For this week’s Power Player’s interview, we spoke to Hershel Gerson, managing director at cannabis-investment bank Ello. Gerson joined the green rush last year after years in accounting and corporate finance. Before then, much of his career has focused on consumer packaged goods and wellness-oriented companies.
In our wide ranging conversation, Gerson discussed his favorite retail strategy, why he thinks the pandemic will accelerate U.S. legalization and several reasons he’s very bullish on the industry.
This interview has been edited for length and clarity.
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Can you give us an overview of ELLO’s business?
We are a financial advisor providing capital markets advice and capital raising expertise, M&A expertise and strategic advisory services. To the extent a company wants to raise capital, sell or buy assets or generally talk about their position in the market, we can facilitate any of those discussions.
WW: What were you talking about with clients before the pandemic?
HG:We all believe cannabis has significant growth opportunities, whether it be new markets opening up or new consumers coming into the industry. Up until Covid, we were going through a reset evaluation. Given the lack of interstate commerce, the U.S. market broadly required significant capital to go vertical in each of those states. So to me that capital intensiveness makes it challenging to have the multiples at the levels that Canadian retail investors [who invested in pot stocks] entered in the market.
With the reset we were: 1) Talking about the sustainability of those levels and 2) Why we weren’t going back to historical multiples. Not everybody’s head had reset — including entrepreneurs and large corporations — related to new capital raises. There was somewhat of a pause in the market. A lot of deals fell apart at the same time.
WW: How did COVID change things?
HG: I’m very bullish. Capital going into COVID was challenged given that the Canadian retail investor was no longer willing to take significant losses. Finding a new capital source was necessary, as was reassessing this capital intensive strategy of going into multiple states.
With COVID-19 essentially three things have occurred. One is that the state budgetary requirements are going to increase as their shortfalls increase. They are going to be looking for any avenues to raise tax revenue.
HG: They had the same issue in 2008 and they took to regional gaming. I anticipate a similar effect with cannabis where the tax revenues are just going to be too attractive for states not to adopt positive legislation, especially when neighboring states are going to have a REC program. The other thing I’d say is gambling never cured epilepsy. So we do have a lot of wellness factors that go with the consideration. You have social justice issues, you have opioid issues.
So I anticipate positive legislation, which will get to a tipping point on federal legalization. There’s also a large employment factor and cannabis has proven to be defensive as an industry.
HG: Correct. Revenues are on par or up [despite the poor state of the economy]. To the extent you are serving the local community, our clients’ revenues are at par or up across the board. The only ones who’ve been significantly impacted were those that were catering to a more transient community.
Planet 13 catered to the Las Vegas Strip, which has been effectively shut down and there are significant consequences associated with that. We have other clients in Nevada that are significantly up even with there only being delivery and pickup. They were servicing locals 80/20.
WW:What are the other two reasons you’re bullish?
HG: We are going into a low interest, potentially even a negative interest rate environment for the foreseeable future. We’ve already said that cannabis companies are defensive, to the extent they’re also cashflow positive offers a significant ability for investors to generate yields. So whether it be sale lease back transactions or asset-backed loans, they generally sit at 10 to 15% range, which is very healthy, even in a regular environment. Now that we’re going to the zero interest rate environment, that’s super appealing to investors.
HG: And then lastly, the growth profile relative to a defensive industry. Generally they’re consumer staples like supermarkets, essentially a-cyclical businesses that are much more mature so they generally grow in only GDP or CPI. With the new markets and new consumers coming in, we anticipate 20% plus growth available to the industry. So you’re looking at a very attractive investment opportunity.
That’s all tailwinds. We hope we’re going to get de-scheduling for cannabis and get [industry-hated tax rule] 280-E out of the way to give us some more cashflow to help support the industry as it grows.
WW: There are lots of different sectors and sub sectors. Who are you especially bullish on?
HG:Can’t go with specific names but I’ll talk strategy.
I think given the capital intensive nature of the business, guys who focused on single states to get density and positive cashflow are in an advantageous state compared to companies that went broad to try to get beachheads in multiple states that felt capital would just be there in perpetuity. They’re now having to make very difficult decisions as to where they’re going to focus. What are their core markets and assets?
WW:You seem to be referencing companies that were started by Wall Street guys that raised money in Canada but seem to be struggling to gain traction with consumers.
Hershel: They essentially rolled up a bunch of assets, took it public in Canada and made a lot of money. That’s financial engineering versus building a solid operational company and taking it out off of fundamentals. You would hope that a steward of the industry would follow the latter versus the former. The former is just not sustainable.
WW: Any other areas where you’re especially bullish or bearish?
Hershel: Again, I like building economies to scale within and doing the cluster strategy, similar to traditional retail. It’s even more important with cannabis given the capital intensity and the lack of true ability to market broadly.
Some interacting with the consumer is important and that’s more easily accomplished in a single jurisdiction than multiple jurisdictions. I’m bullish on good operators coming into the industry including executives from companies like Albertson’s and Smashburger.
Guys who have done it before in traditional industries are a welcome addition to cannabis and may have not been as prevalent in the industry given the regulatory environment. They’re willing to come in and be good stewards to the industry.
WW: There are a lot of pot stocks that seem to have solid fundamental businesses but their stocks are close to worthless. When will it be safe for retail investors to get back in?
HG: There are super attractive opportunities out there without a doubt. There’s a number of cannabis stocks that under the right leadership and capitalization are very strong businesses in good markets.
We’re evaluating those opportunities and getting out to the investors and talking to them. One of the bigger hindrances in getting regular institutional capital into the industry was valuations were crazy and institutional guys weren’t willing to put in the time to understand the industry. Now that the valuations make sense, they still sometimes struggle with the regulatory framework to get their endowments or their larger institutional investors (LPs) across the line to invest.
HG: It’d be helpful to get some regulatory framework that allows everybody to participate and get some more capital coming in. But there’s definitely a lot of opportunity. Generally the market overcorrects.
We are educating institutional investors and we do a lot of teach-ins, educating them on the industry, all the positives related to the industry, and try to get some conversion from funds since they have a lot of capital on the sidelines. They believe in the macro[dynamic]s The missing link is related to regulatory and getting their LPs to give them permission.
WW: Are the LPs getting more interested or getting more flexible?
HG: When they start seeing that their portfolios are down significantly and there are no yields for their investors, they generally start looking at alternatives. We’re hearing of endowments giving a little bit more leeway.
Are you hearing anything from Washington D.C.?
HG:Hemp/CBD is going to change quicker. I believe you’re going to see federal movement as more states adopt specifically adult use [REC] programs. We’re up to 33 on adult and/or recreational. Every state’s going to come into the fold and adopt some program is my bet given the tax issues.