The cannabis industry has been regarded, for good reason, as one of the fastest growing industries worldwide. And while the potential for this fledgling industry remains immense, it met some significant challenges in the second half of 2019.
A problematic Q3 and Q4, which saw a significant correction for publicly traded cannabis companies, resulted in a pullback from growth capital investors that extended through the end of the year.
According to the Viridian Deal Tracker, CY19 ended with a total capital raise of $11.3B. Comparatively, in CY18, $14.2B was raised globally. Across both public and private companies, there were 530 company financings in 2019 versus 609 financings in 2018. The average raise was $21.3M in 2019 versus $23.3M in 2018.
The cultivation and retail sectors still continue to dominate capital raise activity as U.S. multi-state operators (MSOs) and leading Canadian licensed operators aim to scale existing operations and expand into new markets. The biotech and pharma sector showed an uptick in raises, which is an indicator of continued interest in research and development (R&D), clinical trials, and drug development opportunities.
Despite this shakeup and much-needed reset to company valuations, there are some indications that things are improving, particularly in the U.S. Three of the leading MSOs reported average annualized revenue of $200M in Q3, all with positive adjusted EBITDA, moving ahead of their Canadian counterparts on the path to profitability. In Canada, valuations have plunged to justifiable levels. With the approval for the sale of edibles, vapes, and beverages (“cannabis 2.0”), and the Province of Ontario’s decision to accelerate retail licenses, the Canadian market looks ripe for healthy growth in 2020.
Top of mind for investors, as we enter 2020, is what factors will continue to accelerate this early momentum and drive growth over the next 12 months. To follow are several key drivers of growth that will serve to reignite the booming growth to which cannabis investors have grown accustomed.
Cannabis industry growth drivers in 2020
1. FDA progress on CBD regulations
The U.S. Food and Drug Administration (FDA) announced on March 5th that efforts were underway, both internally and with research partners, to develop a stronger body of data regarding Cannabidiol (CBD). The agency said its immediate goal is to “close knowledge gaps in both safety and potential benefits,” while studying the therapeutic claims many have made regarding CBD products.
The hemp and CBD sectors have anxiously awaited the release of the FDA’s regulations on CBD, which it has previously said is not generally recognized as safe (GRAS). New data could avail CBD to GRAS status, streamlining the release of new products, and freeing up marketing teams to promote brands more effectively. Regardless, clear regulations from the FDA would provide guidance for hemp and CBD companies, which is sorely needed in this burgeoning market.
2. Positive financial results from leading MSOs and Canadian LPs
Revenue growth, declining losses, and clear visibility to positive EBITDA will demonstrate to the industry that efficient operating models and capable financial and operational leadership are in place.
There is evidence of progress. For example, Florida-based Trulieve, which is expanding into California and Massachusetts, projects $380M in revenue in 2020 with adjusted EBITDA of $140M. Similarly, Las Vegas’s cannabis superstore Planet 13 has its sights set on Santa Ana, Calif. in the wake of a strong finish to 2019, where it reported $16.7M and $500k in profit in Q3 alone. Analysts are projecting the dispensary generates $93M in revenue this year.
AYR Strategies reported Q4 Rev of $32.3M, and adjusted EBITDA of $9.2M with 3.9M of cash flow. Annual revenue was $124.2 up 75% from 2018, and Adjusted EBIDTA was $34M The company expects revenue of $207M and $93M of adjusted EBIDTA in 2020
Finally, Liberty Health Sciences, the Florida-based company that operates 23 dispensaries as of this writing, reported an operating profit of CA$1.75M. The strength of the cannabis industry is not abstract; real companies are experiencing booming growth even in the wake of a challenging finish to 2019.
Further, many MSOs and LPs will be adopting U.S. generally accepted accounting procedures (GAAPs), as most of their shareholders are American. This will create less variability than existing International Financing Reporting Standards (IFRS) accounting procedures. It is expected that Canopy Growth, Cronos, Green Thumb Industries, iAnthus, Village Farm, and others will adopt these procedures.
3. Demonstration of best practices in corporate governance
From alleged insider dealing by officers and board members — and, in some cases, dismissal of founding teams at companies like MedMen, Aphria, Namaste Technologies, and others — to supply chain breaches from CannTrust, directors are now getting the message about director independence and policies that guard against conflicts of interest.
4. Successful launch of adult-use markets in Michigan and Illinois
Two major Midwest markets began adult-use sales to non-medical patients over the last 12 weeks. In its first month, adult-use cannabis sales in Illinois were $39 million. From December 1, 2019, to February 2, 2020, Michigan sold $17.7M of cannabis products at 26 retail locations. Other states will learn from the tax policies, licensing policies, and social equity programs in densely-populated cities like Chicago.
5. Northeast states approving adult-use programs
On January 8, 2020, New York’s Gov. Andrew Cuomo declared that New York State would legalize cannabis in 2020, including plans to incorporate expected tax receipts in the state’s 2020 budget. Last year, the effort fell short in the state senate by two votes due to a failure to compromise on the allocation of tax receipts and opt-out options for local governments. If New York approves adult use, the pressure to adopt similar programs will be felt by New Jersey (where a ballot referendum is planned for November), Pennsylvania, and Connecticut (where state lawmakers just submitted an adult-use legalization bill on behalf of the governor). That would lead to a boom for new licensees, brand developers, and ancillary companies in the region.
6. Continued enforcement increase and change to tax structure in California
In 2019, California raised its taxes to the point where the price of legal cannabis is ~50% higher than readily-available illicit products. This predictably drove sales to the underground market and created a supply/demand imbalance. It is estimated that about 9 million pounds of cannabis are legally grown annually, but only about 2 million pounds are consumed. California’s Gov. Gavin Newsom has recently vowed to streamline the oversight of tax collection and has made private comments to friends of ours in the VC community that he will fight to reduce the tax burden to better support compliant businesses.
7. Successful roll-out of Cannabis 2.0 in Canada
In October 2019, Health Canada approved the sale of edibles, vapes, and topicals. It is not expected that these new products will hit the shelves just yet due to licensing requirements and manufacturing lead times. Canada’s cannabis industry will likely reach CA$3.7B by the end of 2020, more than double the CA$1.6B in 2019. Sales of edibles, vapes, and topicals will account for CA$900M.
8. Passage of the SAFE Banking ACT
The U.S. House of Representatives passed the Secure And Fair Enforcement (SAFE) Banking Act by a vote of 321 to 103 in September 2019, with 91 Republicans voting in favor. On December 18, 2019, Senate Banking Committee Chairman Mike Crapo (R- Idaho) voiced his opposition to the bill, ending all hopes for a vote on the legislation before year’s end. Chairman Crapo expressed concerns about the bill and other aspects of cannabis policy not related to banking such as limits on potency, marketing tactics aimed at children, and the prevention of bad actors accessing the financial system. On January 16, 2020, a coalition of more than 30 national and state cannabis industry organizations sent a letter to Crapo urging him to advance the House-approved version of a bill. Although presently stalled, most believe that the legislation will pass in 2020, improving financial transparency in the cannabis industry.
The cannabis industry is poised for growth based in reality in 2020
The challenges the cannabis industry encountered in the second half of 2019 mostly represent inflated valuations and unrealistic expectations coming down to earth. Rather than panic, investors should recognize this as a moment to capitalize on the immense potential for healthy, stable growth well into the future. The eight key drivers of growth listed above will play a significant role this year and beyond as the cornerstones of an industry with a long way yet to go. And with more states ready to legalize cannabis and open up new markets to this dynamic and innovative industry, there is much reason for optimism.