Description

Glass House Brands (GLASF) Investment Review

Idea Summary

Glass House is California’s largest cannabis cultivator. The company has a series of compelling near-term catalysts: An earnings inflection beginning 2H24, a September 12^th investor day, and an imminent cannabis rescheduling by the Biden admin. Glass House looks very undervalued at present. We expect the company to do ~$75-100M in free cash flow in 2025, which at today’s price would be a ~15% FCF yield. This ~$75-100M of FCF would be on only 60% utilization of its best-in-class greenhouse in Camarillo, as the company has been turning on greenhouse capacity at 20% increments. We expect 100% utilization by early 2026, setting up $200-250M of 2026 FCF on a company with a current market cap of ~$650M. Simply put, Glass House will become too cheap to ignore.

On this FCF inflection, we think the stock can re-rate to $20-25, with room for substantial upside beyond that. All of this can be achieved with Glass House only able to sell product in California. Interstate commerce is an eventuality for the industry, and Glass House is best positioned for that reality. GLASF also trades OTC – A rescheduling to Schedule 3 should allow for uplisting to a major US exchange.

What had been a busted SPAC is now an underappreciated business. Longer term, we expect this business to be bought by an AB InBev/Constellation/Phillip Morris type of player with an established national distribution network. It is telling to us that in times of market volatility, GLASF used to be a punching bag. Now, the stock is outperforming during macro turbulence, a signal to us of outperformance on the other side when the markets strengthen.

Risks (Discussed Further Below)

• Deep recession
• Regulatory uncertainty
• Key man risk
• Large individual shareholders

Company Overview

Glass House is California’s largest cannabis cultivator, founded in 2015 by Graham Farrar and Kyle Kazan. The company started as a single greenhouse farm in Carpinteria with 50K sq ft. initially, to 3 sites today with a ~6M sq ft. footprint (its Camarillo greenhouse is 5.5M of that), as well as 10 retail stores. The company went public in 2021 to acquire the Camarillo greenhouse, going the SPAC route in a merger with Mercer Park Brands, at a transaction valuation of $567M ($325M purchase price of the company, $24M for certain retail licenses that’re no longer relevant, and $219M to purchase the Camarillo greenhouse). issambres839 posted GLASF on VIC in late 2021, which gives a great overview of the thesis at that time, and is what initially brought the stock to our attention. The thesis is playing out today, albeit more slowly than initially expected, and with bumps along the way, but we’re now at GLASF’s earnings inflection point.

As California’s lowest cost operator, GH enjoys an unrivaled scale advantage. While the industry sits at slightly above breakeven pricing, Glass House earns a ~50% gross margin being at the very low end of the cost curve. Its Camarillo greenhouse is in the country’s premier cannabis growing climate, and is grandfathered in – No new cannabis greenhouses can be built in Ventura County. Glass House’s competitive advantage is secured for the foreseeable future.   

GH’s Wholesale Biomass segment (primarily its Camarillo greenhouse) is the story. We expect this segment to represent ~75% of total gross profits in 2024, growing to >90% by 2026 as the company ramps its Camarillo greenhouse utilization to 100%.

Glass House produces wholesale biomass at a cost of $135/pound, and sells that biomass in the low-$300’s/pound. The product mix within each pound of biomass is ~35-40% flower, ~15% smalls, and ~45-50% trim. As a basic breakdown, Glass House gets 3 outputs from a harvested plant: 1. Grade A flower (buds), currently $500-600/pound for CA greenhouse flower, 2. Smalls, which are well developed, but smaller buds (grow on lower parts of the plant) that don’t look as good, and sell at ~50% of flower price, and 3. Trim, which sells at $30/pound, and gets converted into vapes and gummies. Over the calendar year, Glass House’s product mix changes favorably as more sun allows for better flower yields in the back half of the year (also driving the seasonal, high-supply “Croptober” period). Early in the year, biomass product mix is ~ 25-35% flower, 10-15% smalls, and 50-60% trim. Later in the year, the mix is ~40-45% flower, 15-20% smalls, and 40% trim. 

Turning on capacity at its Camarillo greenhouse comes at a very high margin, with the latest 20% capacity addition requiring $10-15M of cap ex to generate ~$40M of annual EBITDA. The Wholesale Biomass segment earned a 55% gross margin in 2023. We expect the remaining capacity to be turned on at between 70-90% incremental gross margins, with the company achieving its mid-60’s Wholesale Biomass gross margin target by 2026. The idled 60% of the Camarillo greenhouse, which GH leases to the prior owner of the farm, currently grows tomatoes and cucumbers. GH can turn on capacity when ready, completely controlling its organic growth story from here.

The CPG business generated 24% of 2023 gross profit, and we expect that number to drop to <10% as the Wholesale Biomass segment ramps, and Glass House deemphasizes its retail presence. Still, having its own successful brands is important to GH’s strategy, and combined with the company’s 10 stores, allows Glass House to get a better pulse on market.       

Glass House’s Wholesale Biomass Cannabis Economics

The company expects an average selling price of $310-315/lb. for 2024, on a cost of $135/lb., equating to a 57% Wholesale Biomass segment gross margin. With more scale, GLASF aims to bring this cost down to $100/lb., and we believe <$90 is possible. The company’s long term production target is 1.5M pounds, which we believe (supported by management commentary) will be achieved by 2026. Holding a $310-315/lb. price constant on 1.5M pounds at a $90/lb. cost equates to ~$330M of gross profit. 

On $330M of Wholesale Biomass gross profit, we add an aggregate $30M of gross profit combination from the Retail and Wholesale CPG segments, for ~$360M of aggregate 2026 gross profit. Assuming op ex of $100M and interest expense of $8M, we expect 2026 net income to be ~$175-200M, or ~$1.75-2.00 per diluted share (assumes SPAC warrants converted at a .363 exchange rate, more discussion on that in the Valuation & Warrants and Balance Sheet & Capital Structure sections).

Again, this organic growth story is entirely within Glass House’s control. We believe the industry breakeven for greenhouse California flower is $400-500lb., and therefore see a price drawdown risk of ~-20-25%. If that occurred, GLASF could still bring utilization to 100%, and earn ~$1.00 per diluted share in 2026 (assumes $11.50 SPAC warrants expire worthless).

Considering the upside, in a world with interstate commerce, GLASF’s cannabis prices should at least converge towards the US national greenhouse average price of $824 (YTD average as of July), which implies a wholesale biomass price for GH closer to $400. But we can also make a case that Glass House’s greenhouse flower is almost as good as indoor flower across the rest of the country, where prices can range from $1,500-$4,000. Any increase in price for GH would be at a nearly 100% incremental margin. We believe the company eventually recognizes a portion of this upside, as interstate commerce is really just a matter of when. We see significant upside potential, but care more that our downside is well protected relative to the base case.

Upcoming Investor Day

At its 9/14 investor day, Glass House will have a chance to size full-utilization earnings potential. Management has spoken about this in interviews, but has yet to clearly illustrate the upcoming inflection in earnings. The stock goes uncovered by the street – The 1 estimate (Canaccord) for 2025 EBITDA is $64M, which assumes GH turns on no additional capacity, a case that we don’t think makes sense. Hopefully the investor day helps GH pick up more sell side coverage, and interest from institutional investors as liquidity improves (currently trades ~100K shares/day on avg.).

Rescheduling

We don’t have any superior insight into the timing of cannabis being rescheduled to schedule 3, but we’d highlight that the Harris campaign has a strong incentive to finalize rescheduling before the election. Once the final rule becomes effective, cannabis operators will no longer be subject to Schedule 280E of the tax code, which is applied to Schedule 1 substances, and is very punitive on the cannabis industry as it doesn’t allow business expenses to be deducted from taxable income. The industry pays taxes on gross income, often resulting in effective tax rates of 70%+. GLASF estimates that the removal of 280E would be an immediate $10M annual cash flow benefit to the company.

There is also an expectation that a “Garland memo” from the Attorney General will accompany the S3 finalization, as an update to the 2013 Cole Memo, which offered guidance for federal prosecutors considering marijuana investigations/charges in states where marijuana had been legalized. A Garland memo could pave the way for uplisting to a major US exchange, and interstate commerce pacts between states.

We’ll wait to see what happens – Our thesis doesn’t depend on schedule 3 finalization or a Garland memo, though each would definitely help.

Election Impact

We know the Harris-Walz campaign supports cannabis, and we expect they’d make an effort to federally legalize it if elected. We expect the Trump-Vance campaign to take a states-rights type of approach. We also got Trump’s first campaign commentary on cannabis on 8/8, when he said that he’s starting to “agree a lot more” that cannabis should be de-criminalized, as it’s being legalized all over the country. So we now get the sense that both candidates would be positive for cannabis to varying degrees.   

Pushbacks

Cannabis attracts many opinions, with some pushbacks more justifiable than others. We aggregate the major pushbacks below, and give our stance:

1. It’s a commodity product. Longer term, with interstate commerce and a more mature industry, we expect margins to normalize lower. But to expect ag-like margins for Glass House relies on some assumptions that we think are faulty:
1. Cannabis consumer preferences are constantly changing, and cannabis plant genetics have to keep up with that (Graham Farrar likens the cannabis industry to fast fashion: Some things are timeless, but also a lot in the market turns over quickly, and there’s a premium on new and a premium on variety).
2. To date, Glass House is the closest we’ve seen to success by a scaled cultivation player, as no one else has been able to do it in a competitive state. When interstate commerce comes, Glass House will be the lowest cost nationally, and the larger new entrants will recognize GH as a takeout opportunity. It’s hard to tell what the industry will look like, but once IC comes, GH’s wholesale prices should first move higher, as the company enters states that charge multiples of CA prices. How the players in those state markets can adapt is a more pressing question.
2. The cannabis thesis is dependent on easing state/federal government regulations. While it would be a benefit to the industry, our Glass House thesis isn’t dependent on any regulatory advancements. There are also a few key ways in which GLASF benefits from the status quo:
1. Under schedule 3, large national players have chosen, or have been required, to stay on the sidelines.
2. Cost of capital is punitively high in cannabis. If someone today wanted to replicate GLASF’s scale advantage, they’d first need ~$200M to match GH’s real estate footprint.
3. In our opinion, California is basically already an interstate commerce market. After a sold product leaves Glass House’s doors, the company has no control over the ultimate destination of that product. As a result, California product has increasingly shown up in states that’ve legalized recreational cannabis. This shouldn’t be surprising. The retail price discrepancy between states is so significant, that it would be more surprising to us if California products weren’t showing up in New York. We’d love to see interstate commerce formalized – But until that happens, we see an underappreciated element to the status quo for GLASF, which we think offers another layer of downside protection.
3. Large players will control the industry. This seems like an eventuality, but again we’d point out that growing cannabis at scale has yet to really be done, outside of Glass House. As mentioned, we see GH as an eventual takeout candidate by a larger player with a national distribution network. We also see the national industry evolving with a healthy craft market, similar to the alcohol industry, allowing success for smaller players.
4. The cannabis industry has a historically poor track record of capital allocation. We won’t put up a fight on that point. We’re not sure how most of the multi-state operators ultimately survive when the interstate commerce walls come down, and prices nationally converge with the west coast. We think much of the industry is not built for this eventuality.

Valuation & Warrants

We’ve laid out our EPS expectations above: Our base case EPS is ~$2.00 in 2026, and $200-250M of FCF. We have no idea how GLASF will be valued as earnings inflect, but we know it’ll be volatile. We feel conservative assigning a 10x FCF multiple to GLASF’s 2026 FCF, getting to our base case of $20-25. Could it be a 20X multiple? Sure. We feel more confident in saying GLASF is undervalued today than we do in picking a price target.  

The EPS calculation depends on what happens to the 44.6M of warrants, which have the potential to raise diluted share count to 98M from 71M, when factoring in additional dilution from options/RSUs/debentures. Our main concern is the 30.7M of SPAC warrants, with an exercise price of $11.50 and a June 2026 expiration. The warrants trade at $1.19 (ticker: GHBWF), which we think are also a compelling buy here. With ~23 months to expiration, the market is assigning a low probability of exercise, and minimal dilution. If these 30.7M of SPAC warrants expire worthless, then our base case 2026 EPS becomes $2.50. The other 14M warrants are ITM, so we’ll assume full dilution on those for conservatism. Glass House has an accelerated redemption right on the SPAC warrants if the stock exceeds $18, which would result in ~11M dilution on the 30.7M of warrants. Adding all of this together gets us to a 98M share count, which we view as a conservative assumption for a diluted share count.

We’d also note that insiders are very incentivized to see these warrants in the money, with significant warrant ownership.

Balance Sheet & Capital Structure

The upcoming earnings inflection allows Glass House to clean up its balance sheet. The company currently has $62M of debt due Nov 2026 at a 12% interest rate, and $58M of preferred equity through 4 different issues that pay a dividend of 15%+. With a cash flow inflection to $75-100M in 2025, GLASF can call these preferred issues, and continuing paying down debt ($7M in 2025).

We expect GH to turn on its next 20% of greenhouse capacity later this year, and with that might come an equity raise which we don’t believe should exceed $20M (company filed a shelf earlier this year). But once phase 3 of its greenhouse is turned on (utilization would be 60%), we see no need to raise additional capital. GLASF could also even wait until early 1H25 and fund this growth organically, if they choose.

Ultimately, management will be focused on balance sheet improvement, and GLASF’s ability to do this is within its control. Federally, a rescheduling would obviously help lower the industry’s cost of capital and allow GLASF to refi at lower interest rates.

Risks

• Deep recession. A deep, consumer-led recession could lead to another COVID-like shakeout for the industry, where stimulus-driven demand in 2020/2021 led to an oversupply in California. The ensuing bust led to prices well below industry breakevens, as GLASF’s ASP dropped ~-30% YoY. That bust led to California active cultivation licenses dropping ~-35% between early 2022 and early 2024. The amount of supply Glass House will turn on over the next 2 years represents just a small fraction of the supply that’s left the market over the last 2 years, so we believe GH’s growth story will still be in tact in a consumer-led recession. If a recession lowers prices by -20-25%, GH will still turn on the remaining 60% of its greenhouse, and that $200-250M+ fully utilized FCF number may be closer to ~$100-150M. Remember, the incremental supply that GH turns on can be done at 70%+ incremental gross margins. With the greenhouse infrastructure mostly built out already, Glass House is incentivized to turn on the supply almost regardless of the external market landscape.
• Regulatory uncertainty. Our thesis isn’t dependent on regulatory developments, but if they don’t materialize, we wouldn’t be surprised to see weakness in the stock.
• Key man risk. Graham Farrar (President) handles the cannabis cultivation, and Kyle Kazan (CEO/Chairman) and Mark Vendetti (CFO) handle the capital allocation and finance side of the house. Graham is a top operator in the industry, and him or Kyle leaving the company would be a major red flag.
• Large individual shareholders. Large insider ownership is a good thing: >30% of GLASF’s stock is insider owned, to varying degrees of restrictions & voting rights (GH founders have >50% voting interest). However if any insider decides to liquidate unrestricted shares on the open market, GLASF’s lack of liquidity would be on full display.

Catalyst

1. Earnings inflection beginning 2H24 

2. September 12^th investor day

3. Imminent cannabis rescheduling by the Biden admin