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The Bengal Bite - What's in your ETF? - Feb. 5, 2021

The largest Canadian licensed cannabis producers (LPs) trade at significantly higher multiples than their cousins, the largest US cannabis operators, commonly called Multi-State Operators (MSOs). The chart below tells much of the story. 

Not to paint all LPs with one brush, since there are some that have significant potential for growth from both Canadian market share and global opportunities (U.S. companies will likely not compete globally for quite some time). But, the largest LPs trading at such aggressive premiums over the largest MSOs suggests that the Canadian market, which has been operating for almost two years, will grow faster than U.S. markets, including newly legalized Illinois and Michigan (which combined hold 60% of the population of Canada). Based on fundamentals, this is not the case.

Liquidity makes up for fundamentals in this case. LPs continue to trade at a premium because their Canadian federal license allows them to list on major exchanges like NASDAQ and NYSE, naturally increasing exposure and investor demand, translating into substantial trading liquidity for investors and higher premiums, despite the difference in home markets. 

Many investors are now looking to ETFs as a way of investing in specific sectors, including cannabis. Sector ETFs for more common sectors like banking, energy, etc., tend to have very similar holdings. Not so in cannabis ETFs where, as the comparison below shows, what’s under the hood is very different between funds and where different ETFs are effectively placing bets on different sectors. 

To us, MSOS (NYSE: MSOS) is the fund that investors should look to if they value the most convenient way to invest in the “cannabis” (read: US cannabis) industry. MSOS has grown tremendously since inception, and our hope is that MSOS itself begins to provide more liquidity to the companies that it holds, further narrowing the gap in multiples between Canadian LPs and US MSOs.

But, while MSOS ETF is the best in our opinion, we believe it is still worse than simply buying the MSO companies it holds directly because MSOS, and every other cannabis ETF, holds a significant position in GrowGeneration (NASDAQ:GRWG), a cannabis-focused retailer of hydroponic and other growing supplies, which trades at ~461x EBITDA.

Ancillary businesses like GrowGeneration are arguably a proxy for the growth of the US cannabis industry, but they are an imperfect proxy, and it’s clear their presence on large exchanges has also bid up their prices to levels that are hard to rationally justify based on their business model and industry structure. Our choice would be to just own the MSOs instead of MSOS, but if investors value convenience more than optimized returns or can only acquire stocks on one of the two major U.S. exchanges, MSOS is your best bet.
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This week's Bite:

  • Senate surprise: In an unexpected news announcement this week, Senate Majority leader Chuck Schumer (D-NY) shared that cannabis is on the docket for this year. Sen. Schumer, along with longtime cannabis reform advocates Sens. Wyden (D-OR) and Booker (D-NJ), announced in a February 1 joint statement that they would be introducing some sort of reform legislation in the coming weeks. (MarketWatch | Forbes)

  • Easing into a new routine: According to one of California’s largest delivery companies, Eaze, the State of Cannabis is good (especially for delivery companies). Similar to other COVID-caused consumption changes, Eaze has seen a sharp uptick in first time deliveries, signups, order volume, and basket size. (Eaze and see graphics below)
EAZE Delivery stats
EAZE Delivery edibles stats
  • Corona-somnia cure? OTC and prescribed sleep aids are being less frequently used by consumers who have found a new insomnia cure -- CBD. Nearly half of both OTC and prescription sleep aid users have found themselves using them less as they have supplemented with CBD. (Cannabis Business Executive)
  • The Constitutional Case For Interstate Cannabis Commerce: Most students in 8th grade civics learn that the Constitution gives the federal government the power to regulate interstate commerce, but most don’t continue to law school to learn the less-known corollary: therefore, not only can states not regulate interstate commerce, they state laws also cannot substantially burden interstate commerce. Noted cannabis lawyer Marc Hauser, vice chair of the Cannabis practice at Reed Smith, explains why the “dormant commerce clause” may make interstate cannabis commerce an inevitability. (Marijuana Business Daily)

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This material is provided for information purposes and is not a recommendation or investment advice. The accuracy and/or completeness of any material included herein is not guaranteed. Entities associated with or managed by Bengal Capital or its principals may maintain positions in, or provide services to, the issuers mentioned herein.