Time and Price, the ultimate cure for valuation in a high growth Industry

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When we started Poseidon back in 2013 we had no data, no benchmarks for valuations, and a very limited opportunity set. We truly had a blank canvas as we went about investing our first fund. We tried to focus on good people and areas of the industry we felt were essential to building what would become the fast growing, multibillion dollar industry it is today.

We had to build frameworks for valuations depending on what parts of the industry we were investing. We studied external markets as guides to considering inputs like TAM (total addressable market), profit margins, growth rates, to give us some basis of determining valuation. Today is a far different experience. There are dozens of analysts covering Canadian LPs and more and more covering US Operators and Ancillary companies. The quality of their work is quite varied with many exhibiting the biases of their investment bank sales team. Some firms adhere to the proper regulations there but this does not seem to be present with our colleagues to the north. We note this deficiency as a symptom and opportunity of an early stage industry. For example, analysts defend Canopy Growth trading at 16X sales with a very weak fundamental business while only offering nominal credit to much stronger US companies. This behavior is further exacerbated by media like Jim Cramer on CNBC, who continues to give much air time and support to David Klein (CEO of Canopy Growth) than talk about the much bigger opportunities right in the US.

The fourth quarter of 2020 and the first half of the first quarter this year can largely be summed up by the typical ebbs and flows of retail enthusiasm. There are great companies in our space that were clearly cheap this time last year and then the momentum kicked in fueled by the hope of federal legalization post the Blue Wave. The enthusiasm has topped out, which seems to also have coincided with the SPAC mania blow off, high flying tech companies falling significantly, peak option trading, etc etc. The last several weeks has shown rotation on a macro level and a cooling off in cannabis. We believe there is a long way to go for our industry and very attractive returns within specific companies. Moments like mid February can be frustrating knowing what comes next, weeks or months of digesting. Here we are in mid April with US cannabis stocks mostly going nowhere since early January. Though stock prices may not be going up, there is plenty going on under the hood that give insight into future returns.

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Here are some great points from Stifel’s Andrew Carter:

• The U.S. operators have been able to raise equity on attractive terms with the top four U.S. MSOS raising roughly $600 million priced at a roughly 5% average discount to the previous day’s close.
• We now estimate the U.S. state licensed cannabis category will grow to $22.8 billion in 2021 sales, up from $22.3 billion, +31% y/y. State reports suggest a strong start to the year with our estimates suggesting the U.S. state licensed category grew over +50% in 1Q21 with Headset insights suggesting 31% y/y growth in calendar 1Q21 for the markets we estimate account for roughly 50% of the U.S. state licensed market (California, Colorado, Nevada, Oregon, Washington).
• While the U.S. market is in the early innings of its development, leading U.S. multi-state operators have established an early lead leveraging limited licenses in key medical and adults use states with our estimate suggesting the top 15 public companies command 25% of the U.S. overall market. Outside California, we estimate key states for the MSOs (Florida, Illinois, Maryland, Massachusetts, New York, Nevada, and Pennsylvania) grew 113% y/y in 4Q20 with our estimates suggesting 85% growth y/y in 1Q21 from these markets.

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The chart below is an attempt to conceptualize the notion of public cannabis stocks opportunity zone, when there is good underlying growth and good capital allocation happening within specific companies. The resulting drawdown in stock prices supported by positive tailwinds sets up for the next leg of returns.

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Disclaimer
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Poseidon Investment Management (the “Company”) has prepared this presentation solely for the purpose of providing an opinion. The information contained in this presentation is not to be used for any other purpose. This presentation does not constitute an offer to sell or a solicitation of an offer to buy any securities. The Company makes no representations or warranties about the completeness or accuracy of the information contained in this presentation, and the Company expressly disclaims any and all liability for any such incompleteness or inaccuracy. Certain of the information contained herein includes forecasts, predictions, projections and other such forward-looking statements, which involve particular risks and uncertainties since they depend on assumptions that may not prove to be accurate and could cause the actual results to differ materially from the predicted results.
Cannabis remains illegal under federal law. The Federal Government does not recognize cannabis to have any medicinal values. Cannabis cultivation, possession, consumption, sales, and distribution are illegal under federal laws and also certain state laws. Please note that there are differences in cannabis laws from one state, county, or city to another.

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