Canopy Growth Corp (WEED)

[happyglass]

FYI, This is from new cannabis ventures. https://www.newcannabisventures.com/
View this email in your browser

Friends,

This was a banner week for the American cannabis sector, with blowout revenue from not only GTI and Trulieve, which reclaimed the top spot among MSOs with annualized revenue for both at about $500 million, but also for some of the other operators that reported. Across the board, revenue is growing more rapidly than expected. Perhaps even more importantly, operating margins are improving quickly, leaving these companies on stronger financial footing.

As cannabis companies are becoming profitable, their financials are revealing just how punitive the federal taxation for cannabis operators can be. For those not familiar with 280E, it is a federal statute that disqualifies all expenses beyond cost of goods sold for businesses involved in trafficking of Schedule I or II substances that was created in the 1980s. The result is that state-legal cannabis operators can pay extremely high tax rates.

Looking at the most recent quarterly reports for GTI and Trulieve, the tax burden demolished pre-tax income, leaving GTI with an after-tax loss and Trulieve with a puny net profit:

We are excited to see select MSOs generating pre-tax income, but we believe that many investors may be unaware of the extraordinary tax burden on cannabis operators and that this should be considered when valuing companies. We have seen no discussion of this among the analyst community or the financial media, and we note that the most common valuation metrics that analysts use, Enterprise Value to Sales and Enterprise Value to EBITDA, totally disregard taxation.

While we are hopeful that the burden of 280E will go away soon, it's not clear how that will play out. Full legalization or descheduling would address the issue, but it would take government action to change the current system otherwise. We don't expect that the government will just do away with 280E. Instead, it is likely to implement some sort of federal sales tax, though this seems improbable absent legalization. We fear that the status quo or even legislation that codifies the rights of states to regulate legal cannabis will leave this onerous burden intact.

In our view, investors should give thought to how long the MSOs will be forced to pay high federal taxes. If one thinks this is a short-term issue soon to be rectified, it's not important. On the other hand, 280E taxation could weigh down on net income and cash flow for years to come potentially, something that will diminish the value of the companies. Additionally, we note that many of the MSOs took advantage of extended tax payment deadlines this year, which beefed up cash flow from operations and cash balances. Beginning in Q3, balance sheets and cash flow statements will reflect these payments.

While direct cannabis operators are subject to 280E, this is not the case for ancillary companies, CBD sellers or cannabis operators in Canada and other federally legal regimes. When evaluating investments across the sector, we believe that investors should take the levels of taxation into account.
As an early pioneer and leading provider of ancillary products and services to the cannabis and CBD industry, KushCo Holdings has since sold over 1 billion units to growers, processors, producers and brands. The company's relationships with many MSOs, LPs and brands allow it to continue to capture market share across a rapidly growing industry. After a trying year, KushCo has been able to successfully cut costs dramatically in order to sustain itself in efforts to move towards positive EBITDA. With a renewed and lean business model, the company is poised for both revenue growth and profitability as 2020 progresses.