Last time, we saw a relatively good operational quarter. And we expressed concerns over a capital structure that ostensibly allows CEO Charlie Bachtell to operate Cresco Labs ($CL) as a private company. We’ve seen their overhang creep up – as their share price quadrupled during the course of the year.

The volatility this week (brought by NY’s roll-out of 4-Tier regulations and caps on retail, along with suggestions of shenanigans at $GTII) has seen their share price high of $20 now back to $15 as of writing. And while you’ve heard me go off about volatility lately, let me offer yet another another way to think about it: what do you need to be compensated to tolerate that level of risk to capital loss? That’s an operative question, because it’ll force you to think about actual returns and exit points. If one truly believes….over time….. something is always going to go up, or, that assets are fundamentally mis-priced by the market: you have ceased investing and joined a religion.

Regarding $CL’s capital structure, One of the original founders (Joe Caltabiano) quit a year ago – and had held some 20% of the redeemable units in Cresco (which convert into proportionate voting shares no less). I’m curious to see if those were collapsed. I’m also curious to see if there was much movement in SBC and the Supers and such. I’m also curious about movements in their derivatives, and to see if that bullish share price has whipsawed any of their liabilities.

To the financials!

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• Cash up $80MM, inventory up $30MM. SG&A blew out by $22MM QoQ. I’m gonna tap out early here on operations, and defer to GoBlue’s fulsome ‘Quarter in Pictures’ on $CL.
• SBC backed up to $5.7MM in Q4. I might have thought they’d have taken a hard dip of it given share price accretion over Q4.
• There was a negative $20MM in ‘Other Expenses’ QoQ. Its’ contingent consideration linked to $CL’s share price for the Valley Ag acquisition.
• A boatload (22MM) of ridiculously long-dated optionality in stock options. 3MM of them at $1, expiry up to 2026. Average price is around $4, average tenor of 7 years. Extremely inelegant. Overhang from these alone doubled during the quarter, and notional amount has gone up to $140MM from $60MM Q prior.
• 6MM warrants at $7.80. I can’t find any tenors on them.
• That $14MM in expense (from a lawsuit) probably came from Caltabiano’s exit. There was a reduction of some 5% in the ‘Cresco Labs’ non-controlling interest (NCI) as well (~=15MM subordinate shares). Might have been him walking.
• That NCI? A full 50% of the Cresco Labs LLC subsidiary – $CL’s primary operating division with $688MM in net assets – is not owned by subordinate shareholders.
• Some of those hefty proportionate shares were converted during 2020 , which resulted in the creation of 10MM new subordinate shares during the 4th quarter. Might be Valley Ag too.
• This is one of the reasons I wouldn’t rely too heavily on traditional SBC calculations as a gage of a CEO’s self control on taking compensation – especially around companies that have founder’s equities stuffed with conversion ratios.
• I mean, subordinate share count went from 74MM at the beginning of the year to 194MM by the end of it. And there remains another 126MM of them (in a state of ‘redeemable units’). Thus, this company (at a $15 share price) is packing a $6B market cap.
• It had sales of $475MM, SG&A exceeded gross margin. And it lost $82MM during the period. Those are simply statements of fact.
• Yep, growth and expansion and such is the thing. What I suggest you watch is GoBlue’s measures of changes in sales and EBITDA velocity. Growth of revenues QoQ – and whether its’ accelerating or slowing down – is an especially critical measure now that we have a good range of data points.

Ok.

The ‘OCN’ loan – which we noted in early 2020 as being pretty expensive money – was revised prior to repayment. I’m not sure of the utility of packing around a 27% interest rate on debt to be honest, unless of course you see that as cheaper than issuing equity at the time. Share price increases smooth over many potholes, as a far higher priced equity issue (and their cash position) has greatly improved. Still, with $30MM/yr in interest expense….:

CEO Bachtell emphasized on the conference call that branded products and wholesale distribution of those products are the two verticals that Cresco’s thesis is built upon. I’ve not heard any other MSO address 4-Tier regulation, but Cresco did step up – even if only because their conference call was timed with announcement’s by NY State. I recommend you read the transcript, the analysts put some good questions in, always I nice to see.

My take is that $CL got caught flat footed on the development of Tiers. The intro – likely prepared before NY’s announcement – included that reference to ‘wholesale distribution’ – which – in a Tiered commercial world, is like describing oneself as being ‘wet dry’. You can be one or the other, but not both.

Interstate trade came up a couple of times, and I think they’ve had some reflection on it. Not only about its’ inevitability, but pointing to $CL’s development of hubs to support distribution. The challenge for them might be more in picking a lane of distribution or wholesale – and how deeply the fusion of them has been concreted into their business plan.

I went looking for signs of this in their financials, and during the year, Origin House’s activities in California have been developing cultivation and distribution in parallel. There seems to have been no regard for segregation of the activities at the county level, as licensing for both within the same counties were actively sought over the year.

Nothing else to say for now.

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 $CL