Three Secret Killers of Cannabis Profits
A lot of focus in cannabis is on metrics such as grams per square foot of production or ASP (average selling price) of branded 1/8ths. Companies that can push their metrics on cultivation or generate more revenue out of less sq. feet of retail compared to their peers are rightfully usually awarded higher multiples by investors. But just like early Canadian cannabis giants were able to garner huge valuations just by having more canopy, many investors may be missing the boat when it comes to looking a little bit deeper into companies today. We are now entering a world where companies are starting to be judged more on brand value and shelf space, so we think it’s important for investors to understand how the operational efficiency of a company can be a massive competitive advantage, or a cost burden that prevents a company from maximizing profitability.
The Secret Killers of Cannabis Profits
Packaging: Packaging and compliant labeling is one of the biggest challenges in cannabis today. I talked to the CEO of one of the largest private cannabis companies in the world last week and he said, “I’ve figured out pretty much every hard part of this business, but for the life of me I can’t figure out how to get the right packaging at the right price, at the right time”. If a well capitalized and global leader is having these issues, imagine what less capitalized companies with more junior teams are dealing with on this front?
Accounting & Audits: I would venture a guess that 90% of cannabis companies are short on qualified accountants and bookkeepers. It’s certainly an additional challenge dealing with how to account for the wonkey cannabis tax laws with 280E, cultivation taxes, and other landmines. I am not 100% sure if that scares a bunch of accountants off from moving into the industry, or CFO-level talent just doesn’t want to take the risk with signing their names onto financials due to some parts of the business still being federally illegal. But one thing is for sure, every company from the biggest in the world to the smallest are having a lot of trouble building out A+ accounting teams unless they are willing to pay a small fortune for it. Countless companies in the space have failed M&A due to not having proper books, and other groups have not been able to close their next round of private investment for the same reason. Since consolidation is a huge part of the industry it really prevents those companies without their accounting in order from making potentially strategic moves beyond their own organic growth.
Marketing: Companies in cannabis are significantly handcuffed when it comes to the marketing that they are allowed to do. Plant-touching firms cannot advertise on Facebook, Twitter, Google, and other display channels online. They can’t put up signs within certain geographic proximity to schools or churches, and cannot do home-mailers without taking certain precautions to ensure they know what percentage of their audience are over 21. These laws mean that companies often either just opt not to advertise at all, OR they have their costs go way up because they have to compete for limited outdoor billboard space, or use an expensive agency to protect themselves to navigate the complex regulations. This is likely one of the main reasons that despite tens of billions of dollars flowing into the industry, why so few nationally recognized brands have really emerged in cannabis. On top of all this, due to current 280‑e laws, marketing expenses cannot be easily deducted from revenues, making marketing an even more expensive proposition.
So as investors, it’s important that we dig under the hood and figure out how a company or brand we are considering to invest in is handling these tricky challenges. The big MSO winners will likely be some of the most efficient players in these spaces as they try to replicate their processes and leverage buying power on a massive scale across the country. For the smaller private companies, keeping their overall costs in control by ensuring their packaging is compliant, their accounting and audit controls are in place, and their marketing budgets are in line with their revenue expectations will be key to their success.
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