I recently interviewed Marc Lustig, MSC, MBA, former Chairman and CEO of Origin House that was bought by Cresco Labs Inc. (OTCQX: CRLBF) (CSE: CL) in an all-stock deal. His measured enthusiasm when he speaks about his vision for the cannabis industry leads me to reiterate my recommendations made in earlier articles that investors ought to follow my lead and buy CRLBF shares.
A buyer is not chasing the share price down in the current fall nearer to its 52-weeks low of $4.47 than its high +14. They are taking advantage when there is "blood on the street." The nascent legal cannabis industry is in a state of viridity beset by extrinsic factors: e.g., airy promises of spiking profits, a combative Federal government and timorous financiers clenching to restrictive regulations affecting bank lending, cash deposits, credit card processing, stock trading and investing in cannabis companies; local authorities in most jurisdictions pursue prosecutions for possession, reports about the health hazards of vaping are worrisome, and there is the convolution of medical and recreational approaches to cannabis classifications and value assessments.
The Only Limits are Those of Vision
Jeff Bezos and Warren Buffett both talk about vision as the core essential to success. Numbers, valuations, willingness to be a disrupter and luck are all important. My father repeatedly told me, "Success requires 80 percent mazel and 20 percent common sense." Bezos tells entrepreneurs, listen to critics but "You say, 'No we believe in this vision,' then you just stay heads downs, stay focused and you build out your vision." Lustig has the vision and the leadership at Cresco Labs is building out their vision.
He grew Origin House to become California's largest legal cannabis distributor selling allied products and the owner of more than 50 name brands. Today, Marc is a board member at, capital lender to and significant shareholder of CRLBF. Cresco Labs now owns the largest legal cannabis distributor in the biggest marijuana market in the world where there is a 105 year tradition of legal marijuana since becoming the first state in the nation to make possession legal.
From the interview, I draw a picture of Cresco Labs' strategy for growth and profitability. Cresco Labs seems to be following the Amazon (NASDAQ: AMZN) business trail. If you believe in Amazon invest in CRLBF.
Money Makes the World Go 'Round
Lustig stresses the point that the first need of any company is hard cash and for the long term. Suffice to say, Amazon began by selling books over the Internet. The approach was not in vogue. He borrowed money from his parents to launch after answering his father's question, "What's the Internet?"
Cannabis companies are experiencing the effects of tight regulations; large and small, older and newbies are experiencing a cash crunch. Cresco Labs holds about a one-year-long cash runway. According to Lustig, "The biggest key right now to this market is which companies have cash, which have ongoing access to cash and which don't. That is the lifeblood."
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Some are likely to be bought out or fold in the coming 12-18 months. Others are going to institute cost-reduction measures at a time when the industry has spotty inventory and expanding demand. According to Lustig, there is plenty of cultivation and product in California because licenses are relatively easy to get. This is a real positive for Cresco Labs.
Cresco Labs is probably going to lengthen the cash runway term in 2020 when better financials are reported and share price begins bounding from the undervalued share price. I estimate it to be between $16 and $35. Meanwhile, one major competitor is resetting itself with a new CEO, eliminating 500 jobs, drastically scaling-back expenses, and narrowing the market focus for tight liquidity.
Illinois, home-base of Cresco Labs, "logged $39.2M of adult-use recreational marijuana sales in January (2020)…the second-highest sales per capita during the first full month of legalization among eight other states where adults can buy pot for recreational use." Cresco Labs is expecting to close on a ~$300M acquisition in Nevada in the first half of 2020 where recreational sales reach $900M and medical marijuana sales are $60M.
Lustig estimates,
Financing transactions in the global cannabis industry totaled roughly $500 million in the first quarter of 2019, compared to about $2.75 billion in the prior quarter, according to figures from Canaccord Genuity. That dearth of available capital likely means 70 percent of all pot firms will go bankrupt or insolvent within the next several years.
Others will seek M&A partnering with more stable companies that can only bode well for CRLBF. Lustig argues undercapitalized cannabis companies will strain under greater pressures nearing the day when the federal government either legalizes pot or decides simply it is a state's rights issue; cannabis as a commoditized product selling in a more competitive environment means companies have to have ready access to cash. States legalizing pot do so under strict regulations and limitations but that is likely to change.
State officials are legalizing marijuana for medical and recreational use because they want the tax money. Some hold altruistic beliefs: medical marijuana is demonstrating health, medical and psychological benefits, cannabis helps with seizures, nausea from chemotherapies, and too many young people, especially from minority communities, are overpopulating the prison system.
Be in the Marijuana Business Not Real Estate
Here is what management has been doing to raise cash at Cresco Labs. They turned to a core of insiders including Lustig to lend the company hundreds of millions of dollars. The primary downside to this loan is the high-interest Cresco Labs pays for the money (~13%). Traditional lenders and investors caper about the marijuana industry but resistance is fading. A survey of bankers last year reports their support for Federal legislation so they are able to do business with the "pregnant with potential," multi-billion dollar cannabis industry.
There are other downsides for Cresco Labs; sluggish growth in California of legal dispensaries (approaching 600 compared to Colorado with +1000 and 15% of California's population). State and local taxes amount to some 23% on sales of pot in California. Nevertheless, the California cannabis market is worth nearly $3B annually of which Origin House enjoys ~60% market penetration.
Management is turning assets to cash through the sale-and-leaseback of properties. In Ohio and Michigan deals CRLBF raise ~$38M. CEO Charlie Bachtell made it clear last November that Cresco Labs is in the marijuana business, not real estate.
Cresco Labs agreed to sell up to $55M of subordinate voting shares in the company. The share price tumbled proportionately.
These actions were taken to expand both the infrastructure and inventory. Past revenue growth has been astronomical and it is expected to continue. When Bezos talked about vision, he also insists that management must adapt strategies to fulfill growth and customer expectations.
Cresco Labs is forecast to have better than industry annual revenue growth and annual earnings. Marc expects CRLBF will hit $1B in annual revenue soon. Analysts are estimating reported revenues of ~$132M for FY'19 popping to +$500M in FY'20 with recent acquisitions including Massachusetts-based Hope Heal Health.
Leadership, Branding, Manufacturing, Distribution
Amazon was uninhibited, frenetic, unstoppable, but no one in management were braggarts. The team remains leaders in retailing. The team leading Cresco Labs has a vision, rarely gives interviews, and the company may be undervalued in part because it operates largely under the media radar. Peter Drucker once said, "Management is doing things right; leadership is doing the right things." At Cresco Labs the leadership team plugs along building market share in important target markets, raising cash, popularizing their brand names, and like Amazon by expanding, Cresco Labs is positioning the company to constantly increase in size and turn a profit. The market is growing because the public believes, according to Lustig, the pot is not as harmful as it was deemed to be for so many decades. "I challenge anybody to find someone not using cannabis in some way to help them sleep or for pain or some other use."
Marc tells me he is still convinced cash and branding are the keys to success. "Branding is hugely important…In my opinion, building brand recognition is the single biggest opportunity for Cresco Labs and other high-quality cannabis companies especially in the US and especially in California." The license acquired along with other assets of Hope Heal Health allows Cresco Labs to continue selling medical marijuana but also selling brands owned by CRLBF to the growing adults-use market both retail and wholesale. Cresco Labs is expected to build fast and furious on top of the $450M in sales the previous administration of the Massachusetts firm was able to hit in part by adding its brands, Remedi and Mindy's Edibles to the inventories in the 40 dispensaries across the state. People buy brands claims Lustig. It is what creates long-term value.
Distributing products is the most effective and efficient means for building market share. Marc makes no secret of his opinion that it is best to model the cannabis business after the tobacco and alcohol industries, i.e., be distributors. Perhaps this is one reason Cresco Labs hired Greg Butler, former Molson Coors (NYSE: TAP) marketing executive, to be the Chief Commercial Officer.
Don't fret over owning the land where cannabis is grown any more than brewers own the land on which hops are grown, Lustig argues. Cannabis companies will do best in owning the brands, manufacturing them, maintain strict quality control, and controlling their distribution to maximize sales through market penetration and long-term value. But the effectiveness of this approach depends on local and state regulations over which companies have had little control. These regulations will change as the industry becomes more effective lobbyists.
One example is the packaging. Packaging strongly identifies the brand. One of my students told me in preparing for the interview with Marc, that
Marijuana at Cresco Labs' dispensaries in Illinois first was packaged in long, colored, plastic tube containers in which only the flower was able to be seen. Worse, little bits of pot was hard to get out because of the long tube. Now they've switched to short, wide, frosted glass containers, which is nicer and a more convenient container but you still can't see the flower. It's like pot culture 101 to look at the flower before selecting which to buy. Why would they take that away from people?
Marc responded that is a perfect example of over-regulation from the state. If the regulations stymie sales thus tax collections, they will fade away.
One final note demonstrating leadership. Amazon is criticized for its sluggish inclusion toward diversity in leadership and decision-making offices. So, too, the marijuana industry finds Black entrepreneurs struggling to break into the legal business. Cresco Labs is due kudos for launching a community business incubator program for minority-owned cannabis companies. Cresco Labs is providing technical and financial assistance to minorities applying for licenses and launching craft growing businesses. That thinking and action define the difference between management and leadership of which shareholders of Cresco Labs can be proud.
Conclusion
Cash, leadership, branding, and focusing on distributing marijuana are the company's strengths.
Eventually, the cost of capital will come down. The Federal government and states will end intimidating traditional lenders. They cannot afford the costs of incarcerating people or resist the cash flow from taxes. The day the walls of resistance fall Cresco labs will be ready and their investors will flourish. Concomitantly, headlines like "Olivia Newton-John winning breast cancer battle as tumors shrunk thanks to marijuana," bolster sales. So does bad weed bought on the black market.
These extrinsic factors turn into higher valuations for companies; the cost of capital comes down, arbitrage plays out with banks, hedge funds, venture funds, and investors are allowed to buy cannabis stocks through traditional traders. Looking to the future, Lustig argues that long term, the universe we see today with disparate laws in disparate states will go away and they will look more like California. The company making the investment early on in distribution, from warehouses to wholesalers, directly to stores, with recognizable packaging and sparking brand recognition sets a good insurance policy for success. Bigger is better at this stage. Cresco Labs appears to be right at this intersection building for the right time.
