Cannabis Stocks Chart: Renewed Legalization Hopes Widen The Valuation Gap

The graph shows the Enterprise Value to Next Twelve Months (NTM) EBITDA ratios for two groups of cannabis companies: those with market caps greater than $750M (green line) and those with market caps less than $300M (orange line). In addition, the valuation multiple difference, which we refer to as the valuation gap, is shown by the black line.

The recent rally has produced a visible uptick in valuation multiples. The multiple for the large companies has increased from 8.49x at the end of January to 10.0x on February 11, 2022. Similarly, the smaller company multiple has increased from 4.3x to 5.0x over the same period.

• However, the graph clarifies that investors have not entirely bought into the idea that banking reform is imminent. Multiples have only retraced their way back to year-end levels and remain below any month-end levels from 2021.

• The historical valuation gap is fascinating. The gap has widened in up-markets which have tended to coincide with periods of renewed optimism regarding federal legalization.

• The gap has been remarkably steady, averaging 4.6 valuation points since mid-2021 despite significant declines in multiples for both large and small companies over the second half of 2021. In percentage terms, therefore, the gap has widened.

The widening spread is counterintuitive. Smaller companies should benefit more from banking reform than their larger cousins. After all, the large MSOs have no difficulty borrowing money at historically low effective costs. At the same time, the smaller companies are often stuck with heavy warrant coverages or other equity linkages that raise debt costs.

One potential cause for the widening spread is liquidity. It is easier to accumulate significant positions in larger, more liquid names. Despite our belief that better value exists in the 2nd tier, the market buys what it can buy – the tier one MSOs.

The widening spread is bullish for further consolidation and M&A activity. The currency of the MSOs have appreciated both absolutely and relative to their target companies. Meanwhile, these same target companies are happy to accept stock instead of cash, as they believe further significant upside exists.

The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.

The Viridian Cannabis Deal Tracker provides the market intelligence that cannabis companies, investors, and acquirers utilize to make informed decisions regarding capital allocation and M&A strategy. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis and hemp industry. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• Industry Sector (one of 12 sectors, from Cultivation to Brands)

• Dollar value of the transaction

• Region in which the deal occurred (country or U.S. state)

• Status of the company announcing the transaction (Public vs. Private)

• Deal structure (equity vs. debt)

• Key deal terms (Pricing and Valuation)

Since its inception in 2015, the Viridian Cannabis Deal Tracker has tracked and analyzed more than 2,500 capital raises and 1,000 M&A transactions totaling over $50 billion in aggregate value.