In Q2, in the midst of a California cultivator extinction event, Glass House announced an onerous preferred equity raise. The deal will provide US$26.5M of capital, 10M which will go towards short term debt and 16.5M for working capital. The terms:
Holders of the GHB Preferred Shares will be entitled to a 20% dividend which gradually increases to 25% by year four. The dividend will be paid quarterly with 10% in cash and the additional amount accruing to the principal. In addition, with each $10 of preferred equity investment, the holder will receive 2 warrants of Glass House, each warrant being exercisable to acquire one share of Glass House at a price of $5 for a term of 5-years following issuance.
Pretty insane. Insanely bad. How did the stock react?
Instead of falling off a cliff, the stock held up, and managed to stage a recovery, even after the Fed’s Jackson hole announcement. For me, this tells me that 1) all stock tourists have been washed out and 2) the stock is underowned and potentially decoupled from the broad market. Stocks never bottom on great news. Rather, they bottom when bad news (Glass House announced a record low 2% gross margin and this equity raise) is greeted with indifference, i.e. “priced in“.
I added to my positions and now own 22750 shares at average cost of 2.264. I am bullish on the company going forward. This is not to say that I believe the company is perfect. There are many flaws I see:
Glass House expansion has been costly. There has been a lot of stock and cash granted in their acquisitions.
The acquisition of retail for expansion implies that they cannot actually sell all their product in all stores. This is key as it means true expansion costs do not merely include cultivation but also retail costs.
One might say they are trying to do too much at once, focusing on branding, retail all the way down to cultivation.
The terms of this raise are terrible.
The California market remains flooded with product.
The recent gross margin of 2% (vs 46% in Q1 2021) is disappointing to say the least for a company that boasts the best cost structure in the country.
That said, I do see positive signs:
Glass House has brought cultivation costs to 158 per lb this quarter (down 18% from Q2 2021 and lowest ever), and expects to see 124 per lb by end of year.
The gross margin is deflated due to CPG markdowns, new greenhouse startup costs and the fact that new greenhouse was not operational for the full quarter (meaning full quarter cost but only a months worth of sales)
The removal of cultivation tax has yet to kick in and will substantially improve margins. It was expensed for Q2 2022.
No one is making money. Up to 50% of small hold cultivation licenses are not renewed. Major MSOs have pulled out. Major cultivators are writing down cultivation. The market will rebalance, and violently so, and probably soon
Retail and brand expansion is costly, but add to the assets of the company. At the same time, some, such as the acquisition of PLUS brands, was done at good valuations. The rest of the balance sheet has enormous valuable assets, especially the greenhouse, and management recognizes this.
California remains a huge market, with 5x upside from illicit market (and more if Cannabis use grows), and Glass House is a small part of that. Enforcement and license dispensing is speeding up. I expect the legal market to grow at a faster pace.
The valuation remains cheap. The market cap is <200M, and Glass House is on track to hit 200M revenue run rate by EOY. This is for a company with tremendous growth potential with a proven TAM.
Stocks are never perfect at/near bottoms, and I don’t believe you have to, or even can, answer all the questions about a stock 5 years in advance. But Glass House’s core proposition of growing a strong operation in the largest cannabis market, at world beating costs, still looks very viable, and I believe it is a stock to watch and hold in the years ahead.