Member Spotlight: Emerald Park Capital
Emerald Park Capital (“EPC”) is a credit-focused private equity fund providing growth capital to the burgeoning cannabis industry in the United States. The legal cannabis market in the U.S. is expected to eclipse $17.0B[i] in 2020 and more than double by 2024. This rapid growth can largely be attributed to the appeal of cannabis across almost all demographics, not only for recreational use, but also as it relates to remedies for chronic pain, stress management and sleeping disorders. We expect this growth trend to continue over the next several years as state and local governments will be increasingly committed to providing cannabis to their constituents, creating additional jobs and collecting the resulting tax revenues.
While the cannabis sector has grown, access to capital in the market has been challenging. Given the regulatory framework, businesses need to build a vertical supply chain in each state. The original investment thesis in the sector revolved around hoarding licenses and building capacity. Consequently, this approach required continued access to cheap capital. However, liquidity from the public equity markets has been choppy and traditional institutional lenders are precluded from participating. To survive and thrive, companies have quickly realized that they need to have fully funded business plans and/or clear paths to positive cash flow.
To be clear, this strategic shift from breadth to profitability began in late-2019. COVID-19 accelerated rationalization. We believe that the sector will continue to bifurcate as healthier companies fine tune operations, become more capital efficient and focus on cash flow over multi-state expansion. Consolidation will likely accelerate as well. Companies in each state will vie for top five status. To do so, they will need to pick off strategic assets from distressed competitors to bolster their intra-state operations. Companies should be able to access capital for specific acquisitions or tight buildout plans.
These dynamics have created a unique opportunity for capital providers such as EPC to fund top-tier cannabis companies on terms that would otherwise be expected for lower-tier companies. Companies who have gone to market with equity offerings have experienced limited interest from counterparties, providing EPC an opportunity to lend to later stage, market leading companies providing excellent risk adjusted returns. EPC has been able to structure senior secured debt instruments with excellent collateral, current pay interest of 10-15% and equity kickers, targeting 25% IRRs; all with companies in the top decile of US cannabis companies.
Overall, the cannabis market presents a reasonable arbitrage opportunity in the near term and an attractive, long term value creation opportunity for investors. The cannabis sector in North America will have a total addressable market approaching $100B[ii] within the next ten years. Over that time, we expect these businesses to generate average EBITDA margins around 20% and command a standard CPG EBITDA multiple of 15x[iii] or greater. This translates to $300B of potential market value in the sector. Today, all of the cannabis companies that service the U.S. and Canada are valued at less than $50B[iv] thereby creating the potential for massive value creation. Obviously, certain factors need to change to unlock this value including increased recreational approvals, shrinking of the illicit market, greater access to capital, breaking down liquidity barriers, tax reform and continued consumer adoption. Given the total addressable market, broad demographic appeal and illiquidity, we believe it is a prudent time for investors to allocate capital to the cannabis sector, with a focus on debt to achieve the best risk adjusted returns. In summary, today’s cannabis market presents a more attractive pool of investment opportunities predicated on traditional tenets such as transparency, cash flow, operational excellence and organic growth.
[i] Marijuana Business Daily: US retail marijuana sales on pace to rise 40% in 2020, near $37 billion by 2024 (June 30, 2020)
[ii] Barrons: Marijuana Stocks Have Been Pummeled. But One Analyst Still Sees Opportunities (November 12, 2019)
[iii] Capital IQ, a Standard & Poor’s database and exchange website.
[iv] Approximately $35 B is attributable to publicly traded companies. This value represents the combined market valuation of certain publicly traded cannabis companies domiciled in the U.S. and Canada as of September 30, 2020. The remaining $15 B is our estimated value of private companies.
