Seeking Alpha

Cannabis Investors Should Be Looking For Good Stewards Of Capital (Podcast)

by: The Cannabis Investing Podcast

How do you know which cannabis stocks to buy? Nicholas Gastevich, one of SA's best commenters and an experienced cannabis investor with his family firm, helps guide us.

Why he likes Green Thumb Industries, Cresco, + his top 4 picks in the sector.

We also cover the recent Canopy/Acreage deal, iAnthus' debt, excessive executive compensation and being greedy with shareholder money.

We also discuss why many management changes are overblown, adjusted EBITDA and Illinois' once promising social equity program model.

Listen on the go! Subscribe to The Cannabis Investing Podcast on Apple Podcasts, Google Podcasts, Spotify, and Stitcher.

Nicholas Gastevich got an Economics degree from Northwestern University and now co-owns and manages his family's Chicago investment office. Historically concentrated in real estate and private equity investments, in 2014 they made their first investment in the cannabis space into Green Thumb Industries (OTCQX:GTBIF) as they were applying for their very first medical cultivation and retail licenses in Illinois under the Medical Cannabis Pilot Program.

They have now participated in roughly 12-15 private market deals in the US cannabis space including GTI, Cresco Labs (OTCQX:CRLBF), iAnthus (OTCPK:ITHUF), Acreage Holdings (OTCQX:ACRGF), Leaftrade, and most recently Ascend Wellness.

Topics include:

  • 5:30 - Currently co-owns and manages family office in Chicago. Began in real estate space, diversified investment strategy, concentrated on private equity and real estate. In 2013, Illinois signed medical cannabis pilot program into law, which used scored applications, as opposed to looser regulated markets like California and Michigan. State required fingerprints to even invest in a cannabis company. Appreciated the business model of selling cannabis in a limited license market. Spoke with a few groups, most weren't up to snuff, but met a lawyer who was leaving her job to join Green Thumb Industries (OTCQX:GTBIF). Met with their then leaders, liked the management team, who appeared to be good stewards of capital. Invested in Series A, GTI won a retail license, then 3 of those initial 21 cultivation licenses. Then more states followed and MSOs started to form. Have invested in 12-15 cannabis companies, Cresco, Acreage, iAnthus, more recently into LeafTrade, a few brand plays and most recently Ascend Wellness, considered a 2.0 MSO - more narrowly focused in high margin markets.
  • 7:30 - Green Thumb Industries and Cresco Labs - what stands out about them: a lot of insider ownership; treating shareholder capital like their own; never overextended themselves, didn't chase over-aggregation model and licenses like so many others like MedMen (OTCQB:MMNFF), Harvest (OTCQX:HRVSF) and Acreage (OTCQX:ACRGF). For every major buildout or market that they target there is a capital plan in place that makes sense in an upside or downside scenario. Great example with GTI early on, they won 3 of 21 cultivation licenses and they gave back one because they felt like the market wasn't big enough for them to feasibly manage 3 properties.
  • 10:00 - Acreage as a holding was learning experience - lot of hype around the company, a lot of the reason why MSOs were chasing licenses is because underwriting banks in Canada were in favor of them going public and no company had real financial metrics to base off except for licenses held. So on paper it appears like sound operations. Especially with Acreage's political connections. But over time in reviewing their financials quarter after quarter it because apparent they weren't good stewards of shareholder capital - couldn't properly scale into markets; didn't invest into highest ROI states; paid excessively in share based compensation - more than the entire company took in in revenue(!) Drag on cash, dilution to shareholders. Exited that position a while ago and it's only dropped further.
  • 12:00 - Canopy/Acreage deal announced last week - Canopy (NYSE:CGC) is making right moves since David Klein took over as CEO, taking on a more cash efficient model. Getting rid of Kevin Murphy is a good move for Acreage - he was a good salesperson but didn't know how to properly run the operation. Nicholas imagines replacement will be Constellation (NYSE:STZ) or Canopy related. Deal itself, exchange ratio got turned lower for Acreage which makes sense given their poor performance; did loan $100 million to ACRGF's hemp operations, though it seems it would be better served in their THC operations, but that's federally illegal right now.
  • 14:30 - Cresco's new CFO. Nicholas started out in the industry talking to Ken Amend - the former Cresco CFO, bittersweet to see him go. But with these companies that have had success, people over estimate management changes. These companies started as single state operators, the good ones have evolved into national corporations - a big difference between Cresco early on and what it looks like today so change is a natural part of that growth. M&As have been cancelled in Nevada and Florida, and trying to integrate Origin House acquisition so new CFO likely there to also help that process.
  • 17:00 - In 2018, GTI was considering buying out iAnthus and had stepped in to loan them money and asked their shareholders if they wanted to participate in the loan. The deal itself ended up being close to $25 billion, of which GTI loaned $6-7 million, with 15% interest, warrants at $1.99, exercisable for up to 3 year period - that loan ended getting paid off in full because Gotham Green Partners stepped in and loaned iAnthus close to $50 million. Great deal for Nicholas' side, but now warrants have no value, and luckily they were never in the money so will let them expire. But happy to not have equity in that company as they went south fast.
  • 19:00 - Because of the lessons learned - even 2 years ago it was hard to evaluate companies but now, there's clearly top 3-4 in the US: GTI, Cresco, Trulieve (OTCQX:TCNNF) and Curaleaf (OTCPK:CURLF). And then a bunch of others. Their shared characteristics: responsible stewards of capital. Look at how revenue growth and margin profile is evolving Q/Q and how that balances against company expenditures. Do they have excessive overhead that suggests inefficiency? Are they applying investment dollars into opportunities with a high ROI? Trulieve is a great example - they resisted all calls to become huge MSO and instead quarter after quarter have doubled down on Florida market, saw that market as a high ROI environment and stuck with that thesis. Similar to GTI and Cresco in Illinois and Pennsylvania. This is in sharp contrast to companies like Canopy and Acreage where revenue growth and gross margins and EBITDA margins are all over the place quarter to quarter, no upward trajectories. Also putting money into places that won't give them high ROI - evidenced in how many greenhouses Canopy has closed, how many layoffs they've had and got out of a lot of their international opportunities.
  • 25:00 - Social equity component in Illinois adult use bill - in theory has a lot of good parts in it. Original 21 cultivation licenses and 55 medical licenses were grandfathered into adult-use program; holders of licenses are big corporations - Verano, Select (acquired by Curaleaf), Cresco and GTI - have current control of the market. There is supposed to be 75 additional retail licenses, 40 craft grow and 40 processing licenses - all delayed by COVID. Key aspect is the social equity scoring component of the application, a quarter of the score is based on meeting social equity requirements. Good in theory, but now a month further delayed - still hope that these social equity licenses can come online and gain market share given there's so few licenses, but what determines a company's success in this market is capital and operational excellence. So even when they do they'll be competing with some of the biggest US corporations, and they won't be vertically integrated so it's a challenging environment for these social equity holders to become profitable. Social equity program models throughout the States.
  • 30:00 - Cannabis being deemed essential during COVID formally recognises cannabis as an important part of the economy and a medical/recreational need general population needs on a regular basis. Sales have continued to go up throughout this period - cannabis is here to stay, which makes it harder for any government to push back.
  • 34:00 - State by state vs. federal descheduling seems the more likely path which means MSOs have a leg up. Canopy/Acreage deal evidence of this belief that MSOs will have entrenched position. Interstate trade model still unknown so hard to predict how companies will be set up. MSOs though will still likely be successful and likely concentrate more of their grows out West, but will be best capitalized and most well prepared when legality comes. Big corporations, big pharma and big alcohol will be looking to pair with the bigger MSOs.
  • 37:30 - Canadian markets - Nicholas hasn't invested in that market, but is more bullish than ever mainly because 1. Valuations on LPs have come down dramatically - some are still too high, but they're more respectable. 2. Finally seeing retail open up in Ontario - larger than state of Illinois - and it's been really limited and getting in the way of LPs' success. Also agree with LPs decreasing their international positions, like Aurora (NYSE:ACB) and Canopy have recently done. The Canadian companies Nicholas likes have more narrow approaches, keeping expenditures to a minimum, like Aphria (NASDAQ:APHA) and OrganiGram (NASDAQ:OGI); they also have positive adjusted EBITDA.
  • 42:00 - Adjusted EBITDA is not necessarily a useful metric for cannabis companies as you're removing interest and tax portions which are extremely high. It can be helpful on a quarter to quarter basis to see if a company is moving in the right direction. But relating adjusted EBITDA to actual profitability - those are not the same thing. Important to look beyond first page of financials or press releases. Essential to look at operational and investing cash flow statements.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.