILL IT TAKE TO QUELL THE “GROWTH PANIC”
  • We believe one of the reasons for the recent sharp decline in cannabis stocks is that without FL, PA, or VA, it is difficult to point to the next catalyst for a growth spurt.
  • The problem is exacerbated by the continued price compression experienced in nearly every market once it gets past its first 12-18 months of adult use. New Jersey is an example of price compression that is beginning to be felt. Developed markets like Michigan, which have already experienced severe price declines, continue to see even more.
  • Nearly perfect competition from the illicit market and hemp-derived cannabinoids further reduce growth potential.
  • Finally, a firmer outline of the new Farm Bill is beginning to take shape, and it is not kind to hemp cannabinoids. Some variants actually take the allowed THC to zero, although we do not believe this can stand due to the “hot hemp” issue, which would make this standard impractical. Nonetheless, the Bill is receiving rave reviews from cannabis corners and is likely to firm stock prices.
• MSO VALUATION AND FINANCIAL FLEXIBILITY DEPICTED BY FOUR GRAPHS. BOTTOM LINE: MSOs ARE TRADING AT HIGHER VALUATION MULTIPLES AND HAVE HIGHER LEVERAGE THAN STANDARD MEASURES INDICATE!
  • The four graphs below seek to map the financial options available to eighteen of the largest MSOs based on their Valuation, Leverage, and Liquidity. We have updated our measures to look at 2025 EBITDAR estimates as we believe most investors are now looking to these values in their valuations.
  • The first two graphs present different versions of EV/EBITDA on the vertical axis and Debt/EBITDA on the horizontal axis.
  • The first graph presents our latest view of the most appropriate valuation and financial statement-based leverage metrics: Adjusted E.V. / 2025 EBITDAR and Adjusted net debt / 2025 EBITDAR. In calculating Adjusted Net Debt, we make several key assumptions: 1) Leases that are included on the balance sheet are considered debt. We view most leases in the cannabis space as equivalents to equipment loans or mortgage loans. While it is true that a lease default does not necessarily trigger a cascade of events leading to bankruptcy, the distinction is often meaningless in cannabis due to the mission-critical nature of many long-term leases and the absence of bankruptcy protection in cannabis. 2) We consider any accrued taxes (including uncertain tax liability accounts listed as long-term liabilities) in excess of the most recent quarterly tax expense to be debt. Our calculation of enterprise value is now market cap plus debt plus leases plus tax debt minus cash. We now use EBITDAR rather than EBITDA since lease expense is taken out prior to EBITDA.
  • The second graph utilizes EBITDA and employs the traditional calculations of both debt and enterprise values, leaving out leases and taxes.
  • Our adoption of new metrics tends to make the companies look less cheap and more leveraged.
  • Surprisingly, eight of the companies on the enhanced metric chart are still above 3x leverage, which we have identified as the boundary of sustainability in a 280e environment. Four companies now exceed 4x leverage, which we believe will be close to the maximum sustainable post 280e.
  • Valuation metrics can be deceiving when a company is just achieving positive cash flow status. Glass House, for example, has enormous valuation multiples. Still, it is based on small EBITDAs that are likely to expand significantly in the next several years.

• The third graph looks at leverage through the lens of total liabilities to market cap. We believe this is the single best measure of leverage because it is a direct reflection of the market’s assessment of the value of a company’s assets in excess of its liabilities and is sensitive to changes in market perception of a company’s future.
  • On the bottom left are companies with Adj E.V./2025 EBITDAR of under 7x and total liabilities to market cap under 2x. The group includes Vext, GTI, PLTH, Verano, and Cresco. Companies in this quadrant are right to consider stock repurchases or using cash in acquisitions. They can afford some additional debt and can take advantage of the ongoing dislocation in equity prices.
  • In the middle, between 2x and 5x total liabilities/market cap, we see Ascend, AYR, Jushi, and MariMed. Each of these has significant upside catalysts that could mitigate or exacerbate the excess leverage. However, several upside catalysts seem to be neutralized in the short run. Florida rec is indefinitely delayed, PA rec does not seem to be happening this year, and VA rec is probably on hold until 2026.
  • On the right lies Jushi, AYR, Ascend, and Schwazze (not pictured). AYR has moved into our danger zone, but its metrics are not nearly as troublesome as the Schwazze. At the top left are companies with high valuation metrics and low leverage. These companies should look to do an equity issuance depending on their positioning in the liquidity graph below.

• • The fourth graph introduces the free cash flow adjusted current ratio liquidity measure into the mix. Companies with less than 1x on this measure will likely have to raise capital next year. Surprisingly, eight of the companies fall into this bucket (including Schwazze, not pictured).
  • The bottom left group, including Curaleaf, Verano, and Vireo, has low leverage but is below the critical 1x liquidity level. This suggests that Curaleaf and Verano should take advantage of the robust debt market to augment their liquidity (note that Curaleaf just did this). Vireo is a more challenging call. Their adjusted net debt/ EBITDAR is relatively high, which makes them an unlikely net debt issuer and suggests asset sales.
  • On the top left, we find companies with adequate liquidity and low market leverage, including both GTI and TerrAscend, due to their recent refinancings.
  • Companies in the lower middle-to-right generally have constrained liquidity and high leverage, a potentially dangerous combination in a capital-constrained environment. Cannabist’s liquidity is understated in the graph and is likely to be OK based on announced asset sales. 4Front and Schwazze (both not pictured because they are off the scale to the right), despite making moves to restructure their debt, continue to have inadequate liquidity and excess leverage and should be watched carefully. We note that FFNT has no consensus on 2025 EBITDA estimates, but a full year of Illinois cultivation will probably make leverage look significantly better.

• EV/LTM MULTIPLES ARE NOW LOWER THAN BEFORE THE ORIGINAL HHS RESCHEDULING ANNOUNCEMENT ON 8/30/23
  • We continue to believe that at current levels, U.S. MSOs have enormous upside potential. The graph below shows the multiples reached after a number of past legislative/regulatory events. It makes clear that a doubling of prices is a reasonable assumption. We recommend a balanced portfolio that leans toward the companies in the top half of the Viridian Credit Tracker model ranking.
  • Despite the challenges to growth discussed above, we believe that many companies have become stupidly cheap. We recommend a “don’t step in the doggy do do” strategy. With refinancing risks made worse by cratering stock prices, this is no time to be a hero. Focus on building a diversified portfolio of companies ranked in the top 10 in our credit rankings. Put them in your portfolio and follow the total liabilities to market cap indicator that we recommended several weeks ago, as well as the credit tracker rankings. And resist the urge to look at the stock prices every day!

• TRADING LIQUIDITY STAYS HIGHER THAN YTD AVERAGES: DOLLAR VOLUME IS DOWN BUT NOT AS MUCH AS MARKET CAPS.
  • The average daily dollar volume of $22M for the week ending 11/22/24 was below the YTD average of $29M but higher than that for most of the period from May through election day.
  • The Days to Trade Market Cap (DTTMC) series depicts the number of days it would take to trade the market cap of a stock or group of stocks. The current DTTMC of 659, up from the election week spike of 265, implies that an investor who acquired a 5% position in the stock, assuming he wanted to be less than 25% of the average daily dollar volume, would require 132 days to trade out of his position.

• GIVING CREDIT WHERE CREDIT IS DUE
  • The chart below shows our updated 11/22/24 credit rankings for the 31 U.S. cannabis companies with over $3M market cap. The number below the ticker symbol indicates the change in credit ranking since last week, where a negative number suggests credit deterioration, while a positive indicates improvement.
  • We have made recent upgrades to our credit model to more accurately treat lease liabilities and account for non-payment of taxes as a financing source.
  • The blue squares show the offered-side trading yields for each Company. Trading yields have declined significantly since the HHS rescheduling announcement. We are expecting the round of recent refinancings to re-rate the landscape of cannabis debt. Note: The prices shown were obtained prior to the election, as well as some of the recent earnings releases. We consider them to be only indicative, as we expect updated pricing to reflect the dislocations observed in the equity market.
  • Glass House gained two notches while Grown Rogue lost two, but both remain in the top five. Both are disruptors who make money in markets where most competitors do not. Their stocks have not taken the beating that the market averages indicate.
  • AYR’s yield doesn’t look nearly as cheap as it did pre-Florida. We expected the revenue gains for the company in Florida to fuel solid cash flow gains since much of the spending for cultivation improvements has already occurred. There are no near-term debt triggers because the company’s maturities have substantially been pushed out to December 2026. However, the approximately $300 million of 2026 maturities now represent 3.6x the company’s market cap, compared to 1.1x on 11/1/24. The 3.6x exceeds the level of maturities AYR faced at the end of 2024 before it conducted a somewhat disastrous restructuring/refinancing deal. We see asset sales as a possibility to close that gap, and the company’s new Virginia license jumps up as a prime possibility. Verano just paid $90M for a combination of Cannabist cultivation and retail facilities, which evidently require some refurbishment. So, what would a license in VA bring?
  • C21 was the biggest gainer, rising six notches as the company announced that it may purchase up to 6M shares of common, representing 5% of the outstanding shares. This would not usually be considered a positive credit event, and in fact, it means a reduction in asset value coverage of debt. There is also, however, a signaling impact here. The decision to buy back stock indicates that management believes it has excess liquidity and can afford to repurchase equity. It also signals that management believes the stock to be the highest IRR use of corporate resources. We generally support such decisions because we view management as having asymmetric information regarding the company’s prospects.