It’s been awhile since our last Structure on Curaleaf ($CURA) saw the Select acquisition – and $320MM of intangibles/goodwill purchased for some $302MM(!), with potential for another $330MM in earn-outs(!). That’s a lot of potential.

I encourage the interested reader to go through some of our previous research on $CURA – it’s a leveraged shop that’s doing deals ‘aplenty, with many moving parts in the capital structure (we’ll look at this in detail below)

These guys have been on a buying spree since, well, a year. The $300MM they secured in early January was a heck of a number, and they have been deploying it. QoQ: Cash is down $40MM; Inventory up $52MM; PP&E up $25MM; and Goodwill/Intangibles are up some $600MM(!). And now, they’re packing some 660MM shares.

We’ve always had lingering questions about the ‘PT Mass’ transaction, where $CURA’s CEO Joe Lusardi bought a half a grow op for $36k only to sell it 4 months later to $CURA for $46MM. There’s a story there. Perhaps innocuous, perhaps not. I’ve never seen this addressed by the company, and received only silence when I’ve asked.

I referred to $CURA once as being the ‘riskiest’ of the MSO’s’ that I’d been through at that point. Since then, the buying spree and share expansion and BIG acquisitions are coming into the financials…where we can get a better handle on where the company is now.

And $CURA’s a bit of a test. The complexity of the deals isn’t as much unto themselves per se, it’s in their totality and contingencies. No time to linger…..

To the financials!

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• Sales up $80MM, management fee revenue down $15MM (CLMA is now in the family), and SG&A is tracking revenue consistently QoQ and holding at 40%. I’m going to defer to GoBlue’s ‘Quarter in Pictures’ for the operational nuts and bolts this quarter, and focus on acquisitions and the capital structure.
• Executive compensation running around $22MM/yr right now. They can (and do) tout this as being lower than peers. It’s a bit deceptive, inasmuch as many related party transactions exist. More below.
• ‘Grassroots’ was even larger than the ‘Select’ acquisition, coming in around $690MM(!). During the 3 quarters of 2020 reported thus far, Grassroots had $45MM in revenue, and reported a net loss of $1.1MM. Well, there’s that I guess (those values may be only since the July 20th close though, $CURA says its’ a total of 9 months of their fiscal year). More below.
• Blue Kudu – the bakery in Denver they bought for $3.5MM – has reported revenue of $1.4MM and lost $500k so far in 2020.
• PalliaTech – a holding company of dispensaries in the US (I’ve seen 23 claimed) – had previously been acquired. What $CURA did this quarter was buy the final 11.4% of the last outstanding Palliatech subsidiary within a single state (FLA) that $CURA didn’t own. That final 11.4% cost them $29.5MM. More below.
• Professional fees of $40MM so far this year (with a quarter to go). Epic. Harvest Health ($HARV) is probably thinking: ‘hold my beer’.
• Multiple Voting Shares (MVS) hold 15 votes/share, and have control over 74% of total votes. The number of MVS is below 100MM now, Boris having voluntarily converted 10MM of them he held back in April/May (he had previously converted 18.2MM in 2019).
• As mentioned previously, $CURA’s MVS terminates in October 2021. With respect to governance, having fixed sunset/termination clauses around Super Shares (SVS) and MVS is generally accepted best practice. Off the top of my head, I can’t name another MSO that has these clauses other than $CURA.
• $CURA had to disgorge its’ Maryland cultivation asset due to the Grassroots purchase breaching ownership restrictions in the state. Terrascend ($TER) was waiting with a cheque for $27.5MM, and $CURA’s state-level parent company went out the door a month later for $4MM, presumeably to $TER as well.
• Over-hang is relatively modest, at least within core optionality. More below.

There is so much going on with this company, I’m trying to keep strictly to material amounts. With the numbers around $CURA, ‘material’ levels up.

That shopping spree I mentioned is contained within Note 4 (Acquisitions). A picture says a thousand words and all. And this presents only deals from 2020:

And that picture right there says that for $1.19B in cash & shares…..$CURA acquired $213MM in tangible assets.

Licenses aren’t the same as in Canada – limited license jurisdictions and separate classes within them exist in the US – and likely hold much more value than the relatively homogenous (national) Canadian regime. Much is state dependent.

Palliatech is a company not mentioned on that acquisition sheet, but two deals executed this year (January 20 and August 17th) saw the last 22.8% of minority shareholder interest bought out. Palliatech RTO’ed just 2 years ago:

The deal done in January was for $17.9MM, and an identical looking deal done in August went for $29.6MM. Just for waiting, the latter party walked away with $11.7MM more. What gives? Has Boris gone crazy? Nope: he was dragged through arbitration.

In December 2019, the holdout initiated legal action against Boris and $CURA for – among other things – breach of contract, civil conspiracy, breach of fiduciary duty, fraudulent transfer, and probably desired above all….the plaintiff wanted to open the books. Hearings for it were held in the ‘Complex Business Litigation Section’ of the Florida Courts (natch).

The January deal (that was agreed to by both parties) came a month later. In February, an arbiter brought forward by the court proceedings ordered that $CURA purchase the remaining 11% from the minority shareholder. In March, the minority shareholder dropped yet another suit on $CURA, I can’t see much of it though….it’s been since disposed (closed). The whole affair appeared to be settled when the second deal was done for the $29.6MM.

Despite materiality or not, the story presents a look at the undercarriage of the business world. It’s not all pitch decks and sunshine out there.

‘Related Party’ appears often throughout these financials, like all that have come before it. It’s a theme through many of the deals and leases and counter-parties that interact with $CURA. Nothing around related party disclosures should be necessarily seen as ‘bad’. Often people in an industry move around it, and executives tend to be the folks who like to own companies and invest as well. For me, a ‘few’ transactions is one thing, ‘many’ is another. It’s an open question to me which way related party deals should be viewed at $CURA. On the face of it, PT Mass and its’ new baby brother (Verdure) beg questions.

We get to see more of the PT Mass deal, but only in how $CURA’s liability is being satiated. There were milestones attached to the deal, and $25.7MM of the initial $46MM remains outstanding. Now you know interest cost attaches to contingent liabilities:

Another similar deal was done with another ‘MOT’ (MEOT this time) who was under a master service agreement (MSA) held and run by $CURA. July of this year saw a company owned by Joe Lusardi (Verdure) assume this master service agreement from $CURA, and in that same month, Lusardi sold Verdure to $CURA for $8MM with a potential $2MM earn-out. There’s a reference to residency requirements and economic control around MEOT in the description. The whole thing could boil down to being a mechanism to bridge regulatory requirements, but again, it begs serious questions. I’ll find out more via filings and if I get a reply from Investor Relations this time. Verdure looks very similar to the on-boarding of PT Mass (which became CLMA). At least the shop made money over the year…but access to cannabis revenues typically attract much higher values than $8MM:

In February of 2020, Maine allowed medical cannabis companies (previously only allowed as non-profits) to be converted to for-profit businesses, subject to residency requirements. MEOT above – and another cultivator in-state (Remedy) have come under $CURA’s banner in similar fashion, with Remedy being able to be bought for $2.4MM when $CURA’s ‘residency’ is established. That $2.4MM is forgiveness of debt.

These are extremely cheap notionally. As to why there’s litigation surrounding operating and supply agreements? What it looks like from a distance: Distressed not-for-profits/independents seeking help turn to professional management/grow companies, sign MSA’s, become indebted, do a deal. 2 years later, the whole thing blows out, other people get rich, and the earth becomes well salted. It’d be consistent with some of the litigation I’ve seen in California, Washington, Oregon, Michigan, and Florida. Blue sky musing here though.

‘Overhang’ is what TheCannalysts use to describe optionality – I describe it here:

The non-contingent core overhang I calculate is $293MM based upon options (6 year $3 average strike) and RSU’s. Beyond that, it gets somewhat subjective. Will Select and Grassroots be able to hit the numbers that will unlock that $600MM in goodwill $CURA paid for them? Will revenue unleash earn-outs that almost match cost of initial acquisition?

When I extend the calculation around the contingent consideration I can see, I calculate a total overhang of $892MM ($CURA’s irritating here, listing contingencies variously as ‘earn-outs’, ‘conditionally convertible’, ‘contingent’, ‘option rollup’….among other terms). This figure is pretty napkin-level, as the span of these financials is broad and activity is high. What it does reveal is that overhang is not inordinate (at least compared to a Canadian LP). I’ll do an overhang comparison of US MSO’s over the next week or two to establish some perspective. It may be revealing, or not.

One thing we can see is shares reserved for stock options. $CURA’s kind enough to disclose this number quarterly, and options that have been reserved by quarter are (Q0 represents current financials):

• Q0: 73.3MM
• Q0-1: 58.3MM
• Q0-2: 58.6MM
• Q0-3: 52.2MM

This says that $CURA’s ensuring that the maximum of options available to be issued and outstanding is at the ready (the amount is capped at 10% of total share issued and outstanding, per $CURA’s charter). This also represents a first – I can’t recall any other MSO doing this. Does this suggest Boris is going to light the options up like a sailor going on shore leave? Probably not, but there should be a simple answer to why someone would keep so much ammunition stockpiled, and a shareholder should want to know if there’s intention.

The number that jumps out of their Statement of Cashflow – which reports the amount of equity issued by $CURA during the last 3 fiscal quarters for acquisitions – is $955MM(!). The closest analogue we’ve seen in cannabis would be Canopy Growth’s shopping-rampage under Bruce Linton. But. the US isn’t Canada:

Legal cannabis in US is not the same as in Canada – across texture, scale, state compartmentalization, corporate redundancies……functionally, it’s a very different operational environment. The ability to unlock state-level brands and nationally exploit them is a big hinge that many of the large MSO deals are relying upon. Select and Grassroots being 2 of them (‘Cookies’ is a brand showing national promise).

Looking at companies in heavy acquisition mode is like stirring up the bottom of a fish tank: for a period of time, it’ll be hard to get a clear view of all that’s going on. I mentioned at the beginning that the innate complexity isn’t in individual deals, its’ in the whole.

GoBlue has had a look at incremental margin contribution from acquisitions (at least, what can be seen), and we’ll be waiting until next quarter to see if that Select and Grassroots – and the plethora of other acquisitions – begins bringing in the $dough$. Their sales expansion has been impressive.

Look next time to see if that growth and margin trajectory is sustainable, and if they decide to keep maxing out the credit equity card for more assets.

In my opinion, the operating landscape that MSO’s live within presents enhanced risk. This is due to tensions around different state regulations, the barring of intra-state commerce, federal illegality of cannabis, banking regulations, and hard regional disparities in supply/demand. The earnings models and DCF calculations supporting current valuations assumes this all goes away at a point in time. I’m pretty confident that it ultimately will.

But to pick a date it’s going to happen….or to believe that the Democrats will be ‘coming to Jesus’ around cannabis the moment they get the keys to the White House……is folly in my eyes. The froth in US MSO’s right now is heavily weighted to expectations of a federally unified land of milk & honey (buds and shatter?) coming any day/month/year from now.

Should you be thinking about entering MSO exposure, know that most of the money you’re putting into one is based upon these expectations. I suggest reflecting hard on that before pulling any triggers.

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 $CURA or $TER.