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Columbia Care Inc.’s (OTCQX:CCHWF) earnings results (third quarter results are expected to be released Nov. 14) could not have come at a worse time. Between inflation and industry-wide price compression, this demo story suddenly runs into big trouble in its efforts to increase its margins. As the stock continues to trade at cheap multiples based on 2023 estimates, questions remain as to whether the company can truly expand its margins as expected. The best case scenario for the CCHWF is for its merger with Cresco Laboratories (OTCQX: CRLBF) to be completed as soon as possible – but there are better options in the area.

CCHWF stock price

Some may forget that CCHWF went public via SPAC in late 2018 at $10 per share.

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Data by YCharts

It’s been a tough race for shareholders, as despite strong revenue growth, CCHWF is down more than 80% from SPAC prices.

CCHWF Key Stock Metrics

I once called Curaleaf Holdings’ CCHWF cheaper (OTCPK:CURLF), and I think that comparison still holds today. The company has a large footprint with 99 outlets across 16 states (plus Washington DC).

footprint

Presentation Q2 2022

The company is vertically integrated in most of these states, but like CURLF, the company has a significant presence in unrestricted license states. In particular, California and Colorado rank among its top 5 markets in terms of revenue.

main markets

Presentation Q2 2022

CCHWF posted 18% year-over-year revenue growth in the quarter, with gross margins hovering at 43%.

revenues and gross margins

Presentation Q2 2022

Adjusted EBITDA margins, however, fell to 9.2%. The company has shown no indication that it will exit its unlimited licensing markets despite the challenging macro environment. This is an example of a “grow at all costs” strategy. CCHWF has identified New York, New Jersey and Virginia as its priority growth markets.

priority growth markets

Presentation Q2 2022

To its credit, CCHWF has successfully completed many cultivation upgrades and expansions, which should lead to higher yields.

culture highlights

Presentation Q2 2022

Looking ahead, CCHWF is still working on expansions to New York and Pennsylvania.

pending extensions

Presentation Q2 2022

One thing I like about the CCHWF Disclosures is that it provides commentary on market conditions on a market-by-market basis. I believe that all MSOs should go a step further by publishing state-by-state financial statements, but my hopes are falling on deaf ears.

market analysis

Presentation Q2 2022

market analysis

Presentation Q2 2022

CCHWF ended the second quarter with $81.4 million in cash versus $325.7 million in debt (not including $357.6 million in lease and deferred debt). Although this debt load is comparable to that of its peers, the debt ratio is stretched because CCHWF’s EBITDA margins are so thin.

I have already explained my view that legislative reform will not take place for many years. I focus on MSOs that can generate strong cash flow right now, even with 280e taxes and high capital costs. The CCHWF, unfortunately, is not one of these operators. Below we can see a reconciliation of net loss to adjusted EBITDA for the company.

financial overview

Press release Q2 2022

I defined operating free cash flow as adjusted EBITDA minus interest and tax expense (maintenance investments tend to be minimal for cannabis operators). CCHWF’s free cash flow was negative $18.2 million in the quarter and was not positive even after adjusting for a higher than usual tax charge. Between CCHWF’s high indebtedness and its considerable cash consumption, the company presents a significant financial risk in an environment where liquidity is drying up.

Management has guided mid-single-digit revenue growth and adjusted EBITDA margin expansion of 150 to 250 basis points each quarter this year, but forecasts in the cannabis business have been better ignored lately.

Management expects less than $20 million from CapEx for the remainder of this year, with that amount being spent on store openings in Virginia and the aforementioned crop expansion projects.

While many investors seem unaware of CCHWF’s financial risks, they are instead focusing on its upcoming merger with CRLBF. During the conference call, management stated that:

In each market where divestments are planned, potential bidders have carried out initial due diligence. We have assessed that bidders have signed letters of intent prior to executing definitive agreements for each asset sold, granted exclusivity to certain prime bidders and are now moving forward with final negotiations to sign purchase and sale agreements final, which we expect to announce within the next 30 years. at 45 days.

The state regulatory approval process continues to move along a similar fast track. We have already submitted license transfer requests, for more than half of the licenses that require approval.

Management continues to expect the merger to be finalized by the end of 2022.

Is the CCHWF stock a buy, sell or hold?

At recent prices, CCHWF is trading at 2x 2023rd sales, lower than Tier 1 peers and higher than Ayr Wellness (OTCQX:AYRWF) or Ascend Wellness (OTCQX:AAWH). However, the stock trades at a premium of 9x 2023e Adjusted EBITDA and 19x 2022e Adjusted EBITDA – a premium to premium Tier 1 peers Verano (OTCQX:VRNOF) and Trulieve (OTCQX:TCNNF). ). Although the 2023 AYRWF and AAHW estimates imply significant growth in Adjusted EBITDA, I have more confidence in these estimates, largely due to their focus on limited licensing states. CCHWF, on the other hand, will likely continue to see its EBITDA margins under pressure due to its large presence in California and Colorado.

Since CCHWF is not trading cheap compared to Tier 1 or Tier 2 traders, I see no reason to buy the stock here. There is no reason to buy this name for diversification purposes, as it offers neither more value nor less risk than the names already in our portfolio. Expanding on this a bit, I could see the case for owning Green Thumb (OTCQX:GTBIF) due to the lower risk balance sheet and stronger margins, but I also see no reason to own CURLF , as this stock trades richly with worse fundamentals.

Perhaps the main reason for owning CCHWF could be due to the potential for arbitrage with CRLBF. I had already sold CCHWF in March due to the deal. Note that each CCHWF share will be exchanged for 0.5579 CRLBF shares. At recent prices, there is an arbitrage opportunity of around 14%, which means that if one were to sell CRLBF and buy CCHWF, they could potentially gain an additional 14% in shares at close.

I’ve seen many retail investors show great interest in this arbitrage spread but, frankly, I think they vastly overestimated the value of this arbitrage spread. On the one hand, there is a great risk that this agreement will not materialize – it would represent one of the most complicated agreements in the history of cannabis. Second, do you really want to own the resulting entity? The combined company would have net debt of more than $1 billion (including lease debt). Of course, they will be able to repay some of this through asset sales, but I doubt they will get attractive prices on those sales given that public company valuations are so low. The CRLBF itself does not generate envious margins, and I expect the margins to deteriorate only when it takes on the CCHWF. I wouldn’t be surprised if the CRLBF sees its stock pool within months of finalizing the merger agreement.

Those looking for cannabis arbitrage might prefer the Goodness Growth Holdings (OTCQX: GDNSF) situation, which I have discussed with Cannabis Growth Portfolio subscribers. My rating on CCHWF is Buy due to an overall undervaluation, but I’m staying away as there are much better opportunities in the cannabis sector.