Poseidon Asset Management Managing Partner Morgan Paxhia joins Midas Letter to discuss the longest-running cannabis fund in the market today. The company’s funds focus on the emerging cannabis and industrial hemp industry – currently with over $150 million of assets under management. The Managing Partner outlines the companies with the greatest potential in America and Canada with a large focus towards ancillary services. Watch the entire interview to learn more about how Poseidon have become considered a leader and trusted industry insiders within the cannabis industry.
James West: I’m joined now by Morgan Paxhia, Managing Partner at Poseidon Asset Management. Morgan, welcome.
Morgan Paxhia: Thank you for having me.
James West: You bet. Morgan, in a nutshell, what is the business of Poseidon Asset Management?
Morgan Paxhia: Poseidon is an investment firm that’s been dedicated to the emerging cannabis and industrial hemp industry launched back in 2014, and we now have two funds running in the industry, and our first fund being the longest-running cannabis fund in the market today.
James West: Uh-huh, wow. So that’s pretty much at the beginning of the invest-ability of cannabis. How much assets under management across the two funds?
Morgan Paxhia: Sure. Between our two funds, and we have some co-invest vehicles, it’s about 150 million in assets, and we’ve already returned a significant amount of capital out of Fund One. So that’s after that, we’re still running around 150 million.
James West: Okay. So then, tell me: how has the downturn that began in April 2019 treated you?
Morgan Paxhia: You know, we’ve been investing in this space for, you know, going on seven years, and we are used to these cycles. Obviously, this one was pretty significant; it’s just because as the industry is getting bigger, the dollars are bigger, but the cycles have been there.
If you remember back to 2014, as you noted, as it started being an invest-able industry, there was a massive spike and subsequent burst far greater than the last cycle that peaked in, what was that? January of 2018?
So we’re used to these ebbs and flows, and how we’ve managed it is just with the amount of exposure we have to public markets, especially the first one being a hedge fund vehicle. We can dial up and dial down that exposure, and what we do when the markets get frothy is recycle that capital into private markets where we see better entry points.
And today, we’re still running at some of the lowest exposure. Really, just a few core names in that strategy, just while we’re waiting for what we call this phase of the industry is the Darwin phase, where we’re expecting a considerable amount of companies to go away.
And, you know, it’s weird, because normally you’d say, ‘go bankrupt’, but you can’t really say that in the United States because of the Federal laws. So anyway, we’re seeing this recalibration in the industry and just weeding our way through, no pun intended.
James West: Sure. So the consolidation that is essentially the survival tactic in any revaluation to the downside, that has gripped the cannabis space – clearly, you see an opportunity for the strong to survive, as per your Darwinistic comment there. And the same sort of exists in Canada, where we have coincident excess of supply of issuers trying to muscle in on a much smaller market, obviously.
So can I ask you in which companies does your greatest hopes lie, in America and in Canada?
Morgan Paxhia: Yes. You know, it’s interesting: we run diversified investments. Our portfolios are very diversified, but we do have areas that we focus on within that diversification, and when we launched Poseidon, we always had a very bullish view towards ancillary companies. You know, the picks and shovels, compliance solutions, just understanding that this industry would be a highly complex and evolving regulatory landscape, not just in Canada and the US, but around the world.
And if you can solve those complex problems vis-à-vis technology, we believe that is a highly scalable business focusing on a fast-growing industry that is cannabis, longer term having much greater addressable market opportunities in other highly regulated industries.
And so that was one of our core theses, and it was really interesting to us to see the amount of capital that went into plant touching companies. You know, we were early investors up in Canada with some of the licensed producers; just given the regulatory environment, we felt that that would be a very attractive entry point.
But then it did build up a lot of excess, too much capacity buildout, and we saw capital do that very similarly in the United States, where we’ve seen just a tremendous amount of capital flow into the plant-touching companies. And we define plant-touching companies as those that are, in the US, sort of have exposure to 280E, which is that burdensome tax regulation that the industry is still faced with, and will be faced with, for a period of time.
Anyway, so, as this industry is maturing, these businesses are very complex. They need technology. And so we’re starting to see institutional capital picking up interest on that side, on the ancillary side. And for us, it’s very validating, since it was an area that we were very bullish from the beginning on. And so now it’s really coming into fruition, which is great. These technologies are able to penetrate many different markets much faster and easier than the CapEx-heavy plant-touching businesses, and they can scale, and that’s what’s needed in this rapidly changing environment.
James West: You bet. Can you just give us a quick thumbnail on the 280E burdensome tax regime that you’re describing? A lot of people just don’t know what that means.
Morgan Paxhia: Yeah, so this was a tax code that, I believe, goes back to the early 1980s where there was a cocaine dealer in Miami that was trying to run a legitimate business with writing off standard business expenses. And the Federal government caught onto the fact that he was benefitting from tax writeoffs when his business was an illegal business.
They created this tax code called 280E, and really it strips away standard business deductions, and so it makes your effective tax rate explode higher. You know, as a cannabis operator, you can, you know, you can’t, your COGS are even exposed to it, so you end up with an effective tax rate that can be north of 70 percent.
So it’s very hard to be a net income positive business. You know, in our industry right now, we are watching EBITDA margins, because we all know that when you add that tax layer in, it’s really hard to be net income positive.
James West: Sure. And is that only in effect as long as cannabis is Federally prohibited in the United States?
Morgan Paxhia: That’s a very good question. We are watching. There are a couple of policy groups that are trying to resolve that, even ahead of a de-scheduling or a Federal legalization. You know, from our standpoint, that is a known aspect of our industry here in the United States.
But what we think would be more interesting to resolve sooner would be just banking access, making it Federally permissible to bank within the States. You know, we can address the 280-E tax code later on; businesses are still able to build, and investors understand the impacts of 280-E. And so we just believe in time that will be resolved, and we can manage that; but we do need to reduce the risk with the banking side of things.
James West: Sure. So is that one of the key drivers of your interest in the ancillary businesses that are not subjected to that tax regime?
Morgan Paxhia: It certainly has a very different impact on the business, yes. So you have a lot of attributes when you’re on the ancillary side. You have much easier access to banking, your insurance coverage, you know, premiums are far lower. You’re just treated much more like a traditional business. But these are early-stage tech companies, so you know, these are on the trajectory of, you know, 18-month cycles of raising capital. You know, revenues are still low relative to their counterpart on the plant-touching side.
You know, so we look for other KPI metrics when we’re on that side, you know, because we believe, you know, that it will take longer to penetrate deeper into that revenue stack. And a great example of that would be, take like a point of sale company in cannabis. You know, one of our Fund One companies, being Flowhub, is doing a fantastic job expanding across the country, but we still don’t have payment processing. So you know, unlike Square, that is able, you know, some of these others where you get a percentage take rate on transactions, you know, point of sale in our industry is faced with more of just like a monthly SaaS-based model, which is a very different revenue mix.
So, when we can add payments in, that will be a big boom for ancillary-type businesses.
James West: So then, is that sort of the core of the technology aspect of the ancillary focus, is technology platforms related to information technology? Or are there other technologies that are more mechanical, shall we say, in nature, physical?
Morgan Paxhia: Yeah, great question. Technology is a very broad definition, right? So there’s many different ways you can slice technology. You know, we certainly have had a data-forward mindset when it’s come to tech; you know, I mentioned Flowhub. Headset is another company of ours that we’ve been invested in for a long time, and they do data analytics and working with Nielsen with their data sets, because they are so deep and having the ability to be real-time is an incredible competitive advantage.
But, as you’re looking further down the tech spectrum, you know, consumer devices is an area of technology; that’s the hardware, you know, so PAX being an early leader on that side. But we’re seeing a lot of interesting innovation. We do have a company with a new consumer device that has no heating, and created vaporization. So it’s really interesting tech. We think it could be a triumph for the space in the years to come, not only for cannabis, but you could think of how that could play into the tobacco space, as well.
But then you also have like ag tech. Ag tech is an early area we invested in; you know, we believe that the plant is ultimately a commodity, and your cost of production needs to be very finely managed or else you could lose money, and you really haven’t seen that too much, yet. Oregon, Washington, (unintelligible) went through some pretty excessive price drops due to oversupply, but even states like Colorado, more mature markets, they’ve seen a stabilization in wholesale prices to the point where you can still run not the most efficient ag, like, operation, and still be a profitable enterprise.
James West: Sure. Okay, Morgan, how do you onboard investors? How do investors who are interested in investing in your fund, find you?
Morgan Paxhia: Sure. So we are a private fund, so under, you know, our regulatory restrictions, you know, you have to be an accredited investor or higher to be able to invest. But we do have a website, Poseidon.partners, and we’re also very active on social media via Twitter, LinkedIn. So our information is out there; happy to speak with folks. You know, we are at the tail end of raising our second fund, only a couple weeks left. So people that are interested that meet that accredited investor status, please find us on our website.
James West: Great. Well, I’ll look forward to speaking to you again soon. Great contribution. Take care.
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