Description

It’s time to revisit Ascend Wellness after a tumultuous 10 months since it was written up on VIC on June 16, 2022. A lot has happened. The price is now $0.84 and trading like a call option.

Sentiment on the industry has soured tremendously after softer sales across the board in 2022 (after a COVID-boosted bumper year in 2021) and weakening prices in limited license markets as well as in more competitive markets like California. The cannabis industry in California, the largest in the world, has been decimated. As a result, supply has exited, and pricing seems to be stabilizing and trending up. 

In addition, investors got jerked around yet again by politicians in Washington as hopes of the SAFE banking act (which would have allowed cannabis banking and allowed institutional investors to own plant-touching cannabis stocks) passing during the lame duck session in December 2022 first got pumped and then subsequently got dashed. Frustrated investors dumped their shares across the entire industry in a bout of tax loss selling and disgust in an end-of-the-year carnage.

To top it off, AAWH’s Founder & CEO Abner Kurtin was charged with battery in Miami while traveling with his female domestic partner. After an investigation by the Miami police, the charges were dropped in September 2022, but the damage was done and Abner was stripped of his CEO title. He still remains Executive Chairman, a significant shareholder in the company, and very involved in the business. The company is currently actively searching for a replacement CEO while the position is currently being held by Co-CEOs Frank Perullo (previously President) and Daniel Neville (previously CFO). Abner is a sharp, rational capital allocator with an investment pedigree from famed Boston hedge fund Baupost. We feel that his continued involvement in the business is a positive for the company.

The sell off has continued throughout 2023 on relatively low volume. The stock is pretty illiquid with limited institutional and ETF ownership. Institutional investors only account for about 4% of the publicly traded MSO stock ownership. This is a tiny fraction compared to other mainstream CPG companies. It won’t take a big change in sentiment to move the stock higher.

Summary Description of the Company

The company operates in attractive limited license states in the NE and Midwestern states that are mostly contiguous. Below are some slides from the most recent company presentation that shows the operating footprint and the potential built-in growth for 2023 and 2024 as they expand their retail footprint.

Catalysts for the Stock to Re-rate Higher

As the sentiment in the industry and the stock are washed out, we think any number of positive catalysts could move the stock higher. Here are some of the upcoming catalysts:

1. 280E Legislation and Lawsuit

Plant-touching cannabis businesses have been burdened with a very high effective tax rate because IRS section 280E prohibits certain deductions.

There have been numerous nascent attempts by members of Congress to introduce legislation to rectify this burden. Today, Rep. Earl Blumenauer, founder of the Congressional Cannabis Caucus, refiled the Small Business Tax Equity Act. The measure has been introduced several times over recent sessions but has never advanced to a hearing or vote.

https://www.marijuanamoment.net/new-congressional-bill-would-provide-federal-tax-relief-for-marijuana-businesses-by-amending-irss-280e-code/

An intriguing, promising, and previously untried effort is gathering momentum by a group of industry participants: a lawsuit to challenge the legality of 280E. AAWH’s CEO made the following comment on the 4Q22 earnings call held in March 2023:

“We are making progress garnering support for challenging the legality of the Controlled Substances Act through the federal court system. We, at Ascend, believe the use of the CSA and is applied to the state legal business is unconstitutional. Many industries, most notably online gambling, have achieved legality and access to capital markets and exchanges through challenging the constitutionality of certain federal legislation. We think it is quite possible that cannabis follows in their footsteps. In fact, Justice Clarence Thomas had made comments supporting this viewpoint. He explicitly called the federal government's current approach of cannabis legalization as a half-in, half-out regime that simultaneously tolerates and forbids local use of marijuana where the contradictory and unstable state of affairs strains basic principles of federalism and conceals traps for the unwary. Ascend is working with a number of industry participants to advance legalization from a federal perspective. We expect to have more to announce in the coming months, and we'll update you throughout the year on progress. We will not sit idle on the sidelines of this critical issue that could meaningfully lower the cost of capital and eliminate 280E taxation for the cannabis business.”

The industry buzz is that Abner is leading a coalition of top MSOs and prominent investors in the cannabis space to challenge the CSA and interstate commerce and has engaged a prominent lawyer David Boies of Boies Schiller Flexner LLP that has previous experience successfully litigating these kinds of constitutional issues.

https://www.marijuanamoment.net/marijuana-companies-teaming-up-to-sue-federal-government-with-all-star-legal-firm-multi-state-operator-ceo-says/

While the coalition has been working on this for a while, the lawsuits are expected to be filed in short order. The challenge will take time to work through the courts, but the lawsuits and the arguments and precedents highlighted in the brief should act as a positive catalyst to boost investor sentiment. If the cases prevail, the industry could expect to see 280E rendered unenforceable and recovery of all prior excess taxes paid due to 280E and potentially see MSOs listed on US exchanges.

2. New CEO

While it’s been taking time to identify a suitable CEO for the company, we expect to see a good candidate fill the position in 2023. While the interim co-ceo situation is less than ideal, the two executives have been working together at the company for a while and are well-suited to operate the company during the transition. On the 4Q22 earnings call, Abner stated:

“In 2023, we plan to fill our open CEO position. We continue to work with the search firm Russell Reynolds to find a CEO with experience scaling organizations. It is time for the industry to move from founder-led organization to professional operational management teams. We continue to review candidates and hope to have an update for you again during the next call. Meanwhile, we have been in good hands and are happy with the co-CEO roles that Frank and Dan have been filling. Their work has been critical to getting these assets open and will be critical to getting the company to cash flow positive this year.”

3. Inclusion in the Largest MSO ETF 

Currently the largest MSO ETF in the industry, AdvisorShares Pure US Cannabis ETF (MSOS), does not own AAWH even though it owns the other large and mid-tier MSOs. We and other investors have encouraged MSOS to add AAWH to its actively managed portfolio since it is a well-managed mid-tier MSO. Currently, the other actively managed MSO-focused ETF, PSDN, run by well-regarded industry veterans Emily Paxhia and Morgan Paxhia, has AAWH as one of its significant holdings.

4. Listing on TSX and Increased Institutional Ownership

Both Curaleaf and TerrAscend are actively seeking listing on the Toronto Stock Exchange (TSX) to garner institutional ownership support. They are looking to reorganize the company and create a structure similar to what Canopy Growth Corporation used to obtain ownership rights to US operations while being listed on the TSX and Nasdaq (WEED.TO and CGC). Canopy is a Canadian cannabis operator with convertible equity rights to certain US cannabis operations including minority ownership in TerrAscend (TRSSF). AAWH and other MSOs could follow this pathway to listing once the exchanges get comfort from potential TerrAscend/Curaleaf listings. There should be further details on TerrAscend’s structure and listing approval soon. 

https://mjbizdaily.com/marijuana-mso-terrascend-could-list-on-toronto-stock-exchange-by-summer/

5. Potential Acquisition

We believe AAWH will eventually be acquired by larger MSO or a new industry entrant as the industry continues to consolidate. In the past, Abner has been pretty clear that he is not an empire builder and is willing to sell the company at the appropriate time and price. We believe he will act in the best interest of shareholders if an outright sale of the company made sense as he is a significant shareholder and cut his teeth allocating capital as an investor at Baupost. Of all the existing larger MSOs, Trulieve (TCNNF) is the most likely to acquire AAWH and would realize the most synergies as there is less overlap in their state footprint compared to the other large MSOs. At this point, Trulieve has had about a year and a half to digest their large acquisition of Harvest Health. It would make sense for Trulieve to fill out their national footprint with the acquisition of AAWH while prices are depressed. Once there is more clarity on the regulatory front, the industry is expected to rapidly consolidate with new entrants from adjacent industries looking to enter the cannabis space through acquisition of MSOs.

6. Revenue and Earnings Growth

Guidance for 2023 from the 4Q22 earnings call in March was for 15% revenue and EBITDA growth from 2022 revenue of $406mil and Adj EBITDA of $93.2mil to projected 2023 revenue of $467mil and Adj EBITDA of $107mil:  “In 2023, we will shift from a period of hypergrowth to focus on self-financing and being free cash flow generative. Given the realities of the market today, all of our attention is focused on raising the bar for capital allocation and  CapEx, improving our rates of conversion from EBITDA to cash from operations, and achieving positive cash from operations. In light of this, we are changing our targets to 15% revenue and EBITDA growth for the full year and are expecting to generate positive cash flow from operations for the year 2023.”  

As the company expands its retail locations, and the existing medical states convert from medical to adult-use, we expect continued top line and bottom line growth in the future. Currently OH and PA are medical only. MD is about to start adult use sales on July 1, 2023. Typically, when states convert from medical to adult use, the revenue can double or more fairly quickly just from the regulatory change. The trend has also been that states typically convert from medical to adult-use if adjacent states have adult-use programs. Thus, we believe OH and PA will eventually convert from medical to adult-use. We also expect AAWH to benefit from the overall macro tailwinds of this $100bil + industry converting more of the illicit use to legal use over time.

Valuation

At 4x 2023E EV/Adj EBITDA based on management guidance, the valuation is undemanding on an absolute basis and on a relative basis compared to other large MSOs trading at much higher multiples. Once sentiment turns more positive and institutional ownership increases, the EBITDA multiple could re-rate to a 10x-15x level more in line with companies with these tailwinds and prospects. 

The additional catalysts for re-rating are listed below in the catalyst section.

Risks

- Recession

- Pricing weakness

- Financial leverage

- Unfavorable legislative/regulatory action

Legal Disclaimer: This research report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purposes only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and/or his employer has a position in this stock and may trade this stock.

Catalyst

- See the catalysts above.

- More states approve cannabis use and converting from medical to adult-use, including OH and PA.

https://www.cannabisbusinesstimes.com/news/states-that-may-legalize-cannabis-in-2023/ 

- De-scheduling of cannabis by the executive branch.

https://www.marijuanamoment.net/bidens-health-secretary-gives-update-on-marijuana-scheduling-review-directed-by-the-president/

https://www.marijuanamoment.net/congressman-challenges-biden-to-provide-evidence-for-administrations-positions-on-marijuana/

https://www.bhfs.com/insights/alerts-articles/2022/descheduling-or-rescheduling-cannabis-the-road-ahead

- Passage of SAFE banking legislation.

https://www.forbes.com/sites/dariosabaghi/2023/01/24/the-safe-banking-acts-potential-impact-on-the-marijuana-industry/?sh=cb7f5965d31e