Cannabis Investing — Tier 1 MSOs vs. Everybody Else

Since cannabis policy reform began to take hold in the last couple of decades, the number of companies within the industry has ballooned. The Bloomberg Industry Classification Standard (BICS) for cannabis counts 198 solvent companies worldwide. The vast majority are domiciled in Canada or the United States, and less than a third have market capitalization greater than $25 million. The concentration of the industry is largely due to restrictions imposed by the world’s largest market, the United States, which has classified cannabis as federally illegal since the Controlled Substance Act was enacted in 1970. The substance’s use is prohibited federally for all uses including medical, but the federal government has thus far not intervened as states have pursued recreational and medical legalization. Since cannabis operations on a national level including banking, transport, and growing remain illegal, scale is only possible via operating in multiple states individually, each rife with unique regulations. This has led to the emergence of Multi-State Operators (MSOs), the largest companies in the sector which have the resources necessary to tackle these challenges.

The Roundhill Cannabis ETF (WEED) is solely composed of the six U.S.-based “Tier 1” MSOs. Ordered by market capitalization, these include: Curaleaf Holdings, Green Thumb Industries, Trulieve Cannabis, Verano Holdings, Cresco Labs, and Columbia Care. As of October 17th, 2022, every constituent in this category ranks in the top six cannabis companies by market capitalization and revenues. Combined, these six companies grossed $5.06 billion in revenue over their last fiscal year, just over half of the total for all 59 BICS Cannabis companies with market capitalization exceeding $25 million. Furthermore, four of the six U.S. Tier 1 MSOs are profitable on an EBITDA basis, combining for $875 million in EBITDA in their last fiscal year. Of the remaining 53 companies, just 10 are profitable based on this metric, with total EBITDA of -$3.32 billion. MSOs are vertically integrated and have control over the entire cannabis product life cycle, from growing operations to the retail point of sale. This may reduce costs as well as supply-chain related risks. These companies generally also tailor their marketing and pricing strategy on a state-by-state basis.

In terms of profitability, Tier 1 MSOs median EV/NTM EBITDA multiples of 6.7x. While these estimates are subject to revision, as it stands these companies are significantly “cheaper” than the other 53 BICS Cannabis companies, which trade at a median EV/NTM EBITDA multiple of 20.4x (note many still remain unprofitable) For additional context, NYSE/NASDAQ/TSX-listed cannabis companies such as Tilray Brands, Canopy Growth, and Cronos, trade at 13.7x median EV/NTM EBITDA. We believe this valuation discount to be a function of market structure. Due to federal regulations, U.S. plant-touching cannabis companies cannot currently list on major exchanges such as the NYSE, NASDAQ, or TSX. As a result, MSOs have been relegated to smaller Canadian exchanges such as the NEO Exchange, and trade over-the-counter for U.S. investors. While U.S. retail investors may have the ability to access these names OTC depending on their broker, many institutional investors are prohibited due to mandate, aninability to custody the securities, and more broadly, a lack of liquidity. Meanwhile, the Roundhill Cannabis ETF (CBOE: WEED) provides economic exposure to MSOs by trading total return swaps. These structural constraints have led institutional investors to trade ancillary cannabis businesses such as WM Technology, or Canadian cannabis operators such as Tilray or Canopy Growth in order to get exposure to the sector. As a result, we believe that the valuation multiple for Tier 1 MSOs may prove attractive when considering the potential for federal legalization, continued state-by-state recreational and medical legalization, and an eventual uplisting to major U.S. exchanges that will offer the liquidity to meet institutional investor demand.Furthermore, cannabis sales are projected to increase significantly over the intermediate term. Cannabis data firm BDSA forecasts that global cannabis sales will exceed $61 billion by 2026, compared to actual 2021 sales of $29 billion.¹ This represents a CAGR of 16% over the next five years.

Figure 1: Comparison Between Tier 1 MSOs vs BICS Cannabis Sector

Source: Bloomberg, Roundhill Investments, as of 10/17/22.

*Tier 1 MSOs include: Curaleaf Holdings, Trulieve Cannabis, Green Thumb Industries, Cresco Labs, and Verano Holdings.

**The BICS Cannabis Sector comprises 198 companies with a positive market capitalization. For the purposes of this analysis, the 53 companies with a market capitalization above $25 million that are not “Tier 1 MSOs” have been included.

Revenue, EBITDA, and Free Cash Flow data as of the latest fiscal year for each company.

Figure 2: Financial Metrics of BICS Cannabis Sector

Data in millions ($)

Source: Bloomberg, as of 10/17/22. Shaded companies refer to “Tier 1 MSOs” within the Roundhill Cannabis ETF (WEED). Country refers to Country of Domicile. Revenue, EBITDA, and Free Cash Flow as of the companies’ latest fiscal year.