Many believe that cannabis stocks are experiencing a “bubble,” meaning that market valuations are unjustified, unrealistic and based on investor hype as opposed to typical fundamental markers such as revenues, assets and profit. Some, like The Motley Fool, believe this is a bubble ready to burst. The Wall Street Journal includes quotes from new entrants in the space suggesting this is much like the Internet stocks of 1997 or 1998, remembering that in 2000 the Internet stocks crashed mightily, taking years to recover after many companies did not survive the shakeout.
The cannabis data analytics company New Frontier Data reports that, year to date, seven of the top 12 cannabis stocks have posted more than 200% gains. The data company also seems to be recommending that, “As cannabis stocks continue to rally, prudent investors should consider taking profits and exercising caution.” The AP just quoted a stock analyst warning, “[i]f there is a bubble, larger investors will protect themselves and won’t overinvest in single companies, but smaller investors who see a chance to get rich quickly could suffer painful losses.”
It is true that, in particular in Canada, cannabis stocks are trading at extremely high valuations relative to the companies’ financial condition and results. One company, for example, with around $20 million in first half revenues, is trading at the same valuation as Macy’s, which has $25 billion in annual revenue. In the US the valuations are a bit more down to earth, but also considered by most to be high given performance.
Many others, including leaders of companies with these high-flying stocks, strongly believe these valuations are justified based on the tremendous future potential of the cannabis industry as we get closer to federal legalization in the US and global growth proceeds as well. They believe that as long as investors continue to believe in the future of the very rapidly growing industry, the valuations will continue to stay strong and be justified, and performance will grow to further support the bubble pricing. But the thing about bubbles…
Another breakthrough for the cannabis space occurred on Tuesday, February 27, 2018, when Toronto-based Cronos Group Inc. began trading on the Nasdaq Stock Market. (MJN:CN). This marks the first listing of a company focused purely on cannabis on a major U.S. stock exchange. The listing of Cronos comes within two months of the memorandum issued by Attorney General Sessions that rescinded the federal government’s previous guidance regarding enforcement of state-lawful cannabis activities under the Cole Memorandum. That earlier guidance is credited with providing the cannabis space with a window of opportunity for the warp-speed growth the space has seen in recent years. The Sessions memo was intended to slow the growth of the cannabis space, especially with respect to the capital markets. The Nasdaq listing of Cronos suggests that 2018 could be another strong year for cannabis-related investments; 2017 was believed to have resulted in approximately $2 billion in cannabis-related investments in the U.S.
Two big announcements this week on the finance side of the emerging global cannabis industry. First, yesterday’s word that the giant alcohol company, Constellation Brands, the maker of Corona Beer among others, is acquiring a stake in Canada’s Canopy Growth Corporation. Canopy is possibly the biggest medical cannabis producer in Canada and is a public company. The terms? $245 million for a 9.9% ownership interest. Established industries like tobacco, alcohol and pharma have stayed away from investing in US cannabis companies since it is still a federal crime to produce or sell cannabis. But the Constellation investment is into a totally legal enterprise in Canada.
Separately, this week we also learned that a large US operator of cultivation and dispensary facilities in the US announced it is seeking to raise a $250 million investment fund for buying into cannabis companies in several US states. While tremendous capital has flown into the cannabis industry, it has come principally from high net worth individuals and family offices. Established venture and private equity funds generally are prohibited from investing in illegal enterprises. Several funds have been established for cannabis investment, but none known to be as big as this one is planned to be.
One can only imagine the deluge of capital that will descend on US cannabis businesses if/when the US federal criminal restrictions are eliminated. We have already seen it happening in Canada, mostly driven by a group of very active investment banking firms. Once the shackles of the federal restrictions are removed, it appears the growth trajectory of this toddler US industry will expand exponentially.
Last week, in a both exciting and sobering press release, Canada announced a plan to fully “legalize, strictly regulate and restrict access” to cannabis in the Great White North. The release starts bluntly: “The current approach to cannabis does not work.”
The government of Prime Minister Justin Trudeau clearly favors both medical and recreational cannabis legalization. They retain strong concerns, however, about the ease with which teenagers are able to obtain marijuana, as well as alcohol and drug-impaired driving. Thus, their new plan, dubbed the Cannabis Act, will strengthen penalties for impaired driving and selling marijuana to minors.
The hope, as indicated in the press release, is to work with the legislature to implement full cannabis legalization by July 2018. A surprising number of great things were invented or developed in Canada: peanut butter, the egg carton, IMAX, the walkie-talkie, the baggage tag and even insulin. Maybe we can follow the lead of our friends to the North and move towards removal of federal restrictions in the US as well, because doing so would eliminate a good deal of confusion regarding applicable federal and state laws, which has inhibited the US cannabis industry. US cannabis industry participants are certainly urged to retain counsel with expertise in navigating the complex regulatory structure here.