The Measuring Stick
Guest post by Adam Bierman, CEO of MedMen
Given the breadth of the cannabis sector, far too often, I see investors comparing companies in completely different industries with unrelated business models because they are loosely affiliated with “cannabis.” While Kroger, General Mills, and Cargill all operate within the food sector, they are rarely compared to each other from an investment perspective with respect to valuation multiples, growth drivers and margin profile.
There are five primary cannabis-related industries investors can invest in at this point: Agriculture, Consumer Packaged Goods, Ancillary/Software, Real Estate and Retail.
Every “cannabis” company can and should be grouped into one of these verticals so they can be better compared and analyzed based on the metrics that are relevant for their respective business model; same-store sales growth for retailers, cost per pound for growers, sales velocity for CPG companies and ARR for software companies.
Agriculture: This is the most upstream industry within the cannabis sector and consists mostly of Canadian Licensed Producers. Given outsized demand and limited supply of the product, agriculture businesses are taking advantage of enhanced margin profiles. What is yet to be determined is whether these margins are sustainable, given the expected sharp increase in supply and whether we will see price compression and commoditization as we’ve seen in Oregon, Colorado and Washington. While market fundamentals may shift on pure growers once the market normalizes, the leading growers in Canada have an investability head start given their ability to list on Nasdaq and NYSE. Because of their compliance with federal law in Canada, they have been able to access huge sums of capital to fund their expansion plans.
Consumer Packaged Goods: The companies in this industry largely come from California and are now attempting to expand into additional regions. While there are several CPG companies that report strong revenue numbers, long-term distribution and supply agreements are key at this stage, just like they were for the alcohol companies that eventually became national leaders. It’s no longer impressive for a company to be producing substantial results out of limited retail doors with no long-term supply agreements. The winners from this industry will lock down national agreements with retailers guaranteeing shelf space over a period of time. Following that, this industry will start to look and feel more like traditional CPG. Most of the future winners from this industry are still private and may contain the most opportunity for venture-type returns.
Ancillary/Software: The initial outperformers in this industry, which include non-plant-touching business focused on technology, distribution, payments and other services, have been laying the groundwork for quite some time given their compliance with federal law. Given their ability to list on the U.S. exchanges, companies that do not “touch the plant” have been afforded a significant head start to raise capital and capture market share. While it’s too early to tell, one thesis is that the first movers will build substantial niche businesses focused on cannabis and could be M&A targets for non-cannabis companies who want their books of business. It will be very interesting to see if the existing companies will compete with the multi-nationals, be acquired by them or become obsolete because of them.
Real Estate: Cannabis real estate is one of the most intriguing emerging real-estate verticals. Given the capital-intensive nature of the cannabis sector, and as legalization continues to expand state by state, the size of the market will only grow over time. There is only one cannabis REIT that is currently publicly traded while a handful have recently raised capital and are set to go public over the next year. Outsized returns on real estate are becoming increasingly difficult to achieve for generalist REITs, yet those with an industry focus are continuing to attract investors. Cannabis REITs are not only hyper-focused on a high-growth industry, but also offer significant cash flow and superior returns over both the short- and mid-term. The key nuance for investors to consider is whether the cannabis REIT is focused on cannabis retail real estate or cannabis agriculture real estate. The verdict is out as to which of the two will perform better over time as both have their merits. Retail real estate provides slightly lower returns, yet there is far more downside protection given the alternative use for the retail space, the defensibility and margin profile of cannabis retail. Agriculture real estate offers slightly higher returns in the near-term, but a deteriorating competitive dynamic and potential long-term margin compression.
Retail: This industry has the most defensibility and protection to its long-term economics as a result of geographic zoning restrictions placed on cannabis retail businesses, the limited number of total licenses that a state/city allows and the ability for first mover retailers to establish consumer loyalty. Cannabis retail will also be significantly more consolidated than other cannabis-related industries and will play out with one ultimate winner. The winner will be the retailer that is able to establish the most trust with consumers, has locations in the most strategic markets across the U.S. and is viewed as the curator of the highest quality cannabis products. This is not a new concept – we’ve seen other retailers such as Home Depot, Target and Whole Foods all become the ultimate winners in their respective verticals.
Make no mistake about it – these businesses are all early stage in a sector that is still nascent. As Reid Hoffman writes in his book Blitzscaling, “We don’t know of a single start-up that succeeded without starting out as single-threaded. That focus is the key to beating the larger competitors in the early stages of a company’s existence.” This is a very important reality. The likelihood of a company in any of these industries winning starts with a commitment to focus.
Ironically, the public markets have actually been rewarding lack of focus. This has encouraged sub-optimal decision making at many of the top companies within each industry. There are agriculture businesses purchasing distribution companies and coffee shops, investment businesses that are taking on operations of their investments and retailers buying CPG companies to distribute hemp CBD into mainstream retail. These moves are being rewarded with stock price growth, despite the lack of synergy or long-term ROI. Growth for the sake of growth is fatal. The house of cards will eventually fall as it has for many first-movers in other industries. The lack of focus was eventually disrupted by second-movers witness to the mistakes and more mindful of strategic execution.
With separation of the five primary industries above, competent analysis with relevant metrics can be executed. An investor won’t learn anything useful by comparing four-wall margins of a retailer to the margins of a CPG company. To start, here is how we measure ourselves as a cannabis retailer.
Investors will be well served as other companies in the cannabis industry begin to share their key performance indicators.
About the author:
Adam Bierman, CEO of MedMen, co-founded the California-based company nearly a decade ago. Today, MedMen has operations in a dozen states with 37 retail stores in operation.