So far we have taken a look at what the US cannabis landscape would look like IF a 3-Tier alcohol system were to be adopted, the impact of the Dormant Commerce Clause, and the impact from timing of excise tax collection and interstate commerce.

When we released our thesis on “Cannabis Viewed Through the USA’s Federally Regulated Three Tier Alcohol System” on March 12, 2021, it was approached by some retail investors as a dystopian fictional future.  Since then…

• NY dropped legislation that looks a lot like alcohol and capped existing license holders (and new entrants) ability to expand retail footprints, and limited distribution to their own products.  We are still waiting on regulations to see what, if any, canopy restrictions will be implemented,
• Professor of Law at Vanderbilt University Robert Mikos’ paper was released on “Interstate Commerce in Cannabis” and impacts of Dormant Commerce Clause, and has been widely distributed,
• CEO Boris Jordan of CuraLeaf put a 3-to-5-year time frame on federal legalization, indicated that cultivation facilities east of the Mississippi would be worthless as interstate commerce would have cultivation located west of the Mississippi (funny, he has 1 million square feet in cultivation and processing east of the Mississippi), and that he would be willing to sell retail operations and focus on brands, and
• Michael Auerbach Chairman of $GRAMF and SVP of Subversive Capital tweeted: The slight delay in Schumer bill is most likely related to FDA v TTB jurisdiction. My money is on TTB winning. Prohibition is ending. Interstate commerce will happen. Social equity and righting the wrongs of prohibition is central to the post prohibition cannabis economy. $GRAMF

The premise of this article:

This is a “what if” article. The intent is to determine scope of risk.

We are going to look at what would happen to an MSO IF the economic realities of excise tax and interstate commerce rendered their vertical retail operations uncompetitive or less competitive, as we proposed in our article on timing of excise tax.  While the severing of a third of the vertical value chain will have obvious implications on Revenue, Gross Margin, SGA expenses and EBITDA, there are other implications that we flesh out below.

If you want to see what severed manufacturing/processing from retail looks like, albeit with a government acting as a distributor, you could look to Canada.  Outside of Canopy Growth, which owns some retail in provinces that allow same, no other major Canadian LP has a retail presence. Gross Margins for Canadian LP’s are well below their US counterparts who get to capture:

• a vertical margin on their cultivation/processing which runs through their retail operations,
• a retail gross margin on other producers’ products sold through their stores, and
• a wholesale margin on their sales to other retailers.

The adding of retail doors over the past years and presently by MSOs makes intuitive sense.  It is a revenue source, it is an outlet for vertical cultivation, dispensaries opened is an easy metric for retail investors to associate with and track.  These are all things that drive stock price and thus makes raising equity less dilutive.

You will notice in alcohol Coors, Constellation, Diageo, and other manufacturers do not own bars or retail outlets. Under federal regulations they are allowed to own 100% of a retail operation, but many states do not permit manufacturers from owning retail unless they are brew-on premises or smaller producers.

With the spectre of possible federal regulation, I cannot shake the fact that adding retail doors at the very pricey present acquisition costs (versus organically) due to limited licensing is akin to Canadian LP’s and the “funded capacity” metric that was used as an equity raise marketing tool.

We have seen:

• Pennsylvania dispensaries being acquired by TRUL for $15-20 million a door in a limited license market with a present retail cap of fifteen.
• Florida 28 dispensaries and 300,000 sq ft grow at $10.3 million a door by AYR. This amount ballooned due to appreciation in AYR and LHS share price between announcement and close to $14.2 million/store.
• MedMen sold 87% interest in New York operations which included four doors for $73 million ($84 million valuation).
• Whereas four Colorado dispensaries and a 3,000 KG/annum grow were acquired at $10.5 million a door by CCHW.
• Chalice Brands (formerly Golden Leaf) bought 5 stores in Oregon for $10 million, or $2 million a door.

We have a range from $2 million to $20 million for acquisition of dispensaries, the low end being the most open market.

What is driving the price of dispensaries is the limited license nature in the applicable states, and the opportunity to be a first mover when adult use switch is flipped.  Should states increase the retail license allocations, like Ontario did after its first two lotteries, and as Illinois has been in the process of doing for well over a year, the value of the retail assets will be under pressure. Scarcity increase value. 

Ontario Store Count and Sales: (from a subreddit Community member criid1)

Consider the value of retail operations in Ontario.  The first twenty-five lottery winners were flipping their licenses for $3-8 million per store in future purchase contracts even before they sold their first gram.  In Canada, we have national chains and they have been big purchasers in Ontario and other markets. There are now over 670 licensed retailers in Ontario. In January 2020, the Ontario fleet of stores plus online averaged C$1.3 million/month in revenue.  In March 2021, this number had fallen to an average of C$0.2 million/month in revenue.

Do not get me wrong, if there were no threats to retail from regulatory meteors in the USA… opening retail doors is good business, and if you can make back your purchase price before the states open widely then that is great.  However, without disclosure at state level by MSO’s it is very difficult to determine if those acquisitions have a 3, 5, or 10-year repayment.

Let us take a look at what we can distill from two Cresco Labs Illinois dispensaries that they do not have full ownership interests in:

(There are always nuggets of information you can glean from Non-Controlling Interests disclosures.)

Lakeview has a monthly Revenue rate of $3.4 million, whereas Rockford is $6.2 million. Average sales per store from the entire CL fleet was $1.3 million per store per month. These two stores are well above that average, showing a distinct disparity in asset class amongst CL dispensaries.  Lakeview QoQ sales increase was +3% whereas Rockford was +17% (Rockford is a much bigger city). Their present annualized rates are Lakeview $41 million revenue on $14 million in net assets, and Rockford $74 million revenue on $33 million in net assets.  That is rather good revenue.  I bet there are not a lot of privately owned liquor stores doing that volume per door. Profitability, as measured via Net Income, is much better at Rockford at 32% versus Lakeview at 7% as a percentage of sales.

There looks to be a transfer price mechanism for the two IL dispos (as well as Ohio and SLO) as evidenced by Gross Profit of 48% and 51% for Lakeview and Rockford, respectively, straddling CL corporate Q1F21Gross Margin of 49%.

These two IL dispos are $30 million in sales in Q1F21, which represented 17% of CL revenue for the Q. If you isolate Retail revenue of those two stores, they make up 37% of retail revenue in the Q of the 24 operating stores.

Both dispensaries are contributing to not only top line growth but bottom-line growth too.

BUT… these revenue run rates will likely look different after the next two batches of dispensary licenses are handed out by IL. 

AND… what does sales, gross margin and net income look like IF excise tax collection is at first sale and interstate commerce gets added to the equation making retail disgorgement a reality.

Retail Licensing:

Retail licensing is the domain of the individual states in 3-tier alcohol.  No reason to believe that it will be different in cannabis. States have been driving the cannabis bus so far, and they will continue to have an influence even with federal cannabis regulations.  Individual states have forced 100% verticality in FLA, whereas other limited license states like IL and MA have allowed wholesaling. 

The individual states, who would be responsible for retail licensing if a 3-tier alcohol model were adopted, could also impose regulations that removed verticality (Change of government in FLA could be an impetus to open FLA to non-vertical competition. There have already been several attempts to remove verticality in FLA which have been struck down by FLA Supreme Court.)  Or federal regulation of no tied house via Trade Practice Laws & Regulations designed “to promote a level playing field amongst industry players and ensure retailer independence” in alcohol could be replicated in cannabis. 

But even without federal or state intervention to directly limit verticality, the timing of the excise tax coupled with interstate commerce could spell the demise of MSO retail operations in states where their cultivation cannot compete with the likes of California, or at the very least minimal further retail expansion.

As we mentioned in our excise tax article, in both alcohol and tobacco, excise tax is calculated on first sale.  In those industries, first sale is from manufacturer to distributor, BEFORE the product has been fully marked up to the consumer retail price.  In a vertical MSO model that first sale is to the retail consumer.  There is a good reason that the National Cannabis Industry Association’s white paper of federal legalization has proposed the following:

• Taxation: Under this proposal, a federal excise tax could be imposed at the retail level on all nonmedical products. While we remain silent on the level of taxation, we again emphasize that the legal cannabis market is directly competing with an unregulated and untaxed illicit market. While taxes should be sufficient to cover the necessary regulatory structure, the rate should be kept reasonable to allow legal cannabis to compete against the illicit market. We further propose that products sold through this lane’s state-regulated medical retail outlets be exempt from federal tax.

Tax at retail sales level does not jeopardize verticality.  Tax at first sale, like alcohol and tobacco, changes the playing field. Couple the timing of excise tax with interstate commerce and you get a situation that any uncompetitive cultivator (cost and quality) on a national basis feeding their own retail store becomes less competitive.

CURA CEO Jordan also indicated that he could sell his retail and focus on cultivation, processing, and distribution of CURA brands.  However, if 3-tier alcohol is adopted at federal he will likely have to choose between cultivation/processing OR distribution, as federal regulations in alcohol allow you to be one OR the other and not BOTH. 

Is this possible outcome going to change current short term direction of MSO’s?

Not likely, at least without the threat being put on the table in earnest.  They need to raise cash to fund expansion, and in order to do that they must show the best current financial results possible.  They will likely look for retail outlets that offer faster payback of investments.

Until a regulatory meteor puts a stick in the spokes, or states open the licensing like Ontario did, MSOs will remain largely committed to their retail expansion, at least outwardly facing.  Inwardly, I cannot but help think that the MSOs have plans at the ready should these types of regulations come into effect.

Current Retail Landscape

So far, we have seen Illinois cap adult use retail at ten stores, New York cap adult use at 3 unless you are one of the ten existing medical license holders (then it is 6-8), Massachusetts has a cap of four.  Arizona, which flipped to adult use in 2021, does not have a current cap.

Medical markets:  Pennsylvania medical has a cap on stores at fifteen, Ohio caps at five, Maryland has a cap of four. Florida had a cap which was removed.

California, Colorado, Washington, Oregon are open competition states. 

These caps can and likely will be revisited, but any ambitions of a national cannabis retail chain will be severely limited by these caps and whatever caps might come from further state or federal social justice programs.

In the limited license states, there is also an imbalance between supply and demand, which has driven the price in Illinois and Pennsylvania to be approximately 2.50 and 2.40 times higher, respectively, per 3.5 grams of flower than California, Colorado and Oregon.

When interstate trade happens, in a fairly short time we will likely see a similar occurrence in flower pricing across the spectrum as when Hexo introduced the first value offering in Canada.  Hexo introduced Original Stash in October 2019 at C$4.49/gram.  All the large LP’s followed suit and now value offerings are as low as $3.57/gram. Contrast that to CA at US$7.00/gram or Illinois at US$17.26/gram.

Social Justice and Its Impact:

Social justice in cannabis is also impacting cannabis legislation and regulations. New York has been applauded for its legislation incorporating Social Justice, which will allocate 50% of all adult use licenses to social and economic equity applicants (although regulations have yet to spell out limitations on canopy size amongst other items).

The newly formed Parabola Group recently submitted two different proposals for changes to be incorporated in MORE Act. The areas that would impact MSOs are:

Approach #1:

• “OCJ (Office of Cannabis Justice reporting to Treasury) would have authority over regulating interstate commerce and would be required to study state markets to develop the best approach. The proposal says that could take the form of regional compacts allowing for limited interstate commerce between certain states or allowing only equity businesses to sell cannabis across state lines.”

Approach #2:

• For states that follow certain federal guidelines for cannabis regulation, the plant would only be legal within their borders. Interstate commerce would not be permitted under this approach.

• The proposers say this will “allow state governments to continue their experimentation while giving the federal government time to understand those models and develop its own evidence-based cannabis policies.”

I will not comment too much about these “approaches”… but I do not know how the Dormant Commerce Clause would work if interstate trade is somehow limited.  This might be an area where Congress provides a rare exception in order to make the approach work.

Parabola took the approach of providing two proposals to show the flexibility that could be deployed. They are also taking aim at curtailing BOTH big alcohol and tobacco (which echoes Senator Schumer) but also takes aims at the large MSO’s:

• Without the modifications, they say, legal cannabis sales could end up in the hands of a few large corporations—”putting most small cultivators and retailers out of business.”

• “The key is that both approaches eliminate federal penalties for consumers and patients using cannabis, but they don’t open the doors to corporate consolidation we wouldn’t be able to take back,” Title said. “It’s important not to conflate consumer/patient rights with corporate profits. One is an immediate need and one isn’t.”

Molly had once said, “The Holy Trinity of regulatory Meteor Strikes for present MSO operating models is: 3-Tier Alcohol Model, Dormant Commerce Clauses which brings in interstate trade, and Social Justice.”  Any one of those items could change trajectory of growth for existing MSOs, but if two or more hit…watch out.

What the federal, as opposed state level, regulations could bring has always been fuzzy to me, save trade related regulations from alcohol. Social justice has been a “wildcard” to me if you like.  The Parabola suggestions are interesting as to what they think can be operationalized through federal legislation and regulations.  But what strikes me the most is that social justice measures are intended to do more than redistribute taxes from cannabis consumption to groups impacted by the war on drugs.  Social justice is also intended to limit the traction that big corporations, be it alcohol, tobacco, or MSOs, will have over smaller operators. In alcohol they call for a “level playing field”.  Alcohol does not have the stain of the war on drugs.  There is a chance that the playing field will not be “level” but be tilted via social justice away from big corporations is a distinct possibility.

Any investor ignoring potential implications of social justice on MSO operations is whistling past the graveyard, IMO.

Retail and consumption lounges seem to be the most ubiquitous area in the supply chain, the least expensive to fund startup operations, and will likely be a target for any social justice at state or federal level.  But if social justice penetrates cultivation, processing and distribution… then there will be risks that will need to be explored which is beyond the scope of this article.

I would assume any hard regulations by state or federal authorities on limiting verticality where verticality presently exists would have a grace period to unwind.  States may even grandfather verticality for existing medical operations, which they did to an extent in NY.  But even with grandfathering verticality the economics of the timing of excise tax collection and interstate commerce will likely pressure those vertical stores in eastern and northern markets.

The forces of possible social justice and federal regulations (excise taxes and interstate commerce) could lead to retail operations becoming less economically viable to maintain and/or possibly not permitted.  Thus, making retail operations a likely candidate to be cleaved from existing operations.

And to be realistic, it took Canada three years from agreeing to legalize cannabis to the first gram of legal adult use cannabis being sold.  The US has yet to lay out a proposal to be presented to the Senate let alone “agreed to legalize”.  However, I do think three years from federal legalization legislation being passed to operationalizing is a reasonable timeline.

So, a change to retail operations is not imminent … BUT simply the announcing of regulations that impact present operations will reverberate through pubco valuations.

Repercussions to the Seller/Manufacturer of Selling Retail Operations:

• Receives cash for assets sold but has a corresponding decrease in Revenue $’s, Gross Margin $’s and %, SGA $’s and EBITDA $’s and %.

What I have attempted to do above is take the standalone Income Statement provided from CL Notes on MedMar Rockford and distill the impact on various items AS IF CL disgorged Rockford. A semi-live example is better than me pulling numbers out of thin air.

Note: Presently, as CL controls Rockford they consolidate 100% of Sales and Expenses (and balance sheet items), and then they make an adjusting Non-Controlling Interest adjustment (backing out the parts they do not own) on both Income Statement under NCI adjustment and Balance Sheet Equity section.

Sales would drop, but not 100% of retail amount.  The product Rockford purchases post disgorgement from CL becomes CL post disgorgement revenue. Assuming 100% of Rockford sales were CL product (BIG assumption), then CL post disgorgement would see sales equal to the pre-disgorgement Cost of Good Sold of Rockford.  In the above example sales drops 50% for CL with the disgorgement as a Best Case. Illinois allows wholesale, so this would likely drop further as Rockford is likely selling non-CL brands too.

By comparison, GreenThumb Industries provides more disclosure around retail sales of their own brands in their own stores and competitors brands via “Intersegment Eliminations” (this is very handy). We have tracked this and the GTII stores sell 69% of other producers’ brands in their own stores, an improvement from 74% in Q3F20. So, the 50% reduction in revenue we are using above is likely light and should be lower.

GTII has 56 stores at the end of last Q and only FLA and NY (aggregate 11 stores or 19% of stores) are state forced fully vertical. The more of one’s revenue that is generated from state forced fully vertical states, the more at risk the company is to competitors products displacing them IF the forced vertical is subsequently dismantled by regulations or by economics of excise tax and interstate commerce (TRUL for example has 94% of stores in forced vertical states and CURA 39%).

GTII, if they were forced to sell all their retail operations, their sales would drop in Q1F21 from $194 million to $104 million or -46%. Put another way, of $194 million in GTII revenue last Q… $90 million was derived selling other manufacturers products in their stores. A producer makes a better overall Gross Margin percentage by selling their products in their stores, but they still make a Gross Margin on the retail sales of other producers’ products.

CL reports Wholesale Cannabis revenue and Self Owned Retail revenue.  I would be interested to see what the intersegment eliminations would be for CL. Wholesale alone was $95 million last Q.  If they sold $10 million of their own product in their stores (given their retail revenue of $83 million they likely do), Revenue-wise they would likely be better off than GTII post disgorgement.

Gross Margin is presently 100% consolidated.  Post disgorgement CL CoGS would be their cultivation, processing and distribution costs. CL is sporting an “all in” GM presently of 49% which includes retail margin.  That would likely be a high estimate but using same would drop GM from $9.8 million to $4.5 million. ASSSUMING CL retail pulls in a 50% Gross Margin (as per their NCI disclosure) this would mean their wholesale Gross Margin is 48%. Of their $87 million in Gross Margin last Q, $41 million would be retail Gross Margin. 

Gross Margin Table Model:

CAVEAT: This is a model with one assumption which reverberates throughout the model.  Disclosure from the MSOs would be much better than me making a model.

What I did in the above table is assume retail GM was 50% as per CL NCI disclosure.  I applied that GM to CURA, GTII and CL across their entire retail.  Then I subtracted the assumed Retail GM$ from actual GM$ to get an Imputed Wholesale GM$ and %.  From there I looked at the GM Contribution from each Retail and Wholesale as a % of overall GM.

KEEP IN MIND… the Wholesale GM$ would increase as a function of the market share their products would maintain in their own stores that were disgorged.  Only GTII discloses same and they hold a 31% market share of their product sales within their stores.

CURA is most at risk as they have the highest split of Retail-Wholesale revenue and the lowest actual GM%. Interestingly, GTII and CL would generate very similar GM$. 

I had to triple check my GTII Imputed Wholesale GM% as the figure is remarkably high compared to the others. (This is where I should rant some more about MSO disclosure.) The Imputed Wholesale GM% for GTII is high even without comparison.  I would normally think they are spit swapping some CoGS to SGA, but GTII is the industry leader in SGA. I cannot square why their GM on wholesale would be that high…but there it is. If I adjust GTII retail GM to 55%, their wholesale GM would drop to 61%.  Still high comparatively to CL and CURA when I use a retail GM of 50%.

Selling, General & Administrative Expense is presently 100% consolidated.  The disclosure does not show Opex at Rockford.  This expense would go down dollar for dollar on CL books and would remain on Rockford books.

SGA Peer and Trend latest reported Q:

Aggregate SGA is the figure you want to look at.

GTII is 20%, CURA is 31% and CL is 29%. It is tough to determine what direction SGA as % of sales would go post disgorgement.  One would think SGA% would drop as the majority of retail operating expenses would be in SGA as opposed to CoGS, but with revenue also dropping it is tough to tell.  Dollar wise the SGA costs would decrease.

Net income is presently split 75-25 CL and Rockford other shareholders.  CL would get zero going forward but would presumably have received cash consideration for the sale of their 75% interest.

And back to other repercussions…

• Market for the retail assets might be dampened by social justice measures/caps on ownership on the buyer (eg.  One entity can only have three retail adult use licenses in New York or ten in Illinois. Retail caps under an alcohol system are imposed by the individual States.) A dispensary bought for $20 million today has a much different value if the buyer pool is reduced and more competition comes into the market spreading sales across a larger licensed retailer footprint.
• In order to find a buyer for its retail operations an MSO might have to sell the retail assets state-by-state versus in a one-off transaction if the potential buyer is already capped out in a particular state. Thus, the need for multiple buyers.
• Need for more capital to fund trade terms for retail stores. (Accounts Receivable will increase, although inventory levels might decrease, as they no longer have to stock shelves with their own product.) Although the capital received from the sale of those stores would likely be sufficient to cover this.
• Can no longer count on retailer stocking their shelves with 100% of the manufacturer’s brands in true vertical states and puts pressure on existing listings in states that presently allow wholesale. Expect existing product sales from the seller through those stores to also decline. We mentioned this above. Corporate stores likely place their own products in more desired locations than the products of their competitors. A new owner would be untethered from that constraint. And IF a 3rd party distributor gets dropped between retail and manufacturer (like alcohol regulations), those previous sales for the manufacturer through their previously owned retail outlet are now even more at risk.

The last bullet would impact wholly vertical states like FLA to a greater degree versus states that allow wholesale like IL, as the IL stores will have been groomed to compete with a wider offering than the FLA stores.  The question becomes whether the reduction in previously vertical stores will be offset by ability to sell to a wider universe of stores.  Again, IL is a much better proving ground than FLA in this respect. (Ohh… how I long for state-by-state disclosure.)

The good news, selling a retail operation that are running at $330-800 million annually would likely yield a pretty good chunk of cash.  However, a good chunk of these stores were acquired versus organic growth. Would the dollar value ascribed to the retail outlets be as large as when purchased? Especially if the buyer universe is limited, they might need to be sold piecemeal, and the spectre of increased competition?

Valuing the Retail Operations from Buyer POV:

Valuing those assets for a sale will be tricky, as it will likely not be “business as usual” post sale.  But valuing retail operations has a long history.

• Transfer pricing between manufacturer and retail will have to be determined. In the CL case above, because they do not own 100% of the stores, the transfer pricing mechanism is already set. But on sale of a 100%-owned store a transfer pricing mechanism would need to be established.
• Under a 3-tier alcohol model the manufacturer can not offer material inducements at retail to keep the previous flow of sales assured (5:50 mark of the Tied House video).
  • No vendor takebacks to finance the sale, as it is inducement.
  • No preferred pricing, product SKUs or slotting fees
• Think of the retailer who buys the assets.  The retailer will have product choices without a tether to the previous owner. They will want to maintain and grow sales. Which means putting competitor’s product on their shelves that appeal the most to their consumer.

However, valuing retail is not unexplored territory.  Many metrics exist for retail to be applied to these situations (eg, foot traffic, basket size, accessibility … all standard retail metrics) and these would be compared to the cost of opening a new store.

So, what does this all POSSIBLY mean? If excise tax timing at first sale, interstate commerce and social justice arrive, what are the results?

• I do not see how a truly National Retail Chain emerges with a combination of state-imposed caps and any federal social justice initiatives. Chain’s will be limited to state caps and possibly federal regulations. Unless state caps are raised retail dominance will be regional, and in pockets, and not national.
• The universe of buyers for retail stores could be curtailed, reducing purchase receipts from a sale.
• Should states begin a licensing spree (and licensing is in part where the states derive revenue from), consider the value of retail operations in Ontario and how the business has changed in just over a year.  
• The universe of buyers for retail could be impacted by inability to offer vendor take back financing, assuming the tied house rules from alcohol are adopted at the federal level. This is less relevant for profitable stores (which should attract financing) versus marginally profitable stores.
• The seller of the store should expect sales of its own products through that previous channel to face competition and a likely decline in throughput. Losing approximately 50-70% of current retail revenue and 100% of current Retail Gross Margin is likely, counterbalanced to a degree by a reduction in SGA expenses. This loss of Gross Margin might be offset by ability to put products in a greater universe of stores.
• Without retail operations the MSO’s valuations would drop as Sales and EBITDA decline impacts Discounted Cash Flow models. But would that be sufficiently offset by the cash they receive for the sale of their stores?
• Possible impairments on retail operations.  Just like the Canadian LP’s that bought LATAM assets only to impair them later or built cultivation facilities that were too big… US MSO’s might find that $20 million dispo is only worth $5 million a couple of years from now, or $2 million if open markets like Oregon are the measuring stick.  If during that interval the investment paid for itself then … great!  If not… that is where the impairment would hit.
• MSO’s with stores concentrated in vertical states like FLA are more exposed than states with more competition.
• How big are these MOATS investors keep referring to? If a fully vertical retailer becomes less competitive than a retailer buying from a distributor with interstate access… is that a MOAT? If GTII retail store sales are comprised of 69% someone else’s brand and 31% their own brands… is the 31% the moat? IMO the MOAT is the combination of existing wholesale distribution PLUS the defensible product sales through their presently owned stores. That is the repeatable sales of its own brands.

Short Term 1-2 years: Operationally no impact but a potential impact of a regulatory meteor could make vertical retail uncompetitive even if it is permitted. MSO might slow their retail acquisition aspirations. Social justice provisions at state level will curtail retail expansion within the majority of new states legalizing medical or adult use. Expect MSOs to maintain a retail footprint in each state where they cultivate.

Medium Term 3-5 years: Operational transition would begin. “Choose a lane” may occur in earnest.  Disgorgement of retail a possibility.

Long Term > 5 years: Federal regulations are coming.  Interstate is coming. In my opinion, simply based on possible federal regulations and ongoing social justice I do not see how MSO’s will be able to expand their retail within states. The economic realities of interstate commerce will render lower quality flower produced in state as uncompetitive, and price and gross margin compression accelerate. This later point might slide into medium term should legislation actually get passed in the next 12 months.

How long federal regulations remain undefined is the biggest variable.  The longer the feds wait the more toothpaste they might have to put back in the tube. If federal regulations remain undefined state by state models will continue. 

I believe so called MOATS is of lesser value than the interim profitability of MSOs.  These MOATS are largely their retail presence. I believe social justice alone might curtail the retail ambitions and retail MOATS may not be retained if excise tac collection is at first sale and interstate commerce is opened.

Short term, MSO’s will likely not dial back retail store acquisitions and openings.  It makes perfect sense what they are doing.  These companies need to show revenue increases and in many instances their stores are one of the limited outlets for their products, and in FLA the only outlet.  Plus, these stores in limited license states are likely presently quite profitable as the Cresco example above illustrates, some more so than others.

I would expect that FLA would allow some medical stores to convert to adult use stores, as NY and IL allowed, should they allow adult use in the future. Or at the very least offer a transition period. But the allowing of retail versus economic pressures from regulations that might make self-owned retail uncompetitive are two distinctly different things.

How strange is it that an MSO that has vertical retail could make a better margin on product they purchased from a third party and sold at their store versus what they grew/processed themselves, simply due to the timing of excise taxation.

This exercise would have been so much easier IF MSO’s disclosed their segmented Gross Margin and Opex by Retail & Wholesale. I think Cresco would benefit by comparisons IF they disclosed their intersegment eliminations, without same the investor has to guess at the exposure.

AGAIN, the above is a risk defining exercise to define the potential risk SHOULD certain events happen.  It is meant to help investors quantify the risk to retail related regulatory meteors.

From doing this analysis three things jump out:

• MOATs should be sustainable even after regulatory meteors, otherwise it is not a MOAT,

• MOATs, as investors presently think about them with respect to MSOs, should be redefined as wholesale plus present self owned retail in store market share (manufacturers brands).  To include a retail footprint in present day MOATS, when a similar retail footprint does not exist in alcohol due to regulatory framework and with social justice likely tampering down retail expansion in many states, seems to be too extended a definition, and

• MOATs, as presently defined by retail investors, are less important than short term profitability that retail operations are presently generating for MSOs.

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 has positions in GTII and AYR and will not start a new one, or divest, in the next five days. The author does not have a position in any of the other entities mentioned above and will not start a position in the next five days.