Beacon Securities Analyst Comments on the mergerHi All,
Bruce Campbell from StoneCastle here. Here are a few details on the CNNX/4Front Merger. This comes from Beacon Securities Analyst
Full disclosure we own a position in CNNX.
Event: - Cannex announced that is has signed a binding agreement through which it will merge with 4Front, an east-coast based player with current operations in 4 states (Illinois, Maryland, Mass, Penn). The company currently operates 5 dispensaries in those states and expects to have 20 by the end of 2019. It also has cultivation and manufacturing assets.
- In a sense, this is an RTO for 4Front will own ~64% of the combined company with CNNX shareholders owning 36% (share exchange of 1.75 CNNX shares issued to 4Front holders for every 1 CNNX share). By our math, post transaction and based on 184 million basic shares for CNNX, there would be 504 million basic shares outstanding. At a current price of C$1.00, that would imply a market cap of C$504 million (US$387 million)
Analysis: - We believe this is an EXCELLENT transaction for CNNX shareholders as they get immediate exposure to other states while 4Front shareholders get access to CNNX’s operational expertise.
- We would put the benefits of the transaction into 2 primary buckets:
- Geographic Expansion: We believe building a national footprint is important. Currently, Cannex is a one-state operator (Washington State). The addition of 4Front brings 4 more states to the combined entity. Of note:
i)
Not all states are created equal and Combined Entity Has Operations in Some of Most Attractive: We favour states that are currently (or soon may be) recreationally legal. To that regard, Washington State is rec legal. Of the 4 states that 4Front brings, in our view,
Mass and Illinois are the very important. Massachusetts has a population of 7 million people and just became rec legal. We believe this will be a VERY important state. Also, Illinois with a population of 13 million, recently passed its Opioid Replacement Bill which should drive a significant increase in medical sales. We also expect it to become rec legal in the near future. Penn (population 13 million) and Maryland (6 million population) are solid medical states in our opinion. Furthermore, with a footprint of (now) 5 states, we would expect the combined entity to continue to expand to other states that we deem very important including California (rec legal), Arizona, Nevada (rec legal), Michigan (voted to be rec legal), Ohio and New Jersey (legalization to be debated with full vote in mid-Dec).
- Operational Expertise: While Washington State has been deemed by the public markets not be attractive, we noted above that it is rec legal and a US$2 billion revenue market. While competitive, CNNX has “cut its operational teeth” in this market where only the strong will survive. It has been gaining market share and its underlying business (NWCS) is running at ~US$40 million revenue and a 25-30% EBITDA margin and is free cash flow positive. We believe 2019 will be the year that “operations matter”. As such, while the market may not have placed much emphasis on it in 2018, operators such as 4Front clearly want/need to add such capabilities. In particular, CNNX brings cultivation and processing excellence, which will become increasingly important.
- Through this transaction, the pro-forma entity becomes a significant national (multi-state operator) player with operations in 5 states (WA, ILL, MY, Mass, Penn). Furthermore, 4Front/CNNX has short-term plans to be in additional states. If successful, that could put the combined entity in 11 states in 2019.
- As a point of reference, Acreage is currently in 14 states (going to 18) with MedMen and Curaleaf in 12, Ian/MPX in 10 and GreenThumb in 8.
- In terms of numbers, 4Front is a private company. However, in recent presentations, it had forecast FY19 and FY20 rev/EBITDA of US$76m/US$12m and US$143m/US$33m respectively. We would note that such forecasts are predominantly based on Mass and Illinois and clearly do not include any potential new states or margin expansion that could come as a result of the addition of CNNX’s operational expertise.
- Recall that the CNNX accounting is a little uncommon given the regulations in Washington State; however, as noted above, we believe the underlying company (NWCS) is generating ~US$40 million in revenue at 25-30% EBITDA margin (US$11m). Its growth rate would not be as dynamic given the maturity of the WA market. However, it is gaining market share in the state. As such, we believe a 10% growth rate is conservative or US$44m/US$12m
- On a proforma basis, therefore, US$115m/US$23m and US$187m/US$44m for FY19 and FY20 respectively. If we were to assume some synergies between the two companies, we feel US$50 million in FY20 EBITDA is achievable. Furthermore, with ~US$36 million in cash to execute additional acquisitions, the company could grow further grow FY20 EBITDA on a non-dilutive basis.
- Given a ~US$390m EV and assuming our FY20 EBITDA of ~US$50 million, the stock would be trading at under 8x.
Conclusion: - Upon closing of this transaction (expected Feb 2019 albeit definitive agreement by year-end), CNNX will become the newest MSO. With an EV of under US$400 million, it is also the cheapest by far. By comparison:
- Acreage Holdings - ~US$3 billion
- MMEN - ~US$3.3 billion
- GreenThumb - ~US$2 billion
- IAN/MPX - ~US$1 billion
- CuraLeaf - ~US$3.3 billion
- Harvest - ~US$1.7 billion