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This month began with the announcement of a relatively large merger between two publicly traded American cannabis companies, with Verano set to acquire Goodness Growth in an all-stock deal. The transaction is consistent with a theme we have been discussing since 2020, industry consolidation, and follows several other transactions that we think can create value for the acquiring companies. While we have suggested that most of the M&A will be public companies buying private ones, there are some public companies that have been and continue to be appropriate targets. In general, these will likely be single-state operators or companies with relatively narrow footprints, as we discuss below.
A Look at the Verano/Goodness Growth Deal
Goodness Growth operates in five states, but only two were likely important to Verano: Minnesota and New York. In Minnesota, it holds one of just two licenses in a state that will introduce flower into its medical cannabis market next month and that could adopt adult-use within the next few years. Through the first three quarters of 2021, the company generated $16.1 million revenue (40% of its total). In New York, it holds one of the original five and existing ten medical cannabis licenses, franchises that will be very valuable in the upcoming adult-use market due to the ability to operate multiple stores as well as to be a producer. Year-to-date revenue in New York through Q3 was $10.7 million, with 80% retail and 20% wholesale.
Buying Goodness Growth will give Verano deeper penetration in the Northeast, where it already holds positions in the upcoming adult-use markets in Connecticut and New Jersey, and gives it a leading position in a new market. On near-term metrics, the deal might not appear to be attractive, as Verano trades at a much lower multiple of its projected 2022 EBITDA than Goodness Growth does, but, over longer horizons, Verano is likely to create higher returns than Goodness Growth might have done on its own. Verano’s access to capital is substantially better than Goodness Growth’s. Verano’s credit facility is at 8.5%, while Goodness Growth’s borrowing rate is over 16%.
From our perspective, Verano is paying a fair price for rather unique assets that fit with its own strategy.
Drivers of M&A Activity
With federal illegality preventing interstate commerce, cannabis companies must build their businesses state-by-state. Several years ago, cannabis companies would win or acquire early-stage licenses and then work to build them out. The industry engaged in a land-grab, and several companies that engaged in this practice ultimately retrenched. Acreage Holdings and Harvest, later acquired by Trulieve, are good examples of companies that perhaps spread themselves too thin. Today, the leading companies are generating positive EBITDA in their mature operations and no longer have to pursue speculative M&A. Expanding within existing states or entering new states are the key drivers of M&A activity.
The deal announced this week follows Verano’s acquisitions announced in Q4 to enter Connecticut, a new geography for the company on the cusp of transitioning from medical to adult-use. Entering new geographies or going deeper into existing ones have been the primary drivers of the M&A over the last year or so. In 2021, two public companies operating exclusively in Florida sold to large MSOs, Liberty Health Sciences to Ayr Wellness and Bluma Wellness to Cresco Labs. Several MSOs bought operations in Massachusetts that accelerated their time to market to reach the maximum stores or canopy size or allowed entry into the state. GTI entered three new states in the past few quarters, buying private companies in Minnesota, Rhode Island and Virginia. Curaleaf bought a large outdoor grower in Colorado and expanded within Arizona with the acquisition of Bloom Dispensaries. It also has a pending acquisition of a regional operator, Tryke, that will deepen its presence in several western markets. Trulieve’s acquisition of Harvest allowed it to expand within Florida and Pennsylvania and to enter new markets as well. Over the past 12-18 months, several other MSOs have acquired dispensaries or additional cultivation and production in Pennsylvania. PharmaCann is entering Colorado with its pending purchase of LivWell, while Columbia Care went deeper with its purchase of Medicine Man. TerrAscend will be entering a new state, Michigan, when it completes the acquisition of GAGE Growth.
The pace of consolidation has been rapid, and we expect it to continue. Beyond the desire of large operators to expand into new states and to go deeper in existing states of operation, we think that cost of capital will continue to be a big driver of M&A. This was a key factor in the Trulieve acquisition of Harvest, that had a large debt maturity looming. The larger MSOs have substantially lower borrowing rates than smaller public companies or private operators and also have more valuable currency in their stocks given the liquidity.
The Big Challenge to M&A
Because several states limit the number of stores or licenses a company can own, acquisitions of companies with a broad geographical focus can be complex. Trulieve certainly changed that narrative to some degree with its acquisition of Harvest, where it was able to work with the regulators in Florida and Pennsylvania to successfully close the transaction. In general, though, it will become increasingly difficult for companies to merge with relatively large organizations due to these regulatory issues. A key impediment to any deal of this nature would be operations in Massachusetts, which has strict limits on the number of stores and the size of the canopy. Despite continued consolidation ahead, the cannabis industry will remain highly fragmented due to the regulatory limits imposed by states.
Where M&A Could Be Headed Next
We expect large public operators to continue to add small private single-state operators, especially in markets that don’t limit the number of licenses held. Companies with relatively small footprints, like Ascend and TerrAscend, may be in a position to do more meaningful acquisitions relative to their current scale. For example, most large operators are already in Massachusetts, which strictly limits the size of operators. TerrAscend, with no presence there, is one of the few companies that could acquire an existing operator, similar to what Jushi did last year.
One geography that could see increased activity is California, where there has been a hesitancy by large public companies to get more involved due to the regulatory uncertainty and pricing declines. As the market hopefully stabilizes, we view this as a state where we could see more M&A activity. Here, in addition to private companies, there are several public companies that could make attractive targets. We consider Curaleaf as one of the more likely consolidators.
Canada Is Consolidating Too
While the focus thus far has been on the American market, consolidation is an important aspect of the Canadian market, where there are currently 820 license holders. Interestingly, dozens of license holders have turned in their licenses over the past few months, but that’s another story. The Canadian market remains highly fragmented, and the largest LPs don’t have strong market share in aggregate. In fact, data from Hifyre suggests the market share continued to further erode in January for Canopy Growth, HEXO and Tilray, each of which is experiencing sales declines despite the overall market growing.
In 2021, Canopy (Supreme Cannabis) and HEXO (Redecan, 48North and Zenabis) bought LPs in order to try to build market share. The consolidation hasn’t been limited to the very largest companies, as Valens acquired Citizen Stash and Organigram bought Laurentian Organic. Looking ahead, Tilray has hinted at Canadian acquisitions, and we believe it will be focused on premium flower and brands, similar to the prior acquisition of Broken Coast (by Aphria).
Implications for Investors
The consolidation that we expect to persist should prove beneficial to investors in the sector. On the one hand, the ability to go deeper into existing markets and to enter new markets through acquisitions will help drive growth at the larger operators. This is important at a time that regulatory delays are potentially weighing upon near-term revenue growth. On the other hand, while we continue to expect that most of the transactions will involve the purchase of private companies, we see the opportunity for several smaller public companies to be acquired as well, especially those with narrowly focused operations, including certain companies in California and Canada.
TerrAscend is a leading North American cannabis operator with vertically integrated operations in Pennsylvania, New Jersey, and California, licensed cultivation and processing operations in Maryland and licensed production in Canada. With the upcoming closing of the Gage Growth acquisition, TerrAscend will gain full vertical integration in the rapidly growing Michigan market with one of the top operators in the state. In preparation of the industry’s next big catalyst, the company is building up inventory in anticipation of adult-use in New Jersey. Additionally, with a multi-year brand licensing agreement, TerrAscend will be providing the state with exclusive access to Cookies branded products.
Get up to speed by visiting the TerrAscend Investor Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.
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