VIRIDIAN INSIGHTS

• DEA THROWS A CURVEBALL, SCHEDULING A HEARING THAT POSTPONES A RESCHEDULING RULING UNTIL AFTER THE ELECTION
  • The DEA has scheduled a hearing for December 2 to consider differing expert opinions regarding rescheduling of cannabis to schedule 3.
  • The DEA said that there were a number of requests for the hearing from both supporters and opponents or for rescheduling.
  • The cannabis equity market lurched violently downward on the news as it clearly pushed the issuance of final rulemaking to after the election and probably into Spring 2025. The MSOS ETF closed down 13.35% to $6.10 on Tuesday, August 27.
  • The panic is overblown. We were never convinced of the rapid deployment of S3 and have always believed that the old Shakespearian line “Many a slip twixt the cup and the lip” applied in triplicate to anything occurring in Washington, D.C., especially as it relates to cannabis. The reaction stems from fear that if Trump wins the election, he may not choose to continue down the rescheduling track. These fears are not based on logic. Trump has proven to be an advocate of states’ rights, and cannabis is the ultimate states’ rights issue. We admit we are a bit perplexed about why he hasn’t seized the issue to his benefit. One would think it would be relatively easy to campaign against the inability of the Democratic party to make any progress on cannabis legislation or regulation in the time they have been in control.
  • Perhaps a more rational fear is that if the S3 ruling doesn’t happen until 2025, which now seems likely, will companies no longer be able to recoup 280e taxes for 2024? In September 2023, we estimated that the top ten companies would save around $700M annually from S3. Those companies now have an aggregate market cap of about $11.0B. On that basis, a one-year delay in S3 implementation should be worth around 6% of the market cap.
  • 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.

• CANNABIST (CBST: Cboe)(CBSTF: OTCQX) ANNOUNCES DETAILS OF FLORIDA DIVESTITURES
  • Cannabist announced a definitive agreement with an unnamed “leading MSO” for the sale of its Lakeland cultivation facility for $11.4M in cash. The asset includes a 40k+ square foot cultivation facility. The price represents about $285 per square foot, a level that strikes us as relatively low, given the importance of additional cultivation in driving the ability to add stores in Florida. Industry people who looked at the facility have told us that it may need retrofitting and that it is not big enough to move the needle for a major acquirer.
  • It is interesting to speculate who the buyer might be. We would have thought that the buyer would want to announce the deal themselves and might even be required to announce a significant purchase like this. Verano and AYR both seem out because they are busy building their own additional cultivation capacity. The most likely candidate is GTI, which is building out stores in Florida and needs additional cultivation to continue its growth. But wouldn’t GTI want to or have to announce such a deal? Perhaps it is a private company that is not subject to any disclosure requirements.
  • In a second transaction, Cannabist agreed to sell to a JV of Mint Cannabis and Shango 14 dispensaries, two cultivation and manufacturing facilities, and the company’s MMTC license for total gross proceeds of $5M, payable $3M in cash and $2M in notes. The transaction value seems relatively low. If all sales proceeds were credited to the 14 dispensaries, it would equate to about $357K per dispensary, which is only a bit higher than it would cost someone to bring up a new dispensary. That neglects any value for the cultivation/manufacturing facilities.
  • One twist to the transaction is the fact that Cannabist is taking back the Mint/Shango license and has plans to divest the license to a third party. Does this mean that the Lakeland Transaction is with an MSO that is not in Florida currently and will, therefore, need the extra license?
  • All in all, we read these transactions as positive for Cannabist. They are shedding money-losing operations, significantly improving liquidity, and focusing their attention on markets where the company is better positioned.
• WHAT FINANCIAL OPTIONS DO THE MSOs HAVE? THREE GRAPHS TELL THE STORY
  • The three graphs below seek to map the financial options available to eighteen of the largest MSOs based on their Valuation, Leverage, and Liquidity.
  • In the first graph, EV/ 2024 EBITDA is plotted against Adjusted Net Debt/ 2024 EBITDA. 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. 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.
  • The graph shows that thirteen of the eighteen companies have net debt / 2024 EBITDA over 3x, which we view as the cutoff of sustainability in a 280e world. We view 4x as sustainable in a post-280e environment, and nine companies are now over that threshold.
    • Companies like Green Thumb (GTII: CSE), Trulieve (TRUL: CSE), and Verano, with less than 2x Debt / EBITDA and relatively low EV/ 2024 EBITDA valuation multiples, are good candidates for debt-funded Equity repurchases and/or acquisitions using relatively high percentages of debt financed cash consideration.
    • Companies like TerrAscend, with relatively high leverage but also high valuations, should look to complete acquisitions using their stock as consideration.
    • Finally, companies like Cannabist (CBST: Cboe) and 4Front, with low valuations but excessive debt loads, are probably best served by asset sales.

• The second 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.
  • We have excluded Schwazze from this graph because the company now has total liabilities to market cap of over 14x, indicating a market perception of low asset value coverage and potential distress. Interestingly, the company’s Adj. Net Debt/ 2024 EBITDA of 5.63x is high but not indicative of distress. What is the market trying to tell us about Schwazze?
  • On the bottom left are companies with low valuation multiples but also less than 2x total liabilities to market cap. The group includes Verano, Trulieve, Cresco, and MariMed. MariMed’s placement in this graph suggests that the market is far more confident about the company’s sustainability than its 5.63x adj. net debt to 2024 EBITDA would indicate.
  • In the middle, between 2x and 4x total liabilities/market cap, we see Ascend, AYR, and Jushi. Each of these has more than 4x debt/ EBITDA, which is borderline in terms of sustainability, even in a non-280e world. However, each also has significant upside catalysts that could mitigate or exacerbate the excess leverage. FFNT is ramping up production at its mammoth Illinois cultivation facility. Jushi is levered to potential adult rec developments in Pennsylvania and Virginia.
  • On the right lies Cannabist. Cannabist has seen the writing on the wall: to levered to issue equity or debt, its only option was asset sales, and its exit from Florida was a recognition of this. The announcement of the sale of its Arizona properties and portions of Virginia are further ratification of this.
  • 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 third 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). This graph also breaks the sector into three distinct groupings. The bottom left group has low leverage but also modest liquidity. Some of the companies, including Verano, MariMed, and Cresco, have sufficient but not comfortable levels of liquidity, while others, including Curaleaf and Glass House, are below the critical 1x liquidity line. TerrAscend’s recent refinancing has moved the company into a comfortable liquidity position. Companies on the lower right generally have constrained liquidity and high leverage, a potentially dangerous combination in a capital-constrained environment.

• CANNABIS STOCK LIQUIDITY RETESTS ITS LOWEST POINT
  • The average daily dollar volume of $13M for the week ended 8/23/24 ties with the lowest reading since early 2023. Similarly, liquidity in terms of Days to Trade Market Cap (see below) has returned to dismal levels.
  • 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 1078 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 216 days to trade out of his position.
  • We are firmly in the grip of the summer doldrums, but exciting macro events seem likely for the month ahead. Will the bombshell news of the DEA delay in S3 produce a flurry of higher trading volume?

• • GIVING CREDIT WHERE CREDIT IS DUE
    • The chart below shows our updated 8/23/24 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.
    • 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. Specifically,
    • The Viridian Credit Tracker model has shown relative stability since last week, with no significant credit moves in either direction.
    • Cannabist debt pricing fell sharply last week, and the additional sellers remain. At current levels, with improved liquidity coming from the sale of assets to Verano, we believe Cannabist debt is attractive.
    • We are still expecting to hear news about a Green Thumb (GTII: CSE) debt refinancing, especially given the reception to credits lower down the credit ladder such as Ascend, TerrAscend, and Jushi (JUSH: CSE).