Cannabis Chart Of The Week: What SHOULD EBITDA Multiples Be?

We created a discounted cash flow model ("DCF") to calculate a range of theoretically supportable EV/EBITDA multiples, given analysts' expectations for 2022-2024 and reasonable assumptions for the seven years after that.

We based our model on a hypothetical $1 of EBITDA and generated a DCF valuation of that $1 to produce an EBITDA multiple.

Assumptions:

1. Revenue growth rates 2023-2024 are consensus analyst estimates for the ten largest MSOs.

2. EBITDA Margins 2023-2024 are consensus analyst estimates. 2025 & 2026 margins are held constant at 30%, and afterward, margins decline towards an assumed terminal margin, sensitized in the table. We believe it is appropriate to forecast decreasing EBITDA margins for post-legalization.

3. Tax rates are assumed to be 50% on EBITDA from 2022 to 2025 and then are assumed to decline to 25% based on 280e relief.

4. Required Reinvestment is driven by an assumed Sales/Capital ratio of 4.0x. This ratio is derived from the observation of data compiled by Professor Aswath Damodaran of NYU. A 4.0x multiple implies extremely low capital intensity.

5. The range of equity discount rates considered is 16.7-19.0%, which we believe is reasonable given the increases that have occurred in the risk-free rate and balance sheet leverage for the group. Note that we have assumed that equity discount rates decline by approximately 200bp over time as capital costs become lower for the industry. This assumption is likely to be overly conservative, and we could easily see more significant capital cost declines.

The resulting EBITDA multiples are shown in the Sensitivity Analysis Chart.  Multiples range from 7.4x to 12.8x; however, we believe the most likely range to be between 9.5x to 11.4x. The group is currently valued at 6.5x consensus 2023 EBITDA.  Estimated multiples have contracted from 11-16x when we first did this exercise in April 2022. The decline is attributable to commoditized price compression, inflationary cost increases, higher overall rates, and higher industry leverage.

The benefit of making all assumptions explicit is that investors can utilize their assumptions for future growth and margins to determine an appropriate multiple.

The result confirms that the MSOs are cheap relative to their conservatively estimated intrinsic values; however, industry economics and market rates have limited the upside from a year ago.

Our model is available to download upon request. DM us, and we will email it to you for further exploration.

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, CBD, and psychedelics industries. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors - from Cultivation to Brands to Software)

• Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A) Status of the company announcing the transaction (Public vs. Private)

• Principals to the Transaction (Issuer/Investor/Lender/Acquirer) Key deal terms (Pricing and Valuation)

• Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)

• Deals by Location of Issuer/Buyer/Seller (To Track the Flow of Capital and M&A Deals by State and Country)

• Credit Ratings (Leverage and Liquidity Ratios)

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.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.