Cannabist Co Hldgs Inc (CBSTF)

[JohnCM]

Columbia Care: Low Profitability Overshadows M&A Strategy

Apr. 06, 2021 7:32 AM ET
Columbia Care Inc. (CCHWF)
Seeking Alpha
Cornerstone

Columbia Care reported Q4 2020 results which were bolstered by two acquisitions; another acquisition is expected to close in 2021.
We have concerns over CC's lack of scale in each of its markets, and its low margin demonstrates unsatisfactory operational performance.
We are Neutral on the stock due to its below-average profitability and concerns over its acquisition-driven growth strategy.

Columbia Care (OTCQX:CCHWF) reported Q4 2020 results which showed meaningful improvement from the previous quarter but most of the growth was driven by acquisitions. We continue to have reservations about CC's below-average profitability and lack of operational success.

2020 Progress

CC reported Q4 sales of $76M and positive adjusted EBITDA of $8M which were higher than the previous quarter. However, the results were skewed by two acquisitions which made it impossible to assess organic growth. It completed the acquisition of The Green Solution on Sep 1, 2020, and Project Cannabis on Dec 2, 2020, which contributed to the quarterly increase in reported results. Recall that CC acquired Colorado-based TGS which generated $88M in revenue and $18M in EBITDA which equals $22M revenue and $4.5M EBITDA per quarter. CC also acquired California-based Project Cannabis with an estimated revenue of $55M and $11M in EBITDA which equals $14M revenue and $3M EBITDA per quarter. Therefore, it is reasonable to infer that a big chunk of the growth in Q3 and Q4 was driven by these two acquisitions.

It is worth noting that CC has one of the lowest EBITDA margins among the largest MSOs. Without the recent acquisitions of TGS and Project Cannabis, the company would likely still be in negative EBITDA territory. The reason for CC's weak margin is clearly illustrated by the slide below which shows its lack of focus and inefficient footprint. The company has accumulated a portfolio that is thinly spread out across 14 states. The large footprint and a lack of depth resulted in inefficient operation and very underwhelming margins. SG&A is also likely to drag on the margin because of the need to keep such a large and unfocused footprint. We would be very interested to know the state-by-state profitability which will likely show that a majority of CC's markets remain unprofitable.

Another concern is that CC's assets are of lower quality than other MSOs such as Green Thumb (OTCQX:GTBIF) which also has a large footprint but maintained 20-40% EBITDA margins consistently. We have always held the view that Curaleaf (OTCPK:CURLF) is a second-rate operator compared to Green Thumb and Trulieve (OTCQX:TCNNF) but Columbia Care has even lower profitability within the peer group. Acquiring assets in mature, low-growth markets like Colorado is in some ways "cheating" because it helps boost CC's margin while disguising the inferior quality of its other assets. The same EBITDA should not be valued equally in Colorado and Florida.

While we think CC management has done a commendable job of establishing one of the largest footprints among MSOs, the company has a long way to go before demonstrating the quality of its assets. Closing the margin gap would be the first step and one way of doing so is to deepen penetration and reach scale in each of the markets. Trulieve primarily relies on Florida but has the highest EBITDA margin among the top 10 MSOs. CC right now has one of the lowest EBITDA margins which puts it as a show-me story.

2021 Guidance

CC management provided guidance for 2021 which indicates $500-530M in revenue and ~20% EBITDA margin. The Q4 results imply a run-rate revenue of $300M and EBITDA of $30M but the biggest growth driver in 2021 is the pending acquisition of Green Leaf which could add ~$50M in EBITDA on a run-rate basis. CC is also guiding for a modest 5 planned store openings which combined with full-year contributions from Project Cannabis and overall market growth should drive strong growth in 2021. We think the guidance is achievable given the bulk of it will come from the acquisition of Green Leaf and Project Cannabis but we saw that the acquisition-driven strategy has so far underperformed organic growth compounders like Trulieve and Green Thumb. Therefore, we view CC as an inferior choice to these two names.

Valuation

Columbia Care is very expensive as the shares are trading at nearly 54x EV/EBITDA based on annualized Q4 results. The stock has a market cap of $1.2B and has modest net debt of ~$24M. We view CC's valuation as speculative and expensive, which makes the stock unattractive relative to its peers. The market is giving the company lots of credit for its potential ability to close the margin gap but that also implies the upside is limited with big downside risks. Even if CC could obtain a 20% margin per its guidance, its multiple would only drop to 27x, which remains more expensive than industry leaders Trulieve and Green Thumb. We see the risk and benefit calculation as unattractive and disproportionately skewed to the downside.

There is a massive arbitrage opportunity in the cannabis stock public market in that public companies are valued at 10-15x revenue but the private market is much cheaper at <5x revenue. CC claims to have paid <2.0x LTM revenue for both TGS and Project Cannabis and 4.8x for Green Leaf, all of which are significantly cheaper than its current valuation in the stock market. Therefore, the company is earning a massive spread just by aggregating private assets and that is a key reason for private operators to sell to public companies. CC is one of the many MSOs taking advantage of this arbitrage opportunity by acquiring private assets at discounted prices.

However, despite the valuation gap, growth-by-acquisition is not without its risks including integration and dilution/leverage. We still prefer companies that are able to grow organically and generate the highest ROI by investing in operations. Companies like Trulieve and Green Thumb are the best examples of organic growth compounders and their shares are some of the best performers.

Looking Ahead

Columbia Care is one of many MSOs that are trying to gain a piece of the great American cannabis opportunity. However, the company is pieced together through many acquisitions thus lacks integration and efficiency. The company has wrongly focused on expanding into new markets while neglecting the need for scale and margin. We prefer operators who have demonstrated the ability to grow profitably; we are generally cautious about companies built primarily through acquisitions such as Curaleaf and Columbia Care.