Description

Summary

Agrify (AGFY) is a picks-and-shovels play on the emerging U.S. cannabis market trading at a low enterprise value. The company’s core offering is a “vertical farming unit” or VFU which is a controlled growing environment for cannabis. The VFU, using precision lighting, air, and data feedback, attempts to reduce growing costs and increase quality and sales price. Together, this overcomes a higher initial setup cost vs. other grow methods. After recent acquisitions and capital raises, AGFY has extended its offering well beyond the VFU and towards a one-stop shop for cannabis sellers. Via the AGFY total turnkey or “TTK” solution AGFY provides financing, facility design & buildout, VFUs, and ongoing software to industry participants. Given an industry short on both experienced providers and financing options, this is a terrific solution for small and large sellers. Monetizing the TTK through production fees and recurring software, the offering provides very high IRRs to AGFY.

AGFY is at an early stage of development and much of the above such as the TTK represents a business plan as opposed to a tried-and-true process. However, the company has already announced its first TTK signing, has several research-oriented partnerships evidencing a quality product, and expects several more deals in short order including with larger multistate operators (MSOs). Each deal can have a material impact on AGFY’s eventual size, especially if structured to include recurring software or production fees as they now are.

Background

AGFY initially filed for a 2.8 mm share IPO at $10 but upsized the share count to ultimately raise 5.4 mm shares at $10 (6.2 with over-allotment). Shortly thereafter, and after a quick share price rise, the company conducted a secondary offering for another 6.9 mm shares at $13.50. Together, these raised ~$155 mm of cash. As of 3/31/21, cash on the balance sheet was $138 mm. At May 17^th, 20.3 mm shares were outstanding along with 3.9 mm options (2.7 in the money with a strike <$3.5). Using a 23 mm share count and a $9.26 share price, the market cap is $213 mm. LT debt is <1 mm. Enterprise value today is therefore only ~$76 mm, a very low level given the company’s prospects, though I expect the company to continue to burn cash through a combination of operating losses and financing outflows in the near term.

In order to build the complete solution it possesses today, AGFY has acquired or partnered with several companies. In December 2019, AGFY entered a JV (60% ownership) with Valiant LLC, a build-out, design, and engineering consultant that transforms warehouses into cannabis grow buildings. In January 2020, AGFY acquired TriGrow the integrator and distributor of AGFY’s VFUs. In July 2020, AGFY acquired Harbor Mountain Holdings which was a producer and assembler of AGFY’s products. AGFY in 1Q’21 indicated they’ve shifted production to a larger external contract manufacturer. Inventronics (SZSE:300582), a China based manufacturer of LED lighting technology, is a strategic shareholder and their founder is on AGFY’s board. Together, these acquisitions and relationships offer AGFY vertical integration and provide the turnkey solution to their customers.

Value proposition / industry structure

Thanks to a supply demand imbalance, cannabis pricing remains quite high. Even Colorado, which is the most liberalized cannabis state, is still supply constrained. As such, this can be an incredibly profitable business with legal marijuana selling wholesale for >$2,000 (with very high variation state to state and based on quality and source) which dwarfs production cost in the hundreds per pound (also with large variation). Accordingly, while higher quality growing environments such as AGFY’s VFUs cost more money upfront and might be considered overly sophisticated given traditional grow environments, it’s easy enough to recoup this cost via (a) premium sales prices and (b) lower operating costs with additional benefits arising from (c) consistency for customers (d) data driven improvements for the grower (e) competitive differentiation for the reseller. These dynamics can be seen on page 71 of AGFY’s February registration statement (link later) where op-ex per pound is shown to range from $327 (AGFY) to $650 (other methods) and page 6 of the company’s 1Q investor presentation where the company indicates their clients are able to sell for >$500 price premiums per pound. While cannabis is quite easy to grow, it’s not easy to grow with consistency at large scale. Consistency is a frequent discussion topic for the large MSOs who strive to make the industry more CPG-like. I’ve included a couple of articles in the link sections on the importance of consistency.

Projections

From $12 mm of revenue in 2020, AGFY guided to 4x growth for ’21 on the 4Q call (~40 mm) and then raised that to $48-50 mm on the 1Q call (I think there is good chance it gets raised even higher). Analysts forecast 60%+ growth in ’22 ($81 mm rev) and ~$100 mm of rev in 2023 with breakeven expected near that year. Setting those figures aside and focusing on the company’s 1Q investor presentation, page 8 shows returns for AGFY’s TTK product whereby the company is able to offer initial customer “Bud & Mary’s” a $13.5 mm construction loan and $24 mm worth of VFUs to fund a new growing facility. In return, AGFY is positioned to earn $268 mm of mostly software and product fees over a ten-year period. This type of deal appears to be a home run for AGFY and by being able to provide a full turnkey experience including financing, facility buildout, and software monitoring, AGFY effectively positions itself as a business partner rather than an equipment provider and earns its substantially higher economic returns as a result. The Bud & Mary’s deal may generate 27 mm of annual fee income with the use of 774 VFUs whereas AGFY’s recent contract manufacturer has capacity to produce 3,800 units per year (and more upon request). That manufacturing level provides capacity for five such Bud & Mary-sized deals which would theoretically build an annual bookings base of 27*5= $135 mm, which can then be layered on top of each other year over year. While that may be ambitious, on the 1Q call, the CEO indicated that while they’ve only allocated $50 mm initially to the TTK program (in the form of earmarked construction loans) they are seeing interest at 8x that level. $450 mm of interest indications would allow AGFY to make 35 deals similar in size to the Bud & Mary’s deal (which again is expected to generate 27 mm a year in fees). This is the scenario that ends with AGFY generating a billion dollars of revenue over time, or 10x the 2023 analyst forecast. While this upside scenario seems a bit fanciful at this juncture, cannabis is a large industry with a supply demand imbalance, high potential profits, a shortage of expertise and financing, and a limited license structure that could offer some terrific value extraction opportunities for a unique software, equipment, and financing provider such as AGFY.

Peers

HYFM, GRWG, VFF, APPH, SV are in a broad peer group (with the latter two being non-cannabis related) and each has a much higher aggregate valuation than AGFY, who has described itself as more of a comprehensive IoS type solution vs. an android / piecemeal equipment solution such as that provided by HYFM. This comparison resonates as AGFY does seem to be able to uniquely provide everything a grower needs to enter and sustain a cannabis business. HYFM is clearly much larger with an existing near $500 mm revenue base and so AGFY is not yet operating as a true competitor and is more of niche market offering. Notably, HYFM has a $2.2 bn enterprise value vs. <$100 mm at AGFY and so investors don’t need AGFY to dominate the industry to earn an attractive return. Looking at the broader group, AGFY stands out given its focus on cannabis, ability to provide a turnkey customer solution with software driven consistency, and its potential recurring revenue model.

Risks

Early stage of development. AGFY has only four primary existing customers. However, they’ve successfully re-engaged all four evidencing product success (see slide 4 of the 1Q presentation). AGFY generated only $12 mm of revenue in FY’20 with 7 mm of that from facility buildouts and just 4.8 from cultivation solutions (the VFUs). In 1Q’21, the company matched the full year ’20 facility buildout revenue of 7 mm but only sold $230-thousand worth of VFUs. However, this is logical. The company spoke on the 1Q’21 call about how they will build out new facilities this year, to be followed by the emergence of VFU revenue, and followed later by the emergence of recurring software and production fee revenue.

Excess industry supply. Such excess supply has plagued the Canadian cannabis industry making many of those companies poor investments. However, the U.S. market is still very clearly supply constrained market and I don’t think oversupply is a risk for several years given growth in demand and legalizations. The U.S. MSOs frequently discuss their supply constraints on earnings call.

Cost competitiveness proves incorrect. I presented information above demonstrating a strong value proposition for using AGFY solutions based on cost and premium output pricing. Should this turn out to be untrue, demand for AGFY solutions would erode or not materialize. It’s quite easy to grow cannabis and if the market favors low-cost, low quality, low consistency product, this will not favor AGFY’s solution.

Small float / trading volumes. This can cause what appears to be excessive swings in share price often for what appears to be no reason. This can be exacerbated by a lack of institutional buying support.

Customers preferring a mere equipment purchase over a TTK type solution would lower the overall lifetime value of AGFY’s solution. Given that the industry is new (with regulators further encouraging new entrepreneurs to enter) with financing and expertise in short supply, I believe there will continue to be demand for the total turnkey solution. On their own, VFUs sell for ~$25,000 and represent just a fraction of the total value AGFY plans to receive from their first TTK partnership (VFUs in that case are just $24 mm vs. a total $268 mm inflow for the TTK).  Note that given lack of traditional banking participation, lending to cannabis companies itself is a very large business opportunity. AFC Gamma is one public company that focuses on this space with a $300+ mm valuation.

Slow margin emergence and cash burn. AGFY had negative gross margin in the recent quarter. While never impressive, this situation exists (as discussed earlier) because the company is first building out new facilities which is a low margin activity that precedes VFU delivery and then eventually software and production fee income as shown in the investor presentation TTK customer example. Additionally, the company incurred costs associated with moving to a more scaled outsourced contract manufacturing relationship in 1Q. Nevertheless, such negative margins could expose the company to criticism as could the cash burn that is likely to occur as operating expenses also become elevated in advance of revenue. TTK lending outflows will also drain cash balances in lieu of a receivable. I cite a low enterprise value as part of the value here but the EV will expand as cash declines near term (though this low starting point provides entry comfort in my view). 

Links:

1Q’21 earnings slides: https://ir.agrify.com/news-and-events/investor-calendar

Feb ’21 registration statement: https://ir.agrify.com/static-files/83c18f39-3d5d-4848-b02f-d9c58b3a4127

1Q’21 10Q: https://ir.agrify.com/node/6896/html

Announcement of first TKK customer:  https://ir.agrify.com/news-releases/news-release-details/agrify-announces-first-total-turn-key-solution-customer

Articles discussing importance of consistency: https://www.cannabisbusinesstimes.com/article/product-consistency-a-tale-of-two-markets/

https://mgretailer.com/business/growing-horticulture/cannabis-consistency-begins-clear-taxonomic-structure/

Catalyst

Catalysts

Signing new customers, particularly a name-brand MSO which management has alluded is not far away

Increased coverage and trading liquidity

Positive cannabis-related legislative developments (could happen this summer)