MedMen: A Small Step Forward

Summary

• Earnings were a mixed bag.
• Debt remains a major concern.
• Dilution is mounting quickly.
• I can't recommend this for most investors, although I own a very small holding.
• This idea was discussed in more depth with members of my private investing community, The Growth Operation. Get started today »

Source: MedMen

MedMen (OTCQB:MMNFF) is a turnaround cannabis story that investors may be wise to avoid. Its founders created a well-marketed retail cannabis brand that is able to generate significantly more revenue per store in the competitive California market, but they also ran the company and its stock into the ground through massive over-spending.

During 2018 and 2019, MedMen burned through a cumulative $560 million of cash through expansion and over-spending. Through this process, the company took on ~$230 million in debt, about two-thirds of which is with Gotham Green Partners. Wicklow Capital also invested $50 million of equity into MedMen in two rounds (1, 2) at an average price of $0.81 for 61.6 million shares.

In early 2020, MedMen's founders were ousted from power: Co-founder and former CEO Adam Bierman stepped down and Bierman and co-founder Modlin executed agreements which will eliminate their super voting shares (1,000 votes/share, giving them full control of the company) over the next year. Wicklow Capital's Ben Rose was appointed as executive chairman while Tom Lynch now serves as interim CEO and as Chief Restructuring Officer.

The adults have entered the room and things are improving. If only this had happened sooner.

MedMen's core issues are two-fold: Deep unprofitability due to overspending and a heavy debt burden. Since Bierman stepped aside, MedMen has made significant improvements on cost-cutting but debt remains problematic. That debt, if left unchecked, threatens to give Gotham Green Partners billions of shares as I have previously described.

On May 27th, MedMen announced results for its fiscal third quarter, the thirteen weeks ending March 28th (hereinafter "March quarter"). Prior to these results, analysts expected MedMen to grow their revenue by 11% to $49 million and to cut their adjusted EBITDA losses in half to $18 million. MedMen missed both of these targets and shares fell significantly on these misses. Despite that, these results were not all bad.

MedMen remains unprofitable, but operating costs are declining. Source: Author based on company filings.

Anemic growth. MedMen reported anemic 4% sequential revenue growth in the March quarter, which is significantly lower than analyst estimates and its peers (e.g., Curaleaf (OTCPK:CURLF) at 28% q/q; Green Thumb (OTCQX:GTBIF) at 35% q/q; Trulieve (OTCQX:TCNNF) at 21% q/q). This is the third consecutive quarter of low single-digit sales growth. This figure excludes $4 million revenue from Arizona which was also excluded last quarter. MedMen is selling non-core operations in those states with the deal expected to close within the next year and to generate gross proceeds of $28 million.

MedMen attributed this weak growth to the COVID-19 pandemic and continued pressure in California. Most U.S. cannabis companies operate primarily in limited license markets, where licensing regimes limit competition and create higher prices for consumers and better margins for cannabis companies. In contrast, California and other west coast states does not limit licenses on a state-wide level and MedMen and other peers face robust competition from both the legal and the black markets. Many also believe that California's cannabis taxes are too high and make it difficult for legal cannabis companies to compete with black market prices.

MedMen's retail and recreational focus is likely partly responsible for their weaker revenue figures compared to peers. California retail revenue dropped 9% in the quarter while non-California retail revenue grew 37% to $16 million, aided by the legalization of recreational cannabis in Illinois.

(USD in millions)	Dec/18	Mar/19	Jun/19	Sep/19	Dec/19	Mar/20
SG&A	74.3	68.0	58.8	54.9	56.1	39.1
"Corporate SG&A"	38.5	35.1	32.9	30.1	26.8	17.3
Corp SG&A q/q		-9%	-6%	-9%	-11%	-35%

Click to enlarge

MedMen's corporate SG&A has fallen 55% since the December 2018 quarter. Source: Company filings.

Cutting costs. MedMen's management team is actively working to cut costs, and their efforts are bearing fruit.

During the March quarter, operating costs fell 22% to $54 million. SG&A costs fell 30% during the quarter while MedMen's non-GAAP/IFRS corporate SG&A fell 35% to $17 million. MedMen has cut corporate SG&A costs 55% over the past five quarters while increasing revenue, albeit at a modest pace.

MedMen expects to continue improving corporate SG&A through increased efficiency and reducing headcount in the upcoming quarters. Notably, MedMen's sales and marketing costs have fallen 88% since their peak in the December 2018 quarter, down to only $1 million in the March quarter. This reduced marketing spend may be partly responsible for MedMen's single-digit growth rates.

Costs are still too high. Despite lower costs, MedMen is still spending too much money. To reach profitability, MedMen will need to continue cutting costs significantly while returning to meaningful growth.

During the past quarter, MedMen sold $46 million of cannabis at 26% gross margins for $13 million in gross profit. But from that $13 million in gross profit, they spent:

• $54 million in operating costs,
• $13 million in interest expenses, and
• $16 million in income tax.

Suffice to say, this is not a recipe for long-term success especially for a business with $32 million in cash and $229 million in debt.

MedMen's share count has been climbing more quickly than their revenue, resulting in six consecutive quarters of declining sales per diluted share. Source: Author's estimates based on company filings.

Dilution concerns. MedMen has the ability to borrow up to $137.5 million more from Gotham Green Partners, however, that borrowing will come with a very steep dilution cost: New borrowing will be convertible debt and will lower the conversion prices on past convertible debt and warrants. If MedMen uses its full debt facility, Gotham Green Partners will have debt and warrants that converts into 1.4 to 2.6 billion shares.

Even without adding new debt, MedMen shareholders have already suffered significant dilution. In the March quarter, MedMen had an average of 315 million diluted shares, up 43% from the previous quarter. As of May 19th, MedMen had 353 million shares outstanding, up 110% over the previous year.

MedMen burned through only $5 million of cash last quarter, its all-time best results as a publicly-traded company. Source: Author based on company filings.

Improving profitability. MedMen's lower costs have improved profitability, and penny-pinching has helped the company to a surprisingly strong cash flow.

In the March quarter, MedMen reported an adjusted EBITDA loss of $21 million, or $24 million when excluding fair value adjustments and including share-based compensation. This is worse than analysts expected, but better than last quarter's $35 million loss or last year's $43 million loss. Improvement here is due to significantly lower operating expenses combined with a slightly higher revenue base.

Even more significantly, MedMen's free cash flow losses improved dramatically. MedMen burned through $5 million of free cash in the March quarter, down from $38 million the quarter prior and $59 million the previous year. Both operating cash flow and capital expenditures were significantly improved as the company worked with its vendors on better payment plans and slashed their expansion plans.

This free cash flow is likely to be unsustainable without further business improvements. MedMen spent out $3 million on capital expenditures in the quarter, down from $38 million last quarter. This reduced spending, if maintained, would make growth very difficult. Further, MedMen's operating cash flow was accomplished partly by reducing working capital: Inventory fell $15 million to only $19 million during the quarter. Inventory cannot fall $15 million every quarter, so operating cash flow is likely to worsen in the coming quarters.

Thoughts

MedMen is cheap compared to its peers, trading at distressed prices. Source: The Growth Operation U.S. MSO Comparison.

MedMen is cheap compared to its peers, trading at distressed prices of only 1.3x forward sales while peers trade at 3-5x as much. These low prices are well-warranted, in my view. Both Trulieve and Green Thumb reported positive free cash flow last quarter, without the aid of significant reductions in working capital.

Meanwhile, MedMen is still very much in recovery mode and there is little assurance that shareholders, rather than debt-holders, will retain control of the company. New management has done well to reduce costs, but MedMen continues to post significant operating losses and to pay more interest costs than they earn in gross profits. In order to turn this ship around, management will need to continue aggressively cutting costs while also returning to meaningful top-line growth--that is a very big task.

Ultimately, I cannot recommend an investment in MedMen. Investors looking to take a flyer on a very risky turnaround stock with multi-bagger potential may be interested, but I believe that other cannabis companies--like Green Thumb, Trulieve, Curaleaf, and Cresco Labs (OTCQX:CRLBF)--are better ways to invest in potential secular growth in the cannabis sector.

Happy investing!

Analyst’s Disclosure: I am/we are long MMNFF, TCNNF, GTBIF, CURLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.