Practically all markets are in a strange place right now, reeling from the disruption of the COVID-19 pandemic. The common denominator? Trying to figure out what the new normal looks like. The cannabis industry is no exception and yet – as usual – it’s also a peculiar case compared to other markets.
From the investment perspective, this is a critical time for the industry – a period of maturation and hidden opportunity which COVID-19 has exacerbated. What is the current state of cannabis investing? And what do potential or current investors need to know? Green Flower connected with some of the top cannabis investment minds in the space, and they had plenty of valuable insight to share.
The Impact Of Cannabis Being Deemed “Essential”
“It’s never ordinary in cannabis investing, but it’s especially interesting this year. Every year brings a new challenge and a new opportunity,” says Emily Paxhia, managing partner of Poseidon Asset Management.
“In March, we saw a lot of capital retreating from the space, and unfortunately it has not come back quite yet, in spite of the fact that COVID has proven to be an environment where cannabis is considered essential, and also where cannabis is thriving in a downturn – as we’re seeing it already. So, we’re anticipating that it will continue to be recession-resistant, but capital has not yet come back to the space.”
Industry analyst Alan Brochstein has also seen the pandemic bring both positive and negative impacts to the space. Mostly positive in the long-term.
“COVID does make it more challenging for cannabis operators because of social distancing and all that, but everything else seems pretty positive,” Brochstein says.
“First of all because they were deemed essential, a lot of locales were able to implement pickup or delivery, and this is a major boon because if you think about the number one challenge for the cannabis operator, it’s not the [legal] competition but the illicit market. This is a game changer and it has been.”
What makes it a game changer? More cannabis markets now allowing delivery and curbside pickup is huge positive because they’re reporting more people using those services now that it’s more convenient, Brochstein emphasizes.
“Another positive is that the pandemic itself leads to more demand for cannabis because of issues like anxiety, sleeplessness, and also people have more time on their hands, which is enabling higher consumption.”
Weaker Companies Will Not Survive
While cannabis is indeed showing a degree of resistance to recession – one of the clearest examples being a projected 40 percent increase in industry sales – COVID-19 has not been so kind to a lot of cannabis enterprises, specifically those that were floundering before the pandemic.
Multistate operator iAnthus is the most recent, high-profile case here. This week the struggling cannabis enterprise announced a restructuring deal that wiped out more than 97% of its equity in order to pay its debts.
On this front, Brochstein likens the pandemic to a kind of a Darwinian process that is winnowing out some of the weaker companies in terms of their financial position.
“The pandemic is forcing a lot of focus, which is a good thing. A lot of companies struggle – on both sides of the border – with trying to get too big too fast, and the pandemic has sort of reigned them in,” he says.
“There are several companies that will survive because they are scaling back and focusing on what they’re best at as opposed to trying to be everything.”
Poseidon has been calling this the Darwin phase in cannabis long before COVID, Paxhia adds.
“We just knew that there’s only a finite source of capital for cannabis until the federal situation shifts or the banking laws change, and so [previously] we saw a lot of poor use of capital, people spending more than they could generate in terms of revenue,” she says.
“We’ve been calling this the Darwin phase since Q3 of 2019, and it’s only been exacerbated by COVID, with capital leaving the space more quickly.”
Roderick Stephan, partner at Altitude Investment Management, noted the same trend when the industry’s capital market started to shut down in August 2019. “The average cannabis company had probably 6 to 8 months of cash. So when March rolled around and COVID hit, of course everybody was focused on supply chain disruption at first, and they didn’t look at how all this would affect demand,” Stephan says.
These are tough times in the markets in general, Stephan continues, and the companies that seem to have staying power are those with hard assets, such as real estate or a license in states where cannabis licensing is limited.
“Those hard assets could be used to collateralize loans if the worst comes their way. And all these companies that don’t have assets, like a new brand being started where you have to spend on SG&A, marketing expenses, and you’ve got to pay for product development and everything upfront before you get the sales, plus having to build the brand – they’re facing very hard times.”
A New Phase Of Cannabis Industry Maturation & Opportunity
The cannabis industry and many of its investors have learned a lot of lessons throughout the initial phases.
One of the bigger lessons, Stephan notes, is that while you can teach people with corporate experience how to work in cannabis, the bong-to-boardroom folks don’t quite make the best executives.
“This Darwinian shakeout is going to lead to the death of some companies, consolidations of other companies – the fittest are going to survive and they are going to be stronger,” he says.
“It’s like what Warren Buffett said about those who are swimming without their shorts when the tide goes out to sea. Well, the tide has gone out, and for everything you read in the paper, there’s probably five other companies that you don’t read about that are going through administration or are just fizzling out or disappearing.”
The cannabis industry is going through a typical cycle for any emerging market, Paxhia advises.
“You have the early capital that flows in very quickly, where it’s very excited and hype-driven and not very prudent or judicious in terms of what it’s focusing on – and then you tend to see a pretty significant drawdown on the backside of that,” she says, adding that Poseidon Asset Management has always been careful to avoid those imprudent investments.
“And the next wave is really where you see the lasting companies and the lasting investments that really resonate. I think we are about to enter into potentially one of the most amazing phases in cannabis investing because the business models are proving out through those key performance indicators, which has removed some of that mystery as to whether or not this is a viable, long-term industry.”
The cannabis industry is still very much in its early days, she continues, and there is not a lot of capital being deployed into the space, so for investors, it’s a great opportunity to participate and get in on what really is, what we consider, the true foundation of the lasting wave of cannabis opportunities.
“It’s been a difficult time to watch, and it’s never pleasant to see companies failing, but it’s also quite a necessary aspect of the maturation of an industry,” Paxhia says.
A Prime Time To Invest? Further Tips & Considerations
For cannabis investors who are able to find good opportunities, this could be the perfect time to get in before the industry fully hits that lasting wave as described by Paxhia.
Brochstein agrees that the timing could potentially be a perfect storm for smart, informed investors who aren’t intimidated by the optimism – along with the capital – that has left the space. “This is one of the few times I have been really comfortable thinking it’s a good time to be an investor [in cannabis],” he says. “Usually things look good but the stock prices seem too high or something like that, and right now there’s just not a lot of optimism, at least not on my level.”
Looking further out, Brochstein also sees a lot of promise at the policy level. “At the federal level, people are predicting that the Senate will fall to the Democrats, so while legalization is not the story here, at least not yet, the way people talk about it, I think what I like to call rational federal policy could be on the horizon,” he says.
“For example, I would love it if we could see credit cards be accepted at dispensaries. That’s an example of something that could evolve should we have federal legislative progress.”
Another consideration at the federal level, Brochstein continues, is the fact that U.S. cannabis operators can’t trade on the NASDAQ or the New York Stock Exchange. “But I envision that could become possible if there is this change at the federal level. It’s not necessary to make things work, but that is a huge bonus.”
Meanwhile, according to Stephan, another hidden opportunity in cannabis today could lie in the fact that a lot of companies are having to cut costs, particularly in sales and marketing.
“Some teams are cash-rich or are able to raise cash and they see this as a great opportunity to not cut down on sales and marketing,” Stephan notes.
“I read a statistic that as much as 30% of the Canadian cannabis market was laid off. I think there is some good talent out there that’s available, and some of those companies that are rich in cash are able to capitalize on good talent and maybe take advantage of the competitive withdrawal of a lot of companies. That’s an anomaly though, that’s not the rule.”
Cannabis is here to stay despite [the pandemic], Stephan adds. “And if one takes a long-term view, I think it’s a great buying opportunity.”
Due Diligence In The Cannabis Industry Today
While a lot of early cannabis investors were burned by making uninformed decisions based on hype and excitement, investors today have a mountain of resources to conduct due diligence on the companies and the industry itself.
“One of the things to look at are the companies that have been more cautious with their use of capital. If you’re looking at public companies, it’s very easy to review their filings because they file quarterly, and you can see who’s been more careful in terms of deploying capital, acquisition strategies, expansion strategies, and a focus on either that or the bottom line,” Paxhia explains.
“I looked at their filings, and there were only three or four companies who have really excelled in that space in the U.S. market and may be only one or two in Canada.”
Both Stephan and Paxhia agree that fund investments may be the smartest strategy where you have a portfolio manager keeping an eye on things and hopefully practicing stringent due diligence.
“If you’re doing direct investing into the companies – I would spend quite a bit of time on diligence, and I wouldn’t move quickly. I would take my time in this market because there’s a lot to learn and a lot to learn about the companies. It’s not something to rush into,” Paxhia advises.
“This is a rapidly growing industry, more rapidly growing than anything in the U.S. especially – particularly in this crazy time where we are seeing contraction of whole markets like hospitality and travel – yet it is important not to take that at face value and to learn about the industry, learning how things are cultivated and how the industry actually works will be very important to informed investment decisions.