In our last look at Glasshouse Brands (formally known as ‘Mercer Park’) ($GLAS.A.u), we noted a relatively complex state of structuring, and uncertainty in their ultimate initial cash holdings. It’s come in at $134MM as of these financials (I’d expected it around $140MM with the issuance of preferred shares and warrants:

We’ll come back to this later.

What prompted me to follow up was a deal announced earlier this month by The Parent Company ($TPCO) who spent some $56MM (contingently) on a basket of 4 California dispensaries, one under development, and 4-7 incremental ‘Delivery Areas’ (CA’s version of retail/wholesale distribution license, I didn’t go into the guts of the deal to identify specifics). Although I don’t have individual asset breakdowns, I’ll estimate those storefronts coming in ~=$8MM each <NB: the pricing disparity on storefronts compared with the East Coast is profound, as we saw yesterday with Jushi Holdings ($JUSH)> .

The outfit $TPCO is buying is called ‘Coastal’ – which according to their website is only three years old. The deal is an absolute behemoth – clocking in at 84 pages – before Exhibits….which adds another 60 pages. It’s got the standard Master Service Agreements installed – the mechanism with which dispensaries are absorbed (during acquisition, BuyCo runs and finances the operations….. and charges a fee until title transfer takes place). There’s only $16MM in cash involved at this point, with an option to buy a 5th dispo that Coastal has a minority interest in down the line. $TPCO prepaid half of that option cost up front ($4.5MM), so it looks like a pretty firm commit. You can find a short form on SEDAR under ‘Material Changes’ – but for the propeller heads out there, I recommend having a look at the Master document. I think it provides a lot of insights into the nuts and bolts of business.

I mention this deal, because $GLAS.A.u is likely going to be emulating $TPCO in several ways. Our last Structure on $TPCO saw earn-outs getting trimmed and optionality littering the books – and this is where I think the two stories are going to collide on several levels. As well, if there are 2 relatively cashed up outfits on the hunt for assets – we might see some price runs as they strive to get into position.

At any rate, I see I missed $GLAS.A.u’s last quarter. Likely because despite much heat and smoke, a $60MM/yr run rate in CA is pretty whoopee shit for what this SPAC came online with. I expect there will be some hard dealmaking to get them into ramp from here. They closed the Glasshouse deal proper in mid-September, and sent a “Dear Shareholder” letter out a couple of days later (If you can find that letter, good on you. I can’t – and ended up in a closed loop between SEDAR and their IR portal). Other than that news, there’s been nada.

Previous share price resilience is gonzo now. Having survived the Follies of February, the market finally saw some numbers out of them, and it doesn’t look like it was terribly impressed. It looks like the redemption train came into the station, and parked it:

SPACs are complicated arrangements. Despite an internet troll yelling at me they’re ‘different’ than traditional equity: they aren’t. They still have optionality, they still produce earnings and profits – where they differ is in initial formation and birthing, with different mechanics and unique forms of optionality. ‘Redemptions’ by initial investors is a big factor. Once de-SPAC’d – they are identical to any other equity out there. That price chart above is a roadmap – and perfectly illustrative. Valuing the assets is no different than valuing any other asset

Let’s see what happened over $GLAS.A.u’s second quarter of fiscal 2021.

To the financials!

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• Sales increased to $18MM, up $3MM QoQ. Not exactly rock n’ roll.
• Margin 46% – a good number, in line with top of peers on the West Coast. An 11% increase QoQ too.
• SG&A comes in around $7MM, and marginally profitable at the EBITDA level. But for $2MM in Professional fees ($3.4MMM Q prior), they’d report a positive line from operations. A/P at $19MM.
• Cash at $134MM. Interest expense a modest $4MM/yr at the moment.
• It took 3 different statements and 2 separate notes from SEDAR to discover that about half of the initial SPAC shares were redeemed. Yeesh. No wonder there was a ‘Dear Shareholder‘ letter. I caveat that by saying it’s complex, and all I can offer is an estimate without another day on this.
• I don’t see it as worthwhile exercise at this point, the share price says it all.
• SBC for the year at $2.4MM, more below.
• The disposition of ‘Field’ – mentioned last time – came in at $6.1MM formally.
• Inventory up $2.7MM to $11MM. Hmm. I’d of thought we’d see some ramp here with as much canopy as they claim to have in production. Something to watch for.
• Both wholesale and retail sales have improved marginally.
• The Element acquisition – an outfit that aggregates licenses and monetizes them at one point had ’17’ of them ready to convert into operating storefronts. More below.

Gads, these financials are complex. Their operations certainly aren’t. We get to see a high level segmentation at least:

There was a cashless exercise of options in late June – this is what comprises the SBC reported during the year as these were exercised just prior to reporting the post-business combination:

It’s in the options we find there’s not a ton of them left, although long-ish dated and still in the money. Everything that was vested was struck. In option theory – one never strikes an option before expiry. The extrinsic value of an option is 2-fold: time value and volatility. Early exercise eliminates the time value – or in other words – one is leaving money on the table:

Their fully diluted share count is around 40MM (with all units/preferred shares included) – and with today’s price, it implies a market cap of only $242MM. Given a similar run rates: 4Front’s ($FFNT) market cap is $681MM; Cansortium’s ($TIUM) is $78MM.

To myself, these two comparative ‘examples’ illustrate the wildly disparate asset pricing within market. I’m positive some operational items are taken into account – but I maintain that existing optionality on their books is a huge driver as well. It’s no wonder Cantor’s Pablo Zuanic dropped DCF from his models.

And here’s where I’m gonna agree with a sell-side quote, put up by a stock promoter in the space, who tweeted this image out earlier today:

Yep. I think it’s a good quote, because it includes a time horizon, and a return level that is visible. (It also nullifies the silly notion that Institutional investors aren’t in the space).

One of the first lessons in Finance is the ‘8 in 8’ rule. That if one put’s down money and gets an 8% return/yr on it, the money will be doubled in 8 years. I gun for that, inasmuch with risk weighting and variability – if this is one’s ‘floor’ investing returns, you’re doing just fine.

If you make a 25% return/yr, your money will double in just 3 years. From an investing perspective, that’s a beautiful thing. And far more realistic than the promises of moonshots and yacht shopping. Or the nefarious open-ended ‘generational wealth’ trope sell side has been peddling.

So. Given I see and have calculated several dozen Cost of Capital (CoC) rates in the legal cannabis sector (both north and south of the US border) – I’ve seen values from 18-34% thus far. Should the legal industry continue to forment and regulatory becomes certain – I can easily see the broader market and fresh capital come in……along with sales expansion and all of that good stuff. If companies can grow into meeting their CoC – access broader capital pools (regulatory certainty will fix that fast) – then their cost of capital will come down and equity prices (in theory) will capture the risk inherent in CoC, and put it into asset pricing.

If I see a company with a CoC of 25% – I want 25% rate of return on their equity to make me wear that risk. The quote from Emminence aims higher (~=40%) – but at least it’s honest in terms of level and duration.

That’s where sell side fails most often: not setting actual risk/reward levels (along with and not disclosing financial interests).

While that might seem a little off-topic – I think it’s perfectly on topic for what your expectation should be around $GLAS.A.u in terms of an investment. To get that 300% return in three years, $GLAS.A.u will need to triple its’ share price in 36 months. The best CoC estimate I can give you as to $GLAS.A.u is 27%.

I think the path to seeing those assets triple is in a combination of hard sales growth, increasing/durable margins, interstate expansion via exports, and brand widening. Simple right? No. Because nothing exists in a vacuum – and the confluence of those events is extremely uncertain.

Holding MSO’s for the past year has (in general) seen a retreat to prices that existed one year ago. In other words: dead money. For all of that risk one holds, they’ve gotten nothing. That’s not even a step up from losing money either – because if one could have gotten 8% elsewhere, they’d be ahead of the game. Breaking even after a year’s hold is losing money all on its’ own, let alone share price declines.

When I’m in the right headspace, I’ll present a writeup on the notion of how the existence of zero-priced capital impacts asset valuations. l’ll include examples of how skewed voting control can discount assets in the market as well.

With respect to Glasshouse – the shine has definitely gone off. They are stagnant over two quarters now, with a run rate firmly in the third tier status. Half of their initial float has left the building. Comparatively – a ‘peer’ in $TPCO – is adding to their footprint, while $GLAS.A.u’ prediction of having “23 storefronts in production by the start of 2022” is gone. Their latest comments about that has been revised to “22 storefronts operating by end of 1st half of 2022”, and that includes ‘7’ Element licenses. They were supposed to merge with them, but Element isn’t even mentioned in these financials. Which tells me it’ll probably form as a JV. I suspect $GLAS’s share price tanking has perhaps delayed/altered the ‘acquisition’. From the previous financials:

$GLAS.A.u will need to start growing their business, and growing it fast. For the $400MM of the initial invest, returns have been negative so far, and returns on the remaining capital will need to be 25% yearly to simply ‘catch up’. That’s what the investor is facing. Can they get there? I guess we’ll have to see what kind of deals they can do, whether their wholesale business starts moving, and whether they can obtain the capital they’ll need to expand. $135MM bucks isn’t enough to convert their greenhouse conversion and to build/acquire storefronts.

I’m not the only one who is musing about these facts. The share price tells me so.

The one thing I’d like you to take away from this all – because I am as bullish on the space as that Eminence guy is – is that there will be growth and winners in this sector – given my earlier contingencies. The reality – is that it’ll very much depend on who you own, and how it comes together. At this point, as Blue rightly asked me on the last podcast, is who is best positioned in each area of the value chain, and able to make the most of whatever situation we find ourselves in.

I believe a portfolio that is able to capture the best positioned in each segment – cultivation, branding, retail, distribution….. in a post regulatory world will do just fine. And we’re working hard to figure it out. As far as $GLAS goes – it’s a West Coast cultivation play for as far as the eye can see.

The preceding is in the opinion of the author, and is in no way written nor intended as a recommendation to buy or sell any security or derivative. The author holds no positions in any of the companies mentioned.