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If you aren’t growing, time to harvest

By
Stephen Miles
December 22, 2020

In mature cannabis markets, operators have one of two choices

As with most nascent, capital-intensive industries, cannabis will undoubtedly consolidate as it matures. Indeed, it is already happening in the mature adult-use markets, such as Colorado, Oregon, California, and Washington.

Each of these markets has experienced massive supply-demand imbalances at times and corresponding volatility in wholesale prices.

For instance, in Colorado and Oregon, well-established demand levels drove more operators to add grow and retail capacity. Consequently, wholesale prices bottomed out hard in these "open market" states and have stabilized at levels that only generate acceptable returns for the most efficient operators.

In Colorado and Oregon, wholesale flower prices bottomed out at $600 per ton before stabilizing in each state at the $1200-$1500 range.

In mature markets such as these, Darwinism comes into play, and only the strongest survive.  Every operator must ask themselves, am I a consolidator or a consolidatee?

If you are a consolidator, you need to have a sufficiently strong balance sheet and extraordinary access to capital to be ready to acquire smaller operators aggressively. If you are a consolidatee, it is time to get your house in order and start marketing your business to your state's consolidators.

Time is of the essence.  

If you intend to be a consolidator but show up late to the party, you can assume you will be on the outside looking in, with only the weakest targets still available.

Similarly, those operators who conclude that selling into the consolidation is the best course of action would be wise to move quickly, as purchase prices tend to peak early on in consolidation waves, with prospective targets late to the game finding a market with buyers less likely to "pay up" for good assets.  

One fact is for sure, in the end there will be a finite number of uber-efficient operators in your state. One axiom has always proven true in such markets, "either you're growing or you're dying." And why die when you can sell and monetize the value you have worked hard to create?

The pertinent questions then become to whom do you sell, and at what value? Many industry participants have decided that a simple revenue multiple is the right metric. We often hear 1-2x annual revenue depending on where one participates in the supply chain.  

But fresh eyes from new investors may not subscribe to these valuation metrics.  Arguably a dispensary that generates $20mm of revenue in a protected local market with a tax-efficient structure (given 280E implications) should be valued higher - from a multiple of revenue perspective - than a $6mm revenue player in an open market with an inefficient tax situation.

Perhaps just as important, value is in the eye of the beholder, and therefore buyers with strategic rationale or cash flow synergies should pay more for a target versus ambivalent buyers.

Correspondingly, the only way to ensure you get the most for your business is to sell through a competitive process.

To sum up, the clock is ticking. Operators must pick a direction and prepare accordingly. Consolidators need a war chest, and, as we all know, capital remains relatively scarce and very expensive. Sellers need to get their acts together and properly position their assets to those buyers most willing and able to ascribe the highest value.  

No matter what, a massive consolidation in mature markets is on the horizon; licensed operators need to chart a course forward and execute on their game plan with all due haste.

Sharp has assembled a panel of experts to help cannabis owner/operators understand how to navigate cannabis market consolidation. Taking place Thursday, November 12, 2020, at 2:30 pm CT, the webinar will be moderated by Steve Miles, Managing Partner of Livingstone. The panel of experts includes:

Panelists will discuss the current state of the M&A market, explore what large MSOs are looking for in acquisition targets, tackle regulatory issues on the accounting and legal side, and share the steps owner/operators can take to position themselves for a sale in the future.

Click here to register for the event.

Authors:
Rebecca Hawkinson
Steven Ernest
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