(You can have cannabis finance content such as this delivered directly to your inbox. Simply sign up here for our weekly MJBiz Finance newsletter.)
Last week was big for cannabis.
First came a really big deal.
Etain Health, one of New York’s five original licensed marijuana operators, was acquired this week by a Canadian entity financed by Scotts Miracle-Gro, the $7 billion Ohio-based company whose ubiquitous potting soil might well be in your geraniums as you read this.
No one is jockeying for position in the germanium space, but it seems as if everyone is interested to see who will lead the Empire State marijuana market.
New York legalized medical cannabis in 2014; retail recreational sales are expected to begin either later this year or in 2023.
MJBizDaily estimates New York cannabis sales will generate $2.3 billion by the end of the market’s fourth year. That’s a ton of growth for an agricultural giant that’s trading at a modest 16 times earnings.
Scotts, through a series of related entities, is buying Etain for $212 million in cash and $35 million in stock.
Etain’s founders will cede control to a Scotts exec, Mark Sims, its M&A specialist. Etain has four dispensaries, including a Manhattan location, as well as a production facility in Chestertown.
As if on cue, the very next day, the U.S. House of Representatives gave the nod, again, to a bill, the MORE Act, would remove the federal cannabis prohibition that dates to the Nixon era.
The legislation moves now to the Senate, where it is expected to wither and die ceremoniously.
What does a big acquisition plus the MORE Act mean for you?
1. The current valuation case seems wrong
Cannabis valuation is a fraction of normal market valuation.
Cannabis companies can be strongly valued once their market cap reaches 200% of book value. But the wider S&P trades at 4.8 times book value.
Why this gap?
The industry overpromised and underdelivered. It tried to grow too much, too fast. Rising demand combined with reduced prices last year squeezed the industry almost dry. Tons of capital flowed into the industry for the past five years, sure, but so far, the assets this cash bought have not produced to their potential. Hoped-for profits have proved elusive as the industry continues its shakedown cruise toward full legalization.
This means that cannabis assets in this market are typically undervalued vis-a-vis other hard assets as once-bitten, twice-shy investors take a cautious approach to the marijuana industry’s forecasted growth.
Scotts just upended that notion. The company just said these assets are a hot ticket. Scotts just made a quarter-billion-dollar bet on one state’s market, one that, unlike California, Colorado or even Oklahoma, hasn’t even officially opened (or made a dime) yet.
Consider that, in terms of its big picture, Scotts is a profitable company. It operates at a net profit margin of less than but usually pretty close to 10%, and it’s good at increasing its revenue on an annual basis: From 2019 to 2020, as everyone stayed home and tended their yards, Scotts posted a revenue gain of 32.3%. The next year, from 2020 to 2021, it oversaw a 19.5% top-line gain.
Stay informed with MJBiz Newsletters
MJBiz’s family of newsletters gives cannabis professionals an edge in this rapidly changing industry.
- MJBizDaily: Business news for cannabis leaders in your inbox each morning
- MJBiz Cultivator: Insights for wholesale cannabis growers & vertically integrated businesses
- MJBizCon Buzz: Behind-the-scenes buzz on everything MJBizCon
- MJBiz Retail + Brand: New products, trends and news for cannabis retailers, distributors and marketers
- Hemp Industry Week: Roundup of news from hemp farming to CBD product manufacturing
- And more!
The fact is that Scotts can make money and grow its business pretty nicely by simply sticking to what it knows. We can conclude from the deal that Scotts believes it can do more by investing in Etain than by deploying that capital to additional advertising, new-product development or another, more traditional acquisition.
This shift in valuation could pay handsomely for you should companies such as Scotts decide your business could add to the bottom line.
2. This is a trend you can bank on
Scotts took what feels like the first risk. It evidently has concluded this is not only an opportunity to make a short-term business gain but also to make a long-term strategic move. It’s transitioning from being
a passive investor in the space to an active, plant-touching participant with a piece of the action. That is huge.
Expect to see more deals. This is a floodgates moment; corporate America is going to open the spigot in earnest, and it won’t be long before mainline CEOs ask what bolt-on acquisitions they can expedite to benefit from growth in the cannabis space.
3. This is a not a game reserved exclusively for the big players
While Scotts is a large company, it’s hardly a behemoth. It is a modest enterprise with a good track record and a strong industry position. This might well describe your cannabis company.
As the cannabis industry unfolds, there’s just one question to consider: What’s next for you?
How are you going to capture your disproportionate share of this market? What are your strengths? How, and with whom, will you exploit them? You are, today, right now, eligible for these deals. Don’t let large numbers fool you. This is your industry.
When you’re ready to announce what’s next, drop me a note.
Andy Obermueller can be reached at firstname.lastname@example.org.