CCHWF - Cannabis Company Columbia Care Is A Bargain

Summary

• I have followed Columbia Care since it went public.
• The company is moving towards merging with Cresco Labs.
• The stock is trading at an extreme discount to the price implied by the pending deal.
• I think the stock will do well even if the merger fails to close.

I am a bit cautious on cannabis stocks in the very short-term, but my Beat the Global Cannabis Stock Index model portfolio is loaded with Columbia Care ( CCHWF ), a 9.6% position that I boosted again last week. I currently have 19% cash and am up 29.7% year-to-date. I have 32.5% invested in multi-state operators, which is slightly overweight relative to the 28.6% in the New Cannabis Ventures Global Cannabis Stock Index , though I continue to be worried about the very largest ones. I own a 7.3% position in just one of the five largest MSOs, a 10.8% position in a Tier 2 operator and a 4.9% position in a very small California-based operator.

The very largest MSOs have all underperformed the average cannabis stock to start the year, but they remain relatively expensive in my view to the slightly smaller MSOs. Further, I continue to be cautious about AdvisorShares Pure US Cannabis ETF ( MSOS ), which has now 78% of its holdings in the largest five MSOs. I wrote about my concern with the poor diversification in November, and, since mid-December, the ETF has seen 12.8% of its shares get redeemed.

The MSOS redemptions are one of the reasons I am concerned about the near-term potential for a pullback in cannabis stocks, but the other issue is that trading volumes remain very low. My model portfolio has a cash maximum of 20%, so I am positioned about as negatively as I can be. I am not expecting a big decline, but I have locked in large gains. My model portfolio has names that aren't up that much or are down year-to-date as well as some names that I think are very cheap, like Columbia Care, which has dropped 2.5% in 2023.

The Pending Merger

Cresco Labs ( CRLBF ) announced last March that it was going to acquire Columbia Care in an all-stock deal, issuing .5579 shares of its stock for each Columbia Care share. The companies initially suggested that the deal would close in Q4, but they now expect it to close near the end of Q1.

In early November, Cresco Labs and Columbia Care announced a large transaction to dispose of assets in New York, Illinois and Massachusetts to Sean Combs for up to $185 million. The company must still take steps to gain approval in several states, and the closing of the transaction requires that the states in which it operates approve the combination.

The Financials

Columbia Care has grown nicely over time, but it has never been as profitable as its peers. The 9 largest publicly-traded MSOs have a projected average 2022 adjusted EBITDA margin of 23.8%, but Columbia Care is nearly the lowest at 13.8%. Cresco Labs is at 22.1%, which is higher but still below the 4 other largest MSOs, which average 31.1%.

During 2022's first three quarters, Columbia Care grew revenue by 20% to $385.4 million. The growth was from its dispensary operations, as cultivation and wholesale were flat. It saw its loss from operations more than double to -$55.8 million and its gross margin drop from 42.9% to 41.4%. Adjusted EBITDA increased by 34% to $50.0 million. Cash flow from operations was -$116.6 million. Finished inventory declined, but overall inventory expanded by $35.6 million. At the end of Q3, the company reported cash of $50 million and debt of $353 million.

For 2023, six analysts project revenue for Columbia Care will increase 21% to $628 million with adjusted EBITDA growing 73% to $124 million.

The Chart

Columbia Care has performed very poorly and is trading at 0.39X Cresco Labs, a 30% discount to the deal ratio of .5579 shares. The merger is now projected to close near the end of Q1. Since the deal was announced, Columbia Care has actually declined more than Cresco Labs, with a big break-down in December, when cannabis stocks collapsed:

Cannabis stocks have fallen a lot since the deal was announced, but these two are down more than the Global Cannabis Stock Index, which is down 59.8%. Even the New Cannabis Ventures American Cannabis Operator Index , down 59.5%, has declined less.

To me, the short-term stock chart of CCHWF seems to have perhaps bottomed at $0.60:

The Valuation

At the close on Friday, the ratio of Columbia Care's price to Cresco Labs was just 0.39, a 30% discount to the .5579 deal ratio. If the deal were to close and Cresco Labs were to remain at $1.875, Columbia Care would return 43%. I think that Cresco Labs, up 4.2% year-to-date is in line with its peers in terms of valuation at 1.3X enterprise value to projected 2023 revenue and 5.1X enterprise value to projected 2023 adjusted EBITDA.

I have a $3.55 year-end target for Cresco Labs based on attaining a 7X ratio of enterprise value to adjusted EBITDA for 2024, a gain of 89%. This price may be boosted after the merger closes, but it would represent a converted price of $1.98 for Columbia Care shares at the .5579 deal ratio. This would be a gain of 171%.

If the deal were to not go through, I find the current valuation of Columbia Care highly attractive. It trades at just 1.0X enterprise value to projected 2023 revenue and just 5.0X enterprise value to projected adjusted EBITDA. In my view, the stock could more than double on a stand-alone basis by the end of 2023 based on hitting 7X enterprise value to projected 2024 adjusted EBITDA.

Risks

The stock has sold off sharply and trades very much below the expected ratio at closing. Perhaps investors fear that the deal won't close and are concerned about the cash of $50 million being insufficient. The large use of cash in its operations during the first three quarters of 2022 was due in part to a big step up in inventory of $40.3 million as it entered new markets.

The Columbia Care net debt is a risk that is common to its peers, in my view. The net debt of $303 million is 48% of its projected 2023 revenue, slightly higher than the average of the top 9 publicly-traded MSOs by market cap, who average 36.5%.

Importantly, most of the debt isn't due in 2023, when $5.6 million of convertible debt is due. The bulk of its debt is a recent $185 million 9.5% note due in 2026. There is also $74.5 million convertible debt that is due in 2025.

If the deal doesn't go through, I think that there is less upside to investors than if it does go through, but I believe the company is well positioned to do well under that scenario.

My Outlook

I believe that the merger will go through, though Cresco Labs could move to reduce the price from .5579 shares. The reduction, if it were to happen, would be due to potentially lower receipts from the asset sales than had been expected. If the deal closes at the .5579 ratio, Columbia Care would rally by 43%. I don't expect the ratio would fall too much if it were lowered, and the return would be high still. If the deal doesn't close, I think that Columbia Care is in good shape and valued cheaply. I project the stock could more than double over the next year in that scenario.

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