Cannabis Business Valuations Basics (?!)
The year 2018 was a great year for cannabis. In California, it felt like a tsunami and in a matter of months, the industry acquired a high level of trust and respect. I was personally shocked when at AltsLA 2018 I had the pleasure to talk with Michael W. Kramer CFO of MedMen (CSE: MMEN), one of the industry behemoths. It was incredibly interesting to witness cannabis businesses pitching the crowd as a prime alternative investment alongside hedge funds and real estate opportunities. Many analysts report on how the market is booming with M&A activity and stellar revenue growth.
With its incredible expansion, investors are now starting to look into how these companies might accrue value that could potentially lead to an exit.
But what are the value drivers of such a new industry and how long term investors should go about in analyzing the business models? What are some of the key elements that need to be kept in mind on evaluating a cannabis business?
Here is a quick non-exhaustive list of what factors can play an important role and would need to be kept in mind by the early stage investor.
Recreational vs Medical
Brands that focus on the recreational use must have a totally different treatment than those who focus on the medical market. They address different markets that present very different challenges. It is helpful to clarify the regulatory status of the market in which the firm operates before any further analysis. There will be overlaps and this can actually make the opportunity more appealing.
Historical v Predicted Revenues
The nature of revenue plays a huge role. Companies that operate in the medical space in a market that has been developing in the past 5–10 years will be in a better position to be evaluated then newcomers playing in the recreational space in the newly opened market. In the M&A space, the multiples for the latter have been inflated and they are clearly reflecting the current hype.
Licenses and Regulatory Outlook
A careful analyst must compare the compliance of the company with current market regulation. The industry is continually evolving and the revenues are delicate and unpredictable. A compliant company is a company that is in a better position to succeed and adapt.
Value Chain Segment
Growers, manufacturing companies, lifestyle brands, importer/exporters and research labs will play different roles in the industry and therefore will most likely have a different multiple in valuation. Each segment not only has its risks and opportunities but also its own assumptions in valuation. In particular, the Agricultural segment seems to have the highest potential: factors like non-GMO, organic, farm identifiable, certified humane are all elements that are increasingly present in the mind of the consumers. Growers that can leverage this are considered to have the highest potential.
Comp (CCA) analysis: the alcohol and tobacco sectors
A number of similarities can be drawn from the development of the alcohol and tobacco industries. A certain level of substitution effect will play an important role so it might be worthwhile to compare alcohol and tobacco metrics to the cannabis industry metrics.
At the moment, current valuation multiples have been biased by the hype of the current market. M&A transaction prices (an implied EV) appear high if compared to TTM EBITDA. In addition, data sets are limited and therefore it is harder to use traditional methodologies for valuation. It is however undeniable that this is an industry that will stabilize and will generate tremendous opportunities.
