Oh My Goodness!

Thoughts on the Termination of the Verano and Goodness Growth Merger

Warning: The following column is about a microcap company. Microcaps by definition can be illiquid and experience wild gyrations. It is important to do your own due diligence, rely on your own research and understand that microcaps can be very volatile. Please proceed reading using your highest levels of caution. That being said…

A little over a week ago, in rather shocking news, Verano (OTC: VRNOF) terminated the acquisition of Goodness Growth (OTC: GDNSF). Cannabis investors, analysts and observers of the industry were quick to note that this was neutral to good for Verano and that this was maybe the end for Goodness Growth with a possible bankruptcy in the near future.

I disagree with that assessment, and I have been buying Goodness Growth for both of my investment funds.

This broken merger and Goodness’ valuation have major implications for all cannabis Multi-State Operators (MSOs). The summary of my thoughts is that Goodness should be worth more than its current $50 million market cap, and if it isn’t then every multi-state operator that depends on limited licenses is likely worth significantly less than their current valuations if anything at all after debt.

It was only eight months ago that Verano announced that it was acquiring Goodness Growth for $413 million in an all-stock transaction. You can read the press release for all the wonderful reasons they cited for the acquisition. Around the time of the acquisition, I actually thought Verano was getting a pretty good deal. Why?

First, Verano was expanding its geographic footprint by over 27 million people as Goodness operates in three states that Verano does not: Minnesota, New York and New Mexico.

Second, one month prior to the deal, Green Thumb (OTC: GTBIF) bought into Minnesota for $155 million by buying LeafLine.

Then one month later, RIV Capital (OTC: CNPOF) ended up paying $247 million just to enter New York by buying Etain.

Verano would also dispose of Maryland as companies there are only allowed to own one license, not two, thus lowering the purchase price of the total transaction.

The RIV Capital acquisition was seven short months ago. Green Thumb’s acquisition was ten months ago. How in the world do you go from something being a good deal at $413 million to a value of $50 million where no investor wants to own your stock? You get there with little to no institutional ownership, a world class cannabis bear market and retail investors who have gotten pulverized.

From here, I believe that Goodness is an asset play, in which the licenses, dispensaries and cultivation potential have much more value than the current revenue and cash flow. And that the company will either be broken apart or will merge with another MSO, albeit at a lower price than $413 million.

Do I think that Goodness is great at operations? No.

Do I think that Goodness is sub-scale and capital constrained? Yes.

Do I think it is going bankrupt soon? No.

Do I think it is very undervalued? Yes.

So, what value do I see in Goodness?

First let’s start with New York. As we have learned, New York’s cannabis roll-out is messy, there are a ton of illegal dispensaries, and the state government is trying to shake down the original ten license holders (of which Goodness is one) for lots of money to be able to sell adult use.

What used to be a ton of excitement about the potential of the market has turned into queasiness. And this might be the main reason that Verano backed out of the acquisition, they simply got cold feet about the state of New York.

That being said, it is still New York and still a massive market of almost 20 million people. It is an important, limited license state. This license should have value and it’s probably worth more than the current $50 million market cap. There are only 10 existing medical license holders and when all is said and done, this should enable Goodness to have an important footprint in one of the largest and most influential states in the US.

You then get New Mexico, which went adult use in April, and the company has four dispensaries and 19k square feet of cultivation. And you have Maryland, which is about to approve adult use and is a market with 6 million people. Goodness has 2 dispensaries and 38k square feet of cultivation.

But the state market that is potentially the most valuable is Minnesota. In a market of 5.7 million people, there are only two legal operators, Green Thumb and Goodness. There is a strong chance that since Minnesota is a “purplish” state (meaning it’s not a red, conservative state, nor is it a blue liberal state) you aren’t going to get the crazy blue state shenanigans of deliberately trying to delay or penalize existing operators. And this is why Green Thumb paid $155 million for LeafLine.

In Minnesota, Goodness has eight dispensaries in great locations, including one downtown and one within ten minutes of the Mall of America. And all of the dispensaries get great reviews online and on average, better reviews than LeafLine’s dispensaries. They also have 90k square feet greenhouse cultivation, but it’s under built.

The company’s debt load is not very much at $51.3 million, with the only maturity being April, 2023 of $18 million. And it looks like this can be extended for one year with some fees. The company also has almost $17 million in cash on hand as of Q2. Interestingly the company’s cash burn has come down recently to less than $5 million in Q2 and it posted a positive EBITDA and positive income from operations in Q2. It’s likely the company has time to figure out what to do now.

According to Goodness’ lawsuit against Verano, there were five bidders last year for Goodness, and I believe that Verano was not necessarily the highest bidder. Trulieve (OTC: TCNNF) would be a perfect acquirer of Goodness now and probably bid on the company before losing to Verano.

Are we really to believe that the other bidders for Goodness won’t come back to re-visit their offers? I can tell you from personal experience that this is often the case. When we went out to sell The American Home, my single-family rental company, we initially were under contract with a high bidder who ended up backing out of the contract. Nine months later, we ended up selling for a slightly lower price to the company who was initially the second highest bid for our company.

Even if Goodness is not bought by other bidders, if we get SAFE Banking, or a rescheduling or de-scheduling of cannabis, the company’s cost of capital should plunge, plus the number of suitors who would want access to 33 million Americans would soar. Imagine if private equity or the Canadian cannabis companies were able to participate in US cannabis. They would have a field day with a company like Goodness.

And last but not least, Goodness owns some really interesting patents including one fascinating patent that covers adding a cannabinoid to tobacco which may make it safer. This is a real wildcard in a world in which tobacco companies can invest in cannabis. What exactly is the value of this patent and others that Goodness sits on? I’m not sure, but I am sure it is worth more than zero and potentially a lot.

Maybe, just maybe, $50 million in market cap is not the right valuation for Goodness?

As for Verano, the termination makes no strategic sense. This was an all-stock transaction with minimal cash requirements. It gave them geographic access to key markets such as Minnesota and New York to complete their national footprint with minimal cash needs. And further, because this was structured as an all-stock deal, the price of the deal fell from $413 to $130 million the day the deal was terminated. I can make no sense of it. Why is a company with a $2.4 billion enterprise valuation and over $300 million in EBITDA breaking a deal for a $130 million transaction?

It simply makes no sense unless Verano was worried about its balance sheet and cash flow and that even a modest amount of further debt and cash expenditures could hurt the company.

Also, my own due diligence has found that these merger agreements, as Elon Musk is discovering, are very hard to break. In fact, the great feedback I received after writing my column on the Cresco/Columbia Care deal was that you can’t break these contracts and that Cresco can’t get out of it. I now believe that Verano will have to settle or pay some material amount to Goodness, though it may take some time to work through the courts.

Finally, while Verano will show growth from New Jersey, once it laps those comparisons next year, Verano could show little or no growth for 2023 or 2024. Investors for obvious reasons value growth. Further, with a weakening economy and Verano’s focus on the high end of the market, Verano may be vulnerable to significant margin compression as consumers trade down. Is it possible that without Goodness, Verano could see negative growth next year if the economy is in a recession? I don’t know, but it is worrisome.

And it is for these reasons, I’m raising the white flag on Verano and admitting my mistake. I’ve sold my shares in the company and have re-deployed that capital into Goodness and other undervalued cannabis stocks where there is growth, and the companies are making strategic decisions that make sense to me.

Back to Goodness, I’m convinced that if these licenses in such prominent limited license states don’t offer value to a strong operator, then none of the MSOs have much of any value and they are all melting ice cubes. So, cannabis investors should very much pay attention to what happens to Goodness, because what happens to the stock and the company’s valuation has broad implications for the future value of every MSO.