The cannabis industry has been a rollercoaster over the past few years. In 2018, Canada legalized marijuana, and over the past 10 years or so, many U.S. states did, as well, even though cannabis remained illegal at the Federal level.
But two weeks ago, a big shift happened in the cannabis industry when the Drug Enforcement Agency (DEA) endorsed the recommendation by the U.S. Department of Health and Human Services (HHS) to reschedule marijuana as a Schedule III drug, down from the Schedule I classification it previously held. While stopping short of legalization, it's a big step that will ease the tremendous tax burden on U.S. cannabis companies and likely flip many from loss-making operations to profitable ones.
Canadian operator SNDL Inc. (SNDL -2.44%) has been prescient and savvy in attempting to gain access to the U.S. market. On the heels of the DEA's decision, SNDL made an important announcement that should boost its long-term growth prospects, as it found a loophole to enter the U.S. market while still retaining its listing on the Nasdaq Exchange.
SNDL's long, winding road to U.S. markets
SNDL used to be a small cannabis player called Sundial Growers. As the Canadian market became oversupplied during the pandemic, the company nearly went bankrupt. However, Sundial miraculously became a meme stock toward the tail end of the pandemic and saw its share price skyrocket.
Management was smart and took advantage, selling about $1 billion worth of stock at hugely elevated prices that made no sense. With its coffers buffered with cash, management then redeployed that cash into various assets. These included a profitable Canadian liquor retail business, debt and equity securities of distressed Canadian cannabis companies, and a joint venture called SunStream Bancorp, which existed to provide loans to U.S.-based cannabis companies.
This was a clever way to get around limitations for Canadian companies to get into the U.S. market. Canadian cannabis companies like SNDL have been able to list on major U.S. stock exchanges because their activities are legal in their own country. However, U.S. cannabis companies must trade in the less liquid over-the-counter markets due to the federal illegality of cannabis in the U.S. And listed Canadian companies were restricted from owning any U.S. plant-touching operations.
But SNDL used SunStream as a clever way to gain exposure to the high-growth U.S. market. SNDL is only an "investor" in SunStream, which is actually controlled by third-party investors and only invested in the debt of U.S. cannabis companies. The thinking was that if the borrowers of SunStream's loans did well, SunStream would earn high interest on that debt. If the companies restructured or went bankrupt, SunStream would be able to take over their operations.
The lack of direct control and exposure to debt appeared to satisfy U.S. regulators that SNDL, the company, didn't actually engage in "plant-touching" operations in the U.S. But recently, the tough operating environment and high tax burden caused two of SunStream's borrowers, Parallel and Skymint, to need to restructure. The problem was that restructuring could lead to SNDL taking over U.S. plant-touching activities.
But SNDL and SunStream found a way to take over majority equity positions in these companies in a legal manner while still allowing SNDL to retain its Nasdaq listing.
Image source: Getty Images.
How SNDL pulled it off
In a May 2 press release, SNDL noted it had been in discussions with the Nasdaq Exchange listing authority regarding the SunStream position, and that the listing authority conducted a review. SNDL said that, based on the review and advice from its lawyers, it "is satisfied that the SunStream USA Group structure conforms to applicable laws and is not aware of any reason that would cause SNDL to not be compliant with Nasdaq listing rules."
SNDL will essentially take a "placeholder" stake in these two multi-state operators (MSOs) via securities called "SunStream USA" (SSU) Exchangeable Securities. While SNDL will gain exposure to these companies by holding these SSUs, the SSUs won't actually allow for SNDL "to control or to financially benefit from the SSU Exchangeable Securities" as it would from an equity position. So SunStream will continue to be managed by a third party, and SNDL won't be able to benefit financially from the securities until the SSUs are exchanged.
The SSUs will only be exchanged upon a "legalization trigger event" that would come from either the legalization or decriminalization of cannabis in the U.S. In that event, SNDL could then consolidate SunStream and take a beneficial equity stake in the U.S. entities.
Other Canadian cannabis companies have similar arrangements with U.S. MSOs but likely paid a high price for warrants. But SNDL, through SunStream, was essentially a distressed debt investor taking over the assets of Parallel and Skymint at what was likely a bargain price.
What will SNDL own upon legalization?
Parallel is a multi-state operator in Florida, Massachusetts, Nevada, and Texas, and Skymint operates in Michigan. When accounting for SNDL's potential majority stake in these two companies, the combined revenue would put the SNDL U.S. operations within the top 10 U.S. MSOs. When combining the U.S. operations with SNDL's existing Canadian assets, the combined company would be among the top five MSOs in North America.
While legalization is still far away, the DEA's agreement to reschedule cannabis has apparently emboldened SNDL and other Canadian companies to exercise their rights in taking exchangeable shares in U.S. entities. And it appears the Nasdaq listing agents are OK with the arrangement.
Even after its recent surge, SNDL only trades at 0.75 times book value. That book value largely consists of its cash, hard assets, and the debt securities in these U.S. companies.
Whether or not that is cheap depends on whether SNDL's U.S. assets will generate sufficient returns. While that remains to be seen, the likely rescheduling of cannabis will ease a significant financial tax burden on all U.S. cannabis companies. The tax relief alone would likely enable many to transform from loss-making companies to profitable ones.
With a cash position of $195 million and no debt, SNDL appears to be one of the lower-risk plays in the cannabis space with what now looks like a substantial future U.S. operation.
