The following letter was sent to investors in the Bengal Catalyst Fund, LP yesterday.
Dear Investor,
The Bengal Catalyst Fund, LP’s (the “Fund”) performance (preliminary, net of fees, and unaudited) is presented below alongside that of MSOS, a US cannabis-focused ETF. We do not consider MSOS a benchmark, but we do believe it is the closest equity market proxy for the US cannabis industry, so we view it as a reasonable indicator of cannabis investor sentiment.
Assuming an investor had been a part of the Fund since day 1 and therefore participated in the Fund’s side pocket investments (returns of which are not reported in the table above per general fund performance reporting requirements), their return would be modestly better than the since inception figure above.
Your individual account statements are now available at the current fund administrator’s (NAV Consulting) investor portal. Please note that we anticipate moving to our new fund administrator, Panoptic, from October 2023 going forward. The current NAV investor portal will be shuttered and replaced by a new investor portal administered by Panoptic. We will update you with more information as soon as it is set up. Also, a reminder that your results may vary from those above depending on time of investment.
Please also note, consistent with previous reminders, that our fund has grown increasingly illiquid and more concentrated, which tends to increase short term volatility of returns. Our focus remains on long-term value creation and the underlying execution of our portfolio companies.
As is our usual practice, we are sharing some thoughts regarding the cannabis investment environment below as well.
Bengal Commentary - Q3 2023
Because our focus is on the smaller, more complicated stories in cannabis, we expect that our fund will likely perform worse relative to MSOS (which is dominated by exposure to the largest cannabis companies) in times of retail giddiness, which is exactly what occurred in Q3. Positive political and regulatory developments (Senate SAFE markup, speculation on DEA likely acquiescence to schedule 3 recommendation by HHS, etc.) drove sharply increased equity prices, followed by a modest pullback as expectations tempered. Still, our holdings were also beneficiaries of the overall runup in prices.
Politics
We have written before about how many investors in the space do themselves no favors by trying to predict political/regulatory developments in excruciating detail. Any tangible sign of political progress, like a Senate committee markup hearing on SAFE, is treated as an indicator of further imminent change which is then interpreted into equity prices by almost exclusively retail investors. But time and time again political reality has shown that there are many reasons to doubt anything as a sign of imminent change in Washington - the world is simply too complex with many countervailing forces. We may not know what will derail quick progress on cannabis, but we can fairly say that something usually will - e.g., the unprecedented Speaker of the House musical chairs that is ongoing as of this writing. Cannabis investors can take some comfort in the fact that cannabis is exactly like other major political issues in this way.
Many investors in the space, as judged by Twitter (no, we are still not calling it “X”), seem to be practicing an interesting dance: playing a fairly clear game of “greater fool” investing (where you count on making money by selling whatever you hold to a bigger idiot after you) while covering themselves in vaguely fundamental investing verbiage about relative discounts, growth rates, etc. The story goes that as soon as these cannabis stocks can uplist to the TSX, Nasdaq, Cboe, etc., “institutions” will buy them and the increased liquidity will drive up stock prices.
Let’s admit for a moment that some kind of uplisting will boost valuations as capital naturally flows into the (illiquid) cannabis space. How will these investors know when this “boost” has run its course? How many will, like some long suffering Canadian LP shareholders, hold on just a bit too long only to see much/most/all of their payday vanish? Some investors will time it perfectly and surely make money but that is not investing - that's trading. And it may work but, as one Bengal Capital partner with significant prior experience in the world of trading says, the trade that many see coming a mile away is not usually the one that works out well.
There was a time when we ourselves made the argument that this sector was relatively undervalued given its current profitability vs. its growth, and many still do. But the world is different now than when we started the fund in 2021. One major difference is we now have the benefit of almost two full years of demonstrated financial performance which has, by and large, not been particularly impressive and has cast significant doubt on the long term value of certain large MSOs. By the time uplisting actually happens, “institutions” will have the benefit of even more operational track record on which to make their investing decisions. We do not think that additional track record will do most large MSOs many favors in the eyes of seasoned institutions.
Bengal Catalyst Fund Portfolio Update
Below is a list of investments the fund continues to be long, along with some commentary regarding any developments in Q3:
Body and Mind, Inc. (“BaM,” CSE:BAMM, OTC:BMMJ) equity and convertible debt (side pocket): As this letter was in the final stages of drafting, BaM announced the closing of the sale of its Ohio dispensary for $8.225 million and simultaneous repayment of the entirety of its senior secured convertible debt of $7.33 million. The balance of proceeds, along with the company’s current cash reserves, will be used to fund the development of a dispensary in Illinois and one in New Jersey. We continue to believe that BaM is being valued at a significant discount to the sum of its parts and that management is correctly focusing incremental capital on its highest return opportunities.
XS Financial, Inc. (CSE:XSF, OTC:XSHLF) equity and convertible debt (side pocket): XS recently modified the terms of its convertible debt to lower the conversion price and add a few other sweeteners, but as XS’ is an esoteric story (specialty finance) in a very illiquid space, the convertible debt remains significantly out of the money. Despite that, we continue to like XS’ prospects and were recently buyers of its common equity on the open market. To date, despite having exposure to some distressed operators, they have not suffered a default in their equipment leasing loan book per their public disclosures and we continue to think that management is skilled and aligned.
Goodness Growth Holdings, Inc. (CSE: GDNS, OTC: GDNSF) equity: As Bengal partner Josh Rosen is the interim CEO of Goodness and in light of Goodness’ ongoing litigation against Verano Holdings related to their abortive merger, we will refrain from detailed comment regarding this position.
Grown Rogue and urban-gro (“UGRO”), a former fund position, are discussed in more detail below.
Grown Rogue & UGRO: A Tale of Two Companies
Grown Rogue (CSE:GRIN, OTC:GRUSF) continues to be a strong performer for the fund. Entering the year at CAD$0.145 per share, the stock ended Q3 2023 priced at ~CAD$0.31 and currently trades for around CAD$0.35. Our thesis on Grown Rogue has always been that they are a great operator in a market that does not appreciate great operators, and that the potential profit of them entering new states was being significantly underestimated by the market, as well as their long term potential franchise value. In Q3, Grown Rogue continued its expansion by announcing a definitive agreement to enter New Jersey through 70% ownership of a NJ operator, and indicated that they would spend roughly up to $6 million to get the operation up and running. A line from the press release announcing the deal encapsulates our thesis:
“To put [the New Jersey] investment in perspective, Grown Rogue invested US$4,000,000 in capital expenditures in a similar size facility in Michigan and that asset is currently on a run rate of generating nearly $4,000,000 in after tax operating cash flow”
Entering a new market with a right-sized facility means less product to distribute and sell, more craft identity, and much less dependence on long term high pricing in order to justify the initial facility buildout. Grown Rogue’s steady, reasoned expansion has thus far generated terrific returns on capital and is exactly what we want to see - and the market seems to have taken notice as Grown Rogue’s stock has increasingly become a more talked about nanocap story.
Even more importantly, committed investors who have picked up on Grown Rogue’s success have now extended it a significant amount of convertible debt (now in the money but at the time at a premium to market price) at <10% interest - a better deal than many large MSOs could get today. Disciplined execution combined with consistent messaging has created a lower cost of capital, which then in turn supports significant growth in the business. We continue to be excited by Grown Rogue’s prospects and look forward to continuing to be engaged shareholders.
In contrast, we liquidated our urban-gro, inc. (NASDAQ:UGRO) in Q3 at a loss of roughly 85% from our average purchase price (~US$9/share). Our initial thesis was that UGRO had best-in-class technical competence in building cannabis facilities and would be well positioned to capture a large amount of capex spending in the industry, with particularly attractive upside offered by their then-nascent recurring service offerings (which we thought would provide significant value to facility operators). At the time of our investment, the company had no debt and significant net cash, putting it in a great position to be flexible in the industry. All this combined with a seemingly receptive management team made us feel confident in our investment.
Flush with cash and a NASDAQ listing, UGRO embarked on an acquisition spree mostly using their balance sheet cash, which initially totaled an impressive $40 million and made up a significant portion of the share price. The industrial logic of the acquisitions was that they made UGRO more “vertical” - as in, UGRO could in-house more services that make up the full process of creating a cannabis (or other) facility. They bought architecture firms, a construction management firm, etc. All of the purchased firms were touted as being self-sustaining on a cash flow basis (i.e., not losing money). Yet as the acquisitions were completed and the financial results rolled in, one plus one never quite seemed to equal two. As the capital cycle in cannabis inflected negatively in 2023, it seemed clear that capex spending would be limited in the foreseeable future, but UGRO management did not make quick changes in the business as demand for services dropped down significantly thereby burning more precious cash.
We have always been relatively skeptical of investor promotional activities, but we actually have a respect for truly good investor relations. In Bengal’s view, investor relations is meant to communicate where the company has been, where it is going, and why it will get there to current and potential investors. At best, a good investor relations program will frame the company’s “story” in an understandable way and give investors the tools they need to accurately assess company performance. This means that good investor relations allows investors to see when the company has underperformed as well as performed - in the long term this creates trust in management, which then leads to a materially lower cost of capital as a company becomes increasingly trustworthy to institutions and typically valuation multiples that are higher than peers.
Most investor relations teams are not that good, but also not that bad - mediocre investor relations doesn’t add much beyond just summarizing the basic financial performance of the company every quarter. The vast majority of investor relations is regurgitated excerpts from financial reporting.
Good drivers keep their eyes up the road which allows them to drive in smooth, straight lines. Bad drivers keep their eyes pinned to the end of their car’s hood, thereby all but guaranteeing that their driving will be neither smooth nor straight. Bad investor relations is distinguished from good investor relations in much the same way as bad driving is from good: while good investor relations focuses on the long-term goal despite the immediate noise, bad investor relations is constantly hunting for a new way to “excite” investors. Bad investor relations usually entails trying to “manage” the daily random movements of the company’s stock price with a poorly thought out stream of “news” with no unifying theme. Having been in the small cap world ourselves, it’s easy to imagine press releases being put out ad hoc in response to perceived “fires.”
Critically, bad investor relations can also reveal poor management because it can indicate that management themselves do not understand what the strategic drivers of the company’s business are. From that point of view, the bad investor relations makes sense: how can management lay out a course for investors when they don’t really have one? Good management can have resoundingly mediocre investor relations because thinking and executing on a business plan and communicating that plan in an effective way to investors are two distinct skillsets, but in our experience it is rare for good management teams to have truly bad investor relations.
UGRO’s investor relations tribulations can be exemplified by their slapstick sequences of issuing forward revenue/EBITDA guidance, revising said guidance downwards in light of trends that clearly existed at the time the initial guidance was given, and then pulling guidance all together only to again give future guidance a little while later, reiterate that guidance the next quarter, only to again revise guidance down. Whatever this kind of sequence indicates, it is not a firm grasp on the strategic drivers of UGRO’s business. Now, in a fairly recent shift, UGRO seems to be press releasing even its most minor contract wins. A ~$100 million revenue company feeling the need to press release a $1.5 million contract signing strongly suggests a company that has fundamentally lost its way.
Initially, we appreciated the frank discussions we had with the UGRO management team. As time went on however it became increasingly clear that management made a show out of hearing us without really listening. Many may recall a technique they learned as children wherein you ask the same question of so many different people that by the end you can cobble together whatever it is that you wanted to hear - this is what our experiences with UGRO management started to feel like. Our confidence in UGRO management to steward the business properly and execute operationally on a well coordinated plan continued to slip. With a highly concentrated portfolio, when our conviction slips, we view our mandate as either needing to find an exit or lean in more actively. In this case, we elected to exit. We continue to believe there should be underlying value creation with UGRO’s platform and wish the team well.
In some ways Grown Rogue and UGRO had the same conceptual core: incredibly high competence in their area of expertise. The difference was in the strategy employed to try to create value out of that core. Grown Rogue took a seemingly simple but difficult to execute idea and focused on it in an honest and authentic way - a way which is now (in our view) only starting to reap its just desserts. UGRO took another way - a way of trying to play capital markets games and chase shiny objects - and the results speak for themselves. As we continue to focus on the four remaining holdings of the fund, our UGRO experience spurs us to continually focus on a defined strategic direction, coupled with conviction in leadership and often complemented by our ability to support business development and key decisions (said differently, we like to be authentically listened to). We believe that, as with Grown Rogue, this focus will pay outsized dividends in the long run.
Disclaimer
The information contained in this letter is provided for informational purposes only, is not complete, and does not contain certain material information about our Fund, including important disclosures relating to the risks, fees, expenses, liquidity restrictions and other terms of investing, and is subject to change without notice. This letter is not a recommendation to buy or sell any securities.
The information contained herein does not take into account the particular investment objective or financial or other circumstances of any individual investor. An investment in our fund is suitable only for qualified investors that fully understand the risks of such an investment after reviewing the relevant private placement memorandum (“PPM”). Bengal Impact Partners, LLC (“Bengal Capital” or “we”) is not acting as an investment adviser or otherwise making any recommendation as to an investor’s decision to invest in our funds.
Perhaps most importantly, Bengal Capital has no obligation to update any information provided here in the future, including if any positions discussed are sold or purchased, or if different positions are purchased.
This document does not constitute an offer of investment advisory services by Bengal Capital, nor an offering of limited partnership interests of our Fund; any such offering will be made solely pursuant to the Fund’s PPM. An investment in our Fund will be subject to a variety of risks (which are described in the Fund’s definitive PPM), and there can be no assurance that the Fund’s investment objective will be met or that the fund will achieve results comparable to those described in this letter, or that the fund will make any profit or will be able to avoid incurring losses. As with any investment vehicle, past performance cannot assure any level of future results.
We make no representations or guarantees with respect to the accuracy or completeness of third party data used or mentioned in this letter. We provide services, such as strategic consulting services, to certain entities mentioned in this letter and may in the future provide such services to more in the future, or to companies not mentioned in this letter. While we may sometimes advise on issues regarding corporate communications, we do not believe any of the services which we provide are “stock promotion” - we have not been and will not be compensated for the mention or discussion of any of the companies discussed herein. We disclose such arrangements to investors in the Fund and will continue to do so.