Marijuana Investing: The Pros and Cons of MSOs

Multi-state operators (MSOs) are an intriguing model for many cannabis investors. But are these conglomerates evolving into a position at the top of the cannabis investment food chain?

Let's first briefly review what MSOs are, and the pros and cons of investing in them. Then we'll explain how you can go about dipping your toe into MSO stocks.

Pros of MSOs

A multi-state operator helps a brand expand nationally while carefully remaining within federal laws limiting interstate commerce. In short, cannabis grown in one state must remain there.

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Yet a single brand representing a collection of operators can grow and gain brand recognition when sold locally under the same product name – but by legally distinct entities. This tactic means the MSO can build a loyal customer base, and prepare financially and operationally to go national when federal laws do, one day, allow it.

In the meantime, they function and aim for profitability through local, state-by-state "branches" offering seemingly identical products, but all locally grown, processed and distributed.

Challenges of Investing in MSOs

There are three obvious challenges to the MSO model:

• First, complying with varying and inconsistent state regulations means that economies of scale are tough to achieve; there is no single, optimized end-to-end manufacturing process for all products.
• Second, due to the geographical and environmental limitations, product consistency is hard to maintain because of variations in the raw materials. Part of the power of any brand is its consistency, but you can't achieve that when flowers grown in Southern California differ from those grown in, say, Pennsylvania.
• Finally, many investors are hesitant to invest in such a complicated entity, which is technically a conglomerate of many subsidiaries. The red tape and local license/tax requirements mean that an MSO presents a more complex financial structure than many investors have the stomach for.

Are these problems insurmountable? Certainly not.

While the challenges are real, multi-state operators have significant leverage in the market. Well-planned and managed MSOs are flourishing and providing attractive returns and are outperforming the market. In fact, multiple MSOs are reporting year-over-year growth with line of sight to $1 billion in annual sales.

They're clearly doing something right.

So, how can investors invest in multi-state operators?

Publicly Traded Companies

For most investors, the most feasible route to MSOs is tapping the public markets.

Several MSO stocks – such as Curaleaf (CURLF (opens in new tab)), Trulieve (TCNNF (opens in new tab)) and Green Thumb Industries (GTBIF (opens in new tab)) – are traded publicly. Because cannabis is still illegal on the federal level in the U.S., several of these companies can be found on Canadian stock boards and may require investors to use a special brokerage account to purchase. But in some cases, you might still be able to buy their over-the-counter shares in traditional brokerage accounts.

For investors that want to diversify, it's also worth looking at cannabis exchange-traded funds (ETFs). The AdvisorShares Pure US Cannabis ETF (MSOS (opens in new tab)), for instance, holds a number of well-known MSO stocks (hence the ticker).

Recently, cannabis companies have also been taken public through publicly traded special-purpose acquisition companies (SPACs), that make private-equity investments in undervalued private companies. For example, in January, The Parent Company (GRAMF (opens in new tab)) was formed when the SPAC Subversive combined the assets of Caliva, Left Coast Ventures and Jay-Z's cannabis company, Monogram. Other SPACs have announced similar deals. For instance, Silver Spike announced last December that it would take public WM Technology (MAPS), the entity behind Weedmaps.

Private equity exchange-traded funds (ETFs) and publicly traded investment firms could also be a viable option for investors who don't meet minimum thresholds. These publicly traded options allow investors to benefit from the private investments these firms make through the public market. The downside? They're likely to be diluted with many non-cannabis investments.

A new crop of publicly traded cannabis investment companies, lenders and even real estate investment trusts (REITs) such as AFC Gamma (AFCG (opens in new tab)) and Innovative Industrial Properties (IIPR (opens in new tab)) are coming to the markets. These publicly traded equity and investment firms can be accessed through an online brokerage.

Private Investment Strategy

The private investment market can provide much more explosive returns – but the bar for entry is much higher than in the public markets.

A private, single-state cannabis company is an acquisition target for an MSO (like the recent acquisitions of Blue Camo for more than $75 million, HMS Health for $27.5 million, and Dharma Pharmaceuticals for $80 million). The roadmap by which today's cannabis producer establishes itself and expands operations is heavily influenced by the guidelines in place to make itself attractive to an MSO.

The upshot? Investing in the early stage of one such "puzzle piece" means that your return is based on a much steeper growth rate than were you to invest in the "mother ship," who is paying a premium for such companies, then laboring to drive the success of the entire conglomerate. What's more, private equity investors often have influence on strategic decision making including catalyzing organic expansion and consolidation through acquisitions.

Next is the issue of risk. The three MSO challenges we opened with don't exist for the private company, focused in a single state, that can capitalize upon the economies of scale of cultivation and production:

• State regulations are clear and easy to adhere to.
• The financial structure is easier to manage and explain.
• The technologies and branding strategies are now mature, proven, and predictable (when executed well)

Finally, the simple fact that private companies can do business outside of the public eye is also an advantage. Many public firms overly focus on quarterly results. This makes public companies less risk averse and can cause them to miss out on long-term value opportunities.

In contrast, private companies that aren't beholden to short-term expectations from shareholders have a stronger appetite for long-term investments that will produce competitive advantage down the road.

How to Invest in Private Targets

For those who want to invest in private targets, look for a reputable professional fund manager. Any fund worth investing in will have disclosure documents that should be read closely.

The most important thing to note is that there are minimums for private equity investors. Some firms require as much as $25 million while others require as little as $100,000. These investors also need to meet income minimum or have a net worth of typically $1 million or more, excluding primary residence.

Angel groups are another way to invest in private targets. Angel investing can be made up of friends and family that want to invest in a startup. There are also lists of local angel groups (opens in new tab) that can be found online. Angel investing can start off with much lower minimums since people pool their money. For instance, 10 friends can each contribute $10,000, making a $100,000 investment in a company.

Regardless of how you make private equity investments, the same investment principals stand: Look for funds and targets with strong growth. When supported by experienced, creative, aggressive management teams, they join more traditional early-stage startups as clear acquisition targets for an expanding industry.