The headlines around investing into cannabis operators and MSOs (Multi-State Operators) are shifting. Just a year ago, sales revenues were soaring, stocks were ever expanding and M&A announcements were weekly. In fact, between Fall 2018 and Spring 2019, more than a half dozen large deals were announced. 

But now, the headlines seem to have shifted and news of dying deals and layoffs has taken the place of large M&A announcements.  In early October, Med Men announced it was shelving it’s acquisition of PharmaCann. Then, just a few weeks later, CuraLeaf announced they would be re-working the terms of their deal with Cura Partners, previously the priciest cannabis deal in the US. And now, Cresco Labs and Origin House are amending their deal. 

Which begs the question - how did we get here and what does the future look like? 

MSO’s are vertically integrated, highly regulated business operating across multiple markets - all of which have their own rules that change seemingly overnight - in a federally illegal industry. As well, advertising restrictions and the novelty of the industry make capturing market share quickly critical to the success of these businesses - leading to rapid expansion. All of this adds up to serious cash burn.

You have to spend money to make money, they say; but those people probably weren’t considering the impact of dreaded tax code 280e, which requires operators to pay taxes on gross profits. Without the ability to deduct many operating expenses, organizations end up with  tax burdens as high as 70%, shrinking profits. 

Luckily, cannabis is only becoming more legitimate and markets are only getting larger. But, despite growing revenues, operators haven’t been able to catch up to burn rates. For example, despite Curaleaf’s reported 231% increase in revenue in between Q2 2018 and Q2 2019, they reported a net loss of $24.5M compared to $4.9M the previous year.

Further, delays in regulation, permitting and licensing have put many operators behind schedule and disrupted their financial models. For example, it took Massachusetts almost an entire year longer than expected to roll out adult-use - something many businesses had not planned for. 

This leaves cannabis operators in a tight spot - running out of money and unable to get ahead due to tax burdens. Companies face the hard decision of cutting costs to stay alive - like Med Men did recently - or bringing more capital into the business. 

Fortunately, up until recently, MSOs and pot stocks were garnering large prices - making it possible for operators to quickly raise the capital needed to cover their large burn rates. But that’s starting to cool. The Global Cannabis Stock Index declined in November for the 7th straight month in a row, indicating the overall decline in the share price for cannabis companies. This new reality leaves operators with two choices for covering high cash burn: fundraise but dilute shareholder value or take on expensive debt. 

For context, in the first six month of 2019, Trulieve reported positive cash flow at $19.6M but was also reporting a $53M in purchases of equipment, property and acquisitions.  The company ended up borrowing $70M at an interest rate of 9.75%, not a cheap deal for the operator.  

It seems as though many of these organizations are playing a game of chicken - continuing to bet on a repeal of 280e - and a world where they can begin to generate the profits needed to cover rapid expansion. But the clock is ticking. 

Some of these businesses are halting aggressive expansion, cutting costs, and restructuring deals to be more in line with the new reality of the industry. Others are continuing with acquisitions - like Columbia Care - betting on additional profits from expansion and establishment in new markets to hold them over. 

It’s hard to say who will come out on top. As is the case in any new industry, the race has not yet finished and the winners have not yet been chosen. However, this seems to mark the beginning of the end of operator boom we saw over the last year and it remains to be seen where investors will choose to place their capital within this industry, though the trends seem to point away from the public stocks. 

CanopyBoulder plans to continue to place capital with the more agile and less profit crunched picks and shovel businesses of the industry - as we have done since our inception. After all, do you remember any gold miners name? Think it over. Preferably in a pair of Levi’s Jeans.