This piece is going to focus less on this specific operational quarter…….and more on the ownership/capital structure of Cresco Labs ($CL).

Our last look at $CL was back in March 2021, during a frothy period in legal cannabis. N.Y. legislation had just dropped, and the Democrat’s comprehensive cannabis legislation <coming soon!> was still a twinkle in Chuck Schumer’s eye.

And we’ve been on $CL in terms of research. GoBlue laid out his “Quarter in Pictures (QIP)” on their recent June 30, 2021 financials, and those QIP now offers 9 data points of research. We have 5 Structures up – and importantly – I went deep on their optionality calculation last February (that article also contains an extended discussion around asset valuation, cost of capital and rate of return).

$CL seems to attract a fair share of ‘undervalued’ comments from both retail and the ‘inter-generational wealth’ sell sides, like this Jefferies analyst (I think that’s a seriously bullshit sell-side fish-wrapper. Keep reading, and I’ll explain why).

GoBlue mentioned Charlie Munger the other day, a Buffet-esqe sized figure who once coined the term ‘Lollapalooza Effect’, which in essence – identifies the drivers of irrationality.

By claiming something is ‘undervalued’ relative to its’ share price, the person is really saying “the market is wrong”. And irrational. Or, hey…..let’s be more charitable: “the assets are currently mis-priced”. What if many people are saying it? By several of the common measures of price to earnings and market cap to sales – $CL does indeed lag ‘peerset’. Could there be a genuine reason?

Subscribers will likely have a pretty good weathervane for what those reasons might be, but let’s look at it in detail.

$CL packs several notable ‘features’ within their capital structure, as well as a substantial amount of aggregate assets of ‘Cresco Labs’ proper not being owned by common shareholders. TheCannalysts first picked this off in January 2020 – where a useful graphic from their Annual Information Form (AIF) illustrates where the common shareholder lives within $CL’s corporate structure. If you’re a common shareholder, that’s you in that teensy box in the upper left of this image:

GoBlue expanded on the notion of ‘Net’ versus ‘Comprehensive’ income in an exceptional piece detailing EBITDA use and drawbacks in the presence of non-controlling interests (NCIs). I encourage you to re-read this before we go on.

How several MSO’s have formed is a pretty common story: someone owns/acquires an interest in a cannabis dispensary/cultivation/processing business, and then sells it into a public company.

Curaleaf ($CURA) is a relatively clear example, as we saw then CEO ‘Big’ Joe Lusardi acquire a minority interest in a collective called ‘PT Mass’ for $36k, and subsequently sell that interest to $CURA for some $46MM 6 months later. Similarly, an outfit called Palliatech – the outfit that ultimately became $CURA¹ – saw a minority shareholder from initial formation litigate their way to a good sized payout from $CURA to acquire those remaining holdings.

$CURA has executed similar deals in New Jersey and Maine.

Where $CL differs is in their use of ‘Redeemable Units’ – which came into existence when $CL’s RTO was executed. The founders – in exchange for their interest in the initial company – were given redeemable units which could be exchanged for $CL stock at no cost. But. They retained ownership via those Units in subsidiary called ‘Cresco Labs LLC’.

Thing is, the subsidiary held the bulk of assets of $CL proper. And $CL only owns ~=50% of that subsidiary. From their Annual Information Form of March 26, 2021:

Variable Interest Entities trigger a slightly different accounting treatment under IFRS. They are defined by the nature of who directs the operations of a subsidiary with NCI’s. Since $CL proper performs operational decisions and activities, their ‘stake’ or returns from operations are ‘variable’ based upon the decisions they make. IFRS permits consolidation of subsidiaries within this context. Hence, when you see $CL report consolidated – that’s what you get:

From $CL’s latest financial statements – Note 8, Share Capital – we see that common shareholders actually own only $200MM out of a total of $1.3B in Non-Current Assets, the rest owned by Cresco Labs LLC:

As GoBlue pointed out to me……from a credit standpoint, note that from that Corporate structure above how Notes are assigned within $CL proper. They attach under Cresco Labs LLC – not to $CL….and thus to the assets. It’s a tell:

The total NCI percentage has been trending down over the past 6 months, as redeemable shares are tendered for $CL shares at no cost.

Overall – what this says, is that of $1 in EBITDA, common shareholders are only getting 56 cents of it. The rest is going ex-company – into the LLC. Put another way, if $CL reports $1.00 in EPS, shareholders only have $0.56 of it. Cash wise, leakage is possible. We’ve seen companies pay the income taxes on founder’s gains. There could be distributions, grants of warrants or convertible debt….or a different mechanism. Perhaps earnings could simply accrue in the LLC. Still, common shareholders can’t lay claim to anything above the ownership percentage.

So. If one is to hear ‘undervalued’ in terms of $CL’s current share price, you might want to reflect on this.

Of all the excuses of why MSOs – and particularly $CL are stuck in the doldrums (they are a’plenty) – I think the ‘why’ as to $CL is ‘undervalued’ relative to peers is pretty simple. To argue against that needs to assume that TheCannalysts are the only folks in the market who are aware of this capital structure, and that Institutions (you know, like BMO/8Capital/Cannacord/RBC et al) aren’t.

As if a formal equity desk with a full complement of analysts and a $250MM+ trade book – won’t see this too – is fanciful in my eyes. We don’t need US Institutions to tell us this either simply by their absence in market. They will sure as hell know it too. And I’d believe that anytime $CL starts poking its’ price head up, trade desks will be whacking it back down, taking money from those who believe this as ‘undervalued relative to peers’.

Blue and I agree that when Schumer’s legislative laxative is administered, we’ll see an in-rush of capital – similar to that rush and euphoria we saw in Canada during headier times. Indeed, I have little doubt, and will be positioning myself accordingly. For subscribers, I see 2 MSO’s right now (that I don’t like per se), and believe will show great leg a quarter or two from now. And I’ll be looking see if I can’t work a position into timing the catalyst of Schumer rolling out that regulatory hill he’ll die on.

They’re coming up in Structures I’ll be posting next week, and I’ll be sure to point them out then. Have a great weekend….mine is gonna be busy. Much more to come.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in any of the companies mentioned.

1 Joe Lusardi was also CEO of Palliatech when it was founded. Rabbit-hole warning: some Palliatech/$CURA backstory is here, and some additional about another $CURA founder better known for illustration, art, and commercial design…. Dimitry Schidlovsky)