UGRO - Bengal Capital 2022 Year End Letter

Summary

• The Bengal Catalyst Fund, LP’s performance is presented below alongside MSOS, a US cannabis-focused ETF.
• Politics seems to be the major reason cannabis stocks dived, specifically lack of SAFE Banking Act passage.
• Since we put together our very first pitch deck for the Fund, our views on the cannabis space have undoubtedly changed, but our strategy has not.

Dear Investor,

The Bengal Catalyst Fund, LP's (the " Fund ") performance (preliminary, net of fees, and unaudited) is presented below alongside [[MSOS]], a US cannabis- focused ETF. We do not consider MSOS a benchmark, but we do believe it is the closest equity market proxy for the U.S. cannabis industry, so we view it as a reasonable indicator of investor sentiment for the sector. We will share audited financials when they are available, which we currently anticipate being sometime in April 2023.

Assuming an investor had been a part of the Fund since day 1 and therefore participated in the Fund's side pocket investments (returns of which are not reported in the table above per general fund performance reporting requirements), their return would have been approximately -47%.

Your individual investor statements are now being distributed directly from our fund administrator, NAV Consulting (please let us know if you did not receive them). Also, a reminder that your results may vary from those above depending on time of investment.

We share some thoughts regarding the cannabis environment below. Although we normally ask that investors keep these letters confidential, we invite you to share it should you wish to.

Bengal 2022 Commentary

Trouble ahead

Trouble behind

And you know that notion

Just crossed my mind

-

"Casey Jones"

The Grateful Dead

The tale of the tape is grim. While the broader market has roundtripped to roughly the level it was in September 2020, the US cannabis market has done significantly worse. In 2022, MSOS (a useful tracker for the US cannabis industry despite its flaws) was down 73%. Green Thumb Industries, considered by many in the industry to be the gold standard, was down 61% this year. While the Fund "outperformed" MSOS by over 2100 basis points in 2022 and over 2500 since inception, this is both cold comfort and a source of mild amusement for us.

Sometimes there is an instinct to see things as completely new and unprecedented even when historical analogues abound. Cannabis is broadly used and there is undoubtedly a significant amount of growth ahead. But many equate growth with profits by default when history counsels otherwise. The Intelligent Investor by Benjamin Graham, a bible for value investors like Warren Buffett, describes an analogue to cannabis that occurred in the late 1940s and its result:

It was, of course, easy to forecast the volume of air transport would grow spectacularly over the years. Because of this factor [airline] shares became a favorite of investment funds. Despite the expansion in revenues - at a pace even greater than in the computer industry - a combination of technological problems and overexpansion of capacity made for fluctuating and even disastrous profit figures.

The same words may be written about the cannabis industry in the future and those who do not see the resemblance…are simply wrong. We do our best to look beyond the obvious growth and see which companies will create value . This commentary is meant to give investors insight into our current thinking on where value is being created, and how we believe the Fund's holdings are, or will be, creating value.

What Do We See In The Current Capital Markets Landscape?

Politics seems to be the major reason cannabis stocks dived, specifically lack of SAFE Banking Act passage. Why is SAFE important? The real world reasons are:

• It's a first step to easing cannabis dispensaries carrying high cash loads because of lack of above-board credit card processing (VISA/Mastercard refuse to have these transactions cross their network);
• Easing an inability to get bank accounts for cannabis businesses (much rarer nowadays as many more credit unions and small banks have started to provide basic deposit services to state regulated cannabis companies);
• And lowering fees for existing banking services with more competition (the fees on cannabis accounts are, indeed, much higher than other business accounts generally).

This amounts to something important: less incentives for robbers to target cannabis stores. People have been killed because of the failure to address this.

But the reasons for many cannabis investors seem to be, at best, only partially the above reasons. SAFE is important to them because it is a "catalyst" for more attention in the space that will lift valuations and/or a perception that SAFE will allow up-listing to NASDAQ/NYSE, which in turn will inevitably raise valuations, lower cost of capital, etc. This is all moot because SAFE ultimately failed to pass, and doesn't look like it has much of a chance in the near future. In as much as it's supportive of legislative progress, we're hopeful that we're wrong.

In response, investors rushed out of cannabis stocks at an increasing pace. The stocks most hurt were the smaller, more illiquid ones. However, as we describe in more detail below, we feel that the business road ahead is actually tougher for larger MSOs for a number of reasons.

What Do We See In The Current Business Landscape?

Cannabis has had a thriving illicit market to address consumer demand for decades. When regulated operators commence business, it is thought that they take market share away from illicit operators. There are a significant number of consumers that will pay a premium for "legal" cannabis for a number of reasons (e.g., more regulations regarding pesticides, ease and comfort of purchase, variety and quality of products, etc.), but consumers are by and large very price sensitive. Generally, a medical market will allow operators to capture a portion of total demand as patients in the system increase (through liberalization of qualifying conditions, lowering of costs for medical cards, etc.).

Once a system becomes a liberal-enough medical market, growth tends to slow as the next big "unlock" of capturing illicit demand is to allow adult recreational use. In this "air pocket" of slowing patient growth, many limited license states have enough competitors and enough capital deployed to create significant margin compression. We think this "air pocket" large MSOs are experiencing unfortunately demonstrates some of our main points of skepticism as to their long run performance:

• Large MSOs often did not become large by being great cannabis growers, processors, and/or sellers, but instead good raisers of money and license applicants - which made sense for early cannabis. Now that we are moving into a paradigm where core operating abilities matter, larger MSOs are finding their benches short even after having done significant mergers and acquisitions targeted at "operators" in the space. Many large MSOs cost to cultivate, package, and distribute regular trimmed cannabis is over $1,000/lb while smaller, more efficient operators that have not had the benefit of much cheaper and more available capital can do the same for $500.

  When deciding between trying to be more efficient and cut costs by $500/lb or sell through as usual, large MSOs rationally focused on keeping costs flat and selling as much as possible because pricing was often $3,000+ in their markets - so selling an additional pound got you $2,000 in profit while trying to cut costs just earned you $500.But, as we describe below, prices are not staying high in many markets for as long.

• The "competitive advantage" of large MSOs can be summed up as "being early" - i.e., MSOs got to be in limited license markets, which promised higher prices than competitive ones like Colorado, Washington and Oregon. But for how long? The "competitive advantage period" (" CAP ") where being early gives you bigger profits was often assumed to be fairly long for limited license markets, but reality has counseled differently. We often try to qualify this in the terms of surplus vs. sustainable profits (or EBITDA as the industry likes to questionably default to).

  As other industries should have taught many cannabis insiders and observers, price compression can come not just from too many licenses, but also enough licenses with sufficient capital between them…and MSOs certainly raised significant sums of capital. Being early to a market can be incredibly valuable, but it is undoubtedly less resilient than actually having advantages in core operations, which has a much longer CAP.

  Take Massachusetts, which experienced 40% price compression in 2022 in a surprise to many who should have been expecting it. While it may have taken Massachusetts a little longer to compress than Washington, Oregon, or Colorado (which all have significantly more growing square footage per capita), the end result will likely be a similar type of pricing in all of these markets. Many MSOs were not built to turn a profit when pricing becomes even mildly competitive, and the problem has only been exacerbated with their balance sheet choices.

• As cash generation has gone down in previously favorable markets, large MSOs' balance sheets have continued to deteriorate. Sometimes praised as "non-dilutive" by companies, sale leaseback (" SLB ") financing is becoming particularly problematic - both for the companies and the REITs giving the financing. "Dilutive" generally is used to mean "more shares," but technically it means "dilutive to future earnings" - i.e., that you will make less profit per share in the future. So, SLB financing is very dilutive by any reasonable standard because it is a very expensive form of financing which is rapidly making many of their facilities unprofitable on a four-wall basis.

  In simplest terms, let's say an MSO borrowed $50mm from IIPR or the like at 15% per year or more (remember that REITs often include yearly rent escalators of 2.5%+, so even if the cap rate today is 12- 13%, it will likely average closer to 15% over the life of the lease) and built a facility with it to grow, process, etc. So that building, before rent, needs to earn $7.5mm in profit to give to IIPR before shareholders see a cent - a task that was easy the first few years, is getting harder with price compression now, and will almost be very difficult in the out years towards the end of the lease as prices approach currently mature states like Washington.

  So, MSOs need to hit grand slams the first few years to make up for the strikeouts that they will suffer in the last years - and the "being early" CAP shortening has thrown a significant wrench into those plans. It is now much more difficult seeing many of the assets into which MSOs deployed significant capital generating good returns over the course of those assets' life.

• We do not see many, if any, "economies of scale" in large MSOs. These are best looked at as companies with many international divisions that can't share production facilities. We have seen large centralized corporate teams lead to more inefficiency and noise more often than we have seen meaningful savings in SG&A across an MSO's footprint. Large indoor production facilities also do not seem to have meaningful economies of scale beyond a relatively small footprint. The production price at a 100k square foot indoor facility will not be meaningfully cheaper than a 50k square foot facility or a 20k square foot facility, never mind quality (which is harder to keep consistent in a bigger facility).
• Large MSO capital allocation has been highly questionable, and profits in cannabis in our view are heavily weighted towards knowing when to stop investing in certain markets as price compression is around the corner. As this is being written the largest US MSO, Curaleaf, has just announced that it is shuttering operations in California, Oregon, and Colorado completely, in addition to shuttering a cultivation facility in Massachusetts. Curaleaf likely spent over $100mm in cash on acquiring, building, and funding the cash burn of the assets that it just shuttered, in addition to taking ~10% true dilution by issuing 55mm shares for Select - a vape company originally based in Oregon and California.

  Cresco's acquisition of Origin House, TerrAscend's acquisition of Gage, and many others give us serious pause - and it does not make sense to invest in companies which will make high profits only to see them squandered by poor allocation.

  Note that we use the term "price compression" throughout this letter because it is industry convention, but the more accurate phrase in our experience is "price normalization." "Compression" implies that prices will at some point "uncompress" to close to previous highs - a dubious implication given the experience of many mature cannabis markets.

One recent anecdote to bring our points home: on a recent Twitter spaces, Curaleaf chairman Boris Jordan said the following regarding the company's decision to shutter its operations in California, Oregon, and Colorado:

I want to repeat: All those three markets [California, Oregon, and Colorado] were $44 million dollars in sales last year but they represented a $40 million dollar cash drain. Ok? So, we had $44mm in revenues but a $40 million dollar plus cash drain on the company in those markets.

The implications of this statement, even if unintended, are incredible. The largest MSO in America with the cheapest cost of capital, most resources, and furthest reach was spending almost $2 for every $1 its customers gave it - and implying that no other company could be expected to do better even while a company like Grown Rogue is able to make a tidy profit inside of Oregon.

With the above in mind, we have become generally bearish on larger MSOs even as we acknowledge that some of them will likely do fine and be quite successful. We do not think that the larger winners can be predicted with confidence ex ante . Even with high underlying growth, it becomes increasingly difficult to underwrite strong profits going to equity for the issues stated above. There will, of course, be blips of positive developments (e.g., companies with heavy exposure to New Jersey will print money for a time, aka surplus profits) but these new CAPs will come to an end as well and may not make up for bleeds in other parts of large MSO portfolios.

At the same time, we see investors running for the door and large MSOs running into significant business issues, we see unloved, high-quality cannabis companies that are grinding away almost completely ignored. Some of these smaller companies certainly have issues and challenges, as discussed below, but we are comfortable with the risks in large part due to the Bengal team's operating experience and ability to help with precisely the challenges which these companies are facing. We describe our current investment philosophy in more detail below.

Small B all ¹ - Where Bengal Focuses Now

In basketball, small ball is a style of play that sacrifices height, physical strength and low post offense/defense in favor of a lineup of smaller players for speed, agility and increased scoring (often from the three-point line).

- Wikipedia

On a business level, we see many markets coming to high quality smaller players for a few reasons:

• Alcohol is generally a decent analogy for cannabis except where it breaks down completely. One of the areas where the two are aligned is in consumer's demonstrated preference for variety, and an increased willingness to buy, and to pay a premium for, "craft" products. Craft can be many things, but one of the things it almost certainly is not is plentiful - so having too much product in a market actually can work against larger producers. The beer industry has significantly moved away from the largest producers over the last decade and though craft beer makes up 13% of volume, it is 26% of revenue. The experience of mature adult use states largely demonstrates that this carries over into cannabis. So, smaller companies have a structural advantage in being able to fit into this

_{1 The Bengal team has a good relationship with Aaron Edelheit, who manages the Mindset Value funds and has co-invested with us into Body and Mind and Grown Rogue. He recently used the phrase "small ball" to describe his strategy as well. In order to preserve our friendship and in the interests of professionalism, we do not take a position on which of us thought of the phrase first and merely note that we both have unfettered rights to use it.}

niche vs. the larger MSOs.

• There are high quality smaller companies that did not originate in the same way as MSOs because they are operating cannabis companies that were taken public, often as part of the cannabis hype cycle of prior years. Their core is often not capital markets prowess or M&A, but just good old fashioned growing, processing, and selling of cannabis efficiently and at a profit. These are the companies that can make money in markets, like Oregon, that larger MSOs are fleeing.
• These companies may not have great balance sheets, but they often have not taken anywhere near the kind of leverage that larger MSOs have , and have largely avoided SLB financing. This makes these smaller companies, paradoxically, much more resilient to market turbulence than some larger companies.

Also, the Bengal team has operating and capital markets skills that we believe can be helpful to the companies we invest in, and so we look for situations where we can bring those to bear to hopefully create more value for all shareholders.

The companies that meet these general criterions we tend to call our " Scrappy Operator Club " - some investors may recall we wrote a memo not too long ago about companies like this, and we have only grown firmer in our conviction that these types of companies are the best positioned on a risk adjusted basis to create significant shareholder value.

Below we discuss our specific holdings, except for Goodness Growth Holdings, Inc. We avoid discussing Goodness because it is currently in litigation with another large MSO, Verano Holdings, regarding an aborted merger between them and because one of our Managing Partners, Josh Rosen, has taken an interim executive role (a clear example of how we roll up our sleeves).

Bengal's Investments - Talking Our Book

Funds managed by us are long all of these companies, but this is not investing advice - see disclaimer below.

Grown Rogue (CSE:GRIN, [[GRUSF]], "GRIN")

Grown Rogue (" GR ") is a craft cannabis cultivator founded in Oregon which then expanded to Michigan. It grows good quality indoor cannabis in two facilities in Oregon (one which it originally operated and one shuttered facility taken over from Acreage post their retreat from the state), an indoor facility in Michigan, and it has an outdoor farm in Oregon (more as a long term, high optionality investment than as a profit driver - more detail below).

What attracted us to GR is their core competency and commitment to it - they are good craft growers first and foremost. Unlike many large MSOs, they do not need to engage in a large program of cost cutting to try to take costs out of the business because their focus assured that those costs would not be in the business in the first place.

GR did about (all dollar figures in the discussion of GR refer to USD) $18mm in revenue in FY 2022 (ending October 31, 2022) and we estimate it did about

$1.5mm in free cashflow on a "normalized" basis that takes out certain startup costs and capex at their Michigan facility (which is now as built out as they intend for the time being, so no incremental capex is expected). Its market capitalization is around $19mm at the time of this writing, giving it a trailing cashflow multiple of approximately 12.5. (although because the stock is so illiquid, it is volatile in percentage terms - when this letter was initially being drafted its market cap was below $18mm). What do we see as the defining strengths of the business?

• GR's business is straightforward: They grow cannabis with good quality and sell it at a reasonable margin. Because Oregon is a mature market and Michigan is rapidly maturing, we think there is some reasonable chance that revenue and cashflow could be flat to marginally lower in 2023 as Michigan pricing pressure is potentially unmatched by Oregon's modest indoor price recovery. Over the course of a pricing cycle, we are comfortable that GR can maintain a healthy margin even if it fluctuates year to year. Regardless, the main future value driver for GR will be taking its craft abilities into new territories with more favorable pricing, as we discuss below.
• GR's Management is Operations-Focused and Runs Lean: A Zoom call with Obie Strickler, GR's CEO, will provide a glimpse of his relatively Spartan office and the SG&A expenses for the company are in line with his office's ethos.
• Large MSO Distress Benefits GR: As we explained in the commentary above, pricing in many markets is rapidly approaching a point where large MSOs cannot make money but which allows a company like GR to generate better margins than in their current markets. We believe that continued large MSO distress will create opportunities for GR to enter new markets and leverage on the capex spending done by others, and we see this as the primary driver of value going forward.

Indeed, we believe this so much that this is where we are spending the vast majority of our time in helping GR - finding opportunities for GR to enter into new markets by mainly leveraging its human/skill capital and not its financial capital.

• GR Has Significant Underlying Potential With Interstate Commerce: GR's modest investment in attaining as high a level of craft in outdoor cannabis as they do in indoor cannabis creates great optionality because high quality outdoor cannabis from the Rogue Valley, one of the premier cannabis outdoor growing regions in the US, has the potential to trump low/mid quality indoor facilities east of the Mississippi when interstate shipment is allowed. While not critical to our views, this provides a nice bit of potential bonus in the future.

Recently, GR secured a $2mm convertible loan investment led by Mindset Value, which is run by Aaron Edelheit. Aaron is a friend of the Bengal team and is aligned with our view on GR. The loan carries a very reasonable interest rate in light of market conditions (indeed, at 9%, it is likely better than what many large MSOs can manage nowadays), and is convertible at CAD$0.20 (a sizeable premium to the CAD$0.12-.14 trading price of the equity at the time), with participants also receiving ~6.7mm warrants at CAD$0.25. This capital provides a nice buffer for GR to be able to take advantage of distressed opportunities because, even if those opportunities are capital light, there are still costs associated with them in the way of opex.

In 2023, we will be looking for GR to begin generating revenue from at least one new market as it continues its craft mission.

urban-gro, Inc.

urban-gro (UGRO) is a company focused on designing, specifying, architecting, equipping, and commissioning cannabis facilities - facilities that are, in the broader sense, on the frontline of indoor agriculture. UGRO also has a decent amount of non-cannabis business, which we discuss below as well. The company, after completing a few acquisitions last year, has 160 employees - the majority of whom are architects, engineers, construction managers, and horticulturalists.

Just as Grown Rogue's core competency of growing good quality cannabis at reasonable costs is undervalued, so is the core competency of building a cannabis facility that can create quality cannabis at reasonable costs while also being capital efficient. We believe that UGRO has one of the deepest competencies in the latter we have found in the industry, and we believe that they can build significant value from their current depressed price level (market cap of ~US$43mm and an enterprise value of ~US$28mm because they are net cash) for a few reasons:

• Building Cannabis Infrastructure, Like Growing, Is An Underappreciated Competency: Many industry watchers would be surprised to know that the industry suffers from something which we term the "golden toilet" syndrome. The syndrome is that buyers can spend an absurd amount of money for something which functions just as well as a similar object that is orders of magnitude cheaper. We have seen repeatedly that many large MSOs have significantly overspent on facilities that are not meaningfully more productive than Grown Rogue's facilities or even significantly less productive. UGRO prevents golden toilets from being built.
• The Market Has Punished UGRO Unreasonably For Cyclicality: As a construction-linked company, UGRO depends on the industry to invest in capex. As the industry has pulled back on capex, so have UGRO's revenues (not to mention its stock price). However, much of this capex is still necessary (especially with markets coming online and the absence of any sightline on interstate shipment), so we view much of it as delayed versus canceled (e.g., after New Jersey recently switched to adult use, UGRO started to sign design-build contracts for facilities in the state).

Here also UGRO's non-cannabis business becomes more important, as it evens out the volatility of cannabis by providing more stable revenue streams. Construction is a cyclical industry, and UGRO is no different. We expect that its pipeline will continue to improve and revenues will begin to inflect at some point in 2023. UGRO's basic business model is also fairly straightforward, so we feel the downside case is fairly protected - especially when considering that UGRO carries no debt and has significant (est. >$15mm) net cash on its balance sheet.

• UGRO Has A "Virtuous Cycle": As we discussed above, the building of cannabis infrastructure itself is a place where companies can stumble before they even begin to operate the facility. Because of UGRO's focus on infrastructure building and diverse client set, UGRO works on more facilities than any individual cannabis company - even the largest ones. Thus, UGRO's learning compounds at a much faster rate than any individual cannabis company, and so its core competency advantage deepens. Over time, we believe that larger MSOs will realize that they must engage UGRO or a company like it just to stay competitive because, simply put, UGRO will be designing better facilities and it will make more sense for companies to hire UGRO vs. trying to build the same capabilities in house.

Beyond large MSOs, and dovetailing with our commentary on SLB financing above, we believe that REITs will be forced to repossess some facilities in the coming years where incremental capital and know-how is required to make the facility reach minimum necessary efficiency. We believe UGRO is well positioned to see a significant amount of this kind of business - the "remediation" of the capex mistakes of large MSOs.

• An UGRO Subscription Service Offering Has Significant Optionality: Beyond the initial end-to-end designing, architecting, construction management, etc., UGRO has the opportunity to create a subscription service offering in the future involving monitoring, consulting, and assistance in running a facility. Like in building infrastructure, we believe that UGRO's compounding knowhow in cannabis growing/care will provide significant value to operators, which may in turn create a "sticky" service offering with significant pricing power on UGRO's part.

In 2023, we will be looking at UGRO to continue to grow its pipeline of cannabis work while managing its expenses conservatively.

XS Financial, Inc. (CSE:XSF, [[XSHLF]])

XS Financial (" XS ") is a cannabis specialty finance company focused on equipment leasing. The basic XS transaction looks like this: MSO Z is building a new cannabis growing/processing facility. It needs to outfit this facility with some equipment to make the facility work like extraction machines, growing lights, packaging automation, etc. While oftentimes the capex budget comes from REITs like IIPR, oftentimes that does not cover this type of equipment, so XS steps in to provide financing.

For example, let's say a packaging machine Z needs has an MSRP of $100,000. XS would generally get a small discount from the manufacturer off MSRP (say 1%), and also because of how its leases are structured it would receive certain advances (e.g., origination fee, interim rent, payment terms, etc.) that also reduce its initial exposure (say by around 12%, although the amount is anywhere from 10-15% as a general rule). It then leases the machine to Z in a lease that is fully amortizing over about four years with an embedded interest rate of 15% (which is XS' current portfolio yield, but this number will fluctuate with the market). Illustrations of the economics and how the money flows is below:

We believe that XS has a few underappreciated advantages, both generally and with respect to other cannabis lenders:

• Strong Management Team: XS' management team is confidence inspiring and has invested their own cash into the business. We believe they understand their function as debt providers well, and are deeply focused on long-term returns.
• More Effective Security Than a Cannabis REIT: Cannabis REITs' appear to have stronger security at first glance, and their legal documents certainly suggest as much, but we think that practically speaking XS enjoys as good or better security for a few reasons: (1) XS gets a return of its initial investment in around 2 and a half years vs. cannabis REITs that need to wait years (with their attendant disruption and price compression) to see similar results so the risk of losing invested capital is lower; (2) similarly to (1), XS is able to reprice its loans much more quickly than cannabis REITs, which have loaned for significantly longer terms; and (3) XS holds a primary security interest in the leased equipment and could, if necessary, foreclose on it. More so than the salvage value, which may be negligible and serves as a last ditch effort to recover owed monies, this is important because the type of equipment XS loans on is critical for a company's revenue generation - even a cannabis REIT has an interest in making sure that XS is paid because a built out cannabis facility with no equipment is just a pretty box that generates no revenue.

Given all this, we feel that the safety of XS' loans is underappreciated. Although most of their borrowers are large MSOs which we criticized in our commentary, we think XS' unique position gives it a very high chance of being one of the first to be paid in a distressed situation.

• Potential to Build Strong Franchise Value: Many of the current cannabis REITs and other lenders can be boiled down to arbitrage - that is, they are raising money in one place and then loaning it in another to generate higher returns. Money is even more of a commodity than cannabis, so it is difficult to see the long run "franchise" value of the business these lenders are building. Not so with XS, where we see a significant benefit to scale in equipment leasing because of the ability to negotiate discounts with equipment manufacturers, centrally order equipment, and also centrally administer and track maintenance of the equipment. Indeed, our channel checks were unanimous that the XS team were a pleasure to work with, which indicated to us that XS is providing some kind of value to its customers beyond just loaning them money.

The Fund holds a position in XS equity, which is incredibly illiquid even by the standards of the Fund, and also has a side pocket investment of ~US$1 mm (original principal value) in XS' 8% convertible debt, which matures later this year in October 2023, although the company has an option to extend that for a year upon payment of a fee - an option we feel it more likely than not that they will take given that the cost of capital has since increased and the conversion price of CAD$0.35 is far from the current stock price of CAD$0.065, which implies a market capitalization of CAD$7mm.

Valuing a finance company depends strongly on assumptions regarding future returns and market capacity for financing. We feel any exercise in estimating these numbers beyond rough rules of thumb is just precision with the illusion of accuracy so we do not attempt to. That said, we are confident that XS is earning good risk-adjusted returns, that there is more capacity for this type of lending in the market - i.e., that XS has more loans to make beyond the ones that it has to this point - and that, eventually, this will lead to meaningful returns to equity.

In 2023, we will be looking for XS to continue to grow its leasing business to more clients, especially towards smaller cannabis operators with strong underlying cash flows to diversify away from larger MSOs, and monitoring any losses they experience.

Body and Mind, Inc. (CSE:BAMM, [[BMMJ]])

From the outside, Body and Mind, Inc. (" BAM ") looks like a collection of random cannabis assets - some California retail, an Arkansas vertical operation, a grow in Nevada, retail in Ohio, etc. - without an overarching logic. But we have come to believe the logic is an underlying capital efficiency - BAM got into the best markets it could for as cheaply as possible. As we looked deeper, we realized that BAM is a bit in the Grown Rogue mold of lean, scrappy cultivation operations mixed with an intriguing retail asset portfolio - so much so that we recently put together an SPV investment of

$3mm of convertible debt into BAM, with just over $1mm coming from a side pocket of the Fund.

Why pick BAM, a company that generally strikes many as one with too much "hair" on it?

• BAM Is A Systemically Undervalued "Busted Story": "Busted stories" are companies which went public at the height of cannabis boom, did a significant amount of marketing to garner interest, and then either fell out of favor as they hit performance headwinds, engaged in misguided mergers, or the vagaries of fast-money investors shifted sending the stock into the doldrums. As a company like this desperately needs its stock to "work" in order to access capital, when the wind goes out of the stock's sales, so does much of the business progress. The higher quality companies that qualify as busted stories tend to suffer structurally weak stock prices, and BAM had the additional problem of a large legacy holder of the stock which was continually selling shares and functionally pushing down its stock price even further.

To be clear: BAM is certainly not the only busted story that followed the general pattern above - many other companies did similarly things and ended up in the busted story bucket as well. The difference is that, unlike most of the other busted stories, BAM has a core of quality that we believe will create long term value.

• But BAM Continued To Execute: We were especially surprised when BAM announced that it had won two licenses in Illinois' recent retail cannabis expansion and the stock did not respond whatsoever. In our view, Illinois (even after the retail expansion) was on the low side of stores per capita and retail licenses there had the potential to be quite valuable - especially if the location was right. We came to find out BAM's Illinois locations were excellent. Furthermore, when we looked at the then-price of the business, we were relatively comfortable that the downside was protected by what a sale of the assets would bring in a controlled liquidation. The downside being relatively capped, combined with what we felt was a good operating team with two strong cash flowing assets on the horizon in Illinois prompted us to establish an equity position.

Beyond Illinois, BAM is also now entering into the rapidly growing New Jersey retail cannabis market by purchasing an entity that has two critical gating items in establishing a retail cannabis store already done: (1) local approval for the cannabis use, which is usually a critical gating item before one can attain a final state cannabis license and (2) a lease on a location with all of the makings of an excellent retail location (plenty of square footage, ample parking, on a main throughway, etc.). Also, to minimize downside risk to BAM, the vast majority of consideration for its purchase is contingent on attainment of final licensing milestones.

As some additional optionality, BAM has been previously successful in winning licenses through applications - generally the most capital- efficient way of entering a market and one of the best return on investment activities in cannabis - and there is a chance that will continue. Even one additional license win makes a meaningful difference for a company of BAM's size.

• Bengal Rolls Up Its Sleeves: In many ways, BAM has the hardest year ahead of it in terms of execution of all the holdings discussed here. This is why we have been personally involved with BAM more than our other holdings save Goodness Growth and anticipate this to continue - Josh Rosen, managing partner of Bengal Capital, has joined BAM's board.

In 2023, we will be looking for BAM to continue to tighten its focus by shedding some vestigial assets, inflect more of its individual operations into producing cashflow, successfully opening its Illinois and New Jersey stores (likely the most consequential thing on this list), and deleveraging by paying down its senior debt unless there is a truly exceptional opportunity to invest capital (we realistically see such potential high-return opportunities only in acquisitions of strategic craft cultivation assets that can be paired with its new Illinois and New Jersey stores).

Conclusion

Well something's lost, but something's gained In living every day

I've looked at life from both sides now

- "Both Sides Now" Joni Mitchell

Since we put together our very first pitch deck for the Fund, our views on the cannabis space have undoubtedly changed but our strategy has not. Where we once believed that larger MSOs, or an ETF that tracks them like MSOS, would bring good returns but we could do better by focusing on high quality, smaller, overlooked companies and bringing our experience to bear on the problems they faced to enhance returns, we are now extremely doubtful on the first part. Again, we do not doubt that some of the larger MSOs will do well, but we doubt they can be predicted reliably ex ante . Experience matters, and facts change opinions - we have seen the market from both sides now.

We at Bengal Capital are human after all and, like many, enjoy the feeling we get when we see little green indicators of rising stock prices on our screens - especially those the Fund holds. We have not had this feeling for quite a while and we frankly did not see this sustained draining of sentiment coming when we started the Fund in June 2021.

But, going beyond how we feel to what we do , we are doing exactly what we thought we would be from the beginning: investing in scrappy operators and doing our best to help them be better in whatever way we can. We look forward to continuing to do so in 2023 and updating you on our progress.

Sincerely,

The Bengal Capital Team

Disclaimer

The information contained in this letter is provided for informational purposes only, is not complete, and does not contain certain material information about our Fund, including important disclosures relating to the risks, fees, expenses, liquidity restrictions and other terms of investing, and is subject to change without notice. This letter is not a recommendation to buy or sell any securities.

The information contained herein does not take into account the particular investment objective or financial or other circumstances of any individual investor. An investment in our fund is suitable only for qualified investors that fully understand the risks of such an investment after reviewing the relevant private placement memorandum (" PPM "). Bengal Impact Partners, LLC (" Bengal Capital " or " we ") is not acting as an investment adviser or otherwise making any recommendation as to an investor's decision to invest in our funds. Perhaps most importantly, Bengal Capital has no obligation to update any information provided here in the future, including if any positions discussed are sold or purchased, or if different positions are purchased.

This document does not constitute an offer of investment advisory services by Bengal Capital, nor an offering of limited partnership interests of our Fund; any such offering will be made solely pursuant to the Fund's PPM. An investment in our Fund will be subject to a variety of risks (which are described in the Fund's definitive PPM), and there can be no assurance that the Fund's investment objective will be met or that the fund will achieve results comparable to those described in this letter, or that the fund will make any profit or will be able to avoid incurring losses. As with any investment vehicle, past performance cannot assure any level of future results.

We make no representations or guarantees with respect to the accuracy or completeness of third party data used or mentioned in this letter. We provide services, such as strategic consulting services, to certain entities mentioned in this letter and may in the future provide such services to more in the future, or to companies not mentioned in this letter. While we may sometimes advise on issues regarding corporate communications, we do not believe any of the services which we provide are "stock promotion" - we have not been and will not be compensated for the mention or discussion of any of the companies discussed herein. We disclose such arrangements to investors in the Fund and will continue to do so.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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