Things have simply not gone according to plan for marijuana stock investors over the past year. The prevailing issues have been supply shortages and/or bottlenecks in Canada, as well as high tax rates creating wide pricing gaps between legal and illicit product in core U.S. markets. These problems have allowed the black market to continue thriving, all while investors have watched their investments in pot stocks go up in smoke.
But there's another issue cannabis stocks are contending with that doesn't exactly bode well for the entire industry: financing concerns.
Cash concerns are a big problem in the cannabis space
Despite marijuana being federally legal in Canada, as well as medically legal in 33 U.S. states, accessing traditional forms of financing from banks and credit unions, such as a line of credit or a loan, can be difficult.
In Canada, the issue isn't that banks don't have the capacity to lend -- rather, it's that they're treating the Canadian pot industry as a mature business model and therefore placing more rigorous expectations on the companies looking for a loan or line of credit. Following a period of aggressive expansion that featured a number of grossly overvalued acquisitions, banks have seen the balance sheets of Canadian pot stocks and mostly steered clear.
Meanwhile, in the U.S., the federal scheduling of weed has kept a number of financial institutions from offering basic banking services (including a checking account). With banks and credit unions reporting to the Federal Deposit Insurance Corporation, a federally created agency, they fear possible criminal or financial penalties if aiding cannabis businesses. This has left U.S. multistate operators (MSO) with few avenues to raise capital, especially with cannabis banking reform gaining little traction in the Senate.
In recent months, we have witnessed an uptick in sale-leaseback agreements within the U.S. as a means to raise cash. Under a sale-leaseback agreement, an MSO sells a cultivation or processing site to a real estate investment company for cash, and then signs a lease with that same real estate company to become a long-term renter. Understand, though, that not every MSO has this option available.
With its cash dwindling, this pot stock could become the first high-profile casualty
While there are a number of marijuana stocks that look to have insufficient capital positions relative to their proposed domestic and/or international strategies, none looks to be more dire than U.S. MSO MedMen Enterprises (MMNFF -4.55%). I don't use the "b" word lightly, but I genuinely believe MedMen is on pace to become the first high-profile bankruptcy in the North American pot industry.
Despite bursting onto the publicly traded scene with high hopes in 2018, MedMen has faced two key problems. For one, its core market of California has been a gigantic disappointment.
Even though California is still generating more in annual weed sales than any other market worldwide, legal pot sales actually fell by $500 million, to $2.5 billion in 2018, the year the Golden State opened its doors to adult-use weed sales. California's exceptionally high tax rates have made it virtually impossible for legal-channel product to compete with illicit producers, which has constrained the growth prospects of MSOs like MedMen.
MedMen has also been far too aggressive with its U.S. expansion strategy. Aside from organically building out in its core states like California and now Florida, MedMen announced an all-stock acquisition of privately held MSO PharmaCann in October 2018 for a whopping $682 million. Just three days prior to the one-year anniversary of the deal being announced, MedMen canned it.
MedMen's press release offered a number of reasons for the company to back out of the buyout, including that it would have moved MedMen into a number of noncore markets. But the real reason for abandoning the buyout seems to be that MedMen didn't have the capital to take on PharmaCann's operational locations and expansion strategy.
MedMen's fiscal second-quarter results show how bad things are
A little over a week ago, the troubled MedMen wound up reporting its fiscal second-quarter operating results, ended Dec. 31, and it showed just how bad things really are at the company. For example, MedMen reported $44.1 million in revenue for the quarter, representing 50% year-over-year growth.
However, same-store sales in California grew by a far less impressive 16%, which is noteworthy considering that California is MedMen's core market. Such tempered growth is a big problem once you dig into the company's mammoth expenses, which continue to feature some of the highest selling, general and administrative costs among all MSOs.
Factoring out fair-value adjustments, MedMen managed a menial gross profit of $4.5 million on $44.1 million in sales, yet had $69.2 million in operating expenses. Yuck! That's $103.3 million in operating losses through the first six months of fiscal 2020 after losing $231.7 million in full-year 2019. Things simply aren't getting better fast enough for the company or its shareholders.
This is a problem, because MedMen ended the calendar year with only $26 million in cash and $188.8 million in current liabilities (i.e., costs expected within the next 12 months). As part of the company's cost-reduction efforts and to demonstrate just how desperate things have become, MedMen has recently been offering to pay its vendors with its own common stock rather than using cash.
According to the company's quarterly filing with SEDAR in Canada, its outstanding share count has ballooned 84 million over the past six months (ended Dec. 31), and it's using its stock for everything from raising cash to settling debt and making acquisitions. These share issuances are unlikely to slow down, even as MedMen's share price has plummeted more than 95% from its all-time high.
Furthermore, despite having up to $280 million in financing pledged from private equity firm Gotham Green Partners, MedMen announced in December that the final $115 million of this financing was no longer accessible.
In short, MedMen is in real trouble. Without serious belt-tightening and a financial backer, MedMen may not survive more than a couple of months.