Multi-state operator Cresco Labs Inc.
Cresco and Origin House are finally able to move beyond a deal that has likely been in the works for over a year (the official announcement of the deal was on April 1, 2019).
At market close, the deal had been priced in and there are currently no arbitrage opportunities. Instead, we wanted to look at the businesses themselves.
From a top-line perspective, the Origin House deal would add $22.8 million in pro forma revenue to Cresco’s $36.2 million based on 2019 Q3 financials.
While that is a sizeable addition (63%), Cresco will have their hands full trying to right-size Origin House’s operations. The company’s gross profit was $3.8 million, good for a gross margin of 17%. This is less than half of Cresco’s 35% gross margin and should be concerning to Cresco shareholders.
Turning to cash, a precious commodity in the marijuana industry these days, Cresco is sitting flush with $112 million as of the end of Q3 2019, after a sale-leaseback deal.
While they are still in a period of investment and negative cash flow from operations, the substantial revenue boost from Illinois legalization should bode well for their bottom line.
Cresco’s biggest concern remains Origin House’s bloated operations. They will need to act prudently if the deal is to be accretive for shareholders.
Origin House had operating expenses of $19.8 million in Q3, meaning they posted an operating loss of $16 million. Cash flow from operations wasn’t any better at $17.9 million in the quarter.
While Cresco will now receive the $39.7 million that has been escrowed pending closing of the deal, that will be burned through in just over two quarters at Origin House’s current rate.
With the deal, Cresco enters the highly competitive California market in a real way. They now have listings in 65% of dispensaries in the state. While any company striving to be an industry leader needs to be in the largest U.S. marijuana market, it always comes at a cost.
In this case, it is operations that need significant improvement — Cresco has its work cut out for them.
We believe Cresco has an impressive geographical footprint and solid operations. Their management team has shown prudence with its willingness to back out of the VidaCann deal instead of diluting shareholders. The legalization in Illinois, which we believe they will dominate, should bode well to offset the costs associated with Origin House’s operations.
However, from an investment perspective, we need to see more details in terms of their California strategy and how they plan on right-sizing Origin House’s operations before investing.
If they are not prudent, OH’s operations could weigh on their financials for the first few quarters after the acquisition.
Terms of the Deal
The combined entity is now one of the largest vertically integrated multi-state cannabis operators in the U.S. It also makes Chicago-based Cresco a formidable player in California, where Origin House has built up a market-leading position.
The acquisition was first announced on April 1, 2019. It was billed as the largest-ever public company acquisition in the U.S. cannabis sector, with a total consideration of approximately $820 million on a fully diluted basis.
Shareholders in Origin House were told they would receive 0.8428 subordinate voting shares of Cresco Labs and 84.28 Cresco shares for each Class A compressed share as part of the deal.
However, the closing date was set for November, by which time falling pot stock prices and other headwinds slashed the value to approximately $446 million, including nearly $30 million in Origin House equity financing.
This sparked a renegotiation process. In the end, both parties agreed that Origin House shareholders would receive 0.7031 of a Cresco Share for each common share and 70.31 Cresco shares for each Class A share.
The acquisition finally closed today. Cresco chief executive and co-founder Charlie Bachtell called it “a transformational deal” for his firm.
“With the closing of this transaction, Cresco is in a position to accelerate its entry into one of the largest legal cannabis markets in the world [California], while adding valuable expertise in wholesale distribution and brand development, which we expect will drive significant value for all of our shareholders as we scale across the country in the coming years,” he said.
He feels that the combined entity is now in a position to consistently outperform the market on both yield and quality due to the efficiency savings it can make as a result of the deal. Bachtell declared that Cresco is “one of the most fundamentally sound and best-positioned multi-state cannabis operators in the U.S.”.
It now boasts the largest distribution footprint of any U.S. cannabis company, with more than 800 dispensaries across 11 states carrying its brands.
Cresco was already present in 11 states, with 15 facilities, 21 stores, and 51 licenses to open retail locations. It had listings with around 300 dispensaries across those states.
Origin House only operates in California, but that is the world’s largest cannabis market and it has listings with 575 dispensaries across the state. That represents around 65% of the state’s storefronts.
The California cannabis market is tipped to reach $7.7 billion in annual revenue by 2022, according to Arcview Market Research and BDS Analytics, and Cresco is now the largest distributor in the state.
Origin House has 92,000 sq. ft. of indoor cultivation and production facilities, which should allow the combined company to expand its offering of Cresco-branded products across California, growing market share, generating brand equity, and driving shareholder value.
Cresco will now appoint Marc Lustig, chairman and chief excutive of Origin House, to the Cresco board of directors, following receipt of certain U.S. regulatory approvals. The combined entity will have more than 1,000 members of staff.
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