Despite COVID induced headwinds, the cannabis industry has thrived in 2020 while many other industries have struggled. Financial, structural and regulatory drivers have continued to thrust the sector forward. As we enter 2021, the listed cannabis stocks have now delivered nine months of positive share price growth and, driven by a number of positive tail winds in 2020, the sector is primed for further growth this year. The medical cannabis sector is already a viable alternative asset class that investors should be seeking exposure to via Verdite Capital. Underpinned by our $75m cornerstone family office investor, we expect to hit our first close target of $100m by the end of Q1 2021 and to start deploying into a number of extremely exciting investment opportunities we have already identified shortly thereafter. For those interested in hearing more, please contact the investment team here.
2020 CANNABIS SECTOR HIGHLIGHTS
Multiple progressive regulatory advancements in North America and Europe
UN reclassification of cannabis given medical benefits
FCA clarifies the UK listing requirements for medical cannabis and CBD companies
EU Court of Justice declares that CBD should not be considered a narcotic
US House of Representatives passed the ‘MORE Act’ to legalise cannabis
5 US states voted to legalise cannabis in 2020; medical cannabis is now legal in 35 US states and available to over two thirds of the population
Capital raising has fallen 70% from 2018 peak
M&A activity starting to pick up again
Global legal cannabis industry grows 38% in 2020 reaching almost $20bn
Public cannabis stocks bottomed out in March and ETFs have risen 55-170% since
1. Progressive legislative and regulatory changes are rapidly transforming the global industry
Global demand for cannabis products is estimated at c.$344bn annually. The ability to convert existing sales from the illegal to legal channels is primarily being driven by regulatory changes which will accelerate that switch over the next decade. The last quarter of 2020 was a phenomenal period for progressive regulatory changes, providing greater freedom and access to cannabis and helping further position the global industry towards a fully legal framework. Below we review a few of the key legislative changes:
UN cannabis reclassification:
What happened? In December 2020 the UN Commission on Narcotic Drugs, on recommendation from the World Health Organisation, agreed to remove cannabis from Schedule IV, a categorisation reserved for drugs with no medical benefits.
What does it mean? For the first time the UN has publicly recognised the therapeutic and medical benefits of cannabis. The removal of this structural barrier will now provide countries around the world with greater freedom to implement regulatory reform in relation to cannabis, in particular when it comes to medical cannabis. The change is a substantial development and will be a significant boost to the rapidly growing industry. Every new country that implements a legal medical programme immediately opens up a multi-billion $ market opportunity that companies can now legally address for the first time in over 80 years.
UK Financial Conduct Authority (FCA) listing clarification:
What happened? In October 2020, the FCA provided long awaited clarification for the UK listing requirements for companies involved in the cannabis sector. In short, medical, pharmaceutical and wellness companies are now able to consider listing on the London Stock Exchange opening up yet another global financial market to the industry.
What does it mean? We now expect to see several healthcare focused cannabis companies listing on both the LSE Main Market and AIM in 2021. While the US and Canadian exchanges have been the primary locations for cannabis companies going public, we will now start to see such companies listing in London for both primary and secondary capital access. We also anticipate other exchanges around the world following suit in 2021.
EU CBD ruling
What happened? Following a case between a CBD vape manufacturer and the French state, in November 2020 the EU Court of Justice ruled that CBD should not be considered a narcotic.
What does it mean? The landmark case provides clarity around the legal status of CBD in the EU. The ruling applies to the whole customs union and effectively allows the cultivation, formulation and supply of CBD as wellness products to now develop in countries all across Europe boosting the cannabinoid industry and opening up new markets, new products and will help drive significant sector revenues.
Passing of the MORE Act in the US:
What happened? In November 2020 the US House of Representatives passed the Marijuana Opportunity Reinvestment and Expungement Act (MORE Act).
What does it mean? If passed into law at the Senate, the Act would remove cannabis from the US schedule of Controlled Substances bringing an end to the contradiction between current state and federal cannabis policy. This would be a major boost to the industry and would open up the capital markets to the sector. US companies would be able to list on the major US exchanges, and trigger a wave of institutional investment into the industry. The senate will vote on the bill in 2021. The MORE Act would be expected to generate substantial income for the US treasury, as well as reducing the pressures on the federal prison system. According to a non-partisan report by the Congressional Budget Office (CBO), the MORE Act would likely generate $13.7bn in taxes and cut nearly $1bn in federal prison spending over the next decade.
Passing of the SAFE Act in the US:
What happened? In May 2020 the US House of Representatives passed The Secure and Fair Enforcement Act (the ‘SAFE Act’).
What does it mean? If passed into law by the Senate, the SAFE Act would allow US cannabis companies to access banking services for the first time, removing one of the biggest hurdles for the growth of the industry in America. The industry would be able to move away from the predominantly existing cash-only system and be able to secure debt finance to grow.
Five US States passed legalisation:
What happened? During the November 2020 US elections, all 5 states in which cannabis regulations were on the ballot voted to legalise (New Jersey, Arizona, Mississippi, South Dakota and Montana).
What does it mean? This brings the total tally of states with legal medical cannabis to 35 and with legal adult-use cannabis to 15. This equates to over two thirds of the country’s population with access to medical cannabis and one third with access to adult-use. New Frontier Data estimate that these five states alone will add $9bn of incremental legal revenues between 2022-2025.
2. Growth capital remains scarce creating a unique opportunity
What happened? Following the ‘Green Rush’ of 2018, during which almost $14bn was invested into the sector, access to growth capital has reduced considerably. In 2019 $11.3bn was raised, a figure somewhat inflated by a handful of major raises that occurred in Q1 of that year. 2020 saw an even more substantive fall, with just under $4bn being raised. Simultaneously, the average size of capital raises has dropped from a peak of $23m per transaction in 2018 to $14m this year.
What does it mean? Despite the significant growth being exhibited by the industry, access to growth capital supply, even for the fastest growing and best run businesses, remains challenging. However, for sophisticated investors, this current imbalance provides the opportunity to deploy growth capital tickets into some of the best opportunities in the sector on highly attractive terms. Private equity investors in the sector now how significantly more purchasing power than they did 12 or 24 months ago.
3. M&A transaction decrease in total but major transactions are on the rise
What happened? Completed M&A activity decreased 71% YoY, but the number of deals over $750m has risen resulting in a decrease of just 47% in total capital consideration through the year. Major transactions by Curaleaf, Cresco and Aphria have dominated the M&A landscape and activity appears to be accelerating going into 2021. Viridian has tracked a total backlog of nearly $2bn in announced but unclosed deals, not including the $4bn reverse takeover of Tilray by Aphria.
What does it mean? The activity provides further evidence that the industry is continuing to move from extreme fragmentation towards organisation which is typically consistent with value creation. There are now 9 multi-state operators (MSOs) with market caps above $1bn and more are expected to list in Q1 2021. The major players are starting to consolidate and the merging of Tilray and Aphria will form the world’s largest cannabis company, with a combined legal revenues of around $685m. Significant SPAC (Special Purpose Acquisition Company) transactions have also been announced for 2021 and with almost $3bn raised into cannabis SPACS in the last 3 years, there will be more to come next year. Strong industry activity is a positive signal for investors and we have yet to really see the arrival of blue chip companies from other large consumer sectors such as alcohol, tobacco and FMCG.
4. Against the COVID backdrop the legal sector grew 38% to $20bn
What happened? In a turbulent year, global legal cannabis sales are estimated to have grown 38%, reaching almost $20bn and in the process overtaking the size of global music recording industry, even at this early stage of its development. In fact during the pandemic lockdown, many US states deemed cannabis retailers ‘essential service’ businesses that could remain open against wider shutdowns.
What does it mean? Amidst many other sectors that will struggle to grow over the next few years, the cannabis industry’s impressive growth is forecast to continue. A compounded annual growth rate (CAGR) of 22% is expected over the next 5 years and global sales are forecast to reach $47.2bn by 2025.[1] Again, this is further evidence that the sector is a genuinely viable alternative asset class that can deliver significant outperformance for investors.
5. Public market valuations bottomed in March 2020
What happened? Following a tough 2019 for listed cannabis stocks, prices of publicly traded cannabis companies have rebounded materially from March 2020 lows. Appreciation has been driven by a combination of strong Q2 and Q3 financial metric performance, US election results, anticipation of change to the current Federal illegality, and ongoing M&A news. All eight of the cannabis ETFs we tracked are up between 55-170% from March lows..
What does it mean? We believe that 2020 has marked the lows in the sector sell off. The financially weaker and poorly managed public companies are falling by the wayside while the strong companies are starting to deliver and command institutional investor attention. However, in the private markets the strong well-run businesses are still struggling to access growth capital such that there still exists a significant arbitrage between private valuations and their strong growth potential. That remains the compelling opportunity for Verdite Capital being a $200m growth capital fund focused on the cannabis healthcare sectors.
6. Summary
The medical cannabis sector has further highlighted its status as a viable alternative asset class in 2020 and one all sophisticated investors’ should consider including in their investment portfolios. The sector has strong momentum heading into 2021 and existing structural catalysts are expected to maintain this trend. The Verdite Capital investment team has identified a number of compelling investment opportunities that we hope to execute on following first close. We currently have $80m secured and we expect to reach the first close target of $100m by the end of Q1 2021.
We would welcome the opportunity to discuss the sector and the Verdite fund with you. If you wish to do so, please email Verdite@chrystalcapital.com.