A pick-and-shovel play with a major catalyst
Edit: June 13, 2024
I have added a copy of my MAPS presentation I shared at the WSI Conference here:
Hello, Ultimate Value readers!
Today, we will be looking at an incredibly asymmetric opportunity in the US market. It is a great way to play an upcoming catalyst in a bombed-out industry.
The stock’s downside is limited due to the low starting valuation (<3x adjusted EBITDA) and its sizable net cash position (cash is ~20% of the market cap).
While the catalyst is open-ended, there is a chance we get some positive news within the next few months. The stock could be a multi-bagger if this proves right.
Let's dive in and take a closer look.
Investment Thesis Summary
WM Technology (US: MAPS) [disclosure: I own shares] is a compelling opportunity.
The company operates the leading online marketplace for cannabis, Weedmaps.
MAPS currently trades at $0.84 per share, with a market cap of $140m, about ~$30m in net cash, and an EV of $110m. The stock trades ~$400k USD in volume per day.
I believe the stock is compelling for the following reasons:
Cannabis is likely to get rescheduled in 2024. This will eliminate Section 280E, a provision that prevents cannabis firms from writing off expenses other than COGS.
The elimination of Section 280E will have a material impact on the profitability of the cannabis sector. I expect that some share of the profits will be reinvested into marketing, where MAPS will be one of the biggest beneficiaries.
The opportunity looks significantly mispriced, with WM trading at a trough valuation (<3x adjusted EBITDA) and trailing MSOS (the cannabis ETF) in recent performance.
My downside target is $0.65, and my upside target is ~$4.30, which makes the risk/reward very compelling.
Why this might be mispriced
Left-for-dead sector: the cannabis sector has suffered from excess supply, increased competition, price deflation, and increasing costs. This has been a disaster for the industry, particularly dispensaries, of which only an estimated ~24% are profitable. Listed cannabis companies have seen equity values impaired.
Broken SPAC: WM came to market via a SPAC in 2021. Most investors will avoid looking at anything that went public via this mechanism.
Complicated structure: the company used an Up-C structure to go public, which creates messiness for data providers with the share count and minority interests.
Trading dynamics
WM came to market via SPAC in 2021. The stock has traded as high as $29 (February 2021) and as low as $0.60 (April 2023).
MAPS trades ~$400k USD in volume per day.
Capital structure
The company’s capital structure is complicated due to the company IPOing with an Up-C structure.
The company provides a pro forma diluted share count of 164m shares outstanding. There are another 7.3m RSUs, but these are non-vested.
MAPS has 12.5m public warrants and 7m private placement warrants, both with a strike price of $11.50. I will ignore them since they are far out of the money.
WM has a clean balance sheet, with $28m in cash and no debt.
Business background
WM Technology was founded in 2008 in Irvine, California. The company operates the leading online marketplace for cannabis, Weedmaps. The company came to market in 2020 via a $1.5 billion merger deal with special purpose acquisition company (SPAC) Silver Spike Acquisition Corp.
Weedmaps operates as a “marketplace.” However, this is somewhat of a misnomer - the company never “touches” the product or the money that changes hands between consumers and retailers. This structure is necessary in order to avoid the restrictions that are placed on cannabis businesses; the federal-level illegality of cannabis, for instance, prevents credit payment processors (i.e., Visa) and banks from participating. For that reason, I believe Weedmaps functions more as a classifieds business.
Weedmaps brings together consumers and retailers/brands. On the consumer side, the platform provides information that drives purchase decisions, such as strains, clinical effects, pricing (deals), THC/CBD content, and up-to-date in-stock availability. For retailers, Weedmaps serves as a general advertising platform with products such as basic listings (info: location, operating hours), improved placements, and traditional ads. About 70% of the company’s revenue comes from premium deal listings and ads. The company has ~5,400 active clients, paying ~$3,000 on a monthly basis. Retailers include small dispensaries, large delivery operators, multi-location chains within a single state, and multistate operators that span across state lines.
Importantly, Weedmaps has become the dominant platform in the industry. Given the company’s lead in traffic, active users, and retailers/brands on the platform, Weedmaps benefits from strong network effects. Dispensaries have to be on the platform if they want to drive sales. Reddit user Mickjagger2020 described this well in a thread that asked users (on the r/weedbiz subreddit) about their experience with Weedmaps. Many more experiences like that on Reddit illustrate how dominant the platform is in the cannabis space.
Moreover, the federal-level illegality of the product has, up to now, resulted in limited competition from digital advertising behemoths, which currently prohibit the advertising of cannabis. The sale of cannabis is also a complex sale; it’s unlike shopping for typical CPG products with well-established and dominant brands. There is no standardized SKU, and the quality and safety of the products can vary widely. This creates a need for a platform that offers up-to-date information and product reviews so that users can make informed purchase decisions. Even if legalized tomorrow, traditional brand advertising might not be an effective way to drive sales.
In 2023, MAPS will have generated approximately $200m in revenue and ~$38m in EBITDA (20% margin). The business is capital-light, and incremental margins should be high given a healthy gross margin of +90%; sales/marketing and expenses fall in the 20% range. Product development and G&A should also scale as revenues grow from here. I believe MAPS will have high margins at scale, as is typical with classifieds and marketplace businesses.
Recent events
WM has faced a more difficult industry environment since its IPO. A slowdown in the industry, particularly in mature markets such as California, Colorado, and Oklahoma, has weighed on the company’s results.
These markets have experienced a supply glut, increasing competition, and demand shifting to unlicensed channels, causing volumes in licensed channels to drop. Consequently, dispensaries have either had to shut down or cut back on spending.
This has resulted in client churn and a decrease in average monthly revenue per paying client (ARPU) for MAPS.
Challenges remain, however, with a weak industry backdrop and the company having had several top executives leave in the last few quarters. However, the company has aggressively cut costs, shut down non-profitable products, and ultimately returned to adjusted EBITDA profitability over the last 3 quarters.
The Catalyst
Rescheduling Cannabis
At the federal level, cannabis is considered a restricted Class I drug. This means that the government sees “no currently accepted medical use and a high potential for abuse.” Other Schedule I drugs include drugs such as heroin and ecstasy. Schedule II drugs include cocaine and meth, which are considered less dangerous.
Within the last few years, dozens of states have legalized cannabis for medical (34 states) or recreational use (24 states). Consequently, there has been a push to reschedule cannabis to a less restrictive classification. In 2022, President Biden directed Cabinet-level agencies to “review expeditiously” how marijuana is scheduled.
In August 2023, the Department of Health and Human Services (HHS) issued a formal recommendation to the DEA calling for the rescheduling of cannabis to Schedule III, given that they see valid therapeutic uses for the drug. Ultimately, it is the DEA that has the final authority to change the schedule of a drug. The DEA is now undergoing a review to consider a change based on this recommendation.
Timing
Usually, changes in drug scheduling can take years. However, a key difference this time is that the Biden administration has made cannabis reform a key pillar of their policy. It’s very possible that we will see a change in scheduling this year.
A Veda Partners report on the outlook for cannabis estimates that the DEA will issue a final ruling regarding rescheduling in October of this year. This timing would be advantageous for the Biden administration and Democrats to capitalize on during the upcoming elections.
For an October rescheduling to occur, it would mean that the DEA would have to issue a proposed rule sometime between February and April to have enough time to respond to public comments.
Impact on the sector
For Weedmaps, specifically, the change is important because the rescheduling of cannabis would invalidate Section 280E. Section 280E of the Internal Revenue Code “forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act.” In other words, cannabis firms can only write off their cost of goods (COGS). This means that dispensaries end up paying significantly higher tax rates, often as much as 70-90% of pre-tax income, vs the federal rate of 21%.
I put together an illustrative example (below) of the difference between having Section 280E apply and what it might look like for a typical dispensary. It’s more instructive to look at it in relative percentage terms, where the elimination of the 280E tax code would more than double industry-wide after-tax profitability.
This means that cannabis firms will have substantially more money available to reinvest into growing their businesses. If rescheduling is completed sometime in 2024, it’s possible that 280E taxation on the marijuana industry could end retroactively to Jan. 1, 2024.
Thesis
I believe that MAPS is compelling for the following reasons:
The elimination of Section 280E will have a material impact on the profitability of the cannabis sector. I expect that some share of the profits will be reinvested into marketing, where MAPS will be one of the biggest beneficiaries.
Research firm Whitney Economics estimates that state-legal cannabis firms will pay $2.1B in excess taxes in 2023 due to Section 280E.
As Section 280E goes away in a rescheduling, I believe cannabis firms will reinvest some of this. As the biggest classifieds business for cannabis, Weedmaps should experience “winner-take-most” dynamics. There are strong incentives to keep using the platform on both the consumer and retailer sides. Consumers will want to continue using WM as a place to learn more about legal cannabis consumption options available to them. Retailers will want to put their marketing dollars to work where they can get the most eyeballs and, ultimately, the best return on their ad spend. This strong tailwind should ultimately make Weedmaps a disproportionate winner if and when more marketing dollars become available.
Importantly, a rescheduling - rather than a full de-scheduling- also means that other advertising giants are unlikely to tap into the opportunity in the interim, given the illegality of the substance at the federal level. For that reason, Weedmaps will continue to gain dominance as the favored marketing platform.
Lastly, a change in the scheduling of cannabis could unlock further monetization opportunities. MAPS is an intermediary between consumers and dispensaries but doesn’t touch the product or the money. If legislation is passed easing some of these restrictions (SAFER Banking Act, for instance), MAPS could convert its model to charge a percentage of GMV, which should be accretive to the platform’s earnings potential.
MAPS is the best pick-and-shovel play on cannabis.
Cannabis is a nascent industry, and picking winners presents a difficult proposition, given a quickly evolving competitive and regulatory landscape. MAPS, however, is the best pick-and-shovel play. Its breadth of clients and geographies means that it should benefit as the industry continues to grow. [As a side note, the MSOS ETF is actually a bet on ~4 MSOs since these picks have a weight of ~75%.]
Importantly, Weedmaps operates 100% legally since the company does not touch the plant or the money in transactions. The stock trades on the Nasdaq and is incorporated in Delaware, as opposed to most MSOs, which are domiciled in Canada and trade OTC in the US. This makes MAPS one of the best options for institutional investors.
There are long-term tailwinds for the cannabis sector as a whole, which will benefit Weedmaps.
While the end industry has been challenging for operators, consumer demand shows no sign of slowing down. As the transition to legal consumption continues, Weedmaps should benefit from a growth in licenses to dispensaries and increasing adult consumption, which is still significantly behind countries such as Canada.
The bar is set low for near-term results.
Management has been guiding for adjusted EBITDA in the $4-$5m range throughout 2023 despite achieving closer to $10m on average per quarter. Q4 guidance was set at $5m, but I think it would be difficult to see them not achieve ~$10m without a significant deterioration in the business, which sets the company to do about ~$38m for 2023.
I believe that free cash flow generation should also improve from here as SBC has been scaled back and provisions for doubtful accounts continue to decrease; the company has been better about tightening collections and selectively moving away from clients who cannot pay.
The company has also been making inroads with larger, multi-state operators. MSOs have never been a significant driver of business for MAPS. In Q3, the company stated that they see upside for this category in 2024 as they are working through this upcoming year’s ad budgets with these larger players.
The opportunity looks significantly mispriced, with WM trading at a trough valuation and trailing MSOS in recent performance.
MAPS has been left for dead (see below) even as the market has started to notice the opportunity inherent in a re-scheduling. MAPS is currently trading at less than ~3x adjusted EBITDA and ~0.6x EV/sales despite what should be a dominant business with healthy cash generation.
I think this valuation is too low for this sort of asset.
I will get into valuation and scenario analysis in the following section.
Scenario Analysis & Valuation
I will paint two scenarios. The goal here is to try for accuracy, not precision.
The Upside Case
We start off with 2023 as the base year, where the company will generate ~$200m in revenue and ~$38m in adjusted EBITDA. We assume that cannabis will be re-scheduled in 2024, and section 280E tax restrictions will be eliminated. Research firm Whitney Economics estimates that state-legal cannabis firms will pay $2.1B in excess taxes in 2023 due to Section 280E. To keep the math simple, let’s assume this is $2B.
[As a quick sanity check, the licensed retail market in the US is approximately $30B. If the industry net margin is, say, 5% and goes to 12%, that is roughly a $2B delta.]
On a 12-24 month timeframe, let’s say that 10% of these proceeds get reinvested into marketing. That’s an incremental $200m of spend. Let's assume Weedmaps is able to capture 30% of that, which is an incremental $60m in revenue. At a 50% incremental margin, that’s another $30m in EBITDA for a total of ~$68m.
How realistic is the $60m incremental revenue assumption? I would think it’s fairly doable. If you look at the company’s Q3 client count of ~5,400 and back into the implied ARPU at ~$260m of revenue, you get an ARPU of ~$3,900. WM had an ARPU of $3,800 in 2021, so it’s not too much of a stretch to assume that they can get close to that number again, even without adding more clients. If Section 280E is eliminated, I would anticipate WM to get more clients back on the platform and for many to increase their spending substantially.
Weedmaps is currently trading at a depressed multiple (~3x adjusted EBITDA). But given the quality of the business (classifieds-like) and what would be a return to growth, I think a fair multiple would likely be in the low-double-digit EBITDA range (likely 10-15x), or a 2-3x multiple on sales (i.e., 10x EBITDA * 0.27 EBITDA margin = 2.7x sales), which is within the range of where MAPS has traded in the past.
At a 10x multiple on $68m of EBITDA, MAPS could be worth ~$4.30 per share, or about a 4-bagger relative to the current price. Adjusted EBITDA is not super clean, given stock-based compensation. I estimate that EBITDA should convert to FCF at about ~50% after SBC, CAPEX, and taxes. So, free cash flow should be about $37m. The 10x EBITDA multiple would then imply a ~19x FCF multiple, in line with a market multiple.
The following sensitivity tables lay out a broader range of outcomes. Starting on the left, we have a table that calculates the incremental revenue to Weedmaps under different scenarios. Next, we have the total EBITDA generated. On the far right is the implied stock price in those scenarios (at a 10x EBITDA multiple). On the bottom left is the free cash flow generated; on the bottom right is the implied FCF multiple.
The Downside Case
The downside case is simple.
MAPS has about ~$30m of net cash on the balance sheet, which represents about 20% of the company’s market cap. It’s also trading at trough-like multiples on both revenue (~0.6x EV/sales) and adjusted EBITDA (~3x adj. EBITDA).
Let’s assume that Section 280E does not get eliminated (or gets pushed back), and industry trends drive revenue ~20% lower in FY24 (revenue was down ~5% in the last two quarters). Then, if we value the company at 0.5x EV/Sales, WM should be worth about ~$0.65, roughly ~20% downside.
While the stock can trade anywhere in the near term, I think the valuation is already pretty egregious, so the downside should be somewhat limited.
Attractive Risk Reward
The upside/downside skew is attractive. If my scenarios are near the mark, the downside would be about ~20c compared to ~350c of upside, making the r/r about 18x - pretty significant.
Model and Estimates
Here is a copy of the model, in case it’s helpful.
Risks
No re-schedule: there is no guarantee that the DEA will re-schedule cannabis.
Timing: it’s possible that the process will take a lot longer than anticipated. There is no guarantee that it will happen in 2024.
Difficult industry trends: the fundamentals could deteriorate further: dispensaries could stop paying, cut back on ad spending, etc, if consumer demand continues to weaken in markets such as California, Colorado, etc.
Catalysts
Progress/news regarding the re-scheduling of cannabis. A proposed rule by the DEA could come as soon as February (and up to April) for the timing to work for the Biden’s administration benefit.
Legalization in other states. Florida is considering putting the issue on the ballot.
Special thanks to the talented investor,
for sharing his work on the general industry idea (played through MSOS), which inspired this idea.
Be sure to drop a comment below or in the chat. Or simply respond to this email with your thoughts! Thanks for reading!
What's your thoughts on this: WM Technology, Inc. Announces Notification of Delinquency with Nasdaq
https://ir.weedmaps.com/news-releases/news-release-details/wm-technology-inc-announces-notification-delinquency-nasdaq-0
Very cool idea and good writeup. Couple quick thoughts- 1) Sorry if I'm stating the obvious, but it's a very elegant catalyst because the actual cost of MAPS product to its customers goes down since it becomes tax deductible post downscheduling. 2) Practically speaking you are right that the legal risk is zero but theoretically they are probably aiding and abetting. I have zero concern about an actual headline or event risk, but this might make it uninvestible for some institutional investors.
I probably won't buy it but I think the writeup is very well done.