How Retail Investors Should Evaluate Cannabis Stocks

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Bengal Capital’s Jerry Derevyanny shares his evolving thoughts on 280E and the process of rescheduling cannabis (2:20). Some uncomfortable truths about how investors should be evaluating cannabis stocks (8:30). When will companies become more transparent? (21:40) Who is handling debt well and who isn’t (27:15). Examples of sustainable value creation in the industry (34:00).

Transcript

Rena Sherbill: Jerry Derevyanny, welcome back to the Cannabis Investing Podcast. Welcome back to Seeking Alpha. Always like talking to you, so appreciate you taking the time.

Jerry Derevyanny: Rena, thank you for having me here again.

RS: Yes. Glad to have you back on. A lot of discussion lately about cannabis stocks, about rallying cannabis stocks, whether there’s real value there, when the value is going to come, lot of promises on the political side of things. That’s not unusual for us.

So, how are you looking at the cannabis industry? We’re here on Valentine’s Day, February 14th. Any love to be shown to the cannabis industry? I did not have that planned, by the way.

JD: Yeah. Tough love. If anybody’s listened to me before or read any of our stuff, it’s definitely a little bit of tough love. First, I’ll give a proviso real quick.

So, I’m Jerry Derevyanny. I’m a partner at Bengal Capital. We run the Bengal Catalyst Fund, which invests in the cannabis space. So, we can talk about positions that we have in the fund today. Any comments I make on this podcast should not be interpreted as discussing Verano Holdings (OTCQX:VRNOF) because there is a litigation between Goodness Growth (OTCQX:GDNSF), where my partner, Josh Rosen, is a CEO right now. And it is a position in our fund.

So, nothing I say relates to Verano. And also nothing I say relates to 4Front (OTCQX:FFNTF), because I’m an ex-employee there, and I don’t want people getting – any time I speak about 4Front, I feel like people would get the wrong idea that I have a good view of current operations, even though I haven’t been there for a couple of years. So, nothing I say relates to 4Front as well, although I think that team is great and wish them all the best.

So, with that out of the way, yeah, I think it’s a really interesting time. So, one thing I was wrong on, I think before, is that I didn’t really give probably a lot of thought to the rescheduling process. Back a while ago, when I thought that when 280E went away, I thought it’d be legislative, there’d be an excise tax that comes along with it. And it’s going to be much more neutral of a change.

That’s seemingly the way that the things are flowing. That is not going to be the case in that. If the DEA goes to Schedule III, then by operation kind of a law, you don’t get an excise tax, you just have a couple of years of – 280E just goes away.

I think where investors right now are kind of missing the boat is that they are making this out to be a much bigger change in terms of the long-term value of these companies than I think is justified. Also, I think personally, and this is not, my views should not be interpreted as those of Bengal.

My partners definitely have some different views on things that one of the things that we disagree on a little bit is how likely Schedule III is. One of the partners gives it a 95% chance by the end of 2025. I give it a little bit less, maybe 70%, 80%. And I think people right now in cannabis land are underestimating just how hard some of the anti-cannabis forces are going to be fighting and just how hard we are going to be, just how narrow this fight is.

So, it allows them to throw a lot of things at the wall that cannabis investors I don’t think are really used to seeing much of, and that – it might be a little bit of a tougher fight than they anticipate. But still, we still think that the odds to be clear are much more likely than not.

RS: First of all, I want to shout out Bengal Capital. You guys just published your fund letter, which we have on Seeking Alpha, or you can get on their substack. It’s a lengthy read, but super worthwhile, super deep dive, a lot of nuance and detail, which I like, which investors should love. So, wanted to shout that out first and foremost.

And also along the lines of you talking about correcting some of your thinking or rethinking some of your previously thought points, and also speaking to the fund letter and I think the idea of fund letters which, in my experience, reading fund letters is where a lot of smart people work out their investing strategies and thoughts. And it’s a great place to understand how smart people think about investing and the marketplace.

And I think your letter is a great example of that. And I also feel like the cannabis industry, this podcast, myself, a lot of guests we’ve had on, there’s a lot of having to rethink previously held opinion. And I think that benefits everybody. And I also feel like there’s a lot of space for grace because everybody has made mistakes, everybody has gotten something wrong.

This is a really ever evolving industry with a lot of necessary uprooting of previously held thoughts and also previously held regulations and political definitions and legal things and all of the things that make up the cannabis industry. And I’m getting to my point, don’t worry.

But I think one of the things that has been talked about a lot in terms of knowing how to look at the cannabis industry, especially as retail investors, especially when a big swath of people interested or certainly a good amount of people interested in the industry do not necessarily have investing background or don’t have enough investing expertise to develop a strategy around such an evolving and ever changing industry.

So how would you advise investors to be looking at companies, to be looking at the industry? What should they best keep in mind, both in terms of looking at the catalyst coming up and what that means for the existing companies? And also just in general, what are the best metrics to use when looking at a company?

JD: So, thank you for the kind words on the letter, first of all. I really appreciate it. Love to get people’s thoughtful feedback on the letter. Some people have written in and disagreed with a couple of things, and that’s great. We’ve had some really thoughtful responders that have really challenged some of our thinking and that’s exactly one of the reasons why we put out the letter. So, thank you for the shout out.

RS: Can I actually interrupt you before you get to your next point? Was one of your opinions changed based on the feedback that you got?

JD: Does it sound too egotistical to say, no?

RS: No, no.

JD: It wasn’t changed. I think that some of the people that have made points, it’s – the letter would be even longer if we acknowledged even more nuance in the industry. And my basic response to at least one of the people was, I’m not saying you’re wrong, I think that that such and such that you say is a good upside scenario, I just think that that scenario is a little bit less likely than you do. And that’s why I’m not maybe pricing it as much, but certainly it wasn’t like, yeah.

So, didn’t really come off our views, but that said, it would be, I think, I’d like to think we would be the kind of people that if somebody had a good effective argument for why we’re really missing something I certainly hope that we listened to it. So, absolutely welcome people sending in their thoughts.

To your question on metrics, I think it’s good to take a step back real quick and let’s remember the history of metrics in this space. And so, kind of one of the, call it the old way and the new way. One of the old ways of looking at these companies as they were starting up in Canada was the famous metric of funded capacity because the market and analysts, they try to figure out some metric that is understandable and measurable and people can, you know, investors and readers can look at it and understand and something to make sense of the world, right?

Ultimately, the whole point of these, of metrics, what we’re really trying to get to when we are discussing these metrics is that these are shorthand usually and some shortcuts to try to figure out if you’re doing fundamental analysis, how much money are these companies going to make in the future? And how sure am I of those cash flows and kind of trying to get to a present value of that company, leaving aside the speculation and the more trader aspects of this market, which I can get to later, but that’s what metrics are supposed to get to on a fundamental basis.

And so, you had, kind of the old way of doing it was funded capacity. When funded capacity didn’t turn out to be very predictive, you ended up people going to these weird wonky kind of Cannabis 2.0, 3.0 metrics in Canada. Then in America, we started having these TAM battles of total addressable market, where you had companies that were, frankly, some companies were built from the ground up, not to be good operating businesses in all of their different states, but to be able to color in as much states on the map of the United States as possible to be able to show total addressable market of x, as if two stores in Illinois entitle you to the whatever 13 million people addressable market of Illinois.

As we’ve kind of, you know, especially as a Bengal, we’ve been watching this and always kind of been skeptical. And now the market then moved to EV to EBITDA. Some people even use a market cap to EBITDA, which is not correct. Then you start to get to cash…

RS: Do you want to just put out there why that’s not correct?

JD: Yeah, I think the finance people can correct me on the wording of this, but you can’t really use market cap to EBITDA because you’re using a metric that takes out the effects of leverage to only comparing it to one part of the capital stack. So, if you’re doing any EBITDA, you have to compare it to enterprise value, or else you’re missing the whole fact that the company has a bunch of debt that is financing it.

And I think one of the ways that people have been abusing EV to EBITDA metrics is this kind of rote comparisons between companies to see what is “cheap.” And again, people forget that EV to EBITDA has its use, like it has – EBITDA has its history and why it was developed. And EBITDA is a very good tool for, was originally for debt holders, right? It was originally to sell junk bonds.

As you’re using it on these companies, I have seen these arguments where you go, well, such and such company is trading at 3x EBITDA, 2024 EBITDA. This company is trading at 7x, therefore the 3x EBITDA is cheaper and the better buy. Like, you can’t do that because EV to EBITDA is not the be-all and end-all. It leaves out a critical piece, which is leverage. And so, I think the upcoming maturities and stuff like that will definitely flip things around potentially.

And then so going from EV/EBITDA now suddenly everybody found religion on cash flows. And so, now the gaming of cash flows has started in some of these companies’ financial metrics in that they don’t pay taxes. So, the cash flows are not a good representation of what the business is really economically producing.

Plus, you also have some very interesting working capital moves that happen sometimes in these companies where you look at it and suddenly payables jumped in the quarter and the cash generated, at least the big portion of cash generated, very much looks like that payable’s jumped.

So getting back to the core point is, what metrics should investors look at? So one thing I’ll say is, investors should not just look at metrics rotely. They should not just look at, just looking at the metrics, unfortunately in this industry is not enough. And there are a couple of metrics they should frankly stay away from.

And one that I will highlight is tangible book value. Tangible book value, which some analysts are kind of have used widely to analyze companies in the space or to recommend companies, for example, Organigram (OGI) and Planet 13 (OTCQX:PLNH). I’m not really going to mince words. It’s an absurd metric to use. And the reason being that it basically takes us back to Cannabis 1.0 funded capacity metrics.

The book value of Canadian companies in a lot of cases is vastly overstated because you cannot rely on book value when a lot of that book value is composed of facility, hundreds of millions of dollars spent on greenhouse facilities that now trade for pennies on the dollar. That is not a good metric of the company, number 1.

Number 2, the book value of assets in America is just not a good indicator of what they are going to produce in the future in terms of cash flows. It’s just not, you know, it is using accounting in a very wonky, very bad way. And to argue that companies with high tangible book value are better buys than those without is to basically say, because they don’t have debt in some cases. It’s like saying this dump of a house that is absolutely falling apart and is going to cost more to fix than it’s worth, well, at least it doesn’t have a mortgage, so you might as well buy it. Like, it just doesn’t make any sense. So, that’s one that people should avoid.

The more uncomfortable answer is that there are no good metrics for investors to quickly take a look at these companies and get a really good feel for them. And that comes from, as we kind of noted in the letter, the companies really threadbare disclosures about their businesses.

The business of a company, an MSO that operates in Massachusetts and Illinois, those two businesses are distinct. They might share different executives, but they don’t share production facilities. They don’t share any meaningful things. And they’re very, very different margin profiles. They can have different capital employed, all that kind of stuff. Unfortunately, if you just had that kind of business, that’s already difficult to try to tease apart what’s going on where and what’s going to happen in the future.

Take a company like Cannabist (OTCQX:CBSTF) that operates in 16 markets and it becomes almost impossible. And the companies don’t make it any easier. And I think that’s by design, in large part, because they don’t have to. The investors aren’t kind of clamoring for it and it kind of helps hide some of the things that are going on.

The unfortunate reality is, these businesses are not as predictable. These businesses are not as stable. These businesses are not as, there’s not as uniform as a lot of other businesses, and so these broad metrics, where you take all of these different markets and average them out and kind of slap one metric on it, that doesn’t give investors a lot of information about what the cash flows are going to be in the next period.

So, for example, like, you have TerrAscend (OTCQX:TSNDF) that had, I think undisputedly like a big boost from Maryland in New Jersey, and their financial profile looks a little bit different from some of the other companies because of the growth they’ve had. Just looking at them on a multiple basis or whatever, it misses the point of, well, wait a second, they’re in different markets.

So, yeah, their financials are going to look different, but what we’re trying to get to is the long-term value. And it’s just very difficult to tease apart these companies and to realize that they’re built on different foundations, if that makes sense. Does that make sense?

RS: Yeah, I think it makes a lot of sense. I’m curious if you have an opinion, I assume you do, on why the metrics have been, the metrics that have been bandied about are always the wrong, or not always the wrong metrics, but they’ve been proven to be the wrong metrics up until now? Is it because analysts and observers and whoever, podcast hosts, are kind of coming off of the headlines of what metrics to look for?

In other words, if a company is touting, we have really high cashflow and now that’s the metric to look at. Is it coming from that? Is it coming from the evolution of the industry? Like as you mentioned, there’s a time and a place to use these metrics, but it’s ever evolving in the cannabis industry. Is it a more nefarious reason? How would you articulate the reasoning behind it?

JD: I wouldn’t say it’s nefarious necessarily, but I would say that, I think it’s just difficult as an analyst to come to investors and say, I don’t know. To just put out your hands and say, listen, I really don’t have, I don’t have a strong view on this. It’s just really hard to predict. I think you’re forced to at least provide some kind of metric.

And especially if you’re looking at the initial analysts that did this up in Canada, they’re attached to investment banks. And without denigrating anybody’s credibility, a lot of that business is the analyst supports effectively the investment banking business. So they have to come to a conclusion and hopefully a positive one, very much encouraged to come to a positive one about these companies.

So a lot of these metrics were trying to draw these trajectories. I think then the metrics, EV to EBITDA that’s kind of a standard metric. And it wasn’t – it’s not like these metrics are wrongfully used, it’s just that they don’t tell the complete picture. The metric sometimes is useful in some situations, and sometimes it’s much less useful than it normally is because it doesn’t really tell you much about the company, right?

So, if a company is exposed to markets that are rapidly declining in price, then what the EV to EBITDA is telling you, right, in some of these situations is, they are in high-priced markets. That EV to EBITDA is not telling you a lot about what potentially the EBITDA next year is going to be, right. So, sometimes the low EV to EBITDA tells you that the market thinks that the EBITDA is actually lower next year, right, which is the case with some of these companies, it’s not the case in others.

So I think it’s just a — everybody is always trying. Analysts, they unfortunately are pressured into having opinions for one reason or another. And I think companies for a long time, cannabis companies looked great on EV to EBITDA. So, of course, these are the metrics that they used. They looked incredibly cheap on EV to EBITDA with growth metrics kind of attached. I think what was really going on underneath was a little bit different. And arguably the market over the last year has caught up on that and started efficiently pricing some of these securities.

RS: I appreciate that. Something you talk about in your letter is pushing companies to be more transparent and release different metrics. And one of the metrics that you mentioned is that companies should be releasing state-by-state breakdowns of what their numbers are.

In terms of pushing for that and being in touch with the industry and executives and some of the powers that be, and also to your point that people are starting to get more savvy about how to fallibly measure a cannabis company, do you feel that companies are having to be pushed and will execute more transparency? Or do you feel that that probably won’t happen because it doesn’t really benefit them to do so?

JD: I don’t see a lot of that happening in 2024, maybe 2025. I think when I do see it happening is when we are on the cusp of true institutional scrutiny of the sector. I think that companies that are doing better than others are fairly confident that it will give them more credibility to split the results out by state versus other companies that are considered in their same tier, they will do it.

Once they feel it’s advantageous to do so and there’s a little bit of pressure to do it. One of the effects of being a very retail dominated sector is that there’s just not a lot of pressure. There’s not a lot of institutional pressure to do these kinds of disclosures, which would be like we said in the letter, table stakes, in other industries.

Like I think sometimes, cannabis retail investors they don’t have a good sense of what is considered kind of standard non-GAAP disclosure in other industries. And it’s far more transparent than pretty much anything that cannabis companies do.

I will shout out that we try to follow what we say to the industry. So like Josh, I think at Goodness, if you look at some of their recent disclosures, it’s much more transparent than it has been in the past. And I think that’s we very much obviously applaud what’s going on there. And I think that should be a model going forward, but Josh is a CEO there, so it’s a little bit easier to implement that change.

RS: One of my questions to that would be, as anybody who’s read your letter, or listened to you a bit, knows that you don’t love MSOs, but GTI, Green Thumb (OTCQX:GTBIF) is one of the best of that breed. And there’s not a lot of transparency there, something we’ve talked about before on the podcast with a few different guests. What’s your take specifically on Green Thumb in terms of their transparency?

And, I don’t know if this is an add-on to this question, or if it makes sense. But also curious your thoughts on companies not paying taxes and waiting to see how that whole side of the equation works out. What are your thoughts there?

JD: So on GTI, like we said in the letter, they’re the most — they’re the investible one out of the Tier 1s in our view. They’re the kind of the clear leader. But they are not transparent. They do not share. And I think that is — we’ve obviously suggested that to management, not in any — we’re not pounding the table or anything. I think that they just don’t feel any particular impetus to, and they frankly don’t need to because the performance is very good and the financials look good.

And there no indications that there’s kind of – there aren’t great indications that splitting it would kind of show a materially different picture than the combined picture shows. So yeah, there we would love for them to be more transparent. If I had to bet, they would be, once they can see the tide turning, they would be one of the first companies to do it. This is not hard to do on a technical accounting basis, like some of these rudimentary splits are not difficult to do. It’s — and yeah, I would expect GTI to be one of the first.

Your second question was about not paying taxes. So, I understand why companies don’t do it. Sometimes that is kind of the way to go. I question — I have some doubts about some of the strategies that are being employed. I don’t know if they’re going to ultimately be successful on avoiding 280E tax liability, or requesting refunds on that. It seems a little bit riskier to me. And I think the jury is out on that.

I certainly think it should be not looked at as riskless to the companies that are doing it. Trulieve (OTCQX:TCNNF) is certainly kind of going all in on it. I think what needs to be looked at even before the tax strategies is the question of why are they doing this?

Some companies have gotten into a little bit of a cash crunch, and some of it was understandable, sometimes smaller companies there’s some timing issues. That can hurt a smaller company much more than a bigger company. But some of these bigger companies that are kind of kicking out their taxes as a form of financing, that didn’t originally mean to do it as like a strategy, but is now kind of become the strategy. I think some of that comes from making a lot less money than they thought they were going to make.

And it leads to some of the underlying questions on operations that we kind of started with, which is, wait a second, if things are so good, if the business is so good, why do you need to do this? And so I think investors should kind of be asking some of those questions at least, even though again, in some situations, it totally seems to make sense.

RS: So how would you talk about the industry in terms of, one of the topics that I think a lot of companies suffer from and that we talk about on the podcast is the issue of debt and how companies are forced to deal with it, how they’re choosing to deal with it. Who looks best and who looks worst when you’re looking at the industry in terms of their debt picture and how they’re handling it.

JD: So GTI, I think looks the best. I mean, again, some of the companies that don’t have debt, like Planet 13 has no debt. I just don’t think it’s worth — I don’t think it’s worth very much. I think it’s okay, so they have no debt. I just don’t think the business is particularly great. I mean, it’s one store effectively and they haven’t particularly been successful in anything else they’ve done.

GTI, it’s a little bit different. They do have the material debt, but it’s very manageable compared to what their underlying cash flows are and all the metrics look good.

Curaleaf (OTCPK:CURLF) has a significant amount of debt. And Curaleaf has something of a halo in the industry for being the largest, something I think is fairly unjustified if you look at performance. But I think that a lot of the discussion that I hear around Curaleaf and their debt, their material debt maturities that are, I think, coming up in Q2 2025, so not all that far from today.

And they need to demonstrate kind of significant cashflow inflection to kind of potentially grow into, “grow into” their capital structure. A lot of it really, when you really push people, they start to say things like, well, the chairman, he owes a lot of that debt. He’s a pretty connected guy. He’s very successful. So he’ll figure it out. And I think that that kind of reasoning has gotten people burnt, because I think ultimately there are limits to what even incredibly successful people can do. And so, I would be concerned there.

So Jushi (OTCQX:JUSHF) is one that jumps out. I think Jushi, if I remember correctly, the senior debt is held by Sundial (SNDL). And we have seen what Sundial does when companies kind of default at maturity, right? We have experience with this. Surterra, Parallel and Skymint, they went through restructurings. They foreclosed on those assets. So they didn’t play softball.

And so with Jushi, I would say it’s a particularly interesting issue because Sundial has made completely clear, I think that they are assembling kind of a U.S. MSO that they are going to – they’re I believe attempting to list on TSX, NASDAQ, whatever, as kind of using this Holdco structure that Curaleaf and TerrAscend have used. And I think there’s a fair chance that Sundial is going to try to take — it’s going to try to extract a pound of flesh out of Jushi at that maturity. And that one is, correct me if I’m wrong, Rena, but I’m pretty sure that one’s coming up pretty quick, right? It is fourth quarter of 2024. But that material maturity is a concern.

TerrAscend has a little bit coming up. Cannabist, I think is already, I think you’re going to be seeing a lot more of Ayr (OTCQX:AYRWF) type deals in order to right these balance sheets. And I think now it’s something we talk about in the letter is that investors should keep in mind that, “the company” you’re not buying the company, you’re buying the equity generally when you’re going into the market. And the equity may not perform particularly well, even if the company survives and does okay.

The debt and the concessions that are given to debt may end up taking a significant portion of that upside from equity.

RS: In terms of the Ayr situation that you mentioned that the Cannabis is kind of headed towards that path, is there any scenario where you see that working out well enough to make it a worthy investment?

JD: I mean, for all of these companies, we have to be honest and say, okay, there is a chance that if Schedule III comes, if the couple other things kind of line-up the right way, coming into the election there’s a lot of — if there’s a lot of, if we get another kind of one of these marijuana bubbles, then you could be looking at a lot of these companies able to do — would be doing equity raises into those bubbles potentially and significantly changing their balance sheets and paying-off some debt and being in a much, much better position and the equity could turn out to be fine in those situations, certainly.

If that’s your only out, as in like if that’s the only situation where you’re going to do well in the stock, I think that’s a really tough place to be at. And I think for some of these companies, unless you’re being very sophisticated, I would call it very sophisticated, one of the best investors in the space. I don’t want to share who it is. I don’t know if he wants it public or not. But he has kind of a barbell strategy where he has some very safe cannabis picks and then he has some of the highly levered cannabis picks and smaller positions to get kind of the, to kind of balance the risk.

Okay, I get that. For a lot of retail investors, I’m not sure that they’re being as — I’m not sure they’re constructing the portfolio the same way. And just as a general rule, like that’s not something that I am super interested in, that’s not where I think my Bengal strengths are frankly in those kinds of — in assembling those kinds of portfolios.

So certainly there is some chance. I just wouldn’t want to bet on it especially when, why buy cannabis when you can buy GTI and sleep calmly? And, maybe it won’t go up 90%. Maybe it’ll go up 60%. But you’ve still done very, very well and you didn’t take a bunch of risk and you have really, I think much better prospects kind of long-term than a lot of the other Tier 1s. So why not? To me, it just, it doesn’t make a ton of sense.

RS: Yeah, and I think my additional question to that is, how do you see companies that haven’t made good choices until now or that are consumed by debt and having to work themselves out of that, how do you see it… let’s say there is a rosy scenario, do you see any room for sustainable growth for not even just MSOs, but even the smaller companies or the Tier 2s? Do you see a way to sustainable growth?

JD: Yeah, yeah, for sure. So in some scenarios, I do. So for some specific companies, and it’s a position of ours, we highlight Grown Rogue (OTCPK:GRUSF), it’s kind of the easiest one to point to. We see sustainable value creation happening because fundamentally we think that they can enter a market in a very capital efficient way, provide a really good high value product at a little bit of a premium to market price, but give customers a lot of value, create kind of sticky customers to their craft flower and make a nice margin on that flower even in a very competitively stressed environment, while you hopefully get a little bit of time while the prices are pretty high so that you make back your capital investment, but then you’re still left with a very nice business.

And over time, I think those businesses, a business like that stands a good chance of creating some enduring brand power and there’s a bunch of other potential upside that comes. But at the basic core level, they’re able to go into a state for, call it $5 million or whatever it is, it’s under 10, probably under 8, and get to making a pound kind of all in four wall cost at like $500 a pound, a very high quality pound, that then gets sold for $800 plus, $900 plus, for a while $2000 plus. It’s a solid business.

Some of these companies, there is no long-term value creation. Or at the very least, if you are looking at per-share value creation for current shareholders, I’m very skeptical of it because the cycle – like the future for them is unfortunately, you’ll have these kind of temporary bumps, but it’s not great.

Let me give you an example. So some of these companies, we’ve harped on it a million times, but it’s worth harping on again. Some of these companies have taken sale leaseback financing. Sale leaseback financing, when people say capital isn’t available in the industry, capital is fairly available in the form of sale-leaseback financing.

And they built very nice, big facilities. I think there’s strong indications that some of these facilities, they built for $50 million, let’s say a more efficient company could have built for $20 million. But hey, they had the money, the biggest thing was that they wanted to be in that market. And the market had super high prices and all this kind of stuff.

Well, ultimately what they did was they borrowed money. They would always say, it’s non-dilutive and even call it 12% from (IIPR), NewLake (OTCQX:NLCP), whatever. Those leases are 15-plus years, right? And so that facility that they built for $50 million needs to generate, call it $6 million in profit to pay the rent before shareholders see a penny of it.

By the time you get to the end of that lease with 2.5% yearly escalations in rent, you’re paying, I don’t know what it is like, 17% or something like that. And if you calculate 15 years in advance, and if your facility isn’t superefficient, the amount of profit that that facility has to generate, it’s very difficult seeing some of these facilities that some of the major MSOs have created being four wall profitable in the out years of those sale leasebacks.

And that will come back to haunt them, right? As we kind of progress that will continue to haunt them because their most successful facilities will be paying for their less successful facilities because they still have to pay that rent. They’re going to be – they have corporate guarantees, they have cross — a lot of cross defaults.

And so ultimately, unfortunately even with the bump and everything, as you look out to the long-term value, some of these companies, their cost structures on the wholesale side are so prohibitive that even if you get a couple extra really good years, I’m not convinced that really moves the long-term value of these companies much, if at all.

So that’s why we say that the Schedule III thing, if anything, it’s much more pro-debt than pro equity. Because if that Schedule III comes through and you probably have at least some period of time where they don’t have to pay 280E, but prices remain relatively high, all that extra margin that’s probably going to flow to paying debt and making the company easier to refinance, which is much better for current holders of that debt.

And frankly, I thought it was a big boon to IIPR, NewLake, Chicago Atlantic (REFI) – a lot of the lenders, but the market didn’t seem to respond that much. And I think that might be a little bit underappreciated that Schedule III is a, I think a little bit of a bigger boon for them than most people realize. But does that answer your question?

RS: Yeah. And I think to better articulate my original question, it was probably somewhere along the lines of, is it only feasible for a more nimble player to be able to grow sustainably?

JD: No. I think GTI, I think one of the things — the thing is that the retail franchises of these companies, I think are a little bit undervalued in some ways. And you could have a situation where the retail is pretty good, the wholesale is not so good. So you kind of — it ends up being kind of okay, but still floating along. What I think is that – the other thing is that, it’s really hard to — I think it’s fair to say I could very well be wrong on at least one of the Tier 1s, other than GTI, that they will end up doing well.

What I’m really arguing is that, to get geeky, ex-ante, like from right from where I sit right now based on the evidence that we have right now, it’s very difficult to predict who that is going to be. So I admit that the odds are, okay, maybe there’s going to be one or two. I just don’t know how to see who that company is based on what I have in front of me right now. And then later, it could just be kind of, frankly, it could have just been good luck on the part of one of the companies that makes it.

And again, for investors, I think that’s hard. That’s a hard situation to get into on a fundamentals basis. So yeah, I don’t think it’s only the small and nimble guys that are going to win. We focus there at Bengal because for what our skillset and experience is, we think that we can help some of those companies so that we kind of augment the returns by kind of using some of the things that we’ve learned in the industry to try to help these companies with investor relations strategic decision making, capital allocation stuff like that. And so that works for us.

But yeah, I don’t want to say that no big companies are going to make it or anything like that. I think some of them certainly are, I think some of the companies that are around today will still be around. They just will not have generated particularly great returns for shareholders.

So for example, like if you held, like Tilray (TLRY) is still around, they’re terrible. But if you were a shareholder and bought at $29, excuse me, $24 in 2021, you’re probably not particularly happy even though the company is still around. And I think you could be looking at that result with a decent portion of these cannabis companies, these kind of larger MSOs call it.

RS: And I would say that Tilray is, I mean maybe it would still be around, anyways, but it also benefits from a lot of misinformation and misunderstanding of how the…

JD: Yeah, it’s not really a cannabis company, right? It’s like a – it’s – yeah, it’s — and any time I see the CEO go on television and get invited on television to talk about the United States cannabis industry, it’s just I — my eyes roll into the back of my head. I think it’s absurd.

But yeah, a lot of those have been heavily supported as, again, one of the smarter analyst in the space that I mentioned earlier, made the good point that a lot of these companies have been supported by the fact that they have big board access and that they did a bunch of at-the-market offerings when the trading value of these stocks, when the Robinhood craze was going on these stocks.

And they were able to raise a bunch of cash. If they hadn’t done that, these companies would be in, Tilray, especially would be in much more dire straits. And Canopy (CGC) is just a mess, just an absolute mess.

RS: Yeah. I’m sad that we’re getting to the end of our time because there’s a lot more I want to ask you. So I hope you’ll come on more regularly in 2024. But I guess for me, one of my last questions would be for retail investors, you talked about why Bengal Capital is focused on the companies that you’re focused on and among Grown Rogue, you also list Body and Mind (OTCQB:BMMJ), XS Financial (OTCQB:XSHLF).

How should retail investors, if you were advising or when you advise retail investors about, let’s say they’re thinking about getting into a few stocks, how would you best advise them to be thinking about their portfolio?

JD: So I’d say this. So in the letter, in the 2023 letter, we kind of talk about our positions in Grown Rogue, Body and Mind, XS financial and Goodness, talk about why we hold those stocks and kind of give some thoughts on valuations. The lawyer in me, I cannot resist saying that this is not financial advice. So do your own due diligence. So obviously if retail investors want to look and think our reasoning is compelling, they’re very liquid stocks, so be careful. They’re OTC traded. Just have all that in mind, but obviously no objection if they want to buy those.

Unfortunately, I was thinking about this a lot before the podcast – the reality is for retail investors that are, there are, I think roughly two options in this, call it two big options. You can either look at this sector and do maybe just a tiny bit of research, buy GTI, put it away, and don’t look at it for 5 years. Or if you can’t buy GTI directly, maybe (MSOS). I don’t love the outsized Curaleaf exposure in MSOS. Maybe that works.

If you want to be cute, you can buy a little bit of GTI, buy some GTI and maybe a little bit of kind of long-term options on MSOS leaves that are kind of out of the money or whenever to whatever.

Or I think that you can go very, very deep into the industry and really start to try to tease apart some of these companies to see how they’re built and try to really honestly look at what is going to be the future of these companies, not doing this complicated something, but really try to look at it and go, okay, this company that’s been producing this cash, how much of that cash has been because they have been in a protected market that is now not as protected as it used to be.

Once you stress these numbers, what are these numbers going to look like. Where is long-term value really created? And frankly, what is the record of the leadership’s ability to take the money that they’re making and deploy it into other successful projects, which is, we didn’t even touch on how that is a huge question mark in the industry and something that GTI should be credited for, where I think that their capital allocation record is a lot better than others.

So unfortunately, I don’t have an easy answer for how to play around in the space of easily looking at these companies and doing a day of research and going, okay, yeah, these are good, these are bad. Kind of just glancing at metrics and comp tables. I think unfortunately you’re either kind of all in or you take a bet and put it away. And that’s kind of my best advice to retail investors that are thinking about the sector.

But again, I will say some of the retail investors that have reached out have done a lot of really good deep research into the space. And so it’s certainly possible, but it just takes a lot of time.

One thing – I know we’re getting to the end, but I will say like a lot of people are going to think this whole podcast is ridiculous because we basically have talked about fundamentals and analyzing these companies fundamentally. And most investors should be very wary, I think, any times stories change. And where the story that companies tell changes over time, they should be wary about why the story has changed or the story on a sector has changed.

And so the story originally with cannabis, I think, U.S. cannabis was look at limited licenses. Why are limited licenses important? Well, prices stay higher for longer in limited licenses. Okay. Now, the story is kind of, well, actually we need 280E to be gone to make money. And now the story is transitioning to, at least a big part of it in a lot of from what I see is, well, institutions can’t play. And when institutions get in, that’s going to — more liquidity is going to raise prices and these structural arguments.

My spidey sense goes off when I hear stuff like that because I think as soon as one variable moves, there are other variables that move. And so one of the things that I keep watching is, people I think some of the people on Twitter are amazed when we have inflows into MSOS and yet the stock prices are down on the day. I think people really are sometimes missing the fact that, if inflows come, there could be people ready and willing to sell these stocks in volume and stuff like that.

And so I get that a lot of people that listen to this might just think that it’s absurd, but I think people that are engaging in that kind of like speculation are taking a little bit more risk than they realize.

And I’m sure I’ll be called an idiot. This wouldn’t be the first time, but I really think that those kinds of, that’s going to be a way of potentially losing a lot of money for the people. And it frankly has been a way of losing a lot of money, I feel like over the past year. So yeah, that’s my general thoughts on that.

RS: No, look, I think anytime you put your opinion, especially what the more unvarnished it is, you’re going to get love and you’re going to get hate. And I mean, you say that some people are going to laugh and I have no doubt that they will, but I think part of what’s so important to do in this industry and in investing in general and in life in general is to be as informed as you possibly can and to also use your common sense, but also to recognize that there’s psychology afoot, there’s animal spirits, there’s a lot going on in the marketplace that we can’t account for or even when we do account for, can’t always factor it in.

I think, I know that we’re already past our times, but if you would give another like minute or two, and I don’t know if you have an answer to this, and I don’t know if it’s even a worthwhile question to ask, but it strikes me when we’re talking about the evolution of analyzing the industry and how we’ve needed to evolve and adapt along the way, I’m wondering in terms of the companies that are involved in the industry and the executives leading those companies and the executives that have led the companies.

How much do you think is known in terms of the fact that let’s say when they’re focusing on 280E, they’re not focusing on debt when they should be. Are they missing the point? Are we missing the point? Has it just evolved? Is it get your money now and we know that we’re going to be able to get our money now and then we’ll be able to get out? Or is it just this is the nature of investing and there’s wins and there’s losses and there’s risk and there’s reward?

JD: Well, I’m fairly critical of the executive core of the industry generally. I think, frankly, Ben Kovler has talked a lot about 280E, but it’s always, I think it’s been framed a little bit differently. He’s talked about it consistently from the beginning, I think. And he’s always talked about capital allocation in the same vein. And he’s talked about capital allocation, I think, pretty much from the beginning. And you can kind of see that his pattern of action lines up with what he said.

With other executives that I think if I’m being particularly glib, I would say that you could, if it were a more efficient market, you could probably long short, you could probably short the executives that talk about being in Washington, D.C. more than others are working on say banking. You could probably see that’s probably an indication of how much they matter to the actual business of the company. So I’m little bit skeptical there. I think a lot of that is not particularly productive.

And I think some of it is definitely to cultivate an image of someone being very close to the political process. The problem is that people that seem like they’re close with like they don’t have, I think a couple of years of history has shown that they don’t really have much more information than the rest of us in terms of how to predict these things. It’s still very random, very subject to like these random events of God knows what, like it’s cannabis. There’s always going to be something.

You don’t know exactly what it’s going be, but you should always be banking on, okay, well, 1 out of 5 of these, if 5 states go Rec, that’s great, but 1 out of 5 is probably going to be very, like going to be delayed. For whatever random reason, these things just have come up regularly. People should be able to forecast that. So they shouldn’t be particularly surprised when Virginia goes Rec. And then suddenly there’s a huge delay, right? We didn’t know that that particular thing was going to happen, but you could probably guess that that class of thing was going to happen sooner or later. Right.

So I think, yeah, I think, I think frankly, a lot of the executives in this space stick around because of momentum and because they don’t have particularly strong Boards that are able to get them out. And frankly, I don’t think there are a lot of, there’s a very short list of people that would actually be good at running these companies, to be fair.

But I think a lot of these executive teams are not going to stand up to institutional scrutiny in terms of their past decision-making because generally people that have made significant — a pattern of repeated bad decision-making in the past probably doesn’t bode well for the future.

RS: Jerry, I appreciate you. I hope you’ll come on again soon. I’m going to hold you to it if you say it out loud here. Will you come back on soon?

JD: I’m happy to. I do want to say one last thing, and we try to make this clear in the letter too like, I know I sound like a permabear on some of this stuff. We are not bearish on this industry. We think that the value, there is a significant opportunity for underlying value creation. We think some of the companies that are most talked about are actually going to be some of the companies that create a lot less value than people think.

But for sure, we are very positive in general on this, on kind of the trajectory of the industry and kind of where it’s all been going and just I think it’s good for society. It’s going to ultimately be good for businesses. Like this is a very natural business cycle that will shake out and things will get more efficient. But I certainly don’t want people to come away thinking that like, you know, we’re down on everything that we don’t hold in the space. That’s not the case.

RS: Yeah, and I think also, as a listener and as a reader of your words and thoughts, I would say focus on what you’re really saying and don’t just focus on that there’s some negativity. I think it’s more sober thoughtfulness as opposed to a lot of hopium that we’ve been accustomed to, especially in this industry. So I think we should all and can all benefit from a lot of sober analysis and I don’t shy away from it, even though it sometimes is less exciting to tweet about. But I appreciate it.

JD: Rena, just one last thing. I’m sorry.

RS: No, don’t apologize. The floor is yours.

JD: Thanks. So when I talked about Curaleaf, and as I was playing this back in my mind, I want to be very clear on this. When I talked about Curaleaf, I talked about the Chairman being connected. I want to call it out. Okay. So Boris Jordan, the Chairman of Curaleaf, there are very fair things to criticize Boris Jordan for. The way that I phrase my comment, I would hate for it to be misinterpreted.

So the way, unfortunately, some of the criticism of Curaleaf, when I see it online is there are xenophobic bigots that will go after Boris for being “Russian”, whatever. This guy was last I checked, born in America, he’s an American citizen. Even if he were Russian, it does not matter. That kind of xenophobic bigotry in the investing community is disgusting. So I just want to make it clear, like, that’s not — I was referring to the fact that he’s clearly been a successful business person who has a lot of connections to capital, that kind of stuff.

I do want to call out that there is plenty to criticize Curaleaf for, that line of criticism of this Boris Jordan as a Russian plant criticism, conspiracy theories is not one of them. That is disgusting. People need to cut that stuff out.

RS: Yeah, agreed. No hate in our name. And I would echo all of your points, not a believer in reasons to spew hate. It’s completely unnecessary and cruel.

Anything else, Jerry?

JD: Thanks for the time. Would love to come back. We can do a group podcast, me and Julian.

RS: Yeah, awesome, awesome, awesome. I like it. That’s kind of where my head was going to next time also.

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