Brands and Profit Margins Driving M&A

In 2021, a record-breaking flurry of merger-and-acquisition (M&A) deals reshaped the cannabis industry. While the pace of M&A activity in 2022 seems unlikely to exceed last year’s in terms of sheer numbers, there is a good chance we will see a perpetuated trend of consolidation deals as market economics continue to mature.

What’s new for 2022 is how the drivers behind M&A activity continue to evolve with the industry. As cannabis further entrenches into established markets and spreads to newly legalized states, the battle for brand dominance is heating up. Multistate operators (MSOs) are competing with local operations for both shelf space and the hearts of patients and consumers. At the same time, the lack of regulatory progress at the federal level and general market disruptions like wholesale flower price fluctuations mean turning a profit in cannabis hasn’t gotten any easier. As a result, operators of all sizes are seeking opportunities to boost operational and financial strength through M&A deals.

In the industry’s early stages, brand recognition was largely tied to celebrity endorsers, strain reputation, and local access. In recent years, as markets have grown and MSOs have built the ability to be many places at once, the elusive concept of national brand identity has taken shape. Operators leading the way in product quality, packaging, and reach have begun to generate national awareness and brand loyalty.

From an M&A perspective, an example of brand equity at work was last year’s acquisition of the edibles brand Wana Brands, with a presence in thirteen states, by Canopy Growth — to the tune of $297 million dollars.

This deal demonstrates the essential economics of brand power. State market leaders in key retail categories are likely to gain increasing attention from acquirers, whether they be Canadian limited partnerships or American MSOs. This is especially the case when entering a new market, as it is far more efficient for the well-capitalized to acquire an operator with strong brand awareness than to build a competing operation from the ground up.

A company that has positioning power with its products is an appealing one, making the idea of a combination far more attractive — and potentially profitable. It’s likely the industry’s merger-and-acquisition trend will give way to an increase in licensing deals, commercial collaboration, and joint ventures between MSOs and smaller brands that have the potential to go national.

The benefits of owning all levels of the value chain through vertical integration are well-known in the cannabis industry. In many markets, vertical integration is one of the few currently viable paths to profitability. Before 2021, major M&A deals were primarily accessible to operators running with heavy equity and public-market financing. While the appetite and market for equity and public markets dipped in Q4 of 2021, a new option emerged: debt financing. With more debt financing options available, privately owned companies gained access to growth capital. Now non-public operators have the capacity to get in on the M&A game without having to navigate the costs and complexities of the public markets.

As a result, public MSOs aren’t the only operators on the hunt for ways to strengthen operations through an acquisition. We are seeing strong M&A activity in all markets and by operators of increasingly diverse sizes. If a company has strong financial fundamentals, a demonstrable upward growth trajectory, and, in relation to our previous point, strong brand presence, they are increasingly capable of securing financing to acquire operators who can expand their presence and/or vertically integrate.

As private operators make their moves, publicly owned MSOs certainly aren’t waiting on the sidelines. One enduring constant in the industry is the capability and willingness of the public MSOs to continually find value in acquisitions, collaborations, and consolidations with other companies. As long as markets are opening and maturing, the well-capitalized will work ceaselessly to complement their own product lines and services, enter new markets, and increase market share.

It will be difficult to surpass 2021 in cannabis M&A activity, but that doesn’t mean we aren’t likely to see ongoing waves of market-reshaping deals. As companies big and small seek to grasp the intangible power of brand equity and develop a distinguishable market identity, more M&A deals are likely on the horizon.

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Scott Hammon is an audit partner and cannabis practice leader at multinational accounting firm MGO. Over his three-decade career, he has developed significant knowledge and experience in multiple industries: technology, renewable energy, real estate, life sciences, cannabis, consumer packaged goods, and retail. He is thoroughly familiar with public and private equity and debt financing as well as international financial reporting standards.