ASLE - Chris DeMuth Talks Cannabis SAFE Banking + SHF Holdings

2023-09-27 16:35:00 ET

Summary

• Chris DeMuth talks investing in cannabis, legalization, SAFE banking and whether the investment community cares.
• He believes that institutional investors are waiting for full federal legalization before entering the cannabis market.
• Bullish on SHF Holdings, a fully-compliant nationwide fintech company serving the cannabis industry.

Listen here or on the go via Apple Podcasts or Spotify .

Chris DeMuth talks about investing in the cannabis industry (1:30) legalization, SAFE banking and whether the investment community cares (9:00) and why he's so bullish on SHF Holdings (14:45).

Transcript

Rena Sherbill: Okay, Chris DeMuth, welcome back to the Cannabis Investing Podcast. We had you on way, way back talking cannabis SPACs , but it's great to have you on in this new day and age. Thanks for coming on.

Chris DeMuth: Good to be here. Nice to see and hear from you again.

RS : Yes, likewise. Always good to talk to you. Always good to have you on sharing your insights. So talk to us about the cannabis industry . What are you looking at? You're certainly not focused on it. So what are you looking at it in that part of the sector or in that part of the market?

CD : It's increasingly interesting to me. I am as recently as today, looking at doing some kind of private investing in cannabis on my own. At the state level, it's helpful for regulators to have investors from in-states. I live in Connecticut and am potentially looking at bidding on some licenses and kind of getting involved in cannabis in this state with some friends that are kind of ex-hedge fund people who are doing this operationally right now.

And the kind of theme and the idea is that there are at least some kind of vanilla institutional investors that will wait literally until the day after full unambiguous federal compliant legal cannabis once everything's clarified, which I think will be called over the next - to give myself some wiggle room here, I'd say over the next three years or so. I think we're kind of heading towards clarity.

And in most things, the market's a discounting mechanism. And if it's in the press, it's in the price, except in this case, because it could be in the press and not in the price if large institutions are just not willing to do this yet. And so if one is ethically and legally comfortable with the status, and I'm 100% on both, I care a lot about health. I'm interested in what I put into my body, but you own your body, I own my body and I have zero concerns what other people do with theirs. It's none of my damn business. If they want to know my opinion, they can ask. I'm endlessly happy to share it. And until they ask, I try not to.

Where I too concern myself with how much cannabis people should take, I'd also think about how much ultra-processed food they should eat. And I've used about breakfast cereal and endless things, which I'm sure people don't want to hear, and a concern that once people start getting up in other people's business in terms of how you get your dopamine, there's all sorts of perverse consequences and problems.

Just to name one, the decline in nicotine use in the U.S. is almost perfectly correlated with the explosion in obesity that's doing absolutely nothing to help either life quality or life expectancy length. And I don't know the precise mechanism there, but I do know if you just try to take one thing about somebody else and use kind of top-down rules to require or prohibit it, you will subsequently learn so many unintended consequences that sometimes I wonder if there's ever even intended consequences. So kind of that's my preamble on pot.

I've never smoked anything. I've never used cannabis. I'm interested in it. I think the war on drugs, which was in theory, a terrible idea, but in practice, much worse, kind of delayed for decades, sound study of what a lot of things could do from cannabis to mushrooms and other things. We just don't know.

And so, I'm kind of humble about health and safety, but don't like rules about what other people put in their body. In any way, big throat clearing there.

RS : Echo, echo, echo, echo those points. Yeah, yeah.

CD : I like the opportunity to get in ahead of other people. And I like people telling me that they're going to jump in later. And I have one, two or three year runway to get in and build up operationally private businesses to invest in public securities. My personal individual account has one stock in it and it's a cannabis stock. And so it's an opportunity to wait and have a head start with businesses that are already profitable, but could be a bonanza a few years from now once capital is able to kind of flood into this space.

RS : And why did you decide to get into it now? I mean, the case could be made to get into it earlier. Obviously, you mentioned some reasons to get into it later. Why now? In terms of both your personal, like the stock, and also the investment that you're making in Connecticut?

CD : Sure. Some is just specific to life circumstances, people who've left finance and hedge fund industry to go into operations on the private side. On the public side, there was kind of an opportunity that I would say was related to the SPAC destruction where many, many of the, virtually all of the post de-SPACed equities have kind of fallen out of favor, some dramatically so.

And so in at least one case, price, in at least one case just early adopters not getting the tempo quite right, that there have been plenty of delays on all of the puzzle pieces that I think are really important. But politics is downstream from culture and the culture I think is moving to a point that it's almost impossible to come back where you have younger people who are more supportive than older people. And then you also have just a big breadth of reasons for why legalization is supported.

You have people like me, who, once you say, let people be free to, I don't need you to end the sentence. I'm on team liberty for this. I'm in it for the liberty part. And then there's other people who just really like pot and they're willing to get along with libertarians. And there are people who are very concerned about the civil liberty, history of the war on drugs, which is extremely ugly.

I mean, extremely pointed racist and has just strange things about it that need to come to an end at some point. Now it’s pretty good. And anybody can add to kind of the civil liberty concerns, the people who just like smoking pot, the people who are libertarian, the people who -- you have kind of there's all sorts of left wing and right wing versions of why this current status is terrible. And I think it's also just something I get very stuck on.

When you look at the scheduling of cannabis, it's just not true. It's just not, it's just not -- forget about politics and forget about philosophy and liberty and all that stuff, which I think is the fun stuff to think about. At some point, somebody has to just notice that the scheduling makes no sense chemically for this chemical.

And somebody at some point is just going to not have a care about anything, but say let's just do this properly and cannabis will be rescheduled. Also, it is dangerous to have American citizens forced into a cash, literally currency business that's not part of our financial system.

Our country, America, U.S. is broke. And so at some point, the government's going to have to start doing stuff to - that is good for revenue and brings huge number of Americans into 21st century finance.

So those confluence of interests really make the culture one that I think is inexorable and that’s going to go in a certain direction. There'll be hiccups along the way. There have been a decade of delays already. There'll be delays further. We're heading this next year into an election year with the House, the Senate, and the White House pretty close to parity in terms of kind of the jump balls, in terms of partisan politics.

The cleanest, most obvious route to success here would go through the Democrats and would go through Biden winning. I think that would be the lightest lift, but I can see all sorts of ways the Republicans could win and be in the forefront of this reform. A higher percentage of Republicans and Democrats voted for the Civil Rights Acts in the mid-1960s. I think a higher percentage of Republicans and Democrats could vote for a lot of good things that relates to winding down the failed war on drugs, especially as it relates to pot and cannabis.

So yeah, so I think we have a great, clear legislative route. It'll be messy and complicated, but we have dates on the calendar for Senate markup. And this is something that could really make progress on. If you look at the younger members of Congress from both parties, that's where you can see a lot of agreement.

RS : Let me ask you, because typically we talk to real industry insiders, people that are really focused on the cannabis sector. In addition to the investment world, they're typically more focused on the cannabis side of things. But as somebody who's really entrenched in the traditional world of investing, what would you say is kind of the discourse around cannabis at this point? Are people biting at the bit to get in? Are they waiting? Are they waiting patiently? What's kind of the sense that you get?

CD : The more kind of vanilla, long-only mutual fund type people seem to be ignoring it almost completely. Their individual incentives is basically, I don't know what it is, get paid a salary, don't get fired. And if your whole life revolves around get paid a salary, don't get fired, you want to recoil from superficial hairiness.

I love superficial hairiness. I want to massively underpay and get a wildly unfair amount of reward for the risks I'm taking. And I can't imagine how the world would ever hand that to you without some kind of subjective hairiness. Like you have to take something if you want to pay some small fraction of what you get and then get the thing back, which is what I want to do.

So, there's usually something that's gone horribly wrong with anything that interests me, but on the kind of long only mutual fund, don't get fired side, I think there's no interest as far as I can tell. There's kind of niche cannabis investors. I think they've had a lot of pain on and off last few years.

RS : Yes.

CD : I think that there is an awkward transition from the great to the white market. And I think the good thing for this industry as an industry is you're going to have those same kind of white shoe, long only people just flood with capital, but you're also going to flood with competition.

I mean, these huge companies that have great distribution and marketing and branding, cannabis isn't that hard to make. A lot of the skills have spin, the pluck and daringness to wade into this area historically. And pluck and daring doesn't kind of define middle management in corporate America. Altria comes out with Altria Red Marlboros, and Altria green cannabis, and they'll be able to sell things very inexpensively and they'll be able to deal with regulator as well.

So, I think that it's not a big topic. It's a big topic for me in that I've kind of hit this very, very rich vein that is just the strange confluence of all sorts of things I look at between a broken SPAC that came out of a credit union. So, credit unions are something that I spend probably 10% of my time on, because when mutuals convert to banks, there are opportunities for depositors to get kind of a first free peek and access advantageously to equity. That's always been a big part of my investments.

And this little company that is about to become profitable, it could be a huge beneficiary of either direction of legislation. I'm looking at legislation saying either we're going to have clarity, in which case, we're going to have to suffer from that competition I mentioned and benefit from the capital, or we stay in this amorphous grey-zone where all of the mainstream banks are kept out and these guys could just have a longer runway to grow for several more years and kind of become the kind of financial hub of the entire growing industry. And I'm happy either way.

RS : So, talk to us about it. What's the company? Break it down.

CD : I am long SHF Holdings, the ticker is ( SHFS ). It's the only thing that I'm personally long for various reasons. I own it at work and personally. I do almost all of my investing at work professionally. I have responsibly diversified personally and I'm irresponsibly concentrated. It's the only NASDAQ-listed fully-compliant nationwide fintech company that serves the cannabis industry. So, if you want this kind of thing, if you want to be kind of a grown-up serious company, you work with them.

Now, you might not have heard their name because they work with credit unions and banks, but they've been doing it for almost a decade. They're experienced. The credit union that spun them out still owns almost half of them. They converted debt to equity priced at $4 per share. They think it's worth more than $4 per share. I think that they are right. And it's kind of the gold standard in cannabis banking and lending. They do things that nobody else can do. So, they'll do all of the financing for the real estate and so forth.

So, they're a real company. It's a tiny liquid little stock that's been kind of left for dead because of SPACs. It was de-SPACed from a credit union. It's the one company in that category. There's nothing else like it. And so, it has a tiny market cap that I think is a small fraction of what it's worth today. And then, tomorrow, we'll have possibly safe banking pass, in which case, this will be an obvious takeout candidate. These big vanilla guys that want to flood in the market will buy them, somebody will buy them. And until then, it can grow basically without competition.

RS : How does it grow? How does it unlock its potential, notwithstanding SAFE Banking , which anyone that's been listening to more than a few episodes of this podcast is not a big believer in the imminence of that happening?

CD : Definitely not the imminence. No, I think it's -- boy, you know, we could win the lottery and have it next year, I think. But once you look at like 24 months or 36 months out, I think there's more ways to see it happening then. Until now and then, there's kind of four things that are happening.

As we approach, what I would see is more their exit. So, if we ever get kind of regulatory clarity, that's where I'd see that now you have competition, but somebody is going to come in and buy them at that point. Until then, capturing floats on the deposits. So, you have interest rate. It works out to about 4% that they're making on all deposits.

They have an incredibly good deal with the credit union that came out of. They have good deals on other banks and credit unions elsewhere. They just signed a contract with Five Star Bank, which is ticker ( FISI ). It's in New York, but really planning to take deposits nationally. But they're getting kind of 75% on some contracts depending, might be as low as 50%, but call it, 50% to 75% of the float. So that's a lucrative business.

They have service charges on deposit accounts. Given that there's not competition, these service charges and fees are a lot. It's about $800 per account per month to be a cannabis customer. And they pay the financial institution $25 per account per month. They keep the rest. So that's again, a big fee charging business.

They get 1.5% origination fees on loans and 10% net interest to them on loans. Now there, they take the first loss, but they use the balance sheet of their financial institutions to get 11.5% and 10%; so, 1.5% origination, 10% net interest, very lucrative lending business. And it's pretty safe. I mean, I'm nervous about it because they take losses or would take losses, but it's very low loan to value. Its real estate where there's -- real estate is collateral, but also the cannabis license and also a personal guarantee. So, between the three of them, I think that it's very money, good lending.

And then finally, they're really declining their expenses. And I think we're going to get an uptick in earnings from this new Five Star relationship. I think a lot of the growth will come from that specific one, but from other banks and credit unions as well. And that's kind of -- that's how they're growing. So, you know, you have a business that's getting, capturing float, charging service fees, lending very lucratively, and expenses are declining. So, it's a business that has been, you know, not profitable historically, that's become very profitable. And that'll just kind of go for as long as we are in this current regulatory status.

RS : And what would you say about their path to going public? What would you say about that path? And what would you say about the management team?

CD : Yeah, that's a great question. So, I love the management team. The people that are involved here are kind of a combination of people from -- with the partner Colorado Credit Union that owns about half, 47%, today, in this small public company. One route for insiders and managements when people are entrepreneurial and ambitious personally is to demutualize, is to switch from a mutual to a bank for various reasons.

In the case of partner Colorado related to it being a cannabis-focused institution, such conversions require a series of regulatory approvals that might be more complex. So, this set of very good executives doesn't have the normal monetization route that other credit unions might have. This is it. This is their route. The success of this for-profit company is where their upside is. So, they're going to make it work.

I, as an investor, as a outside passive minority investor, sometimes I worry that management is not really aligned with me. This is the only case I can make for a company that I think management is like more than 100% aligned with me. Like, they have all of this scale at the credit union, they have these jobs at the credit union, they have these contracts at the credit union, but their success is completely related to this one business.

So, other insiders, managements have another 17%, and then institutions another 28%. So, when you look at it, it's a fairly sophisticated, concentrated ownership structure. It's a tiny company in the balance sheet. Today's a mess, but it can be handled with people who on all sides want to make this work.

RS : And what would you say to people that -- you know, to investors that would say the challenges afoot, the headwinds, you know, the kind of low volume in investing to begin with, certainly in what we're looking at with this stock, what if it can't kind of move beyond this limited stage of growth?

CD : You know, a number of things could happen. Let me just say kind of caveats. Stock trades for less than $1 today. I think that's just utterly mispriced, but that could threaten their NASDAQ listing. It's hard to get in exchanges and so forth at this tiny market cap in terms of ETFs and so forth. They're kind of orphaned.

Nobody's going to do that much work on this because if you became expert on this, I can testify to the fact there's no other ones. I mean, I put my money in this. I'd love to have 10 or 100 of these. I could have a business out of investing in such things, but you can become expert in this and it's just completely one-off and unlikely to become an important category. And...

RS : Because the pool is so small at this point in time...

CD : Yeah.

RS : ...it's not worth for another one to come along?

CD : And it IPOed at $10 and it's trading under $1. So, clearly the market has rejected it so far, and who's to say that it doesn't keep rejecting it.

Now, the financials are changing dramatically. The business is doing well. They're going to make money. They're going to be able to be in control of their own fate and their own fate legislatively, in my mind, looks extremely favorable, and this is the most leveraged way to get exposure to cannabis full federal legalization that I can find.

It takes a little bit of math to kind of figure out what would happen in different scenarios, but this is basically how I see it. I think that under $1 has been an aberrant opportunity. I think as is, it should be between $1 and $2. I think that after federal clarity, it's worth $3 to $4. And I think its sale price will probably be in the mid-single digits. I'm calling it $5. It could be a lot higher than that in a takeover.

One of their owners that I have no personal knowledge of, and no intent to speak ill of, has had public regulatory problems, that I believe would be consistent with abruptly selling a huge position very, very recently.

So I think there's been some technical pressure from a scandal that in no way spoke ill of this company, but affected this company, and that somebody had to dump a huge position abruptly. And so that was the kind of price opportunity that I saw. I think that was really the only reason it got beneath one and it affected the price.

There's also, for something that's very small and liquid, there's even a smaller and more liquid security that I also own, which is their warrants. And their warrants takes even more assumptions on how to value. There are prefs that will, there's dilution, there's timing that really affects how you value warrants.

And I would say, it's possible that the stock is worthless. I think it's very hard to come up with scenarios that make it worth less than $1. It could be very, very dilutive. I do not think they will file for bankruptcy. I don't think it's in anybody's interest to push around the company that is the exit, that is the upside for everybody involved with decision makers who can make this work net.

The warrant really could be worthless. However, it goes to Black-Scholes valuation in a takeover. So playing with different takeover numbers, it trades for less than $0.05. It's probably worth, you know, call it high-teens Black-Scholes value in a very base case takeover within the next few years. So if the company sells, the warrants are worth something, they cost almost nothing.

Playing around with the upside, it's not that different kind of my base case deal is, you know, you make 2.1 times your money on the stock, 2.4 times your money on the warrants, but then as the price gets higher and as the timeline gets shorter, the warrants have more leverage than the stock. But who needs smaller and illiquid compared to the stock, and who needs more upside relative to the stock, I think you could easily do with worth many, many times what it costs. So I just mentioned that because it's a funny aside. But those are the two things I am related to it.

RS : Can you speak speculatively perhaps about what the business model looks like, if/when SAFE Banking happens and if/when the legalization picture develops?

CD : Boring, it looks like everything else. And it's just a big…

RS : Does it get acquired?

CD : It gets bought the next day.

RS : Yeah.

CD : I mean, yeah, no, because they have all the relationships. Now we get a premium as shareholders. I don't think, you know, I ran through some of the numbers and the fees and so forth. I don't think you get those fees at scale forever, but the scale can be 10 times higher as a standalone and 100 times higher as a kind of more normal company, but it's going to squeeze all of those. What you get as the buyers you get to save six months to 18 months in these various business lines getting up to scale.

But once you're up to scale and your competitors come chomping, you know, so it's going to be a 100x the scale, but all of the numbers I mentioned will start to compress. The days of 1.5% origination and 10% net interest is pretty damn good. And that will just compress with competition through the years. But we will get a big premium for it and I will wish them well, but assuming it's a cash deal, I will wish them well from the sideline.

RS : Yeah. Yeah. Timeline is something we talk a lot. I think it's important in general and investing. I think it's especially salient in cannabis investing to have that in mind when the world feels like it's on fire and spitting you out. What would you say to retail investors who are certainly, many have been burned by the SPAC kind of debacle of the previous years. How would you explain that to the retail investing community kind of what happened there?

CD : Sure. The relationship between sponsors and the retail public was one that very fully compensated sponsors for finding and closing a deal. So there was dilution from that and the timeline encouraged sponsors to take a deal relatively quickly. And the end of the venture capital bubble bursting in the run-up to interest rates rising left them with very, very expensive inventory from which to choose.

I looked at and thought a lot about the post, de-SPAC equity indexes, some of the indexes went away, which made it harder to track information. We can look at the companies and they did horrifically, but they did very similar to the recent IPO index. So SPACs was one way to get to market. IPO is another way to get to market. The last few years of things coming to the public market has been an unmitigated disaster for public holders.

And I think that it doesn't speak too ill of SPAC versus IPO, as it spoke ill of the prices that kind of venture capital backed private companies were getting as being very, very good times to exits and very, very bad times to enter. And you see that in a lot of the kind of VC like hedge fund performance over the last couple years as the world just gets more serious.

When you don't have a market driven cost of capital, you can talk about total addressable markets 10 years from now. And it's all fun and games because there's not much cost in science experiments and incredibly speculative things holding that money. Well, every million dollars you have sitting followed today costs more than the per capita GDP. I mean, it's incredibly expensive to have money not put to work or put to work with something that is very kind of future oriented. So that changes people's mindset and it makes it very, very hard on the kinds of things people chose to SPAC.

Now, some of the things have worked. AerSale, ( ASLE ) is one of my very few de-SPAC equity investments and it's done okay. And this is another, and it's been a catastrophe, but I'm newly in it and think that if somebody says, ha-ha, it's been terrible so far, I'm like, well, yeah, but now I'm spending a tiny fraction of what originally cost for a decent percentage of this business. And they're making money now. I mean, it is a good business. It's profitable. And quarter-over-quarter, they're really just changing the dynamics of their financing so that they're going to get to the finish line. And I think the finish line is legalization and a sale.

RS : Do you have thoughts on, first of all, thank you for that. I appreciate that. And I think a lot of our audience is going to appreciate that too. Do you have thoughts on the other cannabis stocks? I guess primarily, do you have thoughts on the ETF space , of which there's a lot of complaints. Do you have thoughts on the bigger, you know, multi-state operators? Any thoughts on the broader strategy?

CD : Yeah. So basically I would say, no. I would say, I kind of came to this one for kind of this incredibly peculiar way they came to market and their history is something that I think has led to this incredible price dislocation and thus my interest. I have an article I'm putting out on it soon on Seeking Alpha . If somebody follows me on Seeking Alpha, they can be the first to get it. It's going to go out in the kind of a new newsletter form that Seeking Alpha is about to release.

I mentioned Tilray ( TLRY ) as a hedge short candidate against it that I thought would balance out some of the, if you like, the fundamental value as much as I see in this company, but don't want the cannabis kind of top-down sector exposure to the kind of legislative calendar. I named Tilray something I would consider shorting.

I'm not short it right now. I don't think this position needs a hedge. I try to do things in the very simplest form without overly complicating it. So I haven't here, so I'd say, I'm a Tilray skeptic. I don't have a view on the multi-state operators.

I do have a view that in at least one case, there are private small-scale opportunities, especially for kind of in-state investors that could get clean regulatory approval with good operators that are kind of the most sound businessmen who are willing to step in ahead of the most pedantic compliance, or oriented major American corporations that will flood in the day after legislation's clear.

RS : Very good. Very good. I think this is a great dive into a very, very specific lane of the sector, so I appreciate it.

CD : Thank you, Rena. It's been really nice talking with you.

RS : Agreed, agreed. Any last words to share with our audience? Also, if you want to say like a couple lines about the newsletter , I'm sure people are interested in hearing what that's about.

CD : Sure. Just follow me on Seeking Alpha. They have a new format and I just provide content. I do whatever they tell me to do in terms of the format, but it's free. It's a newsletter. It has an intro where I'll kind of tell you a little bit about me and my ideas, and it will have edgy actionable ideas from time-to-time to give a taste to the general public of what I'm working on, both at my hedge fund and in my Sifting the World Investment Community.

And this is the first that I highlight as indicative of the kind of thing I think about because it's the one thing I own personally in my individual account.

RS : Awesome. Edgy and actionable, we like it. We're going to look for it. Appreciate you, Chris DeMuth. Thanks for coming on the show.

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