Description

Agrify – The Applied Materials of the Cannabis Industry

Agrify (AGFY) February 21, 2022

Company Description

Agrify sells premium In-Door Cannabis Growing Solutions named vertical farming units (VFUs) with no strong competitors.  Customers achieve 90% higher harvest yields than the industry average on a consistent basis in many locations. 

Vision: 

The cannabis industry is fragmented with numerous capital equipment suppliers that offer single point solutions. Agrify’s goal is to become the single source supplier of cultivation equipment  to the cannabis industry. The company is only two years old, but has already introduced best in class cannabis cultivation equipment that provides 65% of the equipment (measured in dollars) needed to build out an indoor cultivation facility. The company is overwhelmed with demand.  In order to qualify leads,  in July 2021 the company began asking prospective customers to sign a letter of engagement and pay $15,000 for the privilege of entering the official sales pipeline. In January 2022 Agrify reported bookings of $250 Million in the December 2021 Quarter and reaffirmed $27 Million in sales for the quarter. Thus the book to bill ratio was over 9x to 1.

Investment Thesis:

Agrify’s $6 stock price is backed by $4/share in net cash on the January 2022 balance sheet. 

Agrify is a growth company that has ten year total turn key  (TTK) contracts in place that will generate $56 Million EBITDA in 2024 that will rise over the next ten years.  

The software maintenance business can generate $27 Million EBITDA in 2024 by having an installed base of 15,000 vertical farming units (VFUs). 

I assume zero profit contribution from the VFU hardware, brand royalties and recent acquisitions just to be conservative. 

I arrive at $83 Million in 2024 EBITDA compared to Factset estimates of $33 Million EBITDA. 

If you place a 20x EBITDA multiple on this recurring royalty like cash flow, that leads to a $1.66 Billion valuation or (divide by 30 million shares) $55/share. 

So we have a $6 Agrify stock price with $4/share of cash and upside to $55/share by 2024. 

That is why I recommend that you listen to the Agrify presentation from January 10, 2022 at the ICR Conference.  

Profit Drivers:

The company has five sources of revenue that will drive future profitability.

The “Total Turn Key” or (TTK) solution will likely contribute 67% of profits or  $56 Million EBITDA and $36 million or $1.38/share of free cash flow in 2024. The first challenge new entrants have in the cannabis industry is that the sale of cannabis is illegal on a federal level and banks are prohibited from lending money to cannabis companies.  The second challenge is that the new entrants often have minimal experience growing cannabis indoors. 

Agrify solves both problems with its turn key solution by partnering with their TTK customers and earnings 30% of the profits generated by the facility over a ten year term.  The company is using its $130 million in cash to finance the design and construction of the facilities over 18 months.  Agrify owns the vertical farming units where the cannabis is grown and leases the equipment to the TTK customer.  Agrify employees also monitor the entire harvest to guarantee that optimal cultivation techniques are followed so that optimal harvests are achieved.  Early Agrify customers are generating 50% more in sales from cannabis harvests grown in VFUs versus the legacy cultivation process used by 99% of the industry.

Agrify launched the TTK service in 2021 and has signed six 10 year TTK contracts  over the past seven months, with many more in the sales pipeline. These TTK customer harvests  will begin in the Dec 2022 quarter and should be at full capacity for 2024 and generate $56 Million in 2024 EBITDA that rises over the next ten years.  The net present value of these contracts with a 6% discount rate and a zero terminal value is $10/share or $313 million. If one uses an 8% discount rate the NPV is reduced to $7.50/share. Agrify’s sales pipeline suggests that they will be closing numerous additional TTK contracts in 2022. I have not included any future TTK contracts in my forecasts even though these contracts will be signed. 

The second Agrify profit driver will be software maintenance fees from the outright sales of vertical farming units (VFUs). Some cannabis companies have the ability to internally finance the $27 Million construction and equipment cost for a new 50,000 square foot in-door cannabis growth facility. Agrify has a razor and razor blade business model  for its VFUs.  Most of the profits are earned from the annual $2,000 software maintenance fees paid to operate each VFU over ten years.  Agrify will likely generate in 2022  a 10% gross margin or $2,000 upfront on the sale of the VFU. In year two and afterwards, the VFU will generate $2,000 in recurring software fees at a 90% gross margin.  Each year the installed base of VFUs will grow and the SAAS like recurring revenue will grow. Every 15,000 VFUs installed will generate $27 Million EBITDA a year ($0.90/share) If you place a 20x EBITDA multiple on this cash flow, you arrive at a $18/share valuation. 

The third profit driver is from vertical farming unit equipment or hardware.  Gross margins for the VFUs in 2021 were near zero. The newest 3.7 version shipping in March 2022 has been cost reduced and will generate a 10% gross margin. The target is to reach 20% gross margins at higher volumes and with premium features that will be added. Agrify will ship about 2,700 VFU units in 2021, while the market opportunity is 100,000 VFUs per year. This is based on the assumption that the cannabis industry is adding about 6 million square feet of in-door cultivation space a year. You can dispute how large the TAM is today. The main point is that Agrify’s market share for cultivation equipment is only a few percent.  The largest cannabis companies like Curaleaf are still testing Agrify equipment in their labs and comparing the Agrify harvest yields with the standard operating procedures used in their facilities. These public companies spend over $1 Billion a year in capital expenditures.  When they decide that Agrify offers a superior in-door growth solution, demand at Agrify will Accelerate with a capital “A.”  For now it is the smaller more agile private companies that are the early Agrify customers. 

These small companies today are placing their first and second orders for VFUs. In future years twenty companies could each be placing orders of 500 VFU units each annually with Agrify. This would be a total of 10,000 VFUs annually which at $20,000 per VFU will generate $200 Million in VFU hardware sales.  Just to be conservative I assume zero profits are generated from selling VFU units, even though the hardware will generate a profit. 

The fourth profit driver will be from generating royalties from Agrify’s cannabis brands.  There are dozens of genetically unique cannabis seeds that grow into different plants. Agrify owns the brands for some of these different varieties. One day these brands could generate $1 Billion of annual sales with a 5% royalty or $50 Million in royalty profits for Agrify.  A 20x EBITDA multiple on this royalty stream would be worth $1 Billion.  I assume a zero valuation for Agrify today from these future brand royalty streams. 

The fifth profit driver will be generated by three recent acquisitions that closed late in 2021.  The three companies are Precision Extraction Solutions, Cascade and PurePressure.  The combined annual sales in 2021 for these companies was about $50 Million. The financial results from these companies will contribute to 2022. The companies will be profitable, but I assume zero benefit in my estimates for 2022 to be conservative. 

Selling capital equipment to a growth industry can be a great business. 

ASM Lithogrpahy  (ASMLF) is the largest capital equipment supplier by market cap to the semiconductor industry with annual sales exceeding $18 Billion in 2021. In the past 12 years sales at ASM International have increased in excess of 1,000% while the stock price has appreciated in excess of 2,100% from $35

Catalyst

 The first ten year turnkey contract to generate sales will be in the December 2021 quarter. That event will further validate the business model.