Publications

- February 1, 2019: Vol. 6, Number 2

Cannabis legitimized: The legal marijuana market is maturing and creating ever-greater investment opportunities

by Anna Robaton

Here are two words that illustrate just how far the legal marijuana market has come in a relatively short period: John Boehner.

In April 2018, the Republican and former Speaker of the House joined the advisory board of Acreage Holdings, a company that cultivates, processes and dispenses cannabis in a dozen U.S. states. Boehner — who once said he was “unalterably opposed” to laws that would decriminalize marijuana — now serves on the company’s board of directors, alongside former Massachusetts Gov. William Weld.

Founded by a former Wall Street investment banker, Acreage Holdings is on a mission to become the world’s leading cannabis company. It is just one player in a sector that not long ago many mainstream investors (let alone influential ex-politicians) would not touch with a 10-foot pole.

What has changed?

Attitudes, for starters. A Gallup poll released this past October revealed two-thirds of U.S. adults support the legalization of marijuana. Growing public support has shaped laws at the state and local levels. Today, nearly 80 million people — or 25 percent of the U.S. population — live in a state or jurisdiction that has legalized recreational marijuana. What’s more, 32 states and the District of Columbia have legalized medical marijuana.

In 2018, the multibillion-dollar cannabis industry, which is growing at an estimated 27 percent compounded annual rate, got a big boost when Canada became the first major world economy to legalize recreational marijuana. Medical marijuana has been legal in Canada since 2001.

GROWING UP

Against a backdrop of growing public support for legalization, the industry is maturing and creating ever-greater investment opportunities. Many companies in the sector have moved beyond the startup phase, and some now trade on major stock exchanges in Canada and the United States. A small subset that includes Canopy Growth Corp. and Cronos Group is listed on exchanges in both the United States and Canada.

“In their early days, many publicly traded cannabis companies had no revenue. Many were penny-stock schemes,” says Alan Brochstein, a cannabis industry analyst and founding partner of New Cannabis Ventures, a business and financial news service that covers the industry. “Today, the universe of publicly traded cannabis stocks still includes companies like that, but it now has dozens of companies generating revenue and raising capital.”

Having reached what some call its adolescent phase, the cannabis sector is beginning to attract top talent from major industries, giving rise to management teams that “feel backable” to institutions, family offices and other deep-pocketed investors, says Troy Dayton, CEO of The Arcview Group, which publishes market research and runs a venture fund and investor network focused on cannabis.

“The balance of risk and reward is getting more investors interested,” explains Dayton. “It used to be that only people who were really intrepid investors — in other words, investors who look for deals with a lot of hair on them — would be interested.”

The Arcview Investor Network, with more than 600 accredited investor members, has helped some 1,400 investors place upwards of $235 million in about 200 cannabis companies. Most of that activity, according to Dayton, has taken place during the past two years.

Last year was a banner year for the industry in terms of investor interest. According to Viridian Capital Advisers, cannabis firms raised nearly $14 billion in 2018, up from $3.5 billion the prior year, and more than 300 merger and acquisition deals were inked across the industry. Among the blockbuster deals of 2018 was Constellation Brands’ $4 billion investment in Canopy Growth, a publicly traded Canadian cannabis producer. Based in Victor, N.Y., Constellation is a global producer of beer, wine and spirits. Canopy plans to use the cash to build scale in more than 30 countries pursuing a federal medical cannabis program, while building the foundation to supply new recreational-use markets as cannabis becomes legal around the world, according to the company.

The Constellation-Canopy deal involved Wall Street giants Goldman Sachs and Bank of America Merrill Lynch. Goldman advised Constellation, parent company of Corona and other big brands, and Merrill Lynch provided the financing for the transaction, according to Marijuana Business Daily.

“If you are sitting back and trying to learn about this industry, you should be aware that strategic investments are taking place, and that’s just another sign that the industry is for real,” says Brochstein, who has been following the industry for nearly six years.

PROCEED WITH CAUTION

There is a plethora of ways to gain exposure to the sector, and some unique considerations for investors.

One of the issues potential investors ought to consider is whether to invest in businesses that grow and/or sell marijuana — which in the United States remains illegal at the federal level and classified as a Schedule 1 prohibited drug — or ancillary businesses that stand to benefit, either directly or indirectly, from the industry’s growth, says Dayton of Arcview.

So far, companies that cultivate and sell cannabis in states that limit the number of available licenses have attracted the majority of investment capital, according to Dayton. But investors, he notes, are starting to shift their focus to ancillary business (think agricultural technology, point-of-sale software systems, genetics and so on) because of concerns about overvaluation in the cultivation-and-retail space, among other issues.

“Potential investors need to ask themselves whether they want to invest in companies that actually grow, process or sell cannabis or get adjacent to the space. If it’s the former, they need to determine if they want to invest in U.S. or Canadian companies. The difference being federal legality versus federal illegality,” says Brochstein. “More often than not, the stocks you’ll be interested in buying trade on the Canadian Securities Exchange. Canada is where a lot of the investment banking and research is done.”

To be sure, cannabis is still a quirky business, and plenty of investors have gotten burned as a result of not understanding its nuances. Access to banking services remains a challenge for many businesses, and interstate commerce is banned. Rules and regulations also vary from state to state, with some states imposing residency requirements on investors.

“Many investors and entrepreneurs make a huge mistake by not fully understanding how the industry works,” says Chris Walsh, founding editor and vice president of Marijuana Business Daily. “You are dealing with a federally illegal product [in the United States]. So you need to understand how the industry has developed over time and by extension the legal risks.”

Many investors are gravitating toward companies that have found ways to build a multi-state presence, positioning themselves for “dominance down the road,” says Walsh.

“There’s a lot of promise,” he says, “around multi-state operators,” such as Green Thumb Industries (a national cannabis packaged-
consumer-goods company and owner of a fast-growing retail chain) and Columbia Care (a vertically integrated medical cannabis company).

“There are companies that have found a way to grow into multiple states through retail, cultivation and infused products. They are still small in the scheme of things, but they are becoming the true giants of the industry,” explains Walsh.

A MILLION PIECES

Of course, the industry has a long way to go before reaching its full potential. Nathaniel Gurien of Fincann says it is only at the “top of the second inning,” and thus many more investment opportunities will emerge.

Over the next decade, the industry’s three major segments — industrial products made from hemp (a cousin of marijuana); medical cannabis and pharmacological products; and recreational cannabis and wellness products (think balms and CBD-infused soft drinks) — will give rise to innumerable new businesses with huge potential, according to Gurien, whose firm specializes in connecting cannabis-related businesses with banks. Earlier this year, Fincann was gearing up to introduce a compliant MasterCard/Visa merchant processing system for the legal marijuana industry.

Gurien estimates 75 percent of the industry “doesn’t touch any of the plant ingredients.” Put another way, most firms in the industry have nothing to do with smoking a joint. They sell vape pens or soil, or specialize in hydroponics, greenhouses, marketing, business capital-advisory services, transportation or even tourism, among other things.

“You have three basic branches that will break into innumerable, smaller businesses, each of which has the potential to grow into a multibillion-dollar enterprise focusing on a narrow segment of the whole ecosphere of the cannabis world,” says Gurien.

What advice does he have for investors hoping to identify the future Amazon or Apple of the cannabis business?

First, hedge your bets, he says.

“I’m not an investment adviser, but it would seem to me to be simply prudent that if you are getting in on the ground-floor level, that would argue heavily for some diversification. You invest in 10 things and one or two might be an Apple, a few might make you an okay amount of money and the rest are going to go out of business,” he says.

Not surprisingly, Gurien believes investors ought to focus on companies, like his, that are building the infrastructure of the budding (pun intended) cannabis business, particularly those that are growing organically, rather than through acquisition, during what has been dubbed the Green Gold Rush.

“Right now, we’re building, from the ground up, a brand-new gigantic industry. We’re putting in the roads and railroad trestles, the traffic lights, road signs, highways” and so on, he says.

“My recommendation,” Gurien adds, “is to invest in the nuts and bolts of productive assets in the industry, or companies that are engaged in that. But focus on companies that are building something proprietary, rather than buying it from other people, to avoid paying a huge speculative price.”

FUNDS FLOURISH

Rather than betting on often-volatile pot stocks, some deep-pocketed investors are gaining exposure to the sector through the growing number of dedicated private equity and hedge funds — including funds run by Arcview, Poseidon Asset Management, Gotham Green Partners, Navy Capital, Altitude Investment Management and Merida Capital Partners.

Such funds, says Dayton of Arcview, offer several benefits: diversification, professional management and access to private-company shares with less volatility and lower valuations than publicly traded cannabis stocks.

“In a market that’s moving this fast and is very idiosyncratic, it’s hard for investors to get the kind of diversification that they need in order to benefit from the overall growth of the market. People also want to put money with managers because their full-time job is understanding and evaluating this idiosyncratic market,” says Dayton.

Many investors are keen to own shares of companies that plan to go public soon, or that are likely to be acquired if and when cannabis becomes legal at the federal level in the United States.

THE END OF POT PROHIBITION?

Cannabis-industry experts believe, one way or another, cannabis will become legal in the United States at the federal level over the next few years. They point to the passage of the 2018 Farm Bill, which legalized industrial hemp as a crop, as evidence many lawmakers are following Boehner’s lead and evolving on the issue of cannabis. Senate Majority Leader Mitch McConnell of Kentucky championed the farm bill’s legalization of industrial hemp, which is expected to give farmers in his once tobacco-dependent state a boost.

According to The Brookings Institution, hemp is defined in the legislation as the cannabis plant — the same one that produces marijuana — with a key difference: Hemp cannot contain more than 0.3 percent of THC, the compound in the plant most commonly associated with getting a person high.

The farm bill — which also legalized extracts from hemp, including CBD and other cannabinoids — is expected to unleash billions of dollars in investments from large consumer brands that are eager to cash in on the CBD boom but have been unwilling to flout federal law to do so, according to Hemp Industry Daily, a sister publication of Marijuana Business Daily. A nonintoxicating extract, CBD has been marketed as a remedy for all sorts of ailments, from insomnia to inflammation.

“I take a cautious and conservative view but, for the first time ever, I can see change at the federal level coming in the next 12 months,” says Walsh. “All the stars are aligned for a change to happen in 2019 that would open the door to massive investments, and eventually returns, in this industry.”

Anna Robaton is a freelance business journalist based in Portland, Ore.

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