News of the Week (March 21-25)

The Trade Desk; Upstart; Meta Platforms; SoFi Technologies; Cresco Labs; JFrog; CuriosityStream; The Boeing Company; Market Talk; A Note on American Cannabis; My Activity

1. The Trade Desk (TTD) -- SMB Program

The Trade Desk debuted its “certified service partner program” for Small and Medium businesses (SMBs). The product streamlines and deepens the self-serve functionality within The Trade Desk’s platform. This should lower minimum costs for SMBs using the new product to cater to these entities and their generally smaller marketing budgets with more flexible, customizable models of campaign spend. In a world where every advertiser needs to get the most out of every marketing dollar, that reality is even more true for smaller, less durable enterprises. This release should help that need become a more consistent reality by bolstering access to The Trade Desk’s “industry leading” demand side programmatic advertising platform. All advertisers can benefit from more visibility and objectivity within programmatic advertising in the open internet vs. within esoteric walled gardens.

Goodway Group has been named the first certified partner within this new endeavor. More partners which “represent distinct capabilities in support of client marketing needs” will be named in the near future.

Click here for my deep dive into The Trade Desk's business.

2. Upstart (UPST) -- Subaru & a New Credit Union 

a. Subaru

Another week, and yet another sign of a broadening auto purchase partnership with a major OEM. Subaru became Upstart's first partner in the lending disruptor's new “Build and Price” digital tools program. The feature will allow Subaru's consumers to shop online for nearly finished goods and to connect it with approved buyers. Considering how pressing current supply chain issues are for the auto industry, enhancing a dealer’s ability to tap into inventory from across the production cycle should provide immense value to match more cars with demand. Specifically, this will free Subaru shoppers to pre-build the year, make and vehicle model with accurate pricing every step of the way.

“Many manufacturers are forecasting shortages through 2023… the Build & Price product is an innovative way to help customers get started online and for Subaru retailers to provide extra value early in the purchase process.” — GM of Upstart Auto Retail Michia Rohrssen

The bolt-on feature will be available to all Subaru dealers participating in Upstart Auto Retail with no additional charge or for $175 per month as an independent offering. Upstart already aids the auto industry in underwriting and input cost reduction via automation -- now it will help its partners weather supply chain issues as well.

“There’s nothing more powerful than having everything you need, right up front, to structure a deal that a customer is ready to say yes to.” — Sales Manager at Byers Subaru Shane Fouch

b. Credit Union

Upstart also announced a deepening partnership with Bellwether Community Credit Union to offer Upstart-powered personal loans to people in New Hampshire and two Massachusetts counties. The companies had been working together within Upstart’s referral network since December.

To be frank, this is a small win for Upstart as the credit union (CU) only has 30,000 members in total vs. 400,000 for Patelco -- another Upstart CU partner. Still, a win is a win and this simply serves as another sign of Upstart’s building traction and clout in the credit industry.

c. ABS Markets

More investor concern is circulating around a tightening asset-backed securitization (ABS) market and rising delinquencies. As I've said many times before, Upstart's strong 2022 guide assumes a normalization of delinquencies and liquidity as well as less reliance on ABS markets as we exit this strange stimulus-era. Furthermore, its investors' aggressive usage of the ABS market in 2021 was a factor of that market being so favorable and is not by necessity. For reference, Upstart's investors were selling its sourced loans for 108% of par value in ABS markets just weeks after buying the loans at par. That's not normal. Leadership expects bank and credit unions to retain a larger portion of its sourced loans this year while whole loan sales also account for a growing portion of its overall transaction volume.

The company is and always will be intimately connected to capital markets, and its success will rely largely on how well its loan pools perform when things are most hectic. It thrived on a relative basis during the pandemic, which fostered explosive growth and adoption as soon as credit markets recovered. Credit cycles will always cycle and during the cycling the cream will rise to the top. That's what Upstart needs to continue to do. So far so very good -- but still a long, long way to go.

3. Cresco Labs (CRLBF) -- The Blockbuster Columbia Care Acquisition & an Earnings Review

a. Columbia Care Acquisition

Cresco Labs agreed to acquire Columbia Care in an all stock deal valued at $2 billion. Existing Columbia Care shareholders will own 35% of the combined company upon deal closing.

The transaction will make Cresco Labs the largest multi-state operator in the nation by revenue with a current run rate over $1.4 billion (after “planned divestitures”) -- this sales split will be 65% retail post-closing vs. 47% retail today to juice Cresco’s long term margin potential via more vertical integration. This shift will also help make forecasting revenue more predictable. Compared to Cresco Labs’ current 50 store footprint, the transaction will bring it to 133 retail stores overall giving it the 2nd largest retail footprint in the nation and largest when excluding Trulieve’s Florida stores. Cresco Labs still sees wholesale branded distribution as its long term bread and butter, but it also sees retail as a bridge to get to that future.

With the combination, Cresco’s population footprint will cover 70% of the addressable cannabis market while now putting it in 18 states including all 10 of BDSA’s largest and most promising markets over the next 4 years. Cresco had been in 10 states meaning this translates into an 80% boost overnight. Along with a larger market, Cresco will also get new cultivation and retail assets in Maryland, California and Arizona where it is currently “under-scaled.” With all of the assets being acquired, Cresco will be able to bolster its vertical integration opportunity to raise its profit ceiling in all 18 of its states (including Washington D.C.) besides Michigan (for now).

The two companies feature leading market share positions in four states -- Cresco labs in Illinois and Pennsylvania (+ number 2 in Massachusetts) and Columbia Care in Colorado and Virginia. Together, the companies believe they have a clear path to top 3 market share in New York, New Jersey and Florida as well. Finally, Cresco will now be ideally positioned in all of the states with the most to gain from an expected near-term flipping from medical to recreational cannabis. Cresco Labs currently has 2 states contributing over $100 million in annual sales and expects that to be 5 states this year and 8 next year with the purchase.

The two plan to share best practices in terms of cultivation and operations as well as retail which could be fruitful considering Cresco’s superior dispensary operations vs. the field.

While $2 billion does represent a hefty premium and dilution with Columbia Care assuming a 35% stake, we have to remember the premium is mainly a result of tumultuous times for cannabis stocks. Columbia Care’s enterprise value (EV) has already surpassed $2 billion on numerous occasions, and if you think cannabis remains a promising, early-innings growth story like I do, then that premium becomes far more palatable. Also keep in mind that there will be some cash coming back to the combined organization post-closing. The two have significant licensing overlap in some limited licensing states and will sell off all of the redundant assets it will have in “high-value markets” which should fetch a few hundred million for the organization to utilize. These sales will occur in New York, Illinois, Ohio, Massachusetts, and Florida.

“We believe the combined footprint and operational capabilities will lead to so much more than either company could achieve individually… We’re cognizant of the risks inherent in a deal of this size, but feel confident in our team after integrating 5 companies and 600+ employees in 2021… This acquisition addresses all of our material gaps.” — Founder/CEO Charles Bachtell

The combined entity will also be able to “reduce some of the capital spend” plans in markets where divestitures are coming. In New York specifically, Cresco Labs somewhat recently broke ground on a cultivation facility that will likely be sold as Columbia Care’s is more built. Synergies from typical things like sharing accounting and public cost teams should help create a better company as well.

“Our mission has always been to deliver for our stakeholders… in an evolving industry, the opportunities to better achieve our mission through consolidation led us to this historic moment. We will together create the most investable company in cannabis.” — Columbia Care CEO Nicholas Vita

“The ability to leverage our cultivation , production and brand performance across a much wider footprint is expected to lead to long-term sustainable growth and market share gains. This will turn our tiered brand portfolio into the Miller High Life, Coca-Cola and Johnnie Walker Blue Label of the cannabis industry.” — Founder/CEO Charles Bachtell

Despite the heavy dilution coming, I’m a big fan of the move. Consolidation is inevitable and in my mind, the sooner it happens, the better.

b. Demand:

Analysts were looking for $234.5 million in revenue and it guided to a midpoint of $240 million in revenue . Cresco Labs posted $217.8 million, missing expectations by 7.2% due to various factors discussed below. Revenue for 2021 as a whole grew by roughly 73% YoY.

Cresco’s Sunnyside dispensaries remain the most productive in the industry despite the decline (related to new store openings & M&A). This $2.8 million is 33% higher than fellow tier 1 grower averages and 50% higher in key states like Illinois. This seems to be standard operating procedure (SOP) driven more than anything as M&A in other states like Ohio allowed it to immediately deliver a 57% improvement in retail efficiency. Same store sales grew by 1% quarter over quarter and 28% year over year. Impressive to me that the top selling wholesaler of cannabis flower, concentrates and vapes in the nation is also the most efficient at selling through its own stores.

c. Profitability:

Cresco guided to a gross margin over 50% and was able to deliver on its promises with a 50.5% margin. It had also guided to a 30% adjusted EBITDA margin but fell short there at 26.1% due to the factors cited below. For 2021 as a whole, adjusted EBITDA margin expanded to 23.6% of sales vs. 12.7% YoY as Cresco’s economies of scale took hold.

*Adjusted for a $15 million non-cash impairment charge in Q4 2021 and a $290 million non-cash impairment charge in Q3 2021 related to its Origin House acquisition. Without giving Cresco labs this exemption, net income margin for the quarter would have been (5.4%).

Note that this gross margin data DOES NOT exclude any adjustments for acquired inventory. With this included, gross margin for the year would have been 52.3%. Cresco’s gross margin has now consistently improved during every period over the last year+. Vertical integration in Florida and a shift away from 3rd party brands in California are both fueling this lucrative trend. It expects gross margin over 50% going forward.

The company has $422 million in current assets including $224 million in cash and equivalents. It also has $377 million in debt net of issuance costs. As of the print, it had 435 million shares outstanding on a fully converted basis.

d. Notes from Founder/CEO Charlie Bachtell:

On a weak Q4:

“While Q4 came in below our expectations, we believe these results were more market driven than operational. In fact we competed extremely well during the quarter… we took everything that our markets were willing to give in Q4… There was market growth slowing in Q4 and we are not immune. The good news is that consumers love our brands, we maintained our #1 branded wholesaler leadership and we were the most productive retailer in the industry. We gained or maintained share in 7 of our 10 states… with many more growth initiatives ahead, 2022 is set to be another record year.” — Founder/CEO Charlie Bachtell

The industry is currently in a flux. States are flipping from medical to recreational and that will lead to exploding growth -- so the space has built out capacity in anticipation of that flipping taking place across the nation. The issue is that timelines for regulation are the furthest thing from efficient or certain. As a result of regulatory delays, the capacity (supply) is built but the demand tailwind has not yet been enjoyed. This is leading to short term pricing pressure and underwhelming demand growth. The only way this would be of concern to me is if recreational reform never comes which is not realistic. States want the tax revenue they’re surrendering to black market sales and regulated cannabis is objectively safer for users to consume.

e. Notes from CFO Dennis Olis

On a weak Q4:

“As noted by our peers, the quarter saw unique and unexpected market events resulting in lower revenue. In October, we made a decision to reduce our 3rd party distribution business in California which changed our business in that state while the market also experienced a 6% QoQ demand decline plus a 25% drop in the weighted average cost per pound which impacted us as we sold through our remaining 3rd party inventory.” — CFO Dennis Olis

So this California headwind should be largely behind the company.

Outside of California, the rest of Cresco’s portfolio enjoyed 6% QoQ growth and took market share in its state footprint overall. A fall in wholesale revenue sequentially was driven by its operational shift in California and grew 2% QoQ excluding that.

On brand strength:

• Grew Market share in Pennsylvania thanks to improved flower quality

• FloraCal moved to California’s number 4 selling brand in January vs. 5th in Q4.

• Cresco’s SG&A spend has been level over the last 3 quarters despite the rapid build-out and purchasing of new assets.

On inflation:

“While inflation is making different consumer goods more expensive, we have the opportunity to provide more value to our consumers, convert more people from the illicit market and unlock industry growth. We will continue to optimize our operations through scale and automation.” — CFO Dennis Olis

On 2022:

“Despite all of the growth ahead, the start of the year has seen a tough macro environment. Based on BDSA data, our markets are down mid-single digits compared to the first 2 months of Q4 due to higher inflation stretching the consumer wallet, staffing and consumer access, Omicron and traditional seasonality. As such, and consistent with what you’ve heard from other MSOs, we expect growth to be relatively muted in the first half of 2022.” — CFO Dennis Olis

f. Notes from CCO Greg Butler

On wholesale pricing pressure:

“We expect to see continued pricing pressure in wholesale and that is something we are planning for across our markets. Because we planned for this, we have a strong set of brands that enable us to play at different price points.” — CCO Greg Butler

On California:

Butler alluded to pricing pressure potentially forcing some competition out of the California market which could ease pricing pressure. Cresco will look to pick up these retail assets. Vertical integration is a key enabler for its success through this tough period in that tough market. Also, the fact that 40%+ of Cresco’s retail supply is owned brands across its operations enhances potential margins and its competitive positioning more. Over the last 6 months of 2021, newly issued cultivation licenses grew at double the rate of retail licenses. This is leading to the supply glut.

g. Columbia Care Founder/CEO Nicholas Vita on SAFE Banking

“I’ve always been wrong when it comes to political prognostication, but it is going to happen… assuming it passes and assuming it gives institutional investors the ability to invest in cannabis, they are going to be looking for scale, credibility and best in class.” — Columbia Care Founder/CEO Nicholas Vita 

4. Meta Platfroms (FB) -- Ad Recovery

Following Apple's App Tracking Transparency (ATT) and Identifier for Advertisers (IDFA) changes, Facebook's ad targeting and measurement have both materially suffered. This reality perfectly coincided with a content consumption shift to Reels -- which is still in its early stages of monetization maturity -- and so compounded the issue to place more downward pressure on the company's largest segment.

While we will lap the comp headwind from the changes later this year, small businesses are already beginning to see improvement in selling activity on its sites. It's not clear if this recent green shoot is e-commerce recovery-related or due to Facebook's improving technology stack. Regardless, the social media giant has been hard at work on addressing the issues Apple's change has created. Things like improving Reels monetization, moving ad conversions on-site via Shops campaigns, consolidating its ad suite into "Meta Advantage" as well as heavy investments in AI and automation to do more with less data could all potentially be contributing. Conversely, things like easing supply chain issues could also be the source of this improvement. We'll see if this is Facebook getting better, its market getting easier or likely a combination of both.

5. SoFi Technologies (SOFI) -- Product Launch and Galileo Expansion

a. No Fee Crypto

SoFi debuted a new program allowing its direct deposit customers to invest in crypto with no fees. These crypto purchases can be scheduled in a recurring manner and the program is now live from all members with the appropriate accounts. The launch adds to SoFi’s unique checking and savings utility which already includes perks like two-day early paycheck and an “industry leading” 1% APY. 

I’ve said it before and I will continue to reiterate: Fintech will become fully commoditized over time just like legacy banking is today. The way to compete in a commoditized field is by enjoying relatively higher lifetime value (LTV) from your constituents and/or lower customer acquisition cost (CAC) vs. a majority of the competition. This inherently bolsters unit economics to justify more spend on user growth and also paves the way for more differentiating (and now affordable) features just like this one. SoFi’s one-stop shop of all things finance means its LTV potential per customer is higher than most of its fellow disruptors. Add to that its technology stack vertical integration via Galileo and now Technisys and SoFi can also cut relative cost vs. its fintech competition (not to mention selling these APIs to competition for more, high margin revenue).

Vs. legacy competition, SoFi's lack of physical branch presence compared to other nationwide banks paired with its newly issued banking charter (leveling the cost of capital playing field) both foster competitive CAC for it to lean more into growth.

All of this is to say that SoFi is doing what it needs to be doing to stand out in a dauntingly competitive, low-switching cost field like this one. The way to shine is through providing incremental utility; SoFi is in a great position to do just that.

b. Colombia

In other news, Galileo (SoFi’s payment processing software arm) has launched in Colombia* after debuting its offering in Mexico 2 years ago. In 2 short years, Galileo has “established itself as a leading financial technology company in LatAm, having on-boarded more than one million accounts in the region.” Considering Galileo already serves Uala in Mexico -- which has a deep presence in Colombia -- this should be a successful launch out of the gate.

Surprisingly, Colombia is a hotbed for Fintech investment. The nation has even surpassed gross FinTech investment levels vs. other, more prominent economies like Argentina while boasting strong adoption rates in the country and a “business environment that fosters processes of innovation.” As a reminder, SoFi CEO Anthony Noto wants Galileo on 4 continents in the coming years. This is a global endeavor.

6. JFrog (FROG) -- Proxy Statement Highlights

Executive raises from 2020-2021 were all between a modest 3 and 4%. Founder/CEO Shlomi Ben Haim now owns 5.2% of the company vs. 5.5% in April 2021. This was a product of dilution and not open market selling. Overall, all executive officers and directors owned 38.3% of the company in April 2021 vs. 33.7% today through a combination of shareholder dilution and some selling by non-executives.

7. CuriosityStream (CURI) -- Goodbye

I exited CuriosityStream after another disappointing quarter. I wanted to go through what I saw in the company that made me excited to own it and what changed.

CuriosityStream enjoys dirt cheap production costs. It can make a title for 5% of the cost of a single episode of Game of Thrones. This affordability allowed it to undercut every other streaming service out there while maintaining a gross margin of roughly 50% -- which compares extremely well to public comps like Fubo. This also allowed it do things like bundle with large carriers around the globe to make revenue growth extremely visible via the long term nature of the contracts. Additionally, it was set to turn EBITDA positive this year as of its preliminary investor presentation. I took this guidance somewhat seriously considering the firm's founder created The Discovery Channel and took with him several higher-ups to run CuriosityStream.

So what changed? To put it plainly, poor execution. The company was able to meet its 2021 revenue target, but the quality of this revenue was a red flag. Far more of it than initially expected came from content sales than from more recurring, higher value subscription sales. It leaned on selling off its library to meet 2021 targets that it should have probably never set. After that development became clear, I paused adding (as my readers know from previous posts) but wanted to give it time to turn things around. That slack ran out this week after the company’s earnings report.

Not only did it neglect to offer full year 2022 guidance (so much for great visibility), but the first 6 months of 2022 guidance that it did offer was not good. The revenue midpoint calls for 50% growth (24% below consensus) while the company was expected to grow by roughly 70% YoY in 2021. This implies needing 78% growth in the back half of the year to meet its target which does not seem likely at this point. Its projected EBITDA loss  -- which was more than double estimates -- paired with its fragile balance sheet means shareholder dilution or more leverage is all but inevitable. My confidence in this company has gradually dwindled and I’m now ready to allocate my time and capital to my other, healthy holdings.

As an investor in high growth, young, speculative disruptors, batting remotely close to 1.000 is not possible. Fortunately, the profit structure of common equities makes it so that the unfixed upside we can enjoy with winners can make up for a great deal of losers. This is why I have such strict allocation limits per holding. I could always be wrong, and allocating 10-20%+ of your wealth to one public name up front doesn’t respect that reality enough in my view.

8. The Boeing Company -- More Information Needed

Earlier this week, a Boeing 737-800 crashed in China, leaving no survivors. First and foremost, my heart goes out to all of the families impacted. This event is nothing short of tragic. 

I’m not ready to comment on the implications for Boeing going forward. We are still awaiting the source of what actually caused the plane to crash so abruptly and I will hold my tongue until I see that information. All I can say at this time is that I’m not willing to hold through anything resembling another 737 MAX debacle.

9. Market Talk

Over the last several months, soaring levels of inflation (linked to supply chain chaos) have pushed the Federal Reserve to take a more hawkish tone. The expectation for 5 rate hikes in 2022 is now 7 and Fed balance sheet erosion could now likely begin in May with quantitative easing having already ended. Considering this path of tightening is accelerating if anything, and considering that reality makes the discounted value of long term cash flows less compelling, how are growth stocks not just continuing to fall further?

The stock market is a forward looking discounting mechanism that absolutely loathes uncertainty. It often takes a “guilty until proven innocent” approach to potential headwinds like monetary policy and war. So, when these exogenous factors turn out to be anything other than the absolute worst-case-scenario, we often get what’s called a bad news bottom where scary headlines are met with green markets. I am not saying that’s what we’ve seen these last two weeks -- it’s a possibility that will only be discoverable in hindsight. Like a company expected to post terrible results can be rewarded for posting so-so metrics, I think expectations of where our world and our economy were going become overly pessimistic. As fear grips markets more and more, the bar to clear for relief becomes lower and lower. We seem to have cleared that low bar for now.

A terminal federal funds rate of 2.8% would still remain quite accommodative historically speaking. Furthermore, valuations have already sharply re-set to a point where high quality growth stocks are now trading at PEG ratios around or below 1.

But still, in this hectic, tinderbox of a world we live in, we’re one additional headline away from more capital market volatility. Considering this, I’ll remain mainly invested, but with a cash position (11.3%) that some find elevated.

10. A Note on American Cannabis

News headlines about developments in American cannabis regulation were abundant this week. The House of Representatives is considering new legislation to de-criminalize the plant, The Senate passed a bill supporting broader cannabis research, and New Jersey again delayed a decision on recreational cannabis going live while subsequently scheduling a new emergency meeting in April. It's safe to say the legislative landscape for this industry has been nothing short of frustrating and that has only continued.

We see American growers in prime position to capitalize on reform that are shrugging off positive headlines while Canadian LPs with inferior growth and profitability soar higher without nearly as direct of an ability to take advantage.

With all that said, as long as the companies I own in American Cannabis continue to fundamentally execute, I don't really care when states turn recreational or when laws finally lower cost of capital and tax rates for American growers. All of this will come eventually: New Jersey and others will sell legal cannabis, institutions will be able to purchase MSOs in a safe manner and insurers will be able to offer basic services to these firms in need. For now, the artificial regulatory moat in place allows the biggest and the best to get stronger each and every day. I continue to accumulate knowing these legislative tailwinds are an inevitable when, not if.

Click here for my broad overview of American Cannabis regulation.

11. My Activity

Aside from exiting CuriosityStream during the week, I also made small trims (4% or less of each position) to Lemonade, Teladoc Health, SoFi Technologies and CrowdStrike. All bounced aggressively off of their lows and this was just my way of creating slightly more flexibility to accumulate into more future volatility. Finally, I also added to GoodRx during the week. My cash position now sits at 11.3% of my holdings.