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We hosted Erick Dickens, CEO of Kadenwood Holdings, at a virtual fireside chat this week as part of Needham’s Private Company Showcase Series. Kadenwood is a privately held, CBD focused company, founded and run by a team with decades of innovation and marketing experience running large, well-known consumer brands. Our overarching conclusions from this event are that 1) category growth rates should remain exceptional, but expect a high level of capacity exit with category ‘winners’ likely emerging over the next 12-18 months. 2) DTC (online sales direct-to-consumer) sales might be sufficient to stabilize operations for the larger CBD players, but the category winners will likely be determined at retail.

Poor CBD category performance in ’19 at retail means that brands without the marketing dollars to support advertising and promotion are unlikely to achieve distribution. 3) The 2018 Farm Bill created a hemp and extraction boom in early ’19 that resulted in a bust by early ’20. Lack of quality biomass and extraction capacity will likely be an issue not resolved until at least ’21.

What do we think Kadenwood is doing differently / where will it fit into the CBD category?

  • Experience doesn’t ensure success, but it increases the probability of success materially: The company was founded by a team with significant experience in branding and marketing at large CPG companies. We think the depth of this commercialization and category development experience will set Kadenwood apart among retail merchants that were burned by weak product performance in a high growth category in the 1st wave of CBD products sold.
  • Level of marketing spend: Kadenwood already spends the most on advertising in the CBD space, which helps with brand awareness, drives revenues in its DTC business, and increases interest from big box merchants. National reach radio and athlete endorsements helped increase brand awareness in 1H. A $10mn deal with a major media company for a national TV campaign later in ’20 will represent a material step up in spend and will likely continue to separate Kadenwood’s brands from competition.
  • Vertical integration limits business risk related to ’boom’ and ‘bust’ reverberations in farming and extraction: Over the near-term, inconsistency in production and ingredient quality provide an opportunity to vertically integrate the supply chain. While the overarching focus is on building brands, Kadenwood is in the process of acquiring assets that will enable them to control everything from seed to shelf (proprietary genetics, farming, extraction, production and then sale through its DTC channel or retail). While we do not expect the CBD category to be vertically integrated over the long-term (virtually no CPG businesses are), this will likely be a cost advantage over the near-term, or at a minimum, shifts or mitigates 3rd party supply chain risk to something under Kadenwood’s control. Despite declines in the price of hemp biomass and isolate, CBD is still the most expensive input. Owning the supply chain could materially lower production costs and provide margin cushion should category price points continue to fall, or provides flexibility to invest in promotional spending to support its brands at retail.

At present the CBD category is high growth, but highly fragmented; a wave of consolidation and marginal capacity exit of brands is very likely to occur. We [Needham] estimate that U.S. hemp derived CBD sales were $1.8B in 2019, will likely reach $3-3.5B in 2020, and the category in the U.S. will likely exceed $10B by 2023. Kadenwood expects the U.S. CBD category will reach $15-20B by 2025. Globally, the size of the CBD category is difficult to forecast because of regulatory differences and potential changes to those regulations, channel development, use cases, and customer acceptance of the category. Per Brightfield Group, there over 3,000 companies selling CBD in the U.S. today and 90%+ of these companies have annual revenue <$1mn. It is extremely unlikely that the vast majority of these brands are profitable or have prospects of being profitable with revenue at the <$1mn level, and we expect many, if not most, of these small brands will likely exit the category. By comparison, Kadenwood’s DTC business is “in the multi-millions” and topline revenue is on pace to be “in the tens of millions” in ’20. Disruptions related to COVID are likely accelerating the pace of consolidation / marginal capacity exit.

Early stage industries often experience growing pains along the supply chain and the CBD category is no different. In the U.S., the 2018 Farm Bill allowed farmers to grow hemp for the first time in decades. In 2019, ~500k acres of hemp were licensed, 230k were planted, 125k were harvested, and underlying demand was probably 25-50% of harvested acreage. This overplanting caused biomass prices to drop from >$35/lbs in late ’18 to <$8/lbs in ’19. The company expects a reduction in planted and harvested hemp acreage in ’20, but thinks it could be a few years before larger efficient farmers stabilize pricing and increase quality. Despite significant investment in processing capacity in ’19 by the industry, demand didn’t materialize and much of the investment in extraction equipment never came online. As such, processing will likely remain a choke point for the industry. Large CPG companies are not involved in the category right now, and are unlikely to enter until regulatory clarity is provided by the FDA.

Larger CBD companies have found most success with a DTC model (direct-to-consumer), while product sold at retail has generally not fared well. Early mover brands that achieved retail distribution generally failed to invest in advertising to build the brand or support the product on shelf, and as a result, the early mover brands haven’t lived up to the expectations of retailers. In some cases, when the product performed poorly, the merchant or retailer mindset was often to replace a poorly performing product line with a new product line with the same lack of brand support. Retail closures related to COVID stay-in-place orders and limited consumer desire to leisurely shop likely exacerbated CBD category issues in retail. Of the larger national or regional big box retailers that carry CBD, we‘d estimate that the majority of distribution is with fewer than 20 brands. As poorly performing brands are replaced with fewer, but better supported product lines, we would expect Kadenwood to be among those best positioned to gain distribution with these retailers.

Lower price points and higher levels of ad spending are critical for mass adoption. Kadenwood sees a declines in retail unit pricing and higher levels of advertising spend as critical to drive package velocities to levels that where retailers would keep the product on shelf. Advertising and marketing are needed to educate consumers and build awareness. National reach radio has been an effective medium for them in through ’20, but expects to have a $10mn national TV campaign later in the year. Price points at retail will need to be sub-$40 to make it on the shelf with most major retailers (need both entry priced product for trial, and larger pack sizes for repeat), with most retail pricing likely to fall in the $10-25 range over time.

FDA guidance remains an overhang and will likely limit growth of non-topical product. The lack of clear guidance from the FDA puts the onus on the consumer to figure out what is appropriate on their own. For now, the industry needs to continue to invest in research on CBD and use this to help inform the FDA to shape policy. Over time, the company expects the FDA to issue guidance on dosage on ingestible CBD, but expects this guidance to likely be several years out. Kadenwood has Former Surgeon General Dr. Richard Carmona on its medical advisory board. On the margin, this affiliation likely helps to shape internal product development and formulation, lends credibility to the brand in terms of quality, and will likely be an important voice as regulators assess rules for the category.