This is a story about a struggling state system and a standout operator. California cannabis is over taxed, there aren't enough stores, and the traditional market is still thriving. Only the strongest will survive. For investors with conviction and a long time horizon, Glass House Brands is not just one of the most interesting cannabis companies, but one of the most ambitious businesses in America.
This is the first of a two-part series. Here we’ll explore the basics, and for part two I’m visiting the greenhouses, touring The Farmacy retail store, and reviewing Glass House Farms flower. Please subscribe and part two will automatically be emailed to you.
Glass House Brands (referred to as "Glass House") became public on July 5th, 2021 through a SPAC transaction with Mercer Park Acquisition Corp. Mercer Park is backed by finance veteran and AYR Wellness Chairman, Chief Executive Officer and Corporate Secretary, Jonathan Sandelman. The vehicle was created in 2019 with the purpose of acquiring and growing cannabis brands. Mercer Park sat dormant, seeking an acquisition target, until Glass House entered the equation.
The deal included all of the Glass House brands at the time: Glass House Farms, Forbidden Flower and Mama Sue for a value of $325 million. In addition, they agreed to pay up to $1.5 million per license in stock at $10 per share for 17 licenses totaling $24 million to Element 7 for 17 retail dispensary licenses.
To acquire the Southern Californa greenhouse, Glass House paid $93 million in cash, plus as additional consideration the company issued 6.5 million shares valued at $29 million at the time, and an additional $35 million in earnouts to be paid if certain milestones are met. This brings the total purchase price of the SoCal facility to $157 million.
The pieces of the puzzle are clear: a strong team already growing flower at smaller, but significant size. A massive greenhouse to increase scale and reduce costs. Plus, an additional 17 retail licenses to achieve vertical integration and help sell the greenhouse output.
Kyle Kazan and Graham Farrar lead the Glass House charge. Graham serves as Co-founder, President & Board Director. He previously co-founded software.com, and parlayed that into another exit with SONOS. Entrepreneurs are lucky to bring one company public, Graham is in his 40’s and on his third.
To kick off this project, we met for coffee on a sunny day in Santa Barbara. He’s charismatic, passionate, and was wearing his signature hat. The knowledge he shared is spread throughout this overview, but there are a couple qualitative takeaways.
Graham's intentions are right. Glass House is committed to growing at scale, but in an ESG-friendly manner. They want to do the greatest good, with the least harm. Our kids are similar ages, and we talked about being responsible cannabis users and educating the next generation.
He's highly motivated, but also a proper stoner: I don’t know of another MSO leader that can roll a joint and take a dab. Graham knows quality and understands what California consumers expect.
Graham is complemented by Co-founder, Chairman & CEO Kyle Kazan. He’s a super-successful real-estate investor and runs the Long Beach office. Kyle spent time as a special-ed teacher and a law-enforcement officer. The latter gave him a first-hand look at how the War on Drugs was failing and how cannabis was being misportrayed as the villain, rather than an ally.
Kyle and his investors bought the first 150,000 square foot greenhouse, and later the 350,000 square-foot facility down the road. He is also responsible for securing the real estate in Santa Barbara where the The Farmacy is situated.
Graham and Kyle are two of the top talents in the cannabis space and one of Glass House’s strongest attributes.
Glass House is a single-state operator focused on California: the world’s largest cannabis market. California is home to more people than Canada, by itself would be the world’s 5th largest economy, and the leader in cannabis culture. To paraphrase Graham, “your favorite tequila comes from Mexico, the top champagne from France, and the best cannabis comes from California.”
The firm currently operates four retail locations: The Farmacy has stores in Santa Barbara, Santa Ana, and Berkeley, and there is one The Pottery dispensary in Los Angeles. While California is an open-license state, it is up to each city to decide whether they want cannabis, and if so, how much. I wrote about this in an article “Why Limited Licenses Matter."
Glass House excels at winning limited licenses in key locations. Santa Barbara had a heated competition for three store-front licenses. Glass House won one (along with Jushi and Coastal) and opened a beautiful store in a prime part of town. The Pottery in LA is an award-winning store with a beautiful open layout. The Farmacy in Berkeley is in an affluent city with one of the biggest universities. Santa Ana is their other key location, just south of LA.
More stores are on the horizon, and I’m particularly excited about the new location in Isla Vista. This college town is home to over 30,000 UCSB students. I graduated from UCSB, and can attest that cannabis use is rampant. The Farmacy Isla Vista will be the only dispensary in town.
The Element 7 Deal
When Glass House went public, they agreed to pay up to $1.5 million per license in stock at $10 per share for 17 licenses totaling $24 million to Element 7 for 17 retail dispensary licenses. Having more stores always helps, but being able to feature in-house brands is an even bigger boost. Glass House stores sell 15x more Glass House Farms flower versus other brands.
To date, Element 7 has fully transferred just three of the 17 retail licenses. Consequently, on November 4th Glass House filed suit against Element 7 in Los Angeles Superior Court. Thankfully for Glass House, as of February 22nd, 2022 no shares of stock have been issued or transferred to Element 7. Not promptly getting the licenses is a set back, but not crippling. Had the SoCal greenhouse fallen through, it would have really hurt.
Glass House is vertically integrated—the retail is paired with grow and manufacturing facilities. The 20,000 square-foot manufacturing facility is in Lompoc, an hour north of Santa Barbara. This complex produces extracts, pre rolls and serves as a distribution hub. The output can be sold in Glass House retail stores and sold to other non-Glass House stores. I regularly see Glass House products featured in other dispensaries.
Glass House specializes in greenhouse-grown flower. Greenhouse is the best of both worlds: it’s more affordable than indoor, but better quality than outdoor. When I ran a California collective, greenhouse out-sold indoor 3:1. I prefer the terpene profile of sun-grown cannabis.
Both operational greenhouses are located in Carpinteria, a beachside city 20-minutes south of Santa Barbara. Carpinteria is flush with greenhouses, originally from Dutch flower growers. The flower business moved to Central America and cannabis has taken over.
Glass House has two farms here spanning 500,000 square-feet of combined cultivation, capable of producing 90,000 pounds of dry biomass per year. They own these two greenhouses; no sale leasebacks or other financial trickery.
One of the primary reasons the flower is so good is the weather. Santa Barbara is one of the few Mediterranean climates in the world, distinguished by the tight band between winter and summer temperatures. Add in the ocean breezes, and Glass House’s farms are ideally positioned.
The other edge lies in technology. Dutch greenhouses implement amazing climate controls, allowing ideal conditions for the plants. I’ll elaborate in the second part of this series.
The SoCal Greenhouse
The Carpinteria greenhouses are massive, but their new 160-acre Southern California facility is 11x bigger than the two existing farms combined. Previously, this monstrosity had been used to grow tomatoes. Once converted, it will be the largest cannabis-growing greenhouse in the United States and second largest in the world.
The first phase will be planted in the first-half of 2022. Based on existing Glass House yields, this will add approximately 180,000 dry pounds per year of production. The additional space will be finished in 2023/2024 and expand total cultivation to 3,800,000 square feet. For perspective, this is bigger than Amazon’s largest warehouse.
As scale increases, costs decrease, and margins expand. In the current Carpinteria facilities, it costs Glass House $179 (pre tax) to produce one pound of flower. For comparison, I recently toured an indoor facility in California and their cost is $1,200/pound.
When the SoCal facility comes online, costs drop to $128/pound, a 28% reduction. Full-sun, large-scale outdoor will struggle to compete with these costs, and outdoor does not command the same price as good greenhouse.
Glass House Farms is the best-selling flower in California. Most Glass House Farms flower is sold in 1/8 jars for around $35. For comparison, top-shelf indoor 1/8ths are around $60, while outdoor runs about half that cost. Greenhouse flower hits a middle price point that works for a wide range of consumers.
Pre rolls are a growing segment and Glass House has one-gram singles and half-gram five packs. These smaller joints are great for solo sessions. Infused pre rolls are increasingly popular and Glass House offers Glass House Flower infused with Field live resin. The Farmacy in Santa Barbara sells 28 different pre rolls.
Glass House Brands also offers two celebrity-inspired lines. The Bella Thorne series touts effect-driven products like “hype up”, “turn on” and “chill out”. Mama Sue are the CBD tinctures. CBD sells well with newer users that are intimated by THC, or with medical patients that benefit from the pain and anxiety-relieving qualities.
Finally, Field are the extracts. The lineup is entirely live—derived from fresh/frozen flowers. This terpene-rich material produces live resin, which is extracted using a solvent like butane that is purged later in the process. Field also makes live rosin, which uses the same material as live resin, but employs a solvent-less extraction process. Live rosin are the top-shelf dabs and can cost over $100/gram.
Glass House is not currently producing cured resins. Instead, they sell their trim. I suspect this will change and we will see a more affordable line of extracts spanning shatter, badder, and eventually distillate for use in pens. Plus, pun intended, they could use the trim for edibles.
Plus Edibles Acquisition
On December 20, 2021 Glass House announced the acquisition of Plus Products, a leading edibles company. The deal was valued at $25.6 million and was financed through a combination of convertible debt, equity, and additional performance-based consideration.
Plus operates in California and Nevada, and is best known for their sleep-inducing line and strain-specific products. They are the number-four selling edibles brand in California. Glass House can begin immediately putting Plus in their retail locations and push them through their distribution network to an additional 700 stores. Lack of distribution was one of the biggest challenges in the past for Plus.
The addition of Plus gives Glass House the number-one flower brand and number-four selling edibles brand in the world’s largest cannabis market.
Environmentally Conscious Cannabis
ESG refers to environmental, social, and corporate governance. This trendy acronym is a criteria for measuring the ethical impact and sustainability of a company. When I sat down with Graham, I could tell this was something close to his heart.
Growing cannabis can be environmentally taxing—indoor consumes up to 2,000 watts of electricity per square meter, about 40x what is required to grow lettuce. It is estimated that growing cannabis accounts for more than 1% of US electricity consumption.
Glass House uses sunlight to grow their flower and the result is 95% less carbon than indoor. They estimate that the same amount of electricity used to produce one ounce of indoor flower can grow ten ounces of Glass House Farms flower (source: Seinergy July-2021, GHB commissioned study). The cost savings are enormous, and the environmental benefit is even bigger.
Glass House are also good stewards in the community. I regularly see them at the local food bank, giving back to schools, and trying to make Santa Barbara a better place. The team’s ethics and intentions deserve recognition.
The near-term question is whether Glass House can overcome the the challenges plaguing California. The taxes are too high, the regulations are excessively burdensome, and there are not enough retail stores to sell the flood of flower on the market.
Below are the taxes on a $200 purchase at The Pottery dispensary in Los Angeles:
- $230 after 15% excise tax
- $253 after local cannabis business tax of 10%
- $277.04 after 9.5% sales tax is applied
This does not include the cannabis cultivation tax of $161 per pound that is applied earlier in the supply chain. A bill to eliminate the cultivation tax effective July 1st, 2022 was recently introduced. This would benefit all growers, especially low-cost producers like Glass House, but does not impact the egregious retail taxes.
Lack of retail doors is the other major problem in California. Massive amounts of flower are being grown, and there aren’t enough places to sell it. It is so bad that some farms destroyed their crops this fall, rather than paying the cultivation tax and trying to turn a profit. Others find ways to move inventory off the books and divert product to the traditional market.
If the cultivation tax is eliminated, cities scale back on local taxes, and more retail doors open, the California market will improve and all boats will rise. Quickly, it can be become much more profitable. While it appears tides are changing, I have learned to have low expectations from politicians.
The broader California market is the biggest risk to Glass House. When California accelerates, Glass House is in an excellent position. There is a distinct possibility this all takes longer than expected. In this environment I expect Glass House to outperform peers in the state, but lag limited-license East Coast operators.
Glass House is a growth story and is priced accordingly. Earnings are also very sensitive to wholesale flower prices. When your cost of production is around $180/pound (pre tax), margins change drastically when flower goes from $500 to $750 a pound, or vice versa. In the second half of 2021 California flower prices dropped 50%, crushing Glass House's margins and earnings.
In early-stage growth businesses, near-term valuations are less important. Glass House is a bet on the management team, the California market, and some probability that we see interstate commerce.
The Instersate Call Option
The traditional market tells us the entire country wants California cannabis—a massive amount is shipped and sold in other states. Illegal operators in New York feature California cannabis on the top shelf
If interstate commerce opens, Glass House will be a huge exporter of cannabis. This will help absorb the full capacity of the greenhouses, and at potentially higher prices. In the traditional market, California cannabis sold in Texas commands a 50% premium over what it can be sold for locally. The potential for higher prices with low production costs is a hard to quantify call option.
Glass House is one of the most compelling cannabis stories. They are vertically integrated with greenhouses, manufacturing, and retail across California. Glass House Farms is the best-selling flower brand in California, and the addition of Plus edibles gives them the number-four edibles offering. Filling out the extracts and adding vape cartridges will round out the lineup.
Investors need to decide if they are willing to bet on California. It’s ultra-competitive, highly taxed, and does not have enough stores to sell all the flower being grown. If the state eliminates the cultivation tax, cities cut local taxes, and more doors open, this could be one of the hottest markets. But, those are three big ifs.
From a portfolio-construction perspective, Glass House pairs well with Verano. Glass House specializes in affordable, greenhouse-grown flower, and operates exclusively in California. Verano focuses on premium products, indoor flower, and is in 17 states, but not California. Together, they give you diversification across products, price points, management teams, and geographies.
I recommend Glass House to investors with a long time horizon, strong conviction, and optimism around political progress. They are California’s greatest hope.
Disclosure: At the time of publication (February 22, 2022) I was not invested in Glass House and I was not compensated for writing this report.
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