Rising High: Exclusive talk with cannabis REIT NewLake Capital

In this edition of “Rising High,” The Fly conducted an exclusive interview with Anthony Coniglio, President and Chief Executive Officer of NewLake Capital Partners (NLCP), a provider of real estate capital to state-licensed cannabis operators. Here are some highlights:

CANNABIS REAL ESTATE: NewLake is an internally-managed real estate investment trust that provides capital to cannabis businesses through sale-leaseback transactions and third-party purchases and funding for build-to-suit projects. The company owns a portfolio of 31 cultivation facilities and dispensaries that are leased to single tenants on a triple-net basis. “What we’re trying to do to differentiate ourselves is work with our clients through this difficult period in the cannabis industry to find solutions for their needs around cannabis capital,” Coniglio said. “Our ability to resolve any issues that come up in our portfolio demonstrates to the industry our partnership approach and furthers our relationships. For us differentiating ourselves in a world where capital is a commodity so to speak, its relationships that we think are going to really drive value for our shareholders into the future.”

He noted in Newlake’s corner of the industry, competition is decreasing rather than increasing. “It’s a function of who has the capital to actually deploy into the sector,” the CEO said. “We think we have just as much, if not more capital than anybody else with our $90M available credit facility. When we look over the last 18 months, there is a lack of new entrants to providing real estate capital and in fact, some firms decided to pivot away from cannabis. We see that there is less competition today from what there was 18 to 24 months ago.”

CALYPSO SALE: In November, NewLake announced that Hero Diversified Associates had sold NewLake tenant Calypso Enterprises to Canvas Acquisition Corporation. In connection with the closing and under the terms of the revised lease agreement, NewLake has agreed to provide up to $3M in tenant improvements and has received a six-month rent escrow. “We believe that Canvas is going to be a much better competitor in the state of Pennsylvania than the previous ownership, because Canvas is going to bring with them products, capabilities and relationships,” Coniglio said. “And because this license is a cultivation-only license, for a cultivator without the retail distribution to really grow their business in the state, it is important to have those brands that dispensaries want in the product forms that they want.”

He said Canvas will also be able to leverage relationships across states to ensure shelf space in the dispensaries. “First and foremost, we just believe that they’ll be a much stronger competitor in Pennsylvania,” the CEO said. “But Canvas is also a better guarantor. HDAI as a guarantor of the lease with Calypso is being replaced by Canvas and Canvas is a much better capitalized organization, so we improved credit quality of our guarantor with this.”

He added he also see tremendous upside for the company when Pennsylvania moves to adult-use. “We have a number of tenants in Pennsylvania, but certainly for Canvas,” Coniglio said. “Pennsylvania has currently passed a bill in the House and the Senate that would allow a company like Canvas to gain access to three dispensaries. Even before you get to recreational cannabis, we’re excited for our tenant to be able to go vertical and open up their own dispensaries.”

Q3 EARNINGS: Additionally in November, NewLake reported third quarter results and reaffirmed 2023 AFFO guidance of $39.8M to $40.8M. “The results really point to our ability to deliver earnings for our investors,” the CEO said. “If you took the midpoint of that AFFO guidance that would put us up roughly 4%-5% over 2022. Delivering year-over-year growth in our sector is a strong statement about the quality of our portfolio and the ability of our team to deliver returns to investors in the face of one of the most difficult operating environments that the cannabis industry has yet to see.”

The main factor contributing to guidance is the collectability of rent, he said. “When we reaffirmed that guidance in October, we obviously had some line of sight into November,” Coniglio said. “Now November is in the books and there are some expectations for December. We felt pretty good about reaffirming.”

REVOLUTIONARY CLINICS AGREEMENT: NewLake also announced in November, that in connection with Revolutionary Clinics raising new third-party capital, the company entered into a lease amendment and forbearance agreement for its existing lease with Rev Clinics on NewLake’s cultivation facility in Massachusetts. Under the terms of the agreements, NewLake recovered a portion of unpaid rent, extended the lease term by five years, reduced future monthly rental payments and received up to 9.95% of equity in Rev Clinics in the form of warrants. “The company had cultivation issues back in 2022, which significantly impacted their cash position heading into 2023, and therefore they struggled to pay rent the first couple of quarters,” the CEO said. “At a high-level in that agreement, we recovered some of the unpaid rent, we forbeared some of the unpaid rent and we provided a reduction of rent going forward.”

He noted NewLake took a roughly 10% stake in the company and as sales rebound, NewLake has provisions to allow the rent to step up as revenue hits certain targets. “We thought that was a really good way to drive value for our investors by not taking out the tenant but figuring out a way for us to allow the tenant to rebuild their business as one of the leading wholesalers in the state of Massachusetts,” Coniglio said. “And we’ll get rewarded for that through the step ups in rent over time as the business recovers, but also through our equity ownership.”

SAFER BANKING: A U.S. Senate committee recently voted to advance The Secure and Fair Enforcement Regulation Banking Act bill, which seeks to ensure that all businesses, including cannabis businesses, have access to deposit accounts, insurance and other financial services. “I actually don’t think it is going to go anywhere, I hate to be the bearer of bad news,” the CEO said. “When you look at the change over in the house in terms of leadership to being more conservative and Speaker Johnson not generally supportive of the bill to begin with, I really don’t see this bill coming to the floor in the Senate any time soon. I hope I am wrong.”

Where the bill could gain traction is if the Section 10 language is enhanced, he said. “If you look at Section 10, which is interestingly the longest section of the entire SAFER bill, it really doesn’t have anything to do with cannabis,” Coniglio said. “It is all about preventing regulators from utilizing their regulatory power to discriminate against businesses that are out of favor. The republicans have been using this SAFER bill to enhance the Section 10 language, so if the language gets strong enough it could gain republican support. Absent that, I don’t think it goes very far.”

SCHEDULING: In August, the U.S. Department of Health and Human Services made a recommendation to the Drug Enforcement Agency that cannabis be moved from Schedule I to Schedule III under the Controlled Substances Act. “I think for the same reasons SAFER may fail, i.e. political motivations, we’re likely to actually see some action here,” the CEO said. “I think we’ll see Q1/Q2 action on the DEA side likely to be taking the recommendation from HHS to propose Schedule III rulemaking and then have a final rule for Schedule III. It will be politically expedient for the administration to get that done by the beginning of Q3.”

He said rescheduling of the drug will impact the industry “not so much” and a “tremendous” amount. “At the operating level when you look at the P&L not so much,” Coniglio said. “It’s not going to change EBITDA, create higher sales or reduce costs, but significantly it does reduce the tax liability. It will improve overall free cashflow for those businesses, which makes the industry more investable and is also an acknowledgement by Washington, D.C., that cannabis reform is happening.”

He said he hopes the space gets into a positive feedback loop where rescheduling improves the balance sheet profile of companies, brings in marginal investors and supports equity valuations. The CEO added the rescheduling will create some unknowns, but he does not believe cannabis will fall under FDA regulation. “That is something to be concerned about, however it doesn’t appear that the FDA has the budget or the capability to regulate cannabis,” he said. “When I look at hemp, where they’ve had since 2018 to be figuring out a way to regulate it, what did they do? They kicked it to Congress to say you need to provide us with more guidance for us to be able to regulate it. Cannabis with the myriad of states is going to be more difficult to regulate and I just don’t think they have the capability to do it.”

GROWTH OPPORTUNITY: Looking at some of the analyst commentary surrounding the space, some firms have noted that the focus in 2023 has been around improving operations and efficiency, but they still see cannabis as a multi-decade growth opportunity. “I agree on both,” Coniglio said. “I have been happy with the operating efficiencies that the operators have brought to bear in 2023. If you look at margins but you also look at the G&A line item, across the board most of the operators have done a nice job in bringing in those costs and expenses. At the same time, we still see growth.”

He added the industry will continue to grow as Ohio comes online and New Jersey, New York and Connecticut open more dispensaries. “Then there are the states that we don’t talk about that are really well positioned for the future,” the CEO said. “For example, Georgia, recreational cannabis in Florida that gets to the ballot box next year and Texas is a very large state that still has an extremely nascent medical cannabis program. There are still a lot of catalysts for growth in the cannabis industry.”

CHALLENGES: When asked about the largest hurdles facing the cannabis space, Coniglio said the biggest challenge continues to be cashflow. “While the industry has done a great job of improving operations this year, continuing to focus on generating free cashflow is a priority,” he said. “While Schedule III will certainly help folks, there are too many companies that have significant debt on the balance sheet. Even a cashflow profile unburdened from the high federal taxes will still need to extract additional cashflow advancements in order to be able to refinance maturities or ultimately payoff those maturities.”

OPPORTUNITIES: As the cannabis space develops, the CEO said the biggest opportunity for many cannabis companies is recapitalization of their balance sheets. “We need to get ourselves into a positive feedback loop,” he said. “These companies can become much more investable by institutional investors if the debt that was taken on in the expansion of 2021 and 2022 can be serviced and equitized by issuing equity. Once you have a better debt to EBITDA profile for these companies, institutional investors will find them more attractive to invest in.”

The industry also needs some reform to fix the custody issue so investors can actually execute on their desired investment, he said. “That’s one of the opportunities that I see for this industry,” Coniglio said. “Can we get into this positive feedback loop to improve the balance sheets and hopefully get steps closer to solving the custody of institutional investments?”

The CEO also pointed to the Boies lawsuit against the federal government, which argues the government does not have the legal right to regulate intrastate commerce. “When you take a step back and you think about our government, you have got a process within the judicial system that can rectify states’ rights to cannabis, in the administrative branch with this DEA rescheduling and in the legislative branch,” he said. “You have avenues to unlock this industry at various levels in all three branches of our government. That’s noteworthy because it only serves to reinforce the inevitability of the unlock of the cannabis sector. If you believe in the inevitability, for our investors you get paid a quarterly dividend. Why not get paid a quarterly dividend while you are waiting for that unlock?”

CANNABIS/PSYCHEDELIC STOCKS: Publicly-traded companies in the space include Aleafia Health (ALEAF), Acreage (ACRHF), Atai Life Sciences (ATAI), Audacious (AUSAF), Aurora Cannabis (ACB), Avant Brands (AVTBF), Ayr Wellness (AYRWF), Awakn Life Sciences (AWKNF), Body and Mind (BMMJ), BZAM (BZAMF), Cannara Biotech (LOVFF), Canopy Growth (CGC), Chicago Atlantic (REFI), Clearmind (CMND), Clever Leaves (CLVR), CordovaCann (LVRLF), Cresco Labs (CRLBF), Cronos Group (CRON), Columbia Care (CCHWF), Compass Pathways (CMPS), CURE Pharmaceutical (CURR), Curaleaf (CURLF), CV Sciences (CVSI), Cybin (CYBN), Delic Holdings (DELCF), Delta 9 (DLTNF), Entourage Health (ETRGF), Enveric Biosciences (ENVB), Fire & Flower (FFLWF), Flora Growth (FLGC), General Cannabis (CANN), Goodness Growth (GDNSF), Greenlane (GNLN), Green Thumb (GTBIF), GrowGeneration (GRWG), Hemp (HEMP), High Tide (HITI), India Globalization Capital (IGC), Indiva (NDVAF), Innovative Industrial Properties (IIPR), InterCure (INCR), IM Cannabis (IMCC), Wellbeing Digital (KONEF), Khiron Life Sciences (KHRNF), Lowell Farms (LOWLF), Lotus Ventures (LTTSF), Lucy Scientific Discovery (LSDI), MediPharm (MEDIF), MedMen (MMNFF), MindMed (MNMD), NewLake Capital (NLCP), Numinus (NUMIF), Organigram (OGI), Planet 13 (PLNHF), Reunion Neuroscience (REUN), Revitalist (RVLWF), RIV Capital (CNPOF), Relmada (RLMD), RYAH Group (RYAHF), Safe Harbor Financial (SHFS), Small Pharma (DMTTF), SNDL (SNDL), Sproutly (SRUTF), Skye Biosciences (SKYE), Stem Holdings (STMH), Sunniva (SNNVF), TerrAscend (TRSSF), Tetra Bio-Pharma (TBPMF), Tilray (TLRY), Trulieve (TCNNF), Tryp Therapeutics (TRYPF), Verano (VRNOF), Village Farms (VFF), Wesana Health (WSNAF), Zynerba (ZYNE) and 4Front Ventures (FFNTF).