As Capital Dries Up, MSOs Gear Up

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Illustration: MJ Graphics / Shutterstock

The cannabis industry has gone through multiple ebb-and-flow cycles with capital investment over the past decade, but the situation for cash-starved companies in 2022 may be one of the most challenging—especially for small operators and those without adequate cash reserves.

In 2021, investors were somewhat bullish on cannabis, in part due to the influx of money from stimulus checks and increased consumer consumption. But a recent report published by Viridian Capital Advisors illustrates how much capital investment has waned over the past year:

  • Less capital has been raised year to date in 2022 than in any previous year except 2020, during the previous “capital crunch.”
  • Transactions larger than $100 million accounted for only 37.2 percent of funds raised in 2022, more than twenty points lower than in each of the past three years. In 2021, eighteen equity issues of $100 million or more occurred, compared to just three this year.
  • Debt raises of $25 million to $100 million represent 26 percent of capital raised in 2022,  more than twice the percentage in any previous year.

“So the biggest single decline area is equity deals larger than $100 million,” explained Frank Colombo, director of data analytics at Viridian. “It’s kind of striking, because this time last year we had $3 billion worth of equity deals that were [larger than] $100 million. This year, there’s only been $517 million total.”

On a related note, Colombo also said many large cannabis companies in the United States were trading at almost twenty times EBITDA (earnings before interest, taxes, depreciation, and amortization) at the beginning of 2021, but that ratio had been cut in half to about ten times EBITDA by the end of the year.

“One obvious reason why the big deals aren’t happening is big deals are done by big companies, and the big companies aren’t doing deals because their [stock] price is way down,” he said. “And more importantly, they don’t need the cash. If you look at the balance sheets of the big multistate operators, they have a lot of cash left over from all those big financings they did in 2021.”

That’s fine if you’re a big company, but what about everyone else?

Multistate operators (MSOs) and other large companies are able to tap into public markets and other sources if they need a cash infusion. However, the situation is considerably different for smaller companies. When smaller companies seek investment capital, they usually must borrow at higher interest rates.

“If Verano wants to go out into the market and borrow $75 million, they can do that really easily,” Colombo said. “But if a small company wants to do a private placement, it’s going to be a smaller number, say $5 million or $10 million, and it’s just much more difficult in this environment. So when capital becomes constrained like it is now, it differentially impacts smaller companies.”

Small equity deals of $10 million and less accounted for less than 5 percent of the total capital raises so far this year. “Investors perceive size as having something to do with safety,” Colombo explained.

For companies that are unable to raise the necessary capital to survive and expand in increasingly competitive markets, the most attractive option for the foreseeable future will be mergers and acquisitions, which likely will ramp up this year through 2023. As struggling companies look for a life raft, particularly in distressed West Coast markets, there won’t be many options aside from selling out or merging with a larger company.

“Over the past couple of years, that’s been an impetus for smaller companies to sell to bigger companies, because they find it more difficult to grow with the higher cost of capital,” said Colombo. “I still think there’s going to be a push for more consolidation in this industry, [along with] more deals [between entities] like Trulieve, Harvest, Cresco, Columbia, and Verano—deals where public companies are buying other public companies and using a lot of stock. I don’t think we’ve seen the end of the consolidation wave—not by a longshot.”

In other words, buckle up. The coming year is going to be a wild ride for the U.S. industry, and it’s looking like MSOs will guide the conversation more than ever.