US MSOs – The Big get Bigger

Last week we published an article wherein we suggested that the current cannabis stock market could represent an opportunity for investors to be greedy. Stock prices continue to fall, and with them, investor confidence. But we showed that this is also a seasonal occurrence and that for the most part, the underlying fundamentals of the best prospects in the US market haven't changed.

Our view is that the best prospects (for the most part) are still the US Multi-State Operators (MSO's).

However, just like the legality of cannabis itself, this view has its detractors. In an article written by Steven Goldberg titled Buy Marijuana Stocks Now? You'd Have to Be Stoned, he suggests that "it's almost certainly less risky to inhale than to invest." No offence Mr. Goldberg, but with a statement like that, one could pontificate that perhaps you'd have to be stoned!

He goes on to suggest that the biggest risk to investors and the primary reason they should avoid the industry is that – at the Federal level in the US – cannabis is still illegal. A schedule 1 substance alongside heroin and cocaine. But therein lies the great opportunity.

"Being illegal presents numerous other obstacles. If you're producing or selling marijuana in the U.S., you're violating federal law. Consequently, American marijuana companies can't list on Nasdaq or the New York Stock Exchange. So they list on the Canadian Stock Exchange in Toronto and the OTC Markets Group in the U.S. where disclosure requirements aren't nearly as strict as on the major U.S. exchanges." Yup, Steven Goldberg again.

Cannabis is, in our opinion, the greatest healthcare disrupter of our time, and the medicinal cannabis industry is still only in its infancy. The mother of all stock price catalysts is still coming. The tsunami that will drive the ultimate long-term value of the industry – a fully legalised US market. Not just for recreational, but also more importantly for medicinal, as this is a more profitable market than the recreational space. And this is not as far off as you might think.


The annual BDS Analytic's "State of the Legal Cannabis Markets" report was released this week and is calling for the US market to nearly triple from the US$14.9 billion in spending that researchers projected for this year (2019) as legal sales gain momentum in more jurisdictions.

"North America will almost certainly continue producing the lion's share of legal spending, particularly as more U.S. markets transition from medical-only access for a limited pool to full legalization with sales open to all legal adults,"

Tom Adams, managing director of industry intelligence at BDS Analytics

Thirty-three US states have legalised cannabis for medicinal purposes, while 10 of those states – along with the District of Columbia – have also permitted recreational adult use.

The growing medicinal market is driving the social acceptance of cannabis as a medicinal form of treatment, and in turn this is driving positive public sentiment. In its latest poll, Gallup suggested that 66% of the US population was in favour of legalising cannabis at the federal level. To put that into perspective, when the US legalised gay marriage, only 62% of the population was in favour of it.

Importantly, this was the second poll where the majority of Republicans were in favour of legalisation. And of course, Gen X and Y were unanimous in their vote, with 84% in favour. Like we say, this is not a matter of if, but when.

Add to that the passing of The Farm Bill of 2018, which legalised Hemp and removed it from the Schedule 1 list. That was the gunshot that started the booming CBD-derived wellness industry race, one that The Brightfield Group estimates will be worth $22 billion by 2022. And, importantly, this is also opened up opportunities for the MSO's to take advantage of the Hemp laws to create national CBD-derived cannabis brands.

We honestly believe the US to be 2-3 years away from full legalisation, and this is what creates the big opportunity. Right now, it's still fragmented, small and a little chaotic, but if investors can identify the right companies, then the upside is potentially phenomenal. Think the internet boom of the mid-2000's. And these companies are more likely than not going to be the big MSO's.

The American Cannabis Industry

America's green rush is finally beginning to take hold. There are 33 states that now allow medicinal cannabis, while 11 have legalised it for recreational use. The industry—which presently employs more than 250,000 people—saw an explosion of growth over the last twelve months, resulting in the total number of active marijuana licenses in the US […]

Read More


The term refers to cannabis companies that operate across multiple states in the US. Multi-state operators own cultivation facilities, extraction and manufacturing facilities, and cannabis retail stores across some of the most highly populated and lucrative recreational markets.

Given that federal illegality means that cannabis cannot be transported across state lines (even from one recreational state to another), most of the MSO's are vertically integrated in each of their states.

This means that they can maximise profitability across the entire value chain.  They cultivate, manufacture, distribute and sell their cannabis through their retail outlets. These entities are usually structured as holdings companies with separate state subsidiaries that hold state licenses for these activities.



Although they cannot transport cannabis across state lines, they can share employees, knowledge, genetics, and economies of scale in marketing and branding. It is, however, expensive and difficult to operate stand-alone style businesses in multiple states, each with their own set of cannabis laws and regulations.

Edward Fields, chief executive of DionyMed Brands, puts it succinctly when he states that "the differences on a state by state basis are so nuanced that it's not possible to simply apply the strictest standard and clear the bar. There can, for example, be ingredients within pesticide formulas that are allowed in one place and not another." But there are other problems too.



Many investors are horrified at the amount of cash these companies are burning. But in the current stage of the market, growth is fuelled by cash and acquisition. This is a once-in-a-lifetime land grab, and companies are moving as fast as they can to put a flag in the ground.

But capital spending doesn't stop there. The fact that they almost always need to be vertically-integrated means that they have to spend huge capex setting up the seed-to-sale value chain in each and every state. This really puts a strain on the war chest.

MSO's are spending huge sums to gain both recognition and foothold. Acquiring licenses, setting up cultivation facilities and even making the right hires are all expensive steps. All of it placing an inordinate amount of pressure (and analyst scrutiny) on the cash balances. And this leads to the second problem.



Cannabis companies are extremely limited in their access to US capital. The primary reason that most of the MSO's choose to list on the Canadian Stock Exchange is to gain significantly better access to capital.

"It takes money to make money"

Acreage Holdings President George Allen

Indeed, until the US banks offer standard business lending options to these companies, they are faced with either having to raise capital in the market (sometimes at depressed stocks prices) and risk dilution, or are charged ridiculous amounts of interest on short-term debt.


And Banking

Speaking of the banks, because it's still federally illegal, cannabis companies struggle with banking facilities in the US, as most of them won't touch these companies for fear of running afoul of the Federal Reserve (and the benefits and funding that come from that). Even the major credit card companies want nothing to do with them.

As a result, the MSO's have to deal in large sums of cash. Not only is this a risk (as it can attract shady characters), but it also limits their ability to maximise in-store revenue, as most consumers shop using credit cards these days, and the cash amounts spent in-store are not insignificant.

The second issue is taxation. Given that Cannabis is still illegal at the federal level, and a Schedule 1 drug, any company dealing with or handling cannabis (even in legalised States) are subject to the 280E Tax rule. Basically, they are unable to offset any business expenses against revenue, meaning they pay ridiculous amounts of tax. Oh, and of course, in cash!



Here's the thing though – while the US still continues to operate under federal illegality of cannabis, real institutional money is not entering the market. When the US does eventually legalise, institutional capital and global corporate giants will storm the market like Jon Snow on Kings Landing.

It is at that point, that the market will go parabolic, and investors that are already in the game will reap significant rewards. MSO's are the way to play the US, and they have many advantages over the smaller independent growers and manufactures located sporadically across the country.

For starters, they have the ability to learn from each state they enter, improving their understanding of how to effectively operate under the legal conditions that each state presents. And each additional state adds synergistic economies of scale, as they can replicate the product standards of the state with the strictest regulations. In this way they are covered across every state, even overcompensating in states with less stringent conditions.

They also have the ability to develop brand awareness and recognition at the national level. In Canada, with the regulations governing packaging, it is very hard for the large LP's to build brand recognition. However, in the US it's different. In the US, brands can really own the packaging, and this then helps build loyalty as customers travel interstate, and continue to use brands they like and want.

One of the biggest advantages that MSO's have is their ability to acquire additional state licenses. In fact, it is the complicated rules of each state that also lay the foundation for the MSO's to have an advantage over the smaller players. Companies that have successfully dealt with governing bodies already have, by definition, a better understanding of how to deal with these bodies and government departments, in order to overcome the inherent roadblocks and pitfalls.



We often quote Wayne Gretzky who said that to play like a pro, you have to skate to where the puck is going and not to where it is. Yes the US is federally illegal right now. Yes, this creates a greater level of uncertainty and fear. Yes, this makes the pot stocks riskier. But that's like looking in the rearview mirror. You need to look forward and skate to where the puck is going.

The fact that cannabis is still illegal on the federal level is actually the best argument why cannabis stocks are a good investment. The US is poised to federally legalise. Not striking yet, just poised. And when it does, the real money will have been made by those investors willing to understand the speculative nature of pot stocks, and the associated upside that can be generated from them.


Legalisation would immediately solve two key issues for the MSO's


Banking and tax would be sorted. They would be able to leverage debt the same way other Fortune 500 companies do. Cost effective growth without significant dilution. And given that legalisation would remove cannabis from its current Schedule 1 status, tax rule 280E would fall away and companies could finally write off their business expenses in the usual manner, immediately driving bottom line growth.

Secondly, and importantly, they would be able to leverage real economies of scale. Currently, the fact that they must be vertically integrated in each and every state, means they cannot leverage large production facilities to service greater geographical areas. Once cannabis can cross state lines, they can drive operating leverage, which in turn drives greater profitability.

We have long spoken of our Paper Portfolio's weighting being geared towards the US. We maintain that when the US opens up, these MSO's will thrive, and even potentially be acquired by global retail powerhouses. And when this happens, we expect to see significant gains in our portfolio.

We're skating to where the puck is going to be. Thanks Wayne.

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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