This week saw Illinois become the 11th US State to legalise Cannabis for adult recreational use. However, what made this even more special was the fact that this was the first time legalisation has occurred through the legislative process and not via referendum.
Vermont was technically the first State to legalise via legislation, however, that was for home-grow only and didn't come with the framework for sales and taxes as Illinois has done. In doing so, Illinois becomes the second mid-western State to legalise cannabis after Michigan did so in November last year.
The Cannabis Regulation and Tax Act, which comes into effect on January the 1st 2020, allows anyone over the age of 21 to purchase, and carry up to 30 grams if they are a resident, and up to 15 grams if they are a tourist. This opens up a massive market, with Canaccord Genuity estimating the Illinois market to be worth $2 billion by 2022 and potentially up to $2.5 billion per annum from there on.
This news follows the Alternative to Opioids Act of 2018, which was signed into law last August and allowed access to medical cannabis for individuals who have or could have obtained a prescription for opioids in Illinois.
With a population of 13 million and a tourist-hub in the form of Chicago, this is going to be a very lucrative state moving forward, and will really benefit the current medicinal license holders. Currently, Illinois has issued 55 licenses to a range of Multi-State Operators (MSO's) who have been operating in the medicinal market.
The new regulations will allow for each of the license holders to open one additional retail dispensary and trade recreationally from the 1st of January.
Additional licenses will be granted in two tranches, with the first wave in May 2020 and the second wave in December 2021. In total, an additional 180 retail stores licenses, 100 processing licenses, and 100 craft-growing licenses will be issued over the coming 24 months.
This is very good news for the existing operators in the state as it gives them a significant advantage over new license applicants given that they can trade freely from January 2020.
The three biggest winners are Cresco Labs, Green Thumb Industries and MedMen. The new regulations will also increase the dispensary limit in Illinois from the current five dispensaries per company up to ten, which means there is still room to grow in this market.
Recently we covered the Cresco Labs purchase of Origin House for $1.1 billion and believe them to be one of the best MSO's in the market. We have also extensively covered Green Thumb Industries and believe they too are one of the best ways to play the market.
But what about MedMen? MedMen is by far the most recognizable name in Cannabis in the US. The company's strengths lie in its brand, footprint and asset base. One of the most polarising companies in the sector, investors either love them or hate them. Let's take a closer look.
With 84 potential retail licenses, across 12 US States, and boasting more than 2 million recreational transactions to date, MedMen is one of the largest MSO's in the US. Based in Culver City, California, their stores occupy prominent locations in the highest-end neighbourhoods in the U.S., including West Hollywood, Beverly Hills, Venice Beach, Fifth Avenue in New York, Las Vegas, and at the LAX airport. Often nicknamed the "Apple of weed", their stores are famous for their stylish interiors and upscale retail experience.
"Everything in each store — the technology, the design, the sales team — "is focused on offering an elevated, but accessible, experience that breaks stereotypes of what people expect when they visit a dispensary. We do not run pot shops, we manage class-leading retail stores that happen to sell marijuana and marijuana products." – David Dancer, MedMen's chief marketing officer
The Growth Strategy
MedMen's strategy is pretty simple. First, build the brand through flagship retail stores that create brand awareness and drive customer acquisition. Then, continue to deepen market share in core consumer markets across the US before finally, driving profitability through investments in their supply chain such as scaling their manufacturing capability to drive the production go higher-margin private label/in-house brands.
MedMen is focussed on branded retail and taking a meaningful share in its core markets. The company believes that cannabis retailers are unrestricted in their ability to control the supply chain and relationship with the customer. In the cannabis industry, this is even more relevant. Millions of consumers are shopping for cannabis for the first time, have limited knowledge or affinity to specific products and hence rely on the retail staff for purchase advice.
And with cannabis production on the rise, there will come a time when oversupply kicks in and the wholesale price of cannabis plummets. As this occurs, it is the retailers that will have margin protection on their side given their ability to exert pressure on the suppliers while holding retail pricing steady.
Recently, MedMen has been on a massive expansion campaign, buying dispensaries in Arizona, Northern California, and Illinois, and capping it off with a massive $682 million purchase of PharmaCann. The PharmaCann acquisition allowed MedMen to expand into the states of Pennsylvania, Maryland, Massachusetts, Ohio, Virginia, and Michigan, in addition to gaining dispensaries in New York and Illinois.
MedMen's acquisition model is to try and grab licenses in States that limit and restrict the number of licenses and operators (like New York). This creates a natural moat, making these States more valuable than non-non-restrictive states such as Colorado and Oregon.
MedMen has a focus on increasing its market share in these core markets. Their most valuable market, and where they have the most stores operational in California. California is considered to be the jewel in the US Cannabis Crown. With over 40 million people, California is the 5th largest economy in the world, and Cowen and Co estimate the California cannabis market to be worth over $11 billion.
MedMen dominates this landscape with 13 existing retail licenses and plans to open an additional 30 retail stores over the coming three years. Not only do they have stores in prime locations, but according to the company, their California stores outperform the state-wide average by nearly 8 times (based on implied average per retail storefront license using data from California Department of Tax and Fee Administration and actual system-wide MedMen revenue in California for fiscal Q3 2019).
Recently MedMen paid over $50 million to gain access to the Florida market. Their aim is to replicate their successful Californian strategy in a State that is considered by many to be one of the most valuable in the US. Although Florida is currently a medicinal-only state, when the laws do change and they open up to recreational cannabis, MedMen could be very well positioned to capitalise on this.
Last week MedMen released their Q3 2109 earnings results for the period ending 31 March 2019.
Revenue of $36.6 million (proforma of $57 million if you count the pending PharmaCann revenue) represented 22% incremental growth over the previous quarter ($29.9 million), and 156% over the previous year.
Retail sales across their 21 stores were up 16%, with the greatest increase seen in the Nevada and Arizona markets with 34% quarter-on-quarter growth. With the leading retail market share in California (at ~7%) and pro forma dispensaries already up and running in a total of eight states, MedMen currently has one of the largest pro forma revenue run-rates in the industry to date at US$228M. And with the number of operational retail stores set to hit 50 by the end of the year, this trend looks set to continue.
"We are entering a chapter at MedMen, which is now driven by a path to profitability. The biggest driver in our path to profitability will be revenue growth, and with 15 planned new store openings during the remainder of this calendar year alone, you can expect our top line to continue to grow at a very healthy pace."
– Adam Bierman MedMen CEO, Q3 2019 Earnings Call
However, as impressive as their top line growth is, it is below the line that investors and analysts were watching more closely. MedMen has been burning cash in the past couple of quarters. They lost $64.6 million in Q2 and this quarter was only marginally better, with the company losing $63.1 million. The company continues to burn cash at a very aggressive rate and is probably the primary reason for the stock being under such pressure.
It was also announced that the two founders – Adam Bierman (CEO) and Andrew Modlin (President) were cutting their salaries from $1.5 million per annum each to the lowest possible California Statement amount of $50,000 per annum each in an attempt to curb the burn. The CFO, Michael Kramer, placed a freeze on any additional Opex in Q2, with the company targeting a 20% reduction of the Q2 2019 levels. A 9% reduction this quarter was certainly a move in the right direction.
Given the current burn, cash in the bank is king, and with the recent financing deal with Gotham Green Partners locked away, it looks like MedMen has cover for at least another 12 months of operation.
"We significantly enhanced our cash position with our most recent transaction with Gotham Green Partners. Gotham Green committed up to $250 million in convertible financing to MedMen, which will be drawn down in 3 tranches. The first tranche of $100 million has already been funded. The remaining two $75 million tranches will be drawn down at the company's auction starting at the 6 months and 12-month anniversary, respectively, of the closing last week, subject to certain stock-price hurdles being achieved, " said Michael Kramer, the MedMen CFO, on the company's Q3 2019 Earnings Call.
Big risks remain
Although some of the isolated numbers look very promising, such as MedMen's California four-wall EBITDA figure of $5.74 million at a 24.2% margin, The company is nowhere near profitable and looks a long way from it. It is going to continue to have to fund these losses and the Gotham Green funds will only get them so far. MedMen are going to require almost flawless execution from here on if they are to survive without further shareholder dilution.
Then, there are the lawsuits, the most damaging of which is the one brought against the company by ex-CFO James Parker. Parker made several disturbing allegations against MedMen's CEO and president, claiming they forced Parker too, among other things:
- Wire money to a consultant in order to prop up the company's stock
- Pay unlicensed brokers to sell the company's stock
- Spend lavishly on luxury cars and premium chauffeur services
Though MedMen denies all allegations as false accusations from a disgruntled ex-employee, where there's smoke…
Although the company is still printing a sizeable burn compared to many of its US MSO peers, with US$22M of cash on the balance sheet, US$250M available through its recent convertible debenture financing and another US$45M available via its at-the-market financing program, MedMen is likely fully funded for its initiatives as it looks to steer towards profitability in the coming quarters.
MedMen aim to move towards profitability by driving new store openings and further investments in its supply chain, as it targets a new revenue mix of 50% owned (in-house) brands (currently less than 5%).
Despite the company losing money, many industry analysts still believe the stock to be a Speculative Buy. According to Yahoo Finance, one such analyst is Seaport's Brett Hundley who believes a "huge upside remains in a long term window." He reiterates a Buy rating on MedMen and has set a price target of USD$7 per share. Such a target would prove an upswing of 134% from current prices.
And Hundley is not alone. The analyst's sentiment is echoed by other Wall Street institutions. Yahoo Finance goes on to say that "of the 4 analysts polled in the last 3 months, all 4 are bullish on the stock."
"In summary, we are able to grow revenue by 22% quarter-over-quarter, decreased our corporate SG&A by 9% quarter-over-quarter, with a clear line of sight to achieve our targeted 20% reduction. And we received a commitment from Gotham Green Partners for up to $250 million to fund the balance of our assets. I could not be more excited about the prospects of our business going forward."
– Adam Bierman MedMen CEO, Q3 2019 Earnings Call
We believe that the CFO's cost-cutting measures, combined with solid top line growth have put MedMen on the right track. With the current US legislative winds-of-change representing an unstoppable trend, and MedMen already the most recognisable brand in the US, the company could be very well positioned to deliver outsized gains in 2019 and beyond.