Roth Sees Rare Opportunity For Cannabis Industry, MSOs

The cannabis industry faces a rare opportunity as the drug heads toward a potential rescheduling in the United States. A new Roth Capital report suggests that multistate operators (MSOs) are the most promising companies in the space.

The Analyst

Roth Capital Partners analyst Scott Fortune said the cannabis industry represents a unique and sizable one-time opportunity as it converts from an illicit market to a legal one. 

The Thesis

The reasoning behind rescheduling cannabis in the U.S. is three-pronged, Fortune said in a Friday note.

“Quickening favorable public sentiment, progressive legislation and accommodating regulations should eventually deschedule cannabis as a Schedule 1 drug and bring an end to decades of cannabis prohibition,” the analyst said. 

The report singled out MSOs as they assemble a dominant position in the market. MSOs as the most promising public companies from a risk-reward profile viewpoint and have a presence in the most lucrative U.S. markets, he said. 

"MSOs offer a large potential opportunity to capture market share of a projected $59 to $78 billion in a fully federal legalized U.S. cannabis industry. No other emerging industries, outside of alcohol prohibition, offer an already established large consumer market where the demand is already known, albeit an existing illicit market." 

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American MSOs are trading considerably lower than Canadian LPs, Fortune said.

BDS Analytics forecast that Canada's addressable market will be $5.8 billion and the U.S. market will be $23.4 billion in 2022, the analyst said. 

"With the top 10 Canadian LPs EV worth $37 billion and the top 10 MSOs at $20 billion, there is a substantial 5.5x valuation gap, as the U.S. MSOs are trading at a discounted 0.85x EV/sales in 2022, while the Canadian LPs trade 6.4x EV/sales serving a much smaller Canadian market."

U.S. MSOs could soon have new growth catalysts, Fortune said. 

"We expect the STATES Act to be a significant catalyst where we believe investors will rerate upward the market valuations of the U.S. MSOs." 

The analyst pointed out two "significant value driving catalysts" that could increase valuations:

The STATES Act could open up opportunities for M&A activity with lucrative Canadian LPs, large CPG companies and private equity, he said. "We expect potential values could realistically be in the range of 7-10x sales in an emerging growth market."

The ability to move to U.S. exchanges should encourage additional, significant capital to flow into the industry, Fortune said. If so, the analyst expects another potential revaluation of the sector. "In our view, investors willingly push EV/sales valuations up to 7-10x sales in a large, fast-growing emerging cannabis market."

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