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The highs and lows of cannabis liberalization

The marijuana industry is attracting growing lumps of capital, but its progression is not linear. That makes for excited but cautious investors.

 

Most people probably still recall when they discovered the results of the last US elections, thanks largely to the identity of its mercurial victor. However, few remember the second big winner of that night: marijuana.

On November 8, 2016, voters of California, Massachusetts and Nevada approved the legalization of cannabis beyond medical purposes. The result did not come as a complete surprise. Investors had already started to vote with their wallet before election time, though capital market activity accelerated after the poll. Viridian Capital, a specialist financial advisory firm, reports a spike of more than $120 million raised during a single week in December, amid weeks hovering around $50 million.

Investor’s appetite for cannabis has continued since. Year to date, five weeks have already broken the $100 million threshold (a feat achieved only twice in 2016). The amount raised on private markets since the start of 2017, at $503 million, is already 2.5 times higher than the total collected last year; the same applies to liquidity garnered on public markets, worth $1.4 billion since January. The boost also owes to developments in Canada, where Prime Minister Justin Trudeau and his administration announced in April that they would roll out legalisation by July 2018.

The jump in capital raised is easy to understand. Higher demand for cannabis necessitates higher supply, and to grow more larger cultivation facilities are needed. That also leads to increased adoption of advanced agricultural technologies, such as LED lighting, in order to reduce production costs. That explains why, along with the higher volume of transactions, average deal size has also increased, says Harrison Phillips, Viridian’s vice-president.

Lately though, outside of Canada, capital market activity has slowed. That’s largely because US investors are waiting to see the impact of federal regulation. “Everyone’s eyes are on California. Not only on the industry and investors, but on the federal government as well,” Phillips notes.

As marijuana develops into a legal business, his comments allude to some of the pitfalls. California has long been the main supplier of black-market cannabis products to the rest of the US, Phillips observes. And inside the state, retailers of the stuff have operated for more than two decades without state-wide regulation, with business handled at the local or municipal level. Therefore, there’s likely to be a shake-out of incumbent operators before full-scale recreational cannabis is launched. Finding that they can’t afford to become compliant, some will be forced to sell out or exit the market.

Such pressures will be compounded by the more stringent regulation applied to recreational cannabis compared with its medical peer. This will create new bottlenecks as fewer testing, packaging and labelling facilities are to approve products. When Oregon legalized recreational marijuana in 2015, only two out of 17 testing labs that applied got the green light, causing some shelves to remain empty. Even in Canada, uncertainty exists: the government has left it up to the provinces to decide how retail should be structured, meaning some opportunities, going to government-sponsored or public players, could escape private entrepreneurs.

So it’s only natural for investors to take a break. And by “investors,” we mean high-net-worth individuals and family offices. Large institutions are so far shying away from cannabis, in first instance because backing marijuana ventures would run against the “sin clauses” many have in place (which prevent them from investing in the likes of tobacco, alcohol or weapons). Others have more temporary reasons to be restrained: while it may be a “one step back, two steps forward” affair, it’s hard to deny cannabis liberalization is on a roll.

Write to the editor at matthieu.f@peimedia.com