The Case for Extractors At every institutional investor group meeting that I attend someone says:
"Isn't it just a matter of time until the well-capitalized LPs in-source these activities and cut you out?"
a) There are virtually no "well-capitalized" LPs left, and the two best-capitalized (CGC, CRON) are two of the biggest customers of VGW and LABS.
They and other large LPs such as OGI and TLRY know their value is in their brands and that their (limited and increasingly expensive) capital is better spent on customer acquisition, and as such, are increasingly outsourcing non-core activities. They need to re-focus, not expand.
b) It's not as simple as buying extraction, distillation, filtration & chromatography equipment off the shelf. Set-up, customization, and importantly, scaling up to industrial volumes while maintaining high-quality at high-speeds is *very* time consuming and difficult.
The machinery, processes and teams at $VGW and $LABS took many years to develop and perfect. 2.0 products are mission critical, and LPs can either buy high-purity product in weeks or spend a year+ attempting to copy what is already being done well; the decision is easy, outsource
c) Yes, some large LPs will eventually in-source, but:
- i) there will be dozens of second-tier LPs who still require toll services,
- ii) the evolution of $VGW and $LABS business models are to serve non-LP clients, such as Ace Valley, BRNT today and Red Bull, Red Stripe tomorrow...
This white-label business model is how every major consumer packaged goods business is run today. J&J and P&G manufacture very little themselves; they use co-packers. The myth of vertical integration as an advantage in cannabis is dead, companies specializing is the future.
I could tell you I have a crystal ball, or I could just point you to any mature cannabis market in the US where there are cultivators, extractors, formulators, distributors, retailers & brand entities. There are very few who do all of the above b/c it doesn't make economic sense.
d) The white-label deals for 2.0 products including vape, edible, concentrate and other novel formats not only allow for a higher capture of unit economics, but the generation of valuable IP that can be applied to markets internationally (including the US one day).
For example, with the Ace Valley vape agreement, $LABS is essentially just paying a licensing fee as a % of sales to AV, while capturing the rest of the economics for themselves. AV is just responsible for sales & marketing of the brand, which is of course what they specialize in
The high profitability at $VGW & $LABS is likely continue as they transition from tolling to white-label work over the next 2 years.
w/ earnings growing at a >100% CAGR and strong net cash balances, $VGW & $LABS should not be trading at 4x & 7x 2020E EBITDA, respectively.