Formally known as Cresco Capital Partners, Entourage Effect Capital has invested close to $200M in about 70 cannabis companies. Its portfolio ranges from high profile brands and multi-state operators to a variety of service providers.
For this week’s Power Players interview we spoke to Entourage managing partner Matt Hawkins about what he looks for in a company, why the pandemic could accelerate legalization and the coming industry consolidation.
This interview has been edited for length and clarity.
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A Good Time for Cannabis Investing
WeedWeek: What are you currently looking for in terms of investments?
Matt Hawkins:Like everybody, we’re looking for unique opportunities. This is an interesting time to be investing in cannabis. Consumer demand is at an all time high. But we’ve had depressed values across the board in public and private companies. So from an investment standpoint, it makes a lot of sense to be investing right now.
When you think about investing in distressed assets, the first things that come to mind are either margin shrinkage or top line shrinkage. In a lot of cases in the cannabis industry, that’s not the case: those two things are typically in a positive trend. The only thing that’s really impacting the cannabis industry in the negative sense, at least prior to Covid, was the cash crunch. There’s not enough liquidity and capital to take advantage of all the opportunities.
WW: Are you looking for new entrants or to prop-up existing companies that have been blind-sided financially?
MH:A little bit of both. Obviously, in ’14 and ’15 all we could invest in were startups. Now we’ve had the luxury of being able to see companies grow and there’s a lot of companies that are coming together through M&A activities that are trying to develop scale sooner rather than later. So that’s a strategy. But we do look at new opportunities as well.
WW: Who are your backers, your limited partners?
MH: All of our investors are high-net-worth individuals or family offices. We’ve got over, gosh, close to 250 investors across all of our three funds. There’s obviously no institutional capital to speak of at this point. So we’re just aggregating dollars just like everybody else in our space.
WW: You said you’re friendly with [multi-state operator] Cresco Labs. Are they a limited partner of yours? Is that even possible?
MH: No. the word cresco comes from the Latin word grow. I named Cresco Capital Partners back in ’14 just when the founders of Cresco Labs became Cresco Labs. And we just quite frankly, I got tired of being asked if we were associated with them. But again, I’m friendly with Charlie and we laugh about it.
The Next Six Months
WW: What’s your thesis for the next six months?
MH: Assuming we can get through this crisis sooner rather than later, at least from a quasi-restarting of the economy in some form or fashion, I think the cannabis industry is uniquely situated to take advantage of what’s on the other side.
Having been designated an “essential” business was a huge win for the industry. The rush to getting all the sales that were generated that helped the entire value chain back in early March was a huge benefit too. Obviously decreased foot traffic in the retail sites isn’t great. But we’ve, at least our companies have done a great job of being able to shuck and jive and get curbside pickup and delivery systems in place.
MH: On the other side of this, there are some unique and interesting things that are going to develop. One, I think the expansion of state by state legality is going to be driven to a whole other level with states and municipalities looking for increased revenue streams to offset what’s been lost here recently and will continue to be lost. And the federal government’s no different. I think we can look to the federal government and say, “Look, we’re an essential business, why are we illegal? Why are we not able to participate in the CARES Act?”
MH:We can also say, “Okay, if we were legal. Here’s the revenue that you could be bringing in on a combined basis and actually helping us tamp down the illicit market. You’re looking at a $60, 70 maybe even 80 billion industry domestically.” So I think revenue needs across the board, across all governmental agencies, are going to be at an all time high, at least in our lifetimes. And cannabis can help fill that void, if done smart.
“It boils down to who has money and who doesn’t.”
WW: You’ve predicted a lot of MSOs are going to go away. Why do you think that?
MH:Well, let’s be clear about that. Just like before Covid, there’s going to be some clear winners and some clear losers in the multi-state-operator sector. It really boils down to who has money and who doesn’t. There’s some companies whose stock prices are damn near worthless right now, but they have millions of dollars on their balance sheets. Then there’s also some companies that have decent stock prices that don’t have enough cash to last the rest of this year.
WW: Who are you thinking of in the latter category?
MH: It’s probably best just to use it as a generic statement at this point.
WW: Would you say Canadian companies?
MH: Primarily Canadian companies, but you can also look at the U.S. MSOs listed [in Canada]. Those guys need capital to sustain operations just as much as the Canadian guys, even though the U.S. market is a bit more robust. I think the reality is — and Covid doesn’t change it — there’s going to be a line of demarcation between the winners and the losers. The companies that have the cash and the staying power will be the winners.
WW:Does branding still matter?
MH:Absolutely. Branding matters now and will continue to matter up through federal legalization. The more scale you can build at any point in the value chain prior to quasi- or full federal legalization is going to generate better returns for you when that happens.
WW: You’ve suggested there are opportunities for partnerships among or synergies between MSOs. How do you see those working?
MH: Scale is what matters in putting companies together that can weather this storm. That means a combination of cash, resources, and geographic footprint is going to pay dividends for those companies on the other side of this. And as I mentioned, there’s a chance that this crisis we’re in could lead to a quicker movement to legalization, simply because of the need for additional revenues at all governmental levels.
WW: It seems like you’re saying the amount of money a company has now is the biggest predictor of future success.
MH: Cash on the balance sheet is obviously a big one, but in addition, you need to have the scale to justify that kind of cash on your balance sheet. I think the point I was making earlier is that there’s companies that have $40M, $50M in revenue that are EBITDA positive that may be worth pennies on the dollar on the CSE.
But similar companies could have $12M to $13M to $15M to $20 million sitting on their balance sheets and are worth the same. I mean if you’re an investor, which one do you want to go? You want to go with the company that’s got the staying power and cash to weather storms like this and to make acquisitions and to build when times are tough.
WW:What about outside of the supply chain? What kinds of ancillary businesses interest you?
MH: Our investments are listed on our web site. We’ve invested it in a whole host of small to medium to large scale companies. We’re going to have our share of wins and losses ourselves, we’re a venture capital firm. But some of the ones that we’re concerned about now are the ones that are in the service sector. Before Covid, cannabis was going through a cash crunch and belts were tightened. As a result certain services of the industry were getting squeezed.
The events space in cannabis has long been something that the industry not only thrived on, but enjoyed. We have a very communal and collegial cottage-like industry and when we can’t get out and do those types of things, you can’t have those companies putting those on, that’s going to hurt.
The services that [will thrive] are the ones that are essential to keeping companies going, such as ERP solutions and things of that nature. Software as a service is driving the businesses. Those are going to be winners but, long story short is the service side of the industry is going to suffer.