Better value in this emerging industry can be found south of the border, writes Nawan Butt
Better value in this emerging industry can be found south of the border, writes Nawan Butt
Canada is the global trailblazer in the cannabis industry. In the past five years, we’ve witnessed the incredible growth of Canadian licensed producers and even their development into US multi-state operators [MSOs]. To say that the cannabis trade has caught the attention of mainstream investors would be an understatement.
Potential investors in the cannabis sector often assume that their safest bets are exclusively Canadian companies. It’s a fair assumption, given the rate at which Canadian companies have flourished since the legalization of recreational marijuana. The Canadian market has the infrastructure for service and is building quite the impressive track record. But it’s important for investors to keep in mind that the global cannabis industry is still in its infancy and has a lot of room to grow, which presents even better opportunities beyond our own borders.
The massive international market remains underserviced, but participants are quickly finding their feet as regulations are increasingly clarified. To keep pace with the market and industry, investors need to expand their horizons and consider global opportunities, particularly those in the US.
Cannabis is still illegal at the federal level in the US, despite its popularity and acceptance in the states where it is legalized. Cannabis is currently legal for medical use in 33 states and for adult recreational use in 10 of those states. However, federal illegality still makes it difficult for MSOs to access most avenues of local funding. It also means US cannabis companies must list in Canada when they go public. And even when they do, the companies are limited to listing on junior exchanges.
In spite of these restrictions, the US cannabis industry continues to thrive. In the past year, we saw several reverse takeovers and initial public offerings of US companies in the Canadian marketplace, which were significant contributors to our portfolio’s performance in their respective quarters.
The lack of traditional financing availability pushes MSOs to aggressively raise cash through secondary equity financings. These companies are racing toward consolidation, with the speed of the land grab acting as the pricing multiple of choice, and therefore capital available for acquisitions is very valuable. This financial pressure only increases as state regulations open up at a faster pace than many expected. While Canadian producers continue to experience a valuation premium to American companies, investors should expect this to shrink over time as the larger MSOs gain increased regulatory legitimacy and access to capital.
A prime example of this is the innovative contingent deal between Canopy Growth Corporation, the Canadian industry leader, and Acreage Holdings. In April, Canopy announced it had secured the right to buy Acreage, a retail distribution and cultivation business with licences to grow or sell cannabis in 20 states. Acreage’s footprint reaches a potential 180 million Americans. It’s among the five largest American cannabis companies based on market value, and Canopy is set to pay the $3.4 billion price tag once the US legalizes cannabis federally.
This transaction sets precedence for MSOs to become part of the global push toward wider acceptance of cannabis and to obtain financing to bolster their growth in the US. It also gives proof of better relative value creation opportunities south of the border.
Even though focus has shifted to the US and international plays, it’s still important to recognize the leadership value of Canadian producers. As they follow Canopy’s lead, they will further facilitate the proliferation of the cannabis industry globally. However, investors should acknowledge the sector’s infancy and recognize there will be volatility as companies experience growing pains and consolidation.
But the prospects for the winning companies remain bright. In the past several months, we have focused on investment opportunities in MSOs, as well as Canadian companies with strong operational results and well-defined growth strategies.
While it’s easy to get caught up in the excitement of a budding industry, it’s important to remember that due diligence is extremely important. Not every company and investment can be a winner. Investors need to commit to being ahead of the curve, not riding it, if they want to stay ahead in this competitive and dynamic industry.
Nawan Butt is an associate portfolio manager at Purpose Investments, where he manages the Marijuana Opportunities Fund. He is a CFA charterholder with a master’s degree in finance from Simon Fraser University.
