The Cannabis Titanic: The Reset Ahead, Matt Karnes on What the Numbers Say

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Bryan Fields: What's up, guys? Welcome back to another episode of The Dime. I'm Bryan Fields, and with me as always is Kellan Finney. This week we've got a very special guest, Matt Karnes, founder of GreenWave Advisors. Matt, thanks for taking the time. How are you doing today? Matt Karnes: Doing well. Thank you guys for having me, and thanks for calling me special — not too many people do, so thank you. Bryan Fields: Excited. I mean, how are you doing? Kellan Finney: Doing really well. I'm thrilled to talk to Matt — grateful, actually. Excited. It's a nice, beautiful summer day out here. We're going to dive into MSOs, markets, and all the fun stuff. How are you, Bryan? Bryan Fields: Well, yeah, I'm excited. Matt is going to help solve a lot of the problems that I don't know are solvable, but at least we're going to ask him to help us fix a lot of the issues we have — and maybe they aren't fixable. But before we get into that, Matt, it'd be really helpful for our listeners to get a quick background on yourself and how you found your way into the cannabis space. Matt Karnes: So, I started my career in public accounting. I was an auditor, worked for the Big Four. Then I had a couple of corporate jobs, and after I got my MBA I ended up on Wall Street in equity research — I worked at Cowen as well as Bear Stearns. So I gained solid experience on the sell side, and then I hopped over to the buy side and worked at a hedge fund for a number of years. After our fund — this was around 2010, '11, '12 — sort of blew up, I was looking around thinking, what's the next step for me? At that point there was a lot of buzz around cannabis, around medical marijuana, about what was going on in California. So I packed up and drove up to Boston for what was then one of the first cannabis conferences, and I've just kind of been following the industry ever since. In the summer of 2014 I actually went out to Colorado, because my interest level had stayed up over the prior several months. That was the big conference at the time, and it was about 800 people. To put that in perspective — you guys have been out to MJBizCon, where there's 30,000, 40,000 people — it just shows how much the industry has grown over the last 11 years. So I've been at this now, believe it or not, for 11 years. I thought it was a really good idea at the time, and I still do — I still have hope. But based on my background, my lane is really numbers and things that are more quantitative, so I've stuck to that lane. I started GreenWave in 2014 — it was exactly July 2014 that I filed my LLC, my S-corp — and the goal at that point was to provide industry research. I was really early, though, because there weren't really any investors and there weren't really any real companies to talk about without jeopardizing my reputation. So I started publishing on macro-level issues instead, and along the way I got involved in a lot of different projects — due diligence, valuation work, all kinds of things. Over the years, people came to me and asked, 'Hey, could you help us raise capital?' And I could never do that because I wasn't licensed — all my licenses had expired. So about two years ago, a colleague of mine from Bear Stearns reached out and said, 'Matt, why don't you come join us over at Stonehaven' — which I refer to as Stonerhaven, given the industry I'm in. I came aboard as an affiliate partner, and now I have that capability. What attracted me to Stonehaven is that they cover a wide variety of asset classes and sectors, and it's a great platform to collaborate with other folks in my situation who've come off Wall Street and are still active in the sector in some way. So that's kind of where I am right now — I'm driving in two lanes, one being the consulting arm and the other being capital raising. Hopefully those two lanes won't collide. Bryan Fields: So going back to what you said — two things. One, you said before that you thought it was a great idea, in the past tense — sure, I know that optimism is hard to hold onto after a while; you get beaten down and start wondering if you can stay optimistic until you see some changes. But the second thing I really want to talk about is the numbers. Since your background is in numbers, talk to us about the state of the industry and the health of these companies. Are the numbers reflecting a healthy industry, or something else? Matt Karnes: Well, it depends who you're talking about. I'd say it's unique — nothing I've ever experienced, just because of the dichotomy between federal and state law and everything this industry has gone through. It was great to see you guys in Chicago, by the way. I think the way I'd categorize the industry is... have you seen the movie Titanic? Think about the end of that movie — there were three outcomes. Bryan Fields: Spoiler alert. Kellan Finney: We were literally just talking about this today, Matt — it's wild. I used a Titanic reference like an hour ago after we got off a call. Continue, continue — sorry, I interrupted your chain of thought. Matt Karnes: Yeah — the first outcome is the folks who are on the boat and don't get off; that boat is going down, and they're going down with the ship. That's outcome number one. Outcome number two is the folks holding onto pieces of wood, kicking and paddling, hoping they'll get to shore — maybe they'll make it, maybe they won't. Kellan Finney: No, don't. Bryan Fields: They're dead. Kellan Finney: Rose made it. Matt Karnes: And then you've got the third group sailing away in the rowboats — they're going to make it. And we kind of know who those people are right now. How do you know? You look at the balance sheet — whose ship is going to sink, who might make it, and who already looks like they're going to survive. Bryan Fields: Hold on, let's talk about that. Is it that clear today — that people have already sealed their fates, and there's no chance for the band still playing on the boat to make it onto a lifeboat? Matt Karnes: Well, I remain optimistic, and you never want to say never — if things change at the federal level tomorrow, things could change very quickly, and we just don't know when that day will happen. The way I laid it out, to figure out who's likely to land in which outcome of the Titanic, was to build a heat map of cash flows. What I mean is, I looked over the course of six years — because this is a marathon, not a sprint, so you can't just look from one period to the next — six years being about how long these companies have been public, which is the period for which I have actual financial information. I looked at cash flow from operations and the amount of 280E tax that's been paid as a percentage of that cash flow. The takeaway is that the Tier Ones have basically scaled enough to generate sufficient cash from operations to pay their 280E liability — even though that's a separate topic. Bryan Fields: That's good, right? We're going to use that as a positive marker. Matt Karnes: Yeah, that's a signal that they're on the boat that's going to make it — going to get to shore. That's how I think of those companies. Then there are some that haven't generated quite enough cash flow to pay their full tax liability — maybe the liability is a hundred bucks and they generate fifty, so they have some money but not all of it; they're kind of wobbling. And then there are some that have rarely, if ever, posted positive free cash flow from operations — it's been negative, they've been burning cash every quarter, every year. And now we're at a point where the debt markets — and access to capital is even more challenging than in years past — a lot of these companies have already levered to the max. That's where the real challenge is, if that answers your question. Bryan Fields: No, I think that's super clear. Just to go a bit further — we bucketed all the Tier Ones into the 'safe' category, but they have ranging amounts of debt. How should a retail investor or an everyday person understand the different components well enough to know which ones are more advantageous versus more problematic financially? Names, if you're able to share them. Matt Karnes: I actually have to be careful about naming names, because I'm affiliated with a broker-dealer and subject to compliance rules. That's probably why you — and about two million other people — ask. Kellan Finney: It's just the three of us. Bryan Fields: Ha ha ha. Bryan Fields: God willing. Kellan Finney: We're not showing Rogan — come on. Matt Karnes: In answer to your question — debt is really challenging, because you don't want to issue convertible debt; you'll dilute the hell out of your company. One thing that actually came across the tape yesterday: I believe it was TerrAscend — they're liquidating, or getting out of, the Michigan market, and the proceeds will be used to pay down debt. I'm wondering if other companies facing a debt wall will follow suit and liquidate non-performing assets — that's clearly one method to generate cash to satisfy debt obligations. Kellan Finney: I heard there's a massive debt obligation coming due in 2026 — something like $6 billion due for a lot of these companies in early 2026. Is there validity to that? Matt Karnes: I don't have the exact number, but that's definitely the case. Whether they'll be able to refinance remains to be seen. I think if something doesn't happen at the federal level, it's going to get increasingly more challenging, particularly as the 280E liability builds up — you've probably heard about that over the last couple of years. Kellan Finney: It's big. Kellan Finney: Or twice. Matt Karnes: A lot of companies aren't paying their 280E — they're holding back. At some point that issue isn't going to just go away, but my view is that the IRS will work with these companies to figure out some way to satisfy the obligation. It's still a big question mark. I believe Ascend recently refinanced, and maybe a couple of others are on the way. That's really going to be one of the most important things to watch — how these obligations get paid. Bryan Fields: When this debt comes due, do they have any other options besides refinancing? Essentially, refinancing is just punting — saying 'we'll deal with this later.' Matt Karnes: It's kicking the canna down the road, hold on. What are the options? Say you own a house with a mortgage payment due — say there's a balloon payment and you don't have the money. What happens? The creditors take possession — Bryan Fields: Well played. Matt Karnes: — of your asset, and it wipes you out. Bryan Fields: So in that example, if creditors take possession of assets, would a lot of these creditor companies end up in possession of the Tier Ones, or specific assets in certain markets? Matt Karnes: No, I don't think that happens to the Tier Ones. I think they have enough cash flow from operations to satisfy everything, like I said. It's a lot less favorable if you factor in the 280E — in this heat-map exercise, I looked at the actuals and then asked, what would the cash flow profile look like if the 280E was actually paid? Even then, the Tier Ones still have enough cash — not as much, but enough. It's really the others that are concerning. I don't have a great answer for exactly how each entity will fare, but we just hope the creditors and everybody work something out. In answer to your question, it's not the Tier Ones — it's the companies with debt due that are unable to make their interest payments, and then the creditors are left holding the bag. No pun intended — well, maybe a little. Bryan Fields: Could there be a domino effect there? Some of the Tier Ones are vertically integrated in certain markets, so they're somewhat protected — but in markets where they're not vertically integrated and rely on smaller operators, that could be problematic, since they're all interwoven to make the market work. Matt Karnes: So you're asking, if a Tier One is in a market with a Tier Three, is there a domino effect? I think the strong will get stronger. Bryan Fields: That's a positive statement — survival of the fittest. Unfortunate for some, but at the end of the day the stronger will survive. When you talk about an industry reset, is there something specific you have in mind? Matt Karnes: Yeah. The industry has been very problematic in how it's operated. Early on — and I observed this back in 2014 — the quality of people working at many of these companies was just inexperienced. There weren't people leaving stable jobs to come work in cannabis; there was reputation risk. And being an accountant, a numbers guy, it was clear to me that this industry had to operate in all cash. Think about a grow-op — people sitting there counting money, then putting it somewhere and recording it into the books. It's a complete mess. On top of that, there was no adult supervision, no real instruction, because it was a new industry that nobody had figured out yet. The big accounting firms hadn't stepped in at that point. So problems festered and kept growing. Early on there was a lot of excitement, a lot of acquisitions, a lot of integrations that had to happen — and it got out of control in terms of efficiency. So you have all these problems that materialized, plus what I consider the added cost of prohibition — 280E being the biggest, most onerous cost, but there are others: added compliance costs, higher insurance costs, higher cost of capital. When you factor all that in, once prohibition ends there's clearly going to be an acceleration in free cash flow, because you'll attract more qualified people. A lot of mistakes have been made, and a mistake costs time and money to redo — a perfect example is all these financial statement restatements and delays, which were often just 'oops, we made a mistake.' With more experience on the bench, I don't think we'd see as many of these things. When prohibition ends, I think we'll see a lot of hidden benefits uncovered. That's what I mean by reset. Bryan Fields: Is there a single event that could reset the industry the way you're envisioning? Hypothetically, if I gave you a magic wand and said, 'Matt, you're king for as long as you need' — how do you fix the industry? Matt Karnes: I do believe we're on the cusp of something — I don't want to sound like I'm hyping the industry, and I've been doing this for 11 years, probably even more. But clearly the reset will happen with Schedule Three. At that point, everybody can put their bags down and relax instead of worrying about the IRS coming after them for unpaid 280E. Now, one thing I'd mention — a lot of companies haven't been paying it, so you might ask how the cash position improves if they haven't paid it. Well, we don't know exactly how that will play out going forward — how much will have to be paid, over what period, whether penalties will be assessed. Even though the cash flows themselves won't change much, because a lot of companies haven't paid, what we will see a notable improvement in is net income, because 280E has pretty much decimated any pre-tax income. Companies won't have to accrue for income tax expense, so we'll see more companies show positive net income. That will be noticeable, and at some point — not too far down the road — we'll start to see valuations based on P/E ratios instead of some of the other metrics currently used. Bryan Fields: One of the benefits there could be attracting more investors, right? If companies start showing positive net income, that draws more investor interest to the space. Matt Karnes: What's up? Hello? Kellan? Bryan? Are you there? Kellan Finney: Hello, I'm here — can you hear me? We're good, Matt, I hear you. Kellan Finney: Hey. Bryan Fields: I'm going to kill Verizon — nothing, I'm saying nothing. I realized none of you were moving, and I thought, keep the curses to yourself, Bryan. I don't know if my internet's going to stabilize; I fought this all day yesterday, and I'm glad it decided to act up here. I'll be sure to call Verizon after this. Kellan Finney: Hey, what were you saying? We heard nothing. Bryan Fields: I don't know if we're recording, so let me make sure before I say that. Kellan Finney: It says we're recording — 22 minutes 50, not 23 minutes, 99% uploaded. Matt Karnes: It says we're recording. Bryan Fields: We'll just keep it moving and hope for the best. So, we heard nothing there — let me pick back up. Matt, you were talking about positive net income, and how that could attract investors, which could accelerate growth. So it seems like we've got this... Kellan Finney: No, start from the top of what you were just saying. Bryan Fields: ...circle, or this fire that's ready to rip through — it just needs that first match to get started. Matt Karnes: Yeah, and I'd say things are starting to happen now — they're all coming together. It's hard to imagine that if you went back to 2014 and asked 2014 Matt, 'Will we still be talking about 280E in 2025?' I'd have said no way — I figured we'd be past it by, I don't know, 2020. But what's happening in Washington — I honestly, wholeheartedly believe Trump is going to act. This isn't his first rodeo on this issue; he dealt with it in his first administration, and if he'd wanted to shut it down, he would have. Back in 2012, when they green-lit Colorado to be the first state to legalize recreational use, I don't think the intent was to let this linger forever with everyone spinning in circles and losing money — that would just be bad strategy. Trump is clearly a businessman, and I think he'll see the economic benefits, on top of the social benefits, like getting people out of prison. He's got people in his inner circle — Mike Tyson has his ear, I can't help but mention. There are smart people around him, and a lot of this is just common sense. The dialogue around testing is becoming more of an issue too — that's common sense; this industry isn't going to be fairly legal until the government actually understands it, and they're starting to. There are a lot of working groups now. One issue that's really concerning for investors is the lack of sales growth. You've got an emerging industry with revenue that's flat to slightly down, nothing substantial — you get some growth from new markets, but it lasts a year or two and then decelerates. Now there's focus on the Chinese cartels, on illicit shutdowns in New York — there was a bust — we're hearing about this in different cities. So the illicit-market issue is being addressed, testing is being addressed — a lot of things are starting to come together. One hidden gem a lot of people aren't focused on, because everyone looks at this industry through the lens of recreational use, is the true medical side. There's a lot of new development and research happening — the DEA issued eight licenses for bulk manufacturing and research, and some companies have made great strides. Even though those products won't necessarily show up in the revenue streams of the larger MSOs on the rec side, there are other compelling investment opportunities there. When I launched GreenWave in 2014 and wrote my first research report, part of my thesis was that medical and rec would combine into one much larger market, and there'd be a separate path for pharmaceutical-type products with precise dosage and efficacy. That's part of the reset too — and Schedule Three will enable more research to be done more easily on different aspects of the plant. Kellan Finney: How much movement needs to happen internationally for full rescheduling? Is there an interconnection with what's going on in Europe, and is that part of why we haven't fully pushed rescheduling through — international narcotics treaties and so on? What more movement is needed from a national perspective? Matt Karnes: We know Germany has moved forward, and there's a lot of export activity into Germany from various states — Canada being the most significant. As far as the treaty question, I'm not a lawyer, I don't even play one on TV, so I don't want to opine too much on that. But the international market is moving forward in the right trajectory. It's only a matter of time — I remember going to a conference in London around 2021 and thinking they were five years behind us, and I think that's probably still the case. We keep hearing more about what's happening in Germany. It's a shame, honestly, and kind of annoying to read about all these other countries exporting into Germany — they publish a listing every quarter, and the fact that the U.S. isn't on it is just frustrating. That's another thing Trump will look at — we're really missing out; there's no reason the US shouldn't be the leader in cannabis, there are so many smart people here. That's another reason I have such strong conviction — even though I said earlier I thought it was a good idea 11 years ago, I still think it's a good idea. If you look at the people still standing, the really smart ones, they're successful for a reason — they made the right decisions. I always keep that in the back of my mind: who's still here, who's getting on the boat that's headed to shore. I did an exercise looking at what the export opportunity would be if it were allowed. If you look at U.S. exports for alcohol, tobacco, and pharma, it's something like 5 to 15 percent of the market. So if you assume a hundred-billion-dollar U.S. market at maturity, that's about $10 billion in exports. That's just hypothetical — I can't say with a straight face I know precisely what it would be, but you get the point that it could be substantial. Bryan Fields: That's some solid back-of-the-napkin math. But going back to what you said about Trump — one thing we can probably all agree on is that he'd want the U.S. to be involved in that. The ability for the U.S. to be a global leader or participant is a critical piece that could hopefully influence some change, because we all keep saying we need change, we need reform, however we get it. If it takes him feeling embarrassed about being left out of the global cannabis conversation — and watching what Germany is doing should open his eyes to that — well, his messaging is always 'America First.' This is an opportunity where we can have America first. Matt Karnes: And American cannabis first — let's say that too. I totally agree. Another thing, part of the reset I mentioned, is that at some point I do believe we'll have interstate commerce. That's going to lower prices when... Bryan Fields: Why would people not want California cannabis? Bryan Fields: Are you 100 percent sure we're going to get that? Matt Karnes: At some point. But before that, I think — and this has been talked about for years — there'll be cooperative agreements between local areas, like California, Oregon, Washington. I can't understand any good reason why, if those three states are on board and say 'let's do it,' the federal government would give a damn at this point. Bryan Fields: Stay, stay packed. Kellan Finney: There's a treaty that says they're ready to do interstate commerce like that. Matt Karnes: Yeah, so there should be... Bryan Fields: Why — hold on, what are the benefits of those three states getting together? Should we just do it to put a little pressure on the federal government? Matt, I want to push back on interstate commerce, because the more I think about it, the more I want it to happen, but I don't think it ever will. I think states might opt into some kind of state compact, but I expect states won't want to displace the jobs... Matt Karnes: Well, I mean, for that... Kellan Finney: They're like, 'I have too much weed, you have too much weed, let's just exchange too much weed.' Bryan Fields: ...and the companies they helped spin up, and the revenue they're enjoying. Maybe there are people smarter than me with a creative solution, but I think states are enjoying the tax revenue from cannabis and aren't willing to lose those jobs and that revenue just so everyone can trade freely — that's going to put a lot of people out of business. Matt Karnes: Well, bear in mind, they're not necessarily going to lose tax revenue, because the product's still going to be sold in that state — they'll still get the sales tax. That's not going away. It depends on how everything gets regulated, which is another problem for investors — we don't know yet how the industry is going to be regulated; there's still a lot of uncertainty. Bryan Fields: The jobs, though? The jobs. Matt Karnes: I'm all over the place here because there's so much to talk about. On interstate commerce, I get it, but I think the states will decide — that's what Trump's about, so why would he care? Look at Utah during alcohol prohibition — Utah stayed dry for a long time and just did its own thing. The same should hold true for cannabis once federal prohibition ends. Nobody's shoving anything down anyone's throat. If three states or whoever are on board and say let's do it, and they don't care about the jobs — there's another solution. Have you guys been out to Glass House Farms? Kellan Finney: We've heard about it, we haven't been. Matt Karnes: It's incredible — the climate control, it's a 5.4 million square foot facility, state of the art, AI, all the bells and whistles. Right now they're probably one of the lowest-cost producers, if not the lowest-cost producer, in the country. Over time you don't need to grow in a warehouse somewhere in the winter, which just doesn't make sense — costs are going to come down. Bryan Fields: It's a unicorn. Matt Karnes: That's a given, I think. These are all levers that will help combat the illicit market further, on top of the busts that hopefully continue. I meant to mention — once we have federal legalization, and I think Schedule Three is a prelude to full legalization, the government can roll up its sleeves and better understand the industry, because right now, with the stigma of Schedule One, nobody's really willing to step in and take a look. Once there's full access and everyone's on the same playing field, companies can advertise more effectively, which educates the consumer. So you'll have lower costs of production, and consumers who are better educated — instead of making a left turn to the bodega, if it's still standing, they'll think twice and go to a legal channel. I honestly think a lot of the public is just unaware — they don't live and breathe this like we do. That's another positive I think will come out of all this. Bryan Fields: What does the U.S.–Canada market look like, say, five years from now, if federal reform still hasn't happened? Matt Karnes: When you say federal reform, do you mean nothing at all happens? Bryan Fields: Nothing. Nothing. Bryan Fields: Is it a cliff? If there's no change five years from now, is that a cliff? Matt Karnes: Well, yeah — because, another positive sign, a couple of things I meant to mention: the whole hemp issue is being addressed, they've got their eyes on that now, and the same with banking and with looking into the exchanges. So if nothing happens, the folks who might come aboard — big tobacco, big alcohol, some big conglomerate — won't get on that boat if the industry still remains largely illegal, because they can't consolidate those businesses or list them properly. So I just don't think that's practical. I think there are enough people around Trump, and his business acumen, that will lead us down the right path. Bryan Fields: No, I'm with you — and the reason I asked was I want you to take the other side now. Let's say all the reform you've described has happened five years from now. What does the industry look like? Matt Karnes: If everything happens, or if nothing happens? Well, you guys will be on a beach somewhere. Another thing I meant to mention — lowering costs, like what you two are doing with your extraction business and the technology you've developed — that's another piece of it. There are probably other technologies out there that will facilitate cost reduction too. Bryan Fields: Let's say everything happens — over the next year. Bryan Fields: There are best practices from other industries, and I think the most surprising thing is that cannabis didn't reinvent the wheel — like Kellan's favorite line, we didn't make fire. At the end of the day we're just pulling best practices from other industries and applying them to achieve what every industry wants: running a profitable, sustainable business. Matt Karnes: Yeah, that makes a lot of sense. Where we are now, we've seen a lot and know what to avoid. But when I started this in 2014, there wasn't much to look at or hang your hat on. Colorado was the only state with any real disclosure, and I thought every other state would follow Colorado's best practices, and it'd be smooth sailing to federal reform. Obviously I was very wrong about that. Bryan Fields: So let's do that — five years from now, say all the reform you laid out has happened. What does the market look like? Matt Karnes: We're starting to see this already, and I think it's a consensus view, nothing groundbreaking — the industry will likely consolidate, with acquirers coming from alcohol, pharma, and some of the bigger CPG companies gobbling up the better-performing companies. A lot of us thought this would be the year of M&A, and that didn't really materialize — there were more liquidations than most people expected. But five years out, I think we'll have every state legal that wants to be — nobody's forcing any state to sell weed, but if they want it, fine. I think once we get to a real sale of businesses, we'll see a huge acceleration in free cash flow, for the reasons I mentioned — no more 280E, the other costs of prohibition go away, there's more efficiency, and more talent comes into the sector. A lot of money has disappeared over the years on acquisitions that maybe weren't well thought out and didn't turn out as anticipated. I think we'll see less of that as more experienced people come in and learn from past mistakes. I just think we're at an inflection point for a lot of good things to happen — more things swinging the pendulum toward positive outcomes than negative. Between the hemp situation, testing, and the HHS report waiting to be signed off by the DEA, there's a lot happening all at once, which leads me to believe something is going to happen pretty soon. Bryan Fields: I love it — I think that's the perfect way to end it. Optimism is so back. Matt, for our listeners who want to get in touch, learn more, or see some of your writing — where can they find you? Matt Karnes: www.greenwaveadvisors.com. I'd also point out that I'm available for any type of due diligence — I don't love to say I love crunching numbers, but I kind of do. I think it's important to have somebody who can connect the dots, cross the T's, read between the lines, and ask the tough questions. That's me. All right, thanks a lot, guys — have a great Fourth. Bryan Fields: Love it. Thanks for taking the time — this was a lot of fun. Bryan Fields: I'm going to be totally honest — I don't think... Oh, he's gone. I don't know if this one's going to make it. Can you not hear me?