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Editors’ Note: This is the transcript version of the podcast we posted Wednesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast embedded above if you need any clarification.
Transcript
Tiby Erdely: That investment theme I think was much more alive to the last two to three years whereas today, I think it’s really about surviving kind of the storm clouds that that we’re currently in. It’s been a tough time for the industry overall. And with that being said, I think the name of the game today is preserving the balance sheet and again, cutting — reducing burn and working towards profitability.
Rena Sherbill: Welcome again, to the Cannabis Investing Podcast, where we speak with C level executives, analysts and sector experts to provide actionable investment insight and the context with which to understand that burgeoning cannabis industry. I’m your host, Rena Sherbill.
Hi again, everybody. Welcome back to the show. Welcome to winter for I imagine most people listening. Certainly for me, you can tell by my cold voice. Apologies for that, but an exciting episode nonetheless, cold voice notwithstanding. We have Tiby Erdely on the show, who cofounded KEY Investment Partners out of Denver, Colorado, one of our favorite cities, and one of cannabis’s favorite cities. And he talks about investing in the cannabis space bringing dry powder to the industry, how he thinks about the investing picture. He’s coming from Goldman Sachs.
KEY Investment Partners focuses on private companies. But Tiby is here to show us how that can teach us about what’s happening in the public markets. What’s happening in public companies? What we as investors in the public market should be looking at should be focused on? We also cover a number of different topics in the industry happening now. The layoffs happening across the industry, tenants not paying their rent as it relates to REITs like IIPR and what we as investors should be taking away from that. Canadian operators their intentions for the United States market. And Tiby gives us more reasons to like the top five MSOs. For those following along, that’s Trulieve (OTCQX:TCNNF), Curaleaf (OTCPK:CURLF), Cresco (OTCQX:CRLBF), Verano (OTCQX:VRNOF) and many people’s number one in the industry Green Thumb Industries (OTCQX:GTBIF).
Hope you enjoy this conversation. We have a lot more great conversations coming up. We’re talking to the CEO of Wana Brands. And speaking of the Canadian US markets, and we have the CEO of Organigram (OGI) coming on, really excited to bring you those conversations and many more. My appreciation remains deep for those of you leaving questions, comments, reviews. It makes this podcast better, no doubt about it. Hope you enjoy today’s conversation.
Tiby, welcome to the Cannabis Investing Podcast. It’s great to have you. Thanks for coming on.
TE: Yeah, I’m really excited to be here with you, Rena. I’m an avid listener. And now that I get to be on the show, I can certainly say I’m all giddy with excitement.
RS: Thank you very much. That’s exciting to hear. I’m really happy to have you on. Share with listeners, kind of your journey to the cannabis industry. What’s your background and how you started KEY and what your philosophy and goal is with KEY?
TE: Yeah, absolutely. I’ll save you my full journey with cannabis. My mom probably doesn’t want to hear about what I was doing when I was 15. But I come from a traditional finance background, I started my career with Goldman Sachs, mainly focused on the public markets at Goldman. Doing bottom up stock picking and GCM. Was fortunate to find my way to the buy side in a private equity firm called Partners Group. If you familiar with Partners, Partners is a large Swiss asset manager about $140 billion or so under management today, call it Circa 2015 or so Partners made a strategic decision to open up a new North American headquarters in Denver, Colorado. And I always say it was kind of to their detriment that I left New York and moved out to Denver because ultimately, I got to know the cannabis industry really well.
Through that transition, moving out to Colorado doing traditional middle market buyout, some private equity. I got to know my two cofounders Pete Karabas and Jordan Youkilis. KEY — key people always ask, how did you guys come up with the name it’s actually just an acronym for our last names. Took us about two seconds to figure that out. And the rest was history.
Really, kind of living and breathing and in the heart and soul of the cannabis industry. It became very apparent to us that there was a huge opportunity of growth investing in the asset class. And Circa end of 2019, or sorry, end to 2018 when the Farm Bill had passed, we started to take a very keen look at the space. If you recall the passing of the Farm Bill, legalizing hemp and hemp derived CBD across the nation created a lot of investor interest and appetite in the space. I think a lot of folks saw that as potentially a precursor ultimately to federal legalization. And similar to a lot of folks out there we started to take a hard look at the space as well.
Looking at deals, starting to get deal flow, remind you, we’re still working with our traditional jobs and basically quickly learned that akin to most other traditional hedge funds or private equity firms, we were simply boxed out from investing in the space. And that ultimately was really the kind of lightbulb moment for us we said okay, so on one side of the equation you have to a ton of investor demand, and on the other side, you don’t really have any institutional capital flow into the space.
So we saw it as an opportunity to really bridge that gap there bring in our institutional backgrounds to the cannabis industry, to give investors really a great place to invest in this space. So that is really kind of the impetus on how and why we got involved with the industry. But what I think the most exciting part is, at that point in time, we were seeing some of the fastest growing companies that we’ve seen in our careers coming from traditional private equity. But the cost of capital for these companies was just so high.
So being one of the few pockets of dry powder in the space, certainly puts you in a very fortuitous spot as an investor to go out there and command better deal terms, better valuations, more downside protection to structure into the investments. And we can kind of get into that a little bit more in the podcast. But fast forward to you know, where that’s where we’ve been where we are, we’ve raised and deployed our first investment vehicle, we’ve put probably about $40 million in the ground so far today, we’re still, you know, we’ve done that across about 15 assets.
We’re very active in the space, I’d say, in today’s point in time, where the industry is certainly suffering from a cap market perspective, much like the broader economy, and we’re still very active. We’re deploying capital, we’re structuring deals, we’re helping companies secure their balance sheets, they’re runways, et cetera. We think that it’s a very exciting time, albeit a very tough time also for the industry.
RS: So you’re focused on the private markets, but what lanes of the sector are you focused on? And how do you choose who to work with?
TE: Yeah, great question. So, in the early days of KEY, we really kind of branded ourselves as an ancillary focused fund. You really have to bifurcate the industry between a plant touching company, meaning a licensed business, or a non-plant touching company.
And so our initial focus on the ancillary space, the thesis behind that was simply that ancillary companies have more access to capital, because a lot of the companies are typically tech, much more scalable business models, because they’re not licensed companies, these companies were able to scale their technology across state lines, servicing the entire cannabis space.
So our first focus in theme was really let’s go out there and invest within the picks and shovels the infrastructure behind the tree. Fast forward to today, that exposure to the ancillary space has certainly given us a lot of asymmetrical information and data on the private markets within the plant touching side. So not only do you have an industry that continues to grow from the grassroots movements at the state level, but now you have an industry that we think is simply every day closer to federal legalization.
So we think from a risk adjusted standpoint, the plant certainly looks more interesting to us today, as well. So we have slowly evolved from being a very ancillary focused fund to probably a more holistic fund today now investing across the asset class, both plant touching, non-plant touching. And in today’s investment environment, we think that it’s really more of an opportunistic approach to investing in the space.
So we’re really agnostic whether or not it’s plant touching or not. It’s more about what the opportunity is how the company has been run, what the balance sheet looks like today, and how much capital or sorry, how much runway our capital can give a company today.
RS: Speaking to those points as we look at the industry, I think some of the data that we’re seeing come out now is like IIPR, one of the most famous REITs their tenants are having trouble paying rent. We’re seeing a ton of layoffs in the industry, I mean, across every industry, really, but also in the cannabis industry, for sure. How do you approach a company like how do you try to navigate making sure that the company it has that runway of growth ahead of it? How do you make sure that your money is going to go for run the distance, and that just kind of be a stopgap measure?
TE: It’s a great question. And frankly it’s something that’s very top of mind for us. And I think that the investment landscape in the industry has changed quite a bit in the last few years. And COVID and then subsequently, folks the kind of the deterioration of the cap markets in 2022 has really only caused the issue to be more front and center. So, as we think about investing in the space, there’s a few things that we look at initially.
First and foremost, historical financials are so important, but we really don’t give a while a lot other than wanting to understand the business has been around for four or five years have they performed. It’s really the last 12 months of their performance and then more importantly, probably the last six months of their performance that we’re looking at. Is this company trending in the right direction or not? What is the cash burn? What has the company done in the last 12 months in the midst of a cap markets tightening, done to reduce burn to get closer to profitability or breakeven?
Once we have a good understanding of that, and what the balance sheet actually looks like today, we’d like to understand what does our capital mean to the balance sheet, if the company is still burning? Are we going to able to give these guys enough runway to make it out of what we think is going to be a pretty tough cap markets environment for probably the next 12 to 18 months?
So understanding if we can put enough runway on these companies is super important to us. You get a lot of benefit and an extra kind of check the box from us if you’re already profitable today, or if you’re already a cash flow breakeven, we’re happy to reinvest in growth and to put those dollars behind folks. And then lastly, once we get comfortable with all of that, that’s when really I think the traditional fundamental analysis of the business comes into play.
We have a very rigorous investment due diligence process, not that the length of an investment memo matters, it’s the quality but just to give an idea before we pull the trigger on any deal. You’re typically looking at a memo that’s 100 plus pages long, so very thorough analysis, understanding what the company does, the viability of the business model today and tomorrow, how we think about it post legalization, is the addressable market large enough, are these folks going to be able to compete with the black market or traditional industry operators that may come in and start to offer their services in the industry, particularly in the ancillary space, that’s something that we really look at.
You look at a lot of the ancillary play has been done in a similar vein to banking, right, like the cannabis industry still has trouble with traditional banking insurance deposits. Well, a lot of traditional enterprise software and tech companies that service most Fortune 500 companies with that, behind the scenes, created this kind of copycat model a little bit in the cannabis space.
And a lot of what we do is we say, okay, are these ancillary software companies going to be able to compete with the big kind of ADPs and HR and Payroll solutions, et cetera, when they start to service the industry? What type of moat do they have around themselves today? What type of barriers to entry are there today? Is this a very sticky solution like HR and Payroll, et cetera? So understanding the TAM, and the viability post legalization is very, very important to us.
And once we get past all of that, then you have to get into is that the right valuation versus where comps are today? I think we all know that the public markets are down quite tremendously the cannabis industry. I think shortly after Biden’s election folks saw that, the White House really went quiet on the issue. And subsequently, you’ve seen a rundown on the securities, and then that issue has really just been a multiple of a degree more difficult for the cannabis stocks. As 2022, we saw deterioration of much broader cap markets.
RS: Yeah, it’s been tough for sure. Would you say that the approach that you take to looking at companies is one that you would advise investors looking at public companies or even private companies, like as companies to get invested in, would you I mean, obviously, your approach is very rigorous. Not many people are writing 100 page memos to themselves. But in terms of the things to be looking at, would you say that those are across the board good metrics to look at?
TE: Yeah, I think so. Given my background, specifically and my cofounders’ as well, I think that we had a very holistic investment background, we cut our teeth on Wall Street. Again, I did fundamental bottom up stock picking for public companies. So having that expertise, and then coming in and working with private equity companies, and doing that due diligence, I think has been hugely beneficial to us.
So, really understanding the metrics, I think getting deep on the balance sheet, understanding runway and again, the trajectory that the company has been headed in over the past few months. I think that the past six months are probably the most important should give you a very good feeling of where directionally the company is headed.
So without getting into the 100 page investment memo, I think looking for a solid 20-30 minutes at income statement and the balance sheet, and then just reading the most recent financial filings of company should give you a lot of that intuitive feeling on whether or not this company is headed in the right direction.
And then get digging into again, what markets are these companies operating in? Are we talking about limited versus unlimited license? What type of licenses do they have? A lot of that work sounds like it’s maybe daunting, but everything I just described a cursory one to two hour review of a business, I think you can start to get a really good sense of that.
And frankly, even to us, when we see hundreds thousands of opportunities come across the desk, not all of them go through this 100 page plus due diligence, rigorous process, we screen opportunities. And that screening process for us internally takes 30 minutes to an hour on any given opportunity that we’re looking at. And 90% of what we see is immediately kind of a desk burn. We don’t do it, we get deals done. And that’s it.
But for those that 10% of the deals that come through, where you start to get that, okay, there’s something different about this business, we like directionally, where it seems like they’re headed, that’s where we decide to start staffing real resources on an opportunity for due diligence. But I would say and looking at the publics out there today, there’s a handful of, I think, clear winners that are starting to kind of pull away from the pack, these are going to be the obvious top five MSOs that everybody talks about. The stock prices are trading very cheaply today, I think in our opinion, that’s not to say that there’s no risk involved.
Again, we have the flexibility if we wanted to invest directly in the common, we don’t, because we also have the ability to structure more creative deals that put us at the top of the cap stack in this type of environment. But nonetheless, I think that there’s a lot of opportunity out there. Personally, I do have a public portfolio of holdings. But that’s not how we invest money on our clients’ behalf.
RS: I’m curious, for a second on the filtering process, what gets a red line from you? Are they the obvious things like egregious debt, et cetera, et cetera?
TE: Yeah, the obvious things, I’d say, firstly, the balance sheet is very important to look at. If we don’t think that the debt coverage service ratio is something that these companies can afford, especially if you’re looking at the trend of the company, and it’s been in a downtrend for six to 12 months, that’s a pretty immediate descos for us. We are also fortunate being one of the few pockets of capital deploying, in the private markets today that I think we get to take our pick of the litter out there.
So for us immediate descos are also just not enough traction, not to say that it’s a bad company but, we’re more interested in investing in businesses that have achieved call it at a minimum $10 million plus of annualized revenues. If you’re too small today, we just don’t see the point in taking that risk. We’d love to stay in touch, watch the company grow see how you perform, and then potentially be a capital solution or partner down the road.
So that’s usually something that’s a desco for us, it’s just too early stage. Or also maybe just mismanaged. You go out there you see a lot of headline risks. There’s been reputational risk involved with the companies. There’s very easily googling management and you see distasteful articles about management or how things are being run. We think that there’s just so much opportunity out there today that there’s no reason to spend too much time on taking outsize reputational risk on any businesses.
Admittedly, we’re so deep in the space that we already have an internal kind of shortlist of who we think are some of the best operators or players out there. So we do take that as a means to go out there and really kind of bird dog opportunities for ourselves and for our investors as well.
But that’s not to say that we haven’t been surprised by something random coming across the desk, and we’re like, wow, I’ve never heard of this business before. And, these guys are absolutely crushing. They’ve done a great job, they have minimal burn, or they’re cashflow breakeven. They haven’t taken a lot of investor capital, that’s maybe an opportunity for us as a traditional kind of growth equity fund to come in and say, we can actually help you guys out, give you guys the capital that you need to really accelerate the growth.
Now, that investment theme, I think, was much more alive to the last two to three years. Whereas today, I think it’s really about surviving kind of the storm clouds that that we’re currently in. It’s been a tough time for the industry overall. And with that being said, I think the name of the game today is preserving the balance sheet and again, cutting reducing burn and working towards profitability.
RS: So it’s been talked about a lot this notion of changing the strategy from expansion, which was very much in fashion for a few years to now really getting the balance sheet in order really having focus on cash flow, all the things that you’re talking about.
And then I’ve also been interested in this notion between going federally legal, which is really fantastic for a lot of reasons. But in terms of companies growing, their moat, growing their operational excellence are building on that. And as all these states come online, I’m interested to see this dance this balance between expanding and also growing their cash balance, picking up distressed assets, and also being really smart. How are you looking at that and hearing about it? What are your thoughts on that?
TE: That’s a — you’re kind of a alluding to the answer to the question here. So I appreciate the question, because it’s certainly I think, top of mind for us. And a lot of the more institutional investors in the space today is, we’re at a point in time right now, where I think it’s going to be a tough cap raising environment for a lot of these companies. So a lot of companies that were focused of on growth over every other metric, that have not done a great job of cutting expenses are really finding themselves in a tough position today, because capital is certainly not flowing as freely to those types of business models.
What we think is really going to happen is a really right M&A environment in the space. There’s been a lot of talk about, and we are starting to see a consolidation in the industry. Just the nature, frankly of how cannabis is legal in the United States today on a state-by-state basis. You have an industry that has just a ton of different players in it. There’s not always clear market leaders in whatever niche or category that you’re investing in. And having so much competition, we think, is healthy for growth, but nonetheless, we think that you’re in a period of time right now, where you’re going to see a lot of that competition consolidate.
So with an investment had on what does that mean for us? It means that we think that we can go out there today, back the best operators in the space, and give them an opportunity to take that capital and start to consolidate the industry. And what I think you will see in ’23, is a lot of these top tier operators start to really pull away from the pack through consolidation.
Without getting into specific names or details, even in Colorado, for example, I saw a dispensary a single operator Mom and Pop dispensary come across the desk the other day. These guys are doing $2 million plus in revenue and for reasons I can’t disclose, the operators are desperate to sell the asset for like $400,000 to $500,000.
You’re talking about 0.25x revenue multiple for a dispensary asset. That’s pretty unheard of. And because the mom and pop doesn’t have the efficiencies of scale of being vertical or operating several, their operators in the state today that could certainly consolidate that asset and immediately bring efficiencies of scale to the business and bring better margins, et cetera.
So we think that that’s one really small example, but that narrative I think really resonates across the board. So from an investment opportunity perspective, even with equity prices being so low and trying to get equity financing being so dilutive, we pride ourselves in offering more creative financing solutions for a lot of these businesses, where potentially we are investing in say debt or inconvertible debt that has equity upside via warrant coverage or something like that.
And what that does is it gives the operator less dilutive capital to go out there, consolidate these assets for far more cheap today than they could a couple years ago, and having that kind of let’s say, out of the money warrant coverage, gives them that less dilutive capital to do it with and then from our perspective as an investment opportunity it puts us at typically at the top of the cap stack. So we’re first in line to get paid should things go wrong. But having that additional say warrant coverage on top of it gives us the equity like upside that we’re looking for.
So I think if you’re creative out there, and you can do this with small businesses you can do with big businesses, you can structure deals today that give you the equity upside, but the debt like protection that you like. And so private equity, what — well, it’s a tough environment out there, private markets and venture capital, et cetera, you kind of live for these type of market environments.
If you have the dry powder to put to work today at these depressed valuations, we think that these are some of the best vintages to actually deploy capital into it’s really kind of the our Warren Buffett moment the big greedy when others are fearful type of time. So we think that this is really — it’s tough out there to see how the roller coaster rides been especially on a downtrend with security prices. But on one side of the equation, I see a more mature industry today than I ever have before. More and more states coming online where we’re likely closer to regulation than we ever have been.
Valuations are trading about as cheaply as they ever have. And that’s not to say that there’s not landmines out there to avoid stepping on, I think that it’s you have to be very diligent in how you invest across the space. But if you do it well, and we do come out of this, I certainly think that you’ll see that this will the 23, vintages are going to likely be one of the best vintages we’ve seen in the cannabis space.
RS: Do you feel that the reason that you said that you feel like the MSOs, the top MSOs are separating from the pack? Would you say that’s because of their ability to buy up these distressed assets at kind of good deals?
TE: Yeah, that’s certainly a huge piece of the pie, but also the MSOs have a lot of them are very sophisticated operators today. And they’ve managed to build a moat around themselves via a very massive footprint, that is going to put them in a very fortuitous spot when federal legalization happens, or when safe banking, or the hope back happens where these folks can actually access to capital markets more broadly, I think that the businesses have put themselves in a position to be very attractive. And frankly, that’s why we are actively working with a lot of the top MSOs today to figure out creative private market financing structures with these folks.
In addition to the footprint and how institutional they are, their access to capital is simply a little bit easier. I wouldn’t say it’s easy, but it’s easier than some of the smaller operators in the space, which actually puts them in a in a great position. And then, lastly, there’s special situations that the MSOs have been able to take advantage of. I’ll use New Jersey as an example, right, New Jersey, one of the most populous states and concentrated populations in the United States.
They have a weird kind of licensing model today, where you aren’t really supposed to be vertical, you can have cultivation and manufacturing, or you can have dispensary and manufacturing, but you can’t be fully vertical. Well, the first five or so licenses that were handed out in Jersey were fully vertical, and those basically went to the top tier MSOs. And everybody else isn’t allowed to get that license. I don’t think it’s fair by any means. It’s just the way that that Jersey has put the licenses out there. And that gives the MSOs in Jersey a very unfair competitive advantage.
So they get to take operational efficiencies that they’ve learned from one state to another to another to another. And then they go to a state like Jersey, where they have asymmetrical kind of information and licensing advantage. And that certainly puts them in a very fortuitous spot to be kind of a market leader and more competitive. As we know, being fully vertical certainly gives you a huge leg up versus just having, say a grow license. It helps you kind of mitigate 280E et cetera. So the MSOs are I think are in a great spot.
Now that said, the balance sheets for a lot of these folks are hurting some of them are in states that are experiencing negative growth. I personally don’t I’m not surprised to see, I’m probably getting ahead of myself on this right here, maybe for a different question. But I’m personally not surprised to see some of the negative growth that we’ve seen some of the states. I think a lot of folks forget that COVID really accelerated cannabis consumption. And not to mention that, people were getting free money.
These stimulus checks were going into people’s pockets. And when people were sitting at home bored with nothing else to do cannabis consumption skyrocketed. And that, I think the consumer was smoking or using more cannabis than they ever had before. And now that you’re back into more of a normalized setting where people actually are going back into the office, they’re not just at home bored. There’s no stimulus checks. There’s no surprise that that spike that we saw in cannabis sales looks like a decline in sales today. I actually think that it’s a pretty natural progression. But nonetheless, we remain excited about the overall industry, TAM continuing to grow. I think that we expect about maybe another four or so new states coming online this year via grassroots movements level.
Finally, the White House came out last year and kind of made a statement on the cannabis industry will we see rescheduling happen this year? Given that we’ve been burned by safe banking so many times I wouldn’t say that I bet my chips on it. I would say invest diligently as if the status quo hasn’t really changed and be surprised on the upside whether you get rescheduling or safe banking or if the ’23 Farm Bill comes in this year and they close the Delta aid loophole and all that is very positive for the for the rest of the industry. So I jumped around a little bit a lot there, but there’s a lot that’s top of mind and a lot to be aware of as you’re deploying capital in the space.
RS: Yeah, no, it’s also my head is swirling with many different questions. I’m trying to gain focus on how I want to ask this and where I want to go. But your point to COVID being such a propellant of growth, and now it looks like there’s such decreased numbers. I’ve also been trying to echo that in the podcast that it’s down from COVID, but still trending up. And that’s, I think, really worth remembering.
I think basically, my question will be like, from what you just discussed, is a how do companies keep growing with the illicit markets, kind of growing along with them, even as these — or not even but especially as these states go online? I think the illicit market tends to have this last spurt of growth before it gets fully legal. How are you thinking about the states? And then as long as we’re we can both get ahead of ourselves? How are you thinking about the state’s development? And how do you think of the division between Canadian stocks and U.S. stocks? Do you have, I know your focuses on the U.S., but how would you articulate the growing U.S. and then in relation to Canada? I know, that was a lot.
TE: Yeah. And I’ll try to answer all those and just remind me if I forget something. So with regards to the illicit market, and where we expect to see growth from. I think, first and foremost states like California, I think we’re already seeing New York is going to be a really tough market to begin with, even though ultimately we think it’s going to be another the Super Bowl of cannabis, it’s going to be a great state. I think that first of all, the regulators need to do a better job of handling the black market.
You go to California today, and you walk into a dispensary off of, Venice Beach, there’s no telling if you’re walking into a licensed dispensary or not other than saying that one dispensary is much more expensive than the other, because they’re compliant, they’re licensed and they’re not black market.
The state I think really needs to come in and stop playing whack a mole and do a much better job to help out their cannabis economy. I’m frankly baffled by the state’s not doing more to shut down the illicit markets. It’s like, you went through all this trouble to create this whole grassroots movement to defy the federal government to legalize cannabis. And once you have all this infrastructure in place, you’re not doing anything to help your legal cannabis economy grow, and your black markets running rampant.
So I think first and foremost, we need to see the states —
RS: I was going to ask — sorry to interrupt you, but you don’t think that there’s like a good reason for that. You think it’s just kind of ineptitude?
TE: I think there’s a lot of ignorance. I’m sure there’s probably more nefarious reasons to it, and a lot of politics behind it without calling out anything directly. I think that I think it’s an issue that is slowly but surely being worked on. You saw California last year try to make a move towards making legal businesses more competitive with black market by getting rid of that excise tax, which certainly helps bring down the cost of cannabis to make it more attractive for the consumer to purchase from the legal market. I think there’s a lot of really obvious reasons to go legal versus illicit one.
Typically you know, where the cannabis is coming from. You’re not supporting cartels or black market, Mafias et cetera. You can feel safer about the form factors, et cetera. But nonetheless, I don’t think that the states are acting fast enough to help rid the legal market. Ultimately, what you have to do is you have to be able to let the legal market be competitive with black market pricing. And that’s how you really start to push out the black market.
I think Colorado is a really great example of a state that’s done a good job of legalizing cannabis and pushing out the black market. That’s not to say that legal cannabis in Colorado doesn’t end up in someone else’s black market. But again, that’s probably up to that state to recognize that this is a movement that’s happening across the nation that the people want.
What was your next question, I think was around Canada versus U.S. or? Yeah, so look, the Canadian LPs have benefited from our financial markets. And as we think about general mom and pop or I hate to use the term retail investors, I’m not sure that a lot of retail investors have bifurcated or well understood that Canadian operators trading on the NASDAQ or the Niche are actually really only benefiting from the Canadian and some international markets.
I think that a lot of them see Canopys. (CGC) of the Tilrays (TLRY) of the world as maybe being U.S. companies when in fact they’re not. But with that being said, I think that the Canadian companies will they — when they offer you a taste of International Cannabis, which is still — it’s a slow movement globally but it’s happening. Two, I think that because they are some of the few cannabis companies that can access our capital markets, puts them in a really fortuitous spot to raise capital easier. And what we know about the Canadian LPs like canopy, for example is that their intentions are to get involved in U.S. THC operations, namely through CPG, like through branded products.
And you see that happening, right? You’ve got Canopy’s acquisition of Acreage, of Wana Brands, et cetera. And we’re very close to these folks. We talk to them all the time, to their M&A teams, to their government teams, et cetera. We know that that’s their intention. So I think if they can get ahead of the curve and make some really great acquisitions or options for acquisitions, then you’ll see the Canadian operators, not I’d say come out ahead of the U.S. operators, but will likely survive in the long run.
I do think that the US operators servicing our cannabis market, certainly have a leg up over the Canadian LPs, but they simply just can’t access to the U.S. capital markets. So on one side of the equation, you have Canadian LPs servicing the Canadian consumer listed on U.S. exchanges and then you have the U.S. MSOs listed on the Canadian Securities Exchange. We were calling it the Cannabis Securities Exchange for a while. Because I think 70% of the market cap at one point was actually cannabis companies on the CSE.
But, I think it’ll be interesting to see what happens with Canopy in the NASDAQ this year, I think, as you all know, Canopy acquired Acreage or had the option to acquire Canopy announced after Biden’s pardon announcement back in October, that they were going to move forward with the Acreage acquisition, risking getting delisted off the NASDAQ. Now, it’s not that the NASDAQ wouldn’t let them stay on it’s more an issue of consolidating the financials of Acreage and to Canopy and then and then basically using those on the exchange.
Whether or not the exchange is going to allow that, I think is going to set a precedent for other U.S. cannabis companies to list on the exchanges. It’ll be interesting to see while no one has a crystal ball, I think it was interesting to see that the NASDAQ allowed Canopy to ring the opening bell in early December, post them announcing that they were going to follow through with the Acreage transaction in defiance of what the NASDAQ has had asked.
So while I can’t get into any private details, it certainly seems like there’s interesting conversations happening behind the scenes, I think folks should really keep a close eye on ultimately what the NASDAQ’s decision is. And if that does set a precedent for U.S. companies to actually list on the exchange, albeit I bet it would be with very strict compliance.
My guess is probably no, I think you’re going to have to see safe banking with the HOPE Act attached to it, to see U.S. exchanges and the major investment banks and FDIC insured banks start to bank these businesses and allow broader access to the capital markets. But nonetheless, without a crystal ball, it’s really hard to tell today,
RS: It would certainly be the final irony for a Canadian company to push the U.S. exchanges to start getting better about listing cannabis companies.
TE: That’s very true. It’s a wild comment. I had not even considered that it’s almost like, in a way detrimental to themselves to give the U.S. companies more access to capital markets than they have today. So yeah, it’ll be interesting to see how it plays out.
RS: Yeah, it’s nothing if not an interesting industry. So many different things at play. When you’re looking at the space, what do you feel like is a catalyst or the thing that makes the companies bridge the divide between what their financials are, what their fundamentals are, and what their share prices?
TE: I think again, because the U.S. MSOs, in particular, are trading on the Canadian Securities Exchange that automatically blocks them out from most of the traditional asset managers, investing in those companies. I think, overnight, when you see these companies listed on the U.S. exchanges, you’re going to see these broad market ETFs dump capital into these companies naturally, just for reweighting purposes.
So I think that that’s going to be a huge catalyst, I think seems safe banking in the HOPE Act. If we wouldn’t have that in the lame duck. While the rest of the economy is still nervous about a recession, I think that the cannabis capital markets would have come into this year extremely robust.
Now, unfortunately, we didn’t see that happen during the lame duck session. Frankly, I think that it was foolish not to push this through as a standalone bill at some point last year. We have the bye bipartisan support to get safe bank in the HOPE Act done. I can’t blame Schumer for saying don’t try to just stick this on the omnibus or the NDAA as much as I would have liked to see that. But nonetheless, we have the bipartisan support. I think we could see it in ’23. So look, I think that that’s going to be a huge catalyst. Keep your eye out for any regulatory change.
The industry, if you go back historically, and you look at major headlines like the Biden announcement of the federal pardon, at the end of last year, I mean, really, I mean, well, that’s great to see. We certainly love to see it, federal pardon of I think it was like 6500 or so inmates that ultimately got the part and that doesn’t fundamentally change anything for the industry. But we saw some cannabis securities pop 20% 30% that day, simply on a headline. So it does seem to be very headline driven with regards to the public markets. Again, we like investing in the private markets because we aren’t riding that roller coaster of emotion that the public markets give you. But those headlines certainly do move the market, so pay attention to them.
The headlines that you should really watch out for that do fundamentally change the asset class are safe banking, the HOPE Act, the 2023 Farm Bill getting more FDA guidance and clarity on how minor cannabinoids can be used in broader nutraceuticals, potentially the closing of the Delta 8 loophole rescheduling and ultimately, federal legalization are probably the largest needle movers that actually do have a fundamental impact on the industry.
RS: Do you think the only thing that moves the industry beyond being headline driven catalysts is federal legalization? Or I guess uplisting before that, maybe?
TE: No, I think I think the lowest hanging fruit is the safe banking in the HOPE Act. I think broader access to the capital markets, no longer dealing in cash, broadly accepting credit card payments across the space. I think all that really fundamentally pushes the industry in a really strong direction, just that broad access to capital markets, securing the balance sheets, bringing down the cost of capital is huge for the industry.
In fact, that happening and federal legalization and ultimately interstate commerce, taking a little bit longer, I think actually gives companies more of a leg up to really establish and cement themselves as dominant players in the space. So safe banking in the HOPE Act is going to go a very large way.
I mean, I mentioned payments there. When you think about the fact that, majority of the cannabis industry transacts in cash today, versus how you see people spend money on credit cards, we would just simply overnight see a large increase in the total basket size of the consumer what they’re taking home, you would see broader adoption of DTC services, I think across the board that can now allow for, the same way you ordered Uber Eats or groceries or whatever, allowing for that credit card payment to happen online and that delivery service, I think, a company that, you know, we really like, in California it’s Grass Store. Grass Store is the largest DTC company out there.
What’s been tough for them is having to accept the cash at the point of delivery. That can be dangerous. These folks are carrying high value product in their trunk, et cetera. A lot easier when you’re just you’re not dealing with the cash transaction, you don’t have to open your windows driver and do this weird awkward exchange, allowing for credit card payments is not only going to increase the basket size. It’s going to make the industry a lot safer for the operators out there. So we’re really excited about the prospects of SAFE and the HOPE Act.
RS: Do you feel like when those changes happen, I will not say if, when they when the change has happened, does that change your focus and who you’re choosing to fund like? And as it gets more and more legal, closer to federal legality, does that change your focus? Or will you stay in the private markets?
TE: That’s a really great question. And I think it really comes down to ultimately how we think about investing in the space, we invest in the space today with two things really top of mind is, is this a viable business model today? And if nothing changes, do we believe in the business model for the next three to five years? If we get safe banking, or the HOPE Act or federal legalization while we are holding a position, does that help or hurt the business model? And really, we will only put capital behind a business that we think is viable today and viable post legalization, meaning that they are going to be able to compete with traditional industry operators outside of cannabis that are trying to get their hands involved in the industry.
So I think as you’re looking at investment opportunities, it’s important to recognize do these folks have again, the balance sheet and the runway to get to one of these point — inflection points like safe banking. And post safe banking, what does the environment look like? Now, absent of a crystal ball, you’re using your best guess, but I think that looking to invest in businesses that should have a competitive moat and a competitive advantage, post deregulation or whatnot, deregulation, post-regulation actually coming on board, it is very important.
RS: Tiby, first of all, I’ve really enjoyed this conversation. So I’m really happy that you came on. Thanks for joining us. Anything that you would share that you feel like we were — we left out of the conversation or kind of advice that you would give to investors looking at the space now?
TE: Yeah, look, it’s — first and foremost, money doesn’t grow on trees. Cannabis businesses are just like any other company. You need to fundamentally understand what you’re investing behind and not just though, blind capital behind a company because you heard a stock tip on a podcast or something like that, you should always do your diligence always do your research. Even with that being said, just understand that look, it’s a very exciting industry. It’s a growing asset class, but it’s still an emerging market.
And just like any other emerging market, there’s going to be growing pains alongside. So, there’s no quick bucks to be made. That’s not to say that you can’t get lucky and say, I’m the smartest guy or gal in the world, because I invested in something and it went up, 2x in a short amount of time. That being said, I think if you’re long term focused, and you believe in this asset class, there’s a lot of gold to be mined out there. A lot of really great businesses to support.
And there’s a lot of really great reasons to support the cannabis industry. We didn’t really get into it in the show here, too, but there’s a lot of social justice, social equity reasons why the whole reason for the grassroot movements of why cannabis has been legalized. We didn’t touch on it. But a lot of the podcast right now was about kind of recreational cannabis and how we’re growing that industry. But also, I think that there’s going to be huge medical applications to the industry. So a lot of really great reasons to reschedule cannabis, at a minimum legalize this, that people want it.
And I guess, lastly, I would say, you know, feel free to go to our website, keyinvestmentpartners.com. We are very active podcasters. We have newsletters, blogs, white papers, all of our thought leadership is free, you just go on there, download it, or click a link. So if you’d like to educate yourself on the asset class, that’s a lot. Our job as investors and how we’ve been successful is by educating folks not by pitching an idea.
So please feel free to go out to our website and educate yourselves. And we’re always happy to take questions, fill out the contact form, and we’re always happy to screen phone calls, and et cetera.
RS: That’s awesome. That’s awesome. I’m going leave it with a question if you don’t mind. I’m curious hearing you talk, would you say that the only risk that you see to the industry or to investing in the industry would be who you choose? Another words that you don’t see necessarily any major reason to put a pin in the balloon that is like the growing cannabis industry? Would you say that it’s company specific, private or public, as opposed to industry specific?
TE: That’s a really great question. And it’s a, I won’t give you the super long winded answer. It’s no, we’re trying to wrap it up here. But I think that I think there’s probably several risks to be aware of. I think to directly answer your question, if I’m reading between the lines is, no, I don’t think that we’re going to reverse course and do a 180 and make cannabis fully illegal again, I think that the cats out of the bag, I think cannabis will become federally illegal, et cetera. But again, it is an emerging market. And it is a very heavy regulated industry.
So aside from just traditional fundamental analysis of a business, I think you need to be aware of the potential regulatory risks. And the fact that while I don’t think that there’s going to be a 180, on how cannabis is has been legalized, there certainly is a chance that some of the regulations could change once it’s made federally illegal. So being aware of that and trying to invest in companies that are always compliant, I’d say overly compliant puts you I think, in a better position to really win.
So somebody who’s toeing the line between gray area like these companies today that are heavily putting their operations between behind Delta 8, for example, I think that you — while there’s a quick buck to be made there. We think the Delta 8 loophole could close this here. And if you had invested in behind one of those companies in equity or debt, you’re not the operator that’s walking away with that salary that you’re paying yourself for the bonus, you’re an investor that’s losing out because the company is being shut down because the loopholes being closed.
So we don’t think that there’s any reason to take any outsized risk and an investment that’s operating in a gray area, be overly compliant, be overly transparent, overly aware of what you’re investing in. And then again, try to always invest behind the best operators, the best management team and then with a business model, that’s fundamentally very viable.
RS: Very good. Well, thanks for educating us to be and check out KEY Investment Partners podcasts and articles. Definitely some great education to avail ourselves to. Yeah, may the education be fruitful and plentiful and may the profits come with that. I really appreciate you coming out. I think this was like a really interesting conversation that touched on a lot of things. So thanks for joining us.
TE: Yeah, it was a ton of fun. I really appreciate you having me on the show. And I look forward to hopefully be on the show one day again in the future.
RS: Absolutely. Absolutely. The conversation will continue. It does not end here. Awesome.
Thanks so much for listening to the Cannabis Investing Podcast. Subscribe or follow us on Seeking Alpha Apple podcasts or Spotify, we’d really appreciate it if you left us a review on Apple podcasts. It helps other investors find our show and it makes us feel fantastic. If you have feedback or questions, we’d love to hear from you at rena+canpod@seekingalpha.com. Nothing on this podcast should be taken as investment advice of any sort. And yes, I am still long Trulieve, Khiron, Isracann Biosciences, The Parent Company, Ayr Wellness and the ETF, MSOS. Thanks so much for listening.
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