Capital raise activity exploded out of the blocks in the first half of 2021, buoyed by hopes that the new Democratic presidency and Senate majority would finally produce a legalization breakthrough.
Investors bid up cannabis stocks in Q1 2021 to levels that hadn’t been seen since early 2019, and equity issuance followed with Q1 becoming the highest equity raise quarter in cannabis history. COVID fears had started to dissipate as growing vaccination rates began to reduce hospitalizations and deaths. It seemed like economic life would return to some semblance of normality.
In cannabis land, however, the legalization buzz wore off and stocks began a steep 10-month decline that would leave them 51% below their peaks by year end, and equity issuance followed downward. The saving grace for cannabis capital was a newly invigorated debt market, fostered by the entrance of new institutional capital and riding on the improved profitability of the industry—at least in the U.S.
Capital Raise Activity
Capital Raise Transactions and Invested Capital Declines
We tracked 455 capital raises totaling $12.8 billion in 2021 representing an increase in the number of deals of 50.7% and a 195.4% increase in the dollar volume of deals vs. 2020. The second half of 2021 was softer with declines of 29.6% in transaction numbers and 30.3% in capital raised vs. the first half of 2021.
Shift in Capital Allocation by Industry Sector
Of our 13 industry sectors, Cultivation & Retail continued to lead with 62.3% of all invested capital, up from 58.9% in 2020. The second most active sector was Investments/M&A with 9.1% of all invested capital, up from 7.9% in 2020, due to five SPAC IPOs totaling $943 million. Software showed the largest decline from 2020 in percentage of invested capital raised even though the total capital raised was up.
Debt Increases as a Percentage of Total Capital Raised
Debt financings reached their highest percentage level since we began tracking these stats, reaching 44% of total dollars raised in 2021, up from 38% in 2020. Debt capital raised increased to $5.62 billion in 2021 from $1.65 billion in 2020. Seven of the largest 10 capital raises of the year were debt transactions.
Shift in Capital Allocation by Country
The U.S. represented 71.8% of all invested capital, up from 65.1% in 2020. Canada, which had been the most targeted country for investment from 2015 until 2020, saw its portion of invested capital fall to 27.2%, from 47.9% in 2019.
Public vs. Private Company Capital Raises
Public companies represented 83.2% of capital raises, up significantly from 64.4% in 2019. Public companies represented 81.3% of capital raised in 2020 vs. 32.8% in 2020.
M&A Activity was Drastically Higher, Particularly in the First Half of 2021.
We tracked 319 M&A transactions in 2021, the highest number since 2018 and a 235.8% increase from the 95 M&A transactions recorded in 2020. The total transaction value of $25.2 billion in 2021 was up nearly 573% from 2020 because of the record-size deals logged in the first half of the year. The second half of 2021 was a bit softer with a 12% decline in deal count. Deal activity held up much better than it had in previous cannabis stock price swoons.
M&A Benefited from the Valuation Gap and Increased Stock as a % of Consideration.
We believe merger and acquisition activity has remained robust despite the weak stock market is the valuation gap we have noted between the tier 1 MSOs and their typical targets of under $300-million private companies. EBITDA multiples for the former have fallen, but the gap has been maintained at high levels which make accretive acquisitions the norm. One of our recent charts of the week shows that the percent of stock consideration been rising and this reflects a new willingness of target companies to accept what they view as significantly undervalued MSO stock.
Change in M&A by Industry Sector
Companies in the cultivation and retail sector have been the dominant acquirers as they consolidate within markets and expand to new states. In 2021, the hemp sector became the second most active M&A market by volume as the retail CBD business began to re-emerge. Infused products remain another strong sector as strong brands have attracted active acquisition interest, particularly in the edibles and beverages sectors.
The Outlook for M&A Is More Positive Than for Capital Raises
- Target companies have accepted an increasing percentage of stock consideration in recent transactions based on the belief that MSOs are tremendously undervalued.
- Several large public/public transactions including TerrAscend/Gage and Verano/Goodness Growth, demonstrate the willingness of buyers to pay premiums to achieve long term strategic goals.
- Most transactions where large public companies buy smaller private concerns are supported by the valuation gap we have discussed throughout the year. This gap makes the transactions accretive even at low stock valuation levels.
- A growing roster of states including New Jersey, New York, Pennsylvania, and Virginia that have approved or are in the process of approving adult use. MSOs expanding into newly states are finding it to be more efficient and quicker to acquire new capacity than to internally build it.
Going Public Transactions
Going Public Activity Bounces Back
Public offering transactions grinded to their lowest levels in cannabis history in the second half of 2021. More IPOs were completed in the first quarter of 2021 than in any quarter since the Viridian Cannabis Deal Tracker first began. Total year activity tied 2018, the previous peak year.
Sale Leaseback Financing
Sale-leaseback financing continues to be uniquely suited as an efficient, non-dilutive capital solution to the cannabis space especially when compared to the cost of other forms of capital for the sector.
Cap rates, or the ratio of operating income to the price of cannabis real estate in the cannabis space, have compressed significantly, indicating cannabis property values are increasing. While variance in pricing is considered wide as compared to other sectors, given the capital-constrained nature of the industry, a sale-leaseback can still be considered a relatively attractive financing alternative. Cap rates have declined from as high as 17% over the last couple years to the 11-15% range today, indicating that cannabis properties can earn premium valuations in the current environment.
The same fundamentals that apply to decreasing rates in the debt market in 2021 also apply to the sale-leaseback market. This includes more pools of capital entering the space, low cost of capital from industry participants and larger credits seeking financing.
The public cannabis real estate investment trusts (REITs) were quite active in Q4’21. Notable deals in Q4’21 include IIPR’s acquisition in October of a 201,000-square-foot industrial property in Southern California with Gold Flora, a privately owned company with dispensary locations throughout the state. Additionally, Newlake acquired a 70,000-square-foot research, cultivation and processing property in Missouri for $21.1 million, entering into a long-term triple net lease with Organic Remedies of Missouri.
For the full year 2021, over $450 million in sale leaseback financing was transacted (including committed capital) in the cannabis sector.
For 2022, given continued legalization initiatives, growing credits and additional pools of capital becoming educated in the sector, we expect both continued sale leaseback activity as well as modest cap rate compression in this capital-constrained space.
2022 Capital Raises Are Off to a Slow Start, Facing Political and Economic Headwinds
Cannabis stock prices and multiples are at the lowest level since mid-2020, making equity capital raises unattractive.
Cash levels are still high from successful 2021 raises, but several new states are ramping up adult use programs including New York, New Jersey, New Mexico. This will result in significant capital spending requirements for infrastructure buildout.
The cannabis debt capital markets are still robust, featuring well funded aggressive lending institutions servicing MSOs that are solidly EBITDA-positive with excess debt capacity.
The outlook for the capital markets in 2022 may rest squarely on the prospects for banking reform and other legalization initiatives. These legislative steps are temporarily sidelined but have gained advocates determined to push for passage,
Scott Greiper is the present and founder of Viridian Capital Advisors, founded in June 2014 as one of the earliest corporate finance and M&A advisory firms in the cannabis sector. To date, the Viridian team has closed numerous financings and M&A transactions, and performed dozens of strategic advisory, valuation, financial modeling and board development assignments.
David Rosenberg, CFA is a principal of SLB Capital Advisors, an advisory firm founded in 2020, solely focused on sale leasebacks. The SLB Capital Advisors team leverages its M&A, investment banking and corporate finance backgrounds to advise on sale leaseback transactions for cannabis companies as well as other industries and ownership profiles.