The business model is simple.
To be one of the largest distributors (of both homegrown and 3rd party cannabis brands) to the Californian retail market. From there, replicate, and scale globally.
In reality, this is anything but simple.
In a nascent market, where no "Coca-Cola" currently exists, and with marketing rules that severely restrict how brands can advertise, creating some of the largest, and most iconic brands in the industry is no mean feat.
The California-based distributor is currently the largest 3rd party distributor in the United States. Formally CannaRoyalty, the name change mirrored a change in business strategy from minority ownership and royalty deals with their brands, to taking majority stakes in brands whilst simultaneously becoming the largest distributor in the market.
California is a unique State, in that all retail dispensaries must purchase their cannabis from a 3rd party distribution company. The distribution company is required to monitor and record the taxes, and continuously test the product to ensure that quality controls are being maintained. Dispensaries prefer dealing with fewer distributors and gravitate to the ones that carry the most variety in brand and product. In this area – Origin House excels.
Their business model is to bring smart capital to the table. They can assist brands with their capital, but also with manufacturing, branding and marketing, legal, logistics and, of course, with distribution.
According to their latest investor presentation, there are three specific phases to their business plan. Build the foundation, then internalise and accelerate, and finally replicate the blueprint with international expansion.
Phase 1: Building the foundation
In Phase 1, they aim here is to become the leading, and most prominent, distribution company in California. In doing so, to develop deep relationships with their retail customers, in order to create qualitative outputs from their purchasing data to better understand the market trends, and to develop new and creative cannabis brands, that the market wants.
Origin House has accelerated its brand agreements in recent times. Last month they signed an agreement with Viola Brands, the company founded by NBA superstar Al Harrington, for the exclusive distribution rights to the Californian market. They also signed exclusive distribution rights to Utopia Cannabis in late January, with an investment of $750,000. They did the same kind of deal when they invested $704,000 in Humboldt's Finest and got the distribution rights to the Californian market.
It's their distribution reach that creates the greatest moat. Origin House can immediately get their brand partners into the majority of dispensaries in the State of California. Using the data it collects from over 450 dispensaries in the state, Origin House can then match brands with customer demands, whilst simultaneously accelerating product development to meet customer desires.
Phase 2: Internalise and Accelerate
Using the proprietary data it collects from over 450 retail stores, the company aims to internalise the best and most popular brands in market, whilst at the same time, to accelerate the awareness and sales of their product range in California.
They offer massive infrastructure for brands the internalise. They have super access to capital and financing for growth. With their six active Californian Licenses, and their five licensed manufacturing and distribution facilities covering a massive 125,000 square feet, they are able to provide contract manufacturing for their brands, bringing immediate scale to the table.
And finally, with their distribution reach, infrastructure, and logistics capabilities, they have the ability to accelerate a brand's awareness in market and growth. And they have already internalised some very solid brands.
FloraCal Farms, based in Sonoma County, offer some of the most premium-grade flower in the market. Acquired in July 2018, FloraCal generated $3.2 million in EBITDA and $2.6 million in Net Income last year. They also acquired 100% of Dreamcatcher Labs, the company that produces and manufactures the Greenrock Botanical vape cartridges. In addition, they hold a minority stake in Breeze, who have developed proprietary for dosage controlled smart inhalers.
Phase 3: Replicate the blueprint
Once Phase 1 and Phase 2 are in play, then the aim would be to replicate the Californian model and expand globally. In this phase, Origin House would take their US brands to Canada, expand into other states (as they legalise for adult recreational use), and finally to other countries and continents.
They are already laying the foundation for this phase with their purchase of 180 Smoke in September 2018 for $25 million. With 26 locations in Canada covering coast to coast, and an online e-commerce store, 180 Smoke is Origin House's retail play in Canada. 180 Smoke is a manufacturer and wholesaler of vape products and accessories. In 2018, they recorded just over $11 million in revenue and will look to significantly increase this in 2019 as Canada's recreational market matures.
California – their primary market
California represents the largest cannabis market in the US and the 5th largest economy in the world. Having legalised cannabis for adult recreational use in January 2018, the market is slowly starting to mature. Currently, no one brand dominates the market, and from quarter to quarter, different brands take the #1 spot for sales. No brand seems to be able to consistently grab the majority of market share, and herein lies both the opportunity and the risks.
California is the world's largest regulated cannabis market, and the most significant global exporter of popular culture. This makes it the world's most influential cannabis market.
It will be very difficult to build a strong, dominant brand in California, and given this is Origin House's strategic priority, the success of this plan will come down to management's ability to execute. However, with the power of their distribution network, they certainly have a head start.
In 2018, the company made two key acquisitions that have laid the foundation for the execution of Phase 1. In March, they purchased Kaya and Alta, and in October they purchased RVR Distribution.
Kaya and Alta, based in Oakland are comprised of two parts. Kaya is the licensed manufacturing facility and exclusive manufacturer and producer of the Bhang edible and vape product range. It is this facility that underpins Origin House's ability to outsource and scale up production for their internalised brands. Alta, is the licensed distribution facility that has the exclusive distribution rights for the Bhang product range in California.
In October 2018, they purchased RVR Distribution which supplies most of the retail dispensaries in California and will be a major revenue driver for the company in 2019. However, this is distribution revenue which is associated with low margins. This is one area investors should keep a close eye on (more on margins in the financial overview). RVR is currently in the process of being merged with Alta.
Their latest set of results were the Q3 2018 earnings report for the period ended September 30th, 2018. Their top-line revenue growth was simply phenomenal. In Q1 2018, they produced $644,000 in revenue, and in Q3 2018 this number exploded to $6.6 million (a 929% increase). Most of this growth was driven by their acquisition of Kaya and Alta, with the bulk of the revenue attributable to product sales (Greenrock Botanicals and Soul & Sugar).
What made these numbers even more impressive, was the fact that they included very little contribution from FloraCal (as only closed in July), and nothing from either RVR or 180 Smoke. Expect much larger numbers when these two acquisitions are included in their Q4 earnings report.
In addition, Origin House sold its stake in both Anandia Labs and Wagner for $28 million. Both of these companies were purchased by Aurora Cannabis, and Origin House netted a cool $6.8 million in profit from these sales.
Although these revenue numbers are phenomenal, Origin House is still not profitable. More concerning is the fact that their margins are decreasing and operating expenses are rising.
The margin is a key issue in our opinion. In Q2 2018, their margins were 24% and this has decreased significantly in Q3 to 6%. On their earnings call management explained these lower margins as a result of one time write-offs, and that they expect margins to increase moving forward.
In addition to low margins, there were significant increases in their operating expenses. Indeed, expenses are now growing in a linear fashion with the increases in revenue. But with decreasing margins, this is putting a serious stain on the bottom line numbers. One key area for investors to focus on moving forward is going to be management's ability to see these revenue increases filter their way down to a profitable bottom line.
Ultimately, the increase in distribution revenue is going to be associated with low margins, and hence the opportunity to increase gross profit is going to come from their product sales. The internalised brands offer the greatest opportunity for higher margins and this has to be the key focus moving forward.
Their balance sheet looks healthy with $75 million in cash and only $28 million in long-term debt as of Q3. It doesn't look like the company will need to raise money in the short-term, but they are going to have to focus on managing their cash burn, otherwise, a capital raise will be inevitable.
The Bottom Line
Origin House operates in the best cannabis State in the US. Their distribution reach is second to none, and their business model is very solid. They have demonstrated the ability to make smart acquisitions and to grow their revenue, but really need to focus on gross margins in 2019. The following interview with Marc Lustig, Chairman, and CEO of Origin House is from November 2018, talking about the name change and clearly articulating their business strategy.
Investors should keep a close eye on the distribution revenue and its associated margins. They key will be their growth in product revenue, and in this regard, management's ability to grow brands as a business model will be tested to the max.
We are very bullish on Origin House and hold them in our basket of US Multi-State Operators (MSO's). Although the shares are trading at slightly overbought levels right now, a dollar averaging down buying approach could be the right way to play this stock moving forward.
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