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Investing in Testing Labs: Executive Summary

23 Jun Investing in Testing Labs: Executive Summary

By Matt Karnes, Green Wave Advisors

EXECUTIVE SUMMARY

The proliferation and diversity of the various state legalized marijuana markets have spawned numerous and different ancillary enterprises that are eagerly seeking a permanent foothold in the evolving cannabis eco-system.

As individual states debate the efficacy of current legislative statutes or contemplate initial legalization referendums, lab testing requirements of cannabis products has become an increasing subject of concern and attention. Although the current governing statutes regarding legalized marijuana uses vary in great degrees from state to state, one common theme that has emerged is the increased awareness on the part of legislators and health officials, as well as cultivators and laboratories, of the critical importance of product testing and quality assurance.

With an eye forward to eventual federal rescheduling or possible de-listing, it is reasonable to assume that uniform national testing and operational standardization protocols could eventually be implemented, at least as a baseline binding thread, that will steadfastly assure consumers of an expectant consistency of product. Lab testing services therefore, appears to us as a prime target for investment capital aimed at securing a durable enterprise presence in the evolving cannabis industry.

In this report, we endeavor to provide investors with an overview of the marijuana lab testing sector with a first glimpse as to what the potential market size could approach by the year 2020. In this regard, we build upon the conclusions drawn from our prior research efforts and accordingly, we believe that investment in these businesses will become increasingly more attractive for a number of reasons:

  • By the year 2020, assuming full legalization, lab testing and related service revenues could approximate $850 million (based upon our U.S. marijuana retail revenues forecast).
  • With many players currently jockeying for position, and new entrants appearing as each state moves forward with legalization, the lab testing market will become increasingly saturated. Profitability and survival will depend upon technical prowess and adequate capitalization.
  • The lab businesses that are best positioned to expand market share beyond their initial geographic confines into additional states or regions will provide the most compelling opportunities for investors seeking the prospect of long term growth or other exit strategies such as eventual absorption by established larger cap suitors.
  • Cannabis testing labs appear to be highly scalable with opportunity for significant margin expansion, as other high margin businesses, (data analytics and consulting) contribute more to the mix of revenues. Operating leverage should translate to attractive Free Cash Flow yields abetted by recurring revenue streams.
  • We note that recent moves in New York (regulations require the DEA to license labs) and Colorado (the EPA takes interest in establishing a cannabis crop category for pesticides) could signal that there is an increasing acceptance of the inevitability of rescheduling or delisting and that comprehensive federal oversight will quickly follow. Such eventual oversight will present new technical and financial challenges to succeeding laboratory ventures.

Matthew (Matt) Karnes has over 20 years of diverse finance and accounting experience. Prior to founding GreenWave Advisors LLC, Matt worked in equity research focusing on the Radio Broadcasting and Cable Television industries for First Union Securities. Matt also covered Satellite Communication at SG Cowen and in addition, worked with the top ranked Consumer Internet analyst at Bear Stearns & Co – this team was consistently recognized by the Institutional Investor’s “All America Research Team”.  As a sell-side equity analyst, Matt authored and co-authored numerous industry research reports. Matt is also a Certified Public Accountant. He can be reached at mkarnes@greenwaveadvisors.com and GreenWave Advisors, LLC is based in New York City.

 

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