July 15, 2022 - 12:20pm EST by
2022 2023
Price: 3.15 EPS 0 0
Shares Out. (in M): 155 P/E 0 0
Market Cap (in $M): 500 P/FCF 0 0
Net Debt (in $M): -60 EBIT 0 0
TEV (in $M): 490 TEV/EBIT 0 0

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WM Technology, or as it is better known, Weedmaps, operates the leading online marketplace for cannabis products globally. Virtually all its revenue is currently generated in the nascent, high-growth U.S. market where it holds a near-monopolistic position in all the key states.

Various cannabis MSOs have been written up on VIC over the past couple years (eg Curaleaf in June 2019, Cresco in June 2020 and Green Thumb last December) laying out the long-term bull case for the industry. The sector ought to benefit from long-duration secular growth as the illicit market, which is still >3x the size of the legal market gradually converts to legal operators. In addition, as many states are yet to operate any form of legal cannabis programme the overall national market will grow through broader adoption, wider range of SKUs and form factors and reduced stigma. Across the states that already have some form of legislation in place, around half only operate a medical programme, without any adult-use legislation. History informs us that the switch from medical-only to a full recreational market near-instantly doubles a given state’s cannabis revenue.

However, buying into the MSOs at this early stage of industry development poses many challenges. For starters one can argue that it is analogous to the often-quoted example of the automobile industry in the early 1900s when there were some 2000 companies, basically none of which survived despite the huge secular industry growth. In addition, it is far from clear what the ultimate structure of the market will be on the consumer-facing side of the industry and hence the future margin profiles for publicly listed plant-touching businesses are impossible to predict. On the one hand we see limited-license markets (whereby competition is restricted by the state) earning EBITDA margins in excess of 50% while on the other hand, in many of the most mature Western states and indeed Canada, even vertically integrated businesses struggle to generate any profit whatsoever. Investing in these businesses therefore embeds some speculative hope vis-à-vis their future profitability. Some argue that once federal legislation passes MSO profitability will significantly improve because of the normalisation of their tax expenses, but we are sceptical of this. We believe that due to the price competitive nature of the market and to fend off illicit operators, any gains from a reduction in taxes will be passed onto the consumer through price reductions.

In addition, the fact that at a federal level, recreational cannabis production and sales remain illegal means that U.S. producers and distributors are prohibited from listing on U.S. equity exchanges so institutional investors are unable to invest in them. Federal illegality also makes it more challenging to raise capital and therefore the MSO’s cost of capital is relatively higher.

Weedmaps is the notable exception to all these issues. As the absolute go to online marketplace for cannabis consumers it stands out as a long-term winning play on this high growth market. Thanks to its national recognition, 15 million+ MAUs and the fact that half of all legal dispensaries (i.e. all your competitors) already list and advertise on it, it is imperative for retailers and brands to list/advertise on Weedmaps. The network effects here are as strong as they get. The increasing fragmentation of dispensaries, large travel distances to find stores in most states and restrictive advertising policies of other platforms exacerbate this further. As the industry grows, so will the number of listings, the price per listing, CPMs, etc. Over time, depending on legalisation, Weedmaps could add services such as payments etc as so many other marketplace businesses have done to increase wallet share.

In terms of competition, currently, the only somewhat credible competitor is Leafly (LFLY US). It is the number 1 destination for cannabis content such as learning differences between strains, etc. and over the past few years has tried to use its relatively large user base to build an adjacent marketplace. However, those initiatives have largely been a failure as the network effects of the incumbent appear too strong already. This can be seen in both the absolute revenue levels of the businesses, the growth rates (WM is growing 2x LFLY despite having 5x the revenue base), as well the ARPUs (WM’s revenue per client is 5-6x LFLY’s). Leafly’s MAU’s have stagnated and even started to decline. In addition to the existing consumer base already seeing Weedmaps as the marketplace of choice and Leafly simply as a content hub, new consumers entering the cannabis market who are less sophisticated about cannabis are also more likely to be drawn to the transactional marketplace rather than to a content library. It is also worth noting that content is something that can be added (and WM is doing so). The other competitor that comes up in conversations is I Heart Jane. Their tech, from a marketer perspective, is better at the moment. However, they have extremely low consumer adoption making it very difficult to gain any traction. We expect Weedmaps to close the tech gap shortly.

There are a whole host of names that come up as competitors (eg Dutchie), but those are primarily POS providers who integrate with dispensaries. Weedmaps is in that business as well, but it represents only a small portion of its revenues (<20%) and it is not where the long-term attraction of the business sits.

In terms of profitability, we already know a few things. Firstly, at current scale (<$200m in revenue) gross margins are already around 95% and the business is profitable on an underlying basis. Secondly, dominant online marketplaces at scale and maturity have very high margins (50%+).  Thirdly, the company still investing heavily in growth. For example, this year they earmarked c.$30m of P&L investment into the East-Coast states that are opening up, for which revenue will start only next year. Expenses are inflated right now.

Finally, as it merely operates a marketplace, but does not produce or distribute cannabis, i.e. it does not ‘touch the plant’, its operations are federally legal across the U.S. It is listed on NASDAQ and is accessible to all investors.  

Despite all these attractions, the shares have been an unmitigated disaster. Since they peaked close to $30 in February 2021, shortly after going public, the shares are down 90%! The decline is a combination of a general sell-off in cannabis shares, an optical slowdown in revenue growth last year as they removed revenue from illegal operators in Canada (in 2021 revenue growth slowed to 19%, but ex-the Canadian revenue in the 2020 base they grew 48%) and the large sell-off in de-SPACs and growth companies this year.    

At the current share price of $3.15, WM’s market cap is just under $500m. If we include the 19.5m warrants (which have an exercise price of $11.5) the market cap if $560m.  Net of cash, that’s an EV of $500m or 1.4x forward revenue (2023).  If we assume this marketplace has an underlying steady state EBITDA margin of 50% (i.e. they no longer invest in growth) which is probably conservative, then the shares are currently on 2.9x EV/EBITDA (2023).

But lets look at the bigger picture. A decade from now, we believe the total US cannabis market will be >$150bn. That’s a mere 4% CAGR from the current market size. If we assume 2/3 is legal (that would be considered a failure of regulation in our view), the addressable market for Weedmaps will be $100bn. With an 80% market share and a mere 5% take rate (anyone who knows marketplace businesses knows the take rate could easily be 3x that, but we take into account the mix of not all businesses being online offset by brand advertising revenue, market/consumer data aggregation revenue and payments) the company will earn $4bn in revenue. At 50% EBITDA margin (it will probably be 60-70% at that level of revenue) that’s $2bn in EBITDA. Any business with these kind of dynamics (dominant, high margin, non-cyclical, GDP+ growth, etc) sells for at least 10x EBITDA (more like 15x in normal markets), so this is a $20bn market cap…40x from today…and we have completely ignored potential upside from Europe (Weedmaps already has strong brand recognition in some markets there, notably Spain) and/or Canada. There are of course a lot of assumptions here that are anyone’s guess, but between and attractive return and 40x+ over 10 years there is a very wide margins of safety.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


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