Problems Deepen for MedMen

MedMen is the best-known cannabis retailer in the United States. But is it going down the drain? Yet, in what could be a warning for the American marijuana industry, it is racing to raise cash to cover its mounting losses.

Financial statements released in February showed that MedMen risked running out of money within months unless it raised more money. Last week, MedMen alleviated any immediate financial crisis by securing a $100 million credit line from a cannabis-focused investment company. The loan may ultimately be raised to $250 million if MedMen's performance improves.

The terms of the financing are onerous — MedMen must repay it at 6 percent over Libor and issue warrants — but the fresh cash will buy the company time. Its shares, which had fallen almost 60 percent since October, have risen slightly since the announcement. At its current share prices, MedMen is worth about $1.6 billion, down from a high of roughly $3 billion last year.

Still, MedMen's struggles show the challenge that cannabis companies face in operating in states where high taxes and dispensary restrictions have driven up prices for legal marijuana. In California, MedMen's core market, highly regulated legal companies are struggling to compete for customers with illicit dealers who charge far less.

In fact, legalized dispensaries and regulators have begun to call for greater enforcement against the illegal market in California, raising the potential that legalization may actually lead to a new wave of cannabis-related arrests.

Meanwhile, MedMen has had limited success in its efforts to attract new or infrequent users, raising questions about how big that market may be.

With 16 stores at the end of 2018, California-based MedMen has aggressively tried to market cannabis to new users. Some dispensaries — the industry's term for stores — compete for existing marijuana users on price or product strength. But MedMen aims to become a national retail chain and brands itself as offering an upscale experience with stylish stores.

'The New Normal'

To that end, the company recently released a two-minute ad called "The New Normal" — which conjures up the acronym for the National Organization for the Reform of Marijuana Laws — to extoll legalized cannabis. The ad, from the director Adam Spiegel — aka Spike Jonze — ends with a suburban couple carrying a distinctive red MedMen bag home. "The symbol of counterculture is now just culture," the ad concludes. "It's normal again."

But behind the gloss, MedMen's finances are dismal.

During the last six months of 2018, MedMen lost $131 million — more than $2 for every dollar in marijuana it sold.

To cover those losses and fund its expansion plans, MedMen raised almost $200 million from September through November. That money is already gone. At year-end, MedMen had around $80 million in the bank. That is four months of cash, based on how quickly it lost money last fall.

In its most recent financial report, issued on Feb. 27, it warned: "At our current operating level, we will not have sufficient funds generated from operations to cover our short-term and long-term operational needs."

To give itself more time, MedMen has sold off some properties, including dispensaries. But that strategy has limits. MedMen has already sold much of its best real estate, and when it sells assets, the company further drives up its costs, because it must now pay rent to the new dispensary owners.

The loan that MedMen announced last week from Gotham Green Partners is another short-term solution. In a sign of just how tight the finances have become, MedMen can roll its first-year interest payments into the loan rather than paying cash. Although MedMen called the loan a $250 million investment when it announced the deal, it disclosed in its press release that it could borrow the final $150 million only "subject to certain conditions and share price thresholds being achieved."

Asked for comment, the company said, "Improving MedMen's financial profile and cash flow has been one of our top priorities, and we've already made significant improvements as we've implemented smarter spending initiatives. … We are committed to being strategic about our SG&A [selling, general and administrative] spend, including instituting new processes and efficiencies."

Some of MedMen's problems appear specific to the company.

On Jan. 29, James Parker, who was MedMen's chief financial officer until November, sued the company in California state court. Parker alleged it forced him out because of his concerns about spending and unprofessional behavior by its two top executives, Adam Bierman and Andrew Modlin.

Both showed "disdain for compliance with the law in general," as well as regulations covering cannabis companies, according to the lawsuit. It said Bierman regularly came to the office "high," and both tolerated cocaine use by employees. MedMen also engaged in schemes to keep its stock price up, Parker claimed. MedMen denies those allegations and calls the suit baseless.

An illicit advantage

MedMen's problems also point to bigger issues in the legal cannabis industry — especially in California and Massachusetts, which have heavily regulated and high-cost markets.

On Feb. 19, the state of California disclosed that excise taxes on legal sales of cannabis and THC extracts actually fell during the fall of 2018 from the summer. Excise taxes are collected on sales of medical and recreational cannabis, meaning that overall legal sales actually dropped.

One promise of legalization was that regulated cannabis would lure consumers away from illegal sales. But legalization has hardly dented California's huge illegal cannabis market. The illicit trade includes everything from farms in the state's rural north to unregulated dispensaries that operate in plain sight to delivery services that bring marijuana to users' doors.

The black market providers don't face regulatory, insurance, or tax expenses and can thus undercut prices at legal operators like MedMen. "The unlicensed market continues to flourish, due in part to the competitive financial advantage such operations have over legal cannabis businesses," the state's cannabis advisory commission complained in its 2018 report.

Tom Adams, managing director of industry analytics for BDS Analytics, which covers the cannabis industry, said high taxes and limits on legal dispensaries have damaged the California market. Taxes and regulators mean that legal marijuana can cost nearly double black-market prices, Adams said.

Even worse for legalized operators, cannabis consumption is concentrated among a small group of heavy users, the 1-in-5 users who get high every day. Because they use so much, they are price sensitive and appear happy to buy through black market suppliers.

"Lots of people came into stores," Adams said, speaking of the California market — though not specifically MedMen. (BDS does not comment on specific companies.) "They took a look at product prices, especially the heavy using, long-time consumer, and they said, 'I know what the right price is, and that ain't it.'"

As a result, BDS estimates that the illicit market still provides about 80 percent of all California sales, and dispensaries only 20 percent. The problem is so severe the head of the state's cannabis regulatory commission is now calling for increased law enforcement activity against illegal suppliers.

Some of the other states to legalize, like Colorado and Oregon, pursued a different strategy, liberally granting dispensary and farm licenses. In those states, retail legal prices have plunged, and dispensaries now account for about 60 to 70 percent of all sales

.

But profit margins are tighter in those states. MedMen has avoided them, focusing on those where legal supply is constrained — and instead focusing on trying to charge premium prices to new users, people who were not willing to use cannabis much, if at all, when it was illegal.

Unfortunately, despite the help of Jonze, MedMen hasn't found those users fast enough to cover its costs. Now it is running short on time to do so, raising the question whether legal cannabis companies will ever be able to earn big profits serving the price-sensitive market of current heavy users — and whether the new-user market is nearly as large as investors hope.