The Burns & Levinson 2019 State of the Cannabis Industry Conference concluded with a final panel, covering the current status of the industry’s M&A and other capital markets, finishing off with a look into the future. The capital markets discussion centered on the effects of the industry’s recent nosedive earlier this year and how that has played out the related capital markets. Drawing across a broad spectrum of specialists, from investment bankers and accountants to operators and lawyers, the seasoned professionals on the panel echoed a few key points that those in the industry should be aware of, in adjusting for the capital landscape of the coming months.
The cannabis industry is one that is continuously plagued by public sentiment, for better or worse; as can be seen in the past several days with public company share prices rollercoasting up (when the U.S. House Judiciary Committee approved a bill legalizing marijuana) and down (with the FDA’s recent issuance of warning letters to companies selling CBD), often with daily deltas in excess of 1,000 bps. Over the past several months, the public sentiment and along with it, company valuations, have diminished drastically, as the cannabis market corrects for what has been referred to as overly cavalier multiples. Coupled with the industry’s general difficulty in accessing debt or equity in general, the panel noted that many cannabis companies had been hard hit by the market pullback, with many unable to obtain cost-effective capital or even raise bridge facilities to “wait out the storm.” Unfortunately, many of those companies, who otherwise have healthy business operations, have faced a degree of “guilt by association” endemic in the industry, which has exacerbated the recent capital crunch and piled on stressors to the industry as a whole. However, as panelist Dan Foley of CuraLeaf pointed out, this may come as a boon for those operators that are well-positioned to show real profitability and separate themselves from the rest of the pack, especially those with a cash-rich balance sheet.
While Dan and his team are focusing on becoming self-sustaining, so as not to require injections of outside capital while valuations are low, many other operating companies on the sell-side are seeking to avoid cash deals, if possible. For example, the panelists have noticed a recent M&A trend of sellers (usually in strategic acquisition or mergers) opting to receive buyer equity in lieu of cash. The thinking there being that both seller and buyer valuations are currently depressed in equal magnitudes and the seller will be able to ride the expected upward rebound in market prices, divesting of the buyer equity after valuations have recovered. Even though migration to stock-for-stock deals has buoyed the industry’s M&A activity, there has nonetheless certainly been an identifiable pullback, both in terms of deal volume and overall dollar amount. There is, however, a silver lining associated with the overall general diminution in valuations and slowdown in M&A activity – an increase in investor interest from those not known to regularly invest in the industry.
Whether directly resulting from the cannabis market pullback, a result of recent policy and regulatory reforms, or simply a quest for risk-adjusted returns, the panel noted that a growing number of private equity shops are jumping into the cannabis industry like never before. While private equity has always been in the mix, especially in the form of family offices uninhibited by extensively restrictive LP agreements, more and more shops have been dipping their toes into the industry of late. This is likely, in large part, due to the seemingly low valuations and shortage of available capital, which have made the industry appear to be almost too good to keep overlooking. While more and more existing funds explore entering the industry (often by way of ancillary businesses), the panel indicated that several financiers have been raising marijuana-specific private equity funds, many of which will begin to come online in the next two quarters.
The recent cannabis market crash has sent many reeling, and the ensuing shake-up and adjustments to the capital markets are signs that the pendulum is set to start swinging in the opposite direction. While some have found opportunity in their ability to locate cash during a time of limited access to capital, scooping up distressed assets at discount prices, others have opted to trade their securities in-kind and hope for an increase in industry sentiment to lift the value of their holdings. Despite these current downward pressures on the industry and the difficulties in locating well-priced capital, there is hope on the horizon. A sentiment parroted by the capital markets panel indicates that the heralding of a new age of private equity funds may be coming in the near future – as existing shops enter the space, enticed by discounted valuations; and as new cannabis-specific private investment funds are raised, with an arsenal of dry powered ready to be deployed.