Cannabis Investment Themes During COVID-19

Show Notes

What are your thoughts on cannabis regulations changing at the Federal level in the United States? 

• While the United States is a dominant global superpower, there are treaties in place that dictate international drug policy. The United Nations (UN) and the World Health Organization (WHO) implement international drug policies and make changes to them. Some of the treaties that the United States has agreed to include; The Single Convention on Narcotic Drugs of 1961 and The Convention on Psychotropic Substances of 1971. 
• Before we see federal legalization in the United States, we will likely see decriminalization similar to Portugal. Medical cannabis will take priority as laws change. 
• Legalizing cannabis at a federal level under current international conventions would put the United States in clear violation of international law and likely have consequences related to the manufacture, import, and export of pharmaceuticals and psychotropic substances. 
• When it comes to federal legalization, our industry is so nascent. It's not ready to be federally legalized. We do need decriminalization; we need the war on drugs to stop. We need to stop putting people in jail for having a gram of cannabis and ruining their chances to get student loans or jobs in the future, especially if they're using it for medicinal reasons. 
• The next four to five years are just an opportunity for the industry to mature in each legal state and jurisdiction. Companies will grow and continue to expand their market share, develop new products, and deepen their understanding of consumer trends. When federal legalization occurs, the industry will be primed for strategic M&As, real IPOs, and disruption as interstate commerce changes the landscape. 
• We need federal reform that restricts the use of federal funds to interfere with state-legal medical and adult-use cannabis programs. 
• With hospitality and tourism way down, municipalities and states will increasingly look to cannabis legalization to increase tax revenue and create local jobs. 

Considering the current circumstances, what are your thoughts on cannabis investments? What do you like? Distressed assets? Limited license opportunities? Cash flow companies?

• When comparing last week's data with that from a year ago, there were almost 15 times more direct investments in the cannabis industry during the same week the previous year. 
• Consumer spending is down, but cannabis sales remain up. 
• The plant itself is recession and depression proof. The cannabis industry not so much. 
• Cannabis businesses have been unable to receive federal support due to the industry's illegal status. 
• As many investors backed out as the pandemic unfolded, companies that were growing and scaling on a healthy trajectory lost access to capital. A lot of money has come off the table.
• Investors have been attracted to public cannabis investments as they provide quick liquidity. 
• For businesses across the cannabis industry, the priority is to survive and weather the storm. Many companies that were doing great are now struggling to secure the capital to keep the doors open. 
• Businesses have had to adapt fast and implement entirely new operating procedures to meet changing regulatory requirements. 
• The best investment opportunities that I see right now are ancillary and hands-on companies with proven track records, positive reputations, and cash flow that need a little extra capital to stay in business. 
• There are many licensing opportunities available right now, and the competition is less than before in specific markets. My stance on licensing opportunities has remained the same as it was pre-COVID. I look for new markets with limited licenses that either have adult-use or comprehensive medical programs. An excellent recent example of a market that met these qualifications is Illinois.
• A significant challenge has been the disruption of supply chains. Cultivation, extraction, and manufacturing operations all require specific components to operate, and it's getting harder and harder to order certain goods. Many ancillary product manufacturers are raising their prices, creating opportunities for domestic producers to capture market share.
• There have been a few public companies, investing in ancillary product manufacturers that produce goods for commercial-scale cannabis operations, a wise move when you look toward where the industry is headed long term. 
• Creating and operating a startup is always an uphill battle. Founders and employees get burned out. During the pandemic, we've seen the burnout escalate. Founders are looking for an exit and are ready to sell at low valuations. We've seen a few companies that are cash flow positive but need to invest another $10 million to scale-up their operation, but they would take a full exit right now as they don't know what the future holds. 

When looking at investments, what signs do you see that make you say, no, not interested? When do you walk?

• As an investor, it's always what you say no to that's more important than what you say yes to. 
• There is a lot of hype about cannabis businesses. When I first look at an opportunity, I look at it like any other business, and if the team, the idea, the financials don't make sense, then it's not attractive to me. 
• Key things I look for include:
• What is your strategic advantage? 
• What's unique about your company that no one else is doing? 
• Is it protectable? 
• Is it scalable? 
• Is there a possible exit?
• If it's a hands-on company, I ask the following questions:
• What's the local municipality?
• What's the state?
• What's the trajectory for that state for adult-use legalization? Or how's the adult-use legalization going? 
• What are the neighboring states? 
• How many licenses did they issue locally and statewide? 
• What are the taxes?
• What are the costs of maintaining the license? 
• What's the management team like? Do they know cannabis? Do they know outside industries? Outside industry experience is much more important to me than just having some unique way of growing or a new lighting technology.
• If a company is not forward-looking, I'm not interested. While I'm grateful for the small mom and pop operators who have been making medicine for the people for years, their production cost is so high compared to a large scale company. The industry's long-term trajectory is toward production and manufacturing at scale, intellectual property, and drug discovery and development. Many pitches I see currently aren't looking to the future. 
• In the short term, we will make our money in U.S. companies. It's one of the world's largest cannabis markets, and sales are growing. But the international arena is where we are looking long term as it will be much more profitable. I expect to see Active Pharmaceutical Ingredients (API) for medical purposes and adult-use products imported to the United States in time. 
• Right now, we have to operate in small regional markets. So I look for unique products with market share that do not have past mistakes (recalls, workplace safety violations, etc.), operational problems, or lawsuits. 
• Acronyms like CBD are almost instantaneously a NO. The market for CBD is far too saturated. We need more research on CBD and other cannabinoids.
  

Let's follow on to that with some talk about diligence. You've covered some of these items in what you just said, but how do you evaluate a deal and identify issues?

• The numbers don't lie. Trust, but verify. 
• Existing companies looking to raise capital need to work with a CPA, a controller, or an outsourced CFO to put together audited financial statements. 
• Specific details I look for include:
• How much money did you start this company with? 
• How have you been using that capital? How have you redeployed capital strategically? I need to be able to trust you with my capital or my LPs capital.
• Do you have all of your legal ducks in a row? 
• Is the company formed correctly? 
• Do you have a board of directors? Who are they? 
• Stock options? Warrants?
• Is the company protected?
• Do you have a data room? Is it thorough, organized, easy to navigate? Running compliant cannabis businesses requires organization and attention to detail.
• Do you have a detailed business plan?
• Do they have the licenses they say they do? So much of this is public record.
• How transparent are they? 
• Who are your other owners? 
• What's your five-year plan? If you don't have a clear answer to this, I'm out. With this capital, you're supposed to get bigger, expand your market share, and be a more impactful company than you are today. If you don't have a clear vision of where you are headed, will you spend this money wisely tomorrow?
• What is your projected cash flow? 
• How will you deploy the capital? 
• What is your monthly burn rate for staffing, payroll, marketing, branding, legal, and tax compliance?
• What are the line items in your budget that will help you grow your business?
• What does your next stage of growth look like?

Let's talk about global markets for a second. Which global markets are you looking at next? Where do you think the best opportunities are?

• Cannabis is a dioecious plant meaning that there are male and female plants; they make one crop per year, go to seed, then die and come back the following year. Equatorial regions are the most advantageous to grow cannabis. 
• I look for markets that can grow the plant inexpensively at a high standard of quality in countries with favorable pharmaceutical compacts that will open the doors to bulk oil and flower export. 
• I also look for countries that have set up their laws and policies with the International Narcotics Control Board. 
• Cannabis programs need to be well thought out to ensure that local patients are taken care of and international export opportunities exist. 
• Mexico
• I've been excited about Mexico for years, but it's become a mess with all of the regulatory delays and the meddling of Canadian public companies. I think Mexico will be an excellent place for hemp and adult to use tourism in the future, but it's not going to be an international medical cannabis leader. 
• Colombia
• Colombia has a really good law but some problematic processes at first. While the country is near the equator, there are many microclimates from coastal regions to high mountains, so the right location is crucial. The country's history of narco-terrorism and unstable governments is not to be overlooked. That said, there are massive opportunities in Colombia. 
• Peru
• Commercial cannabis licensing is underway. 
• Brazil
• I think Brazil will be a nightmare, great for hemp in the future, but problematic in the near term. 
• Portugal
• Portugal has amicable laws and licenses and could become a leading EU-GMP bulk Active Pharmaceutical Ingredient (API) producer. It will also likely be a bridge for countries outside of the EU to import and process materials for the European market. 
• Asia
• Malaysia and the Philippines have some very unique economic opportunities. 
• Australia
• Australia had some opportunities early on with their medical programs, which is getting better. Similar to South Africa, this is not the best climate for production.
• Internationally, I look for countries that are the least unstable with the best regulations, the best agricultural climates, favorable pharmaceutical laws, and that have not had issues with the International Narcotics Control Board (INCB).
• Israel
• A leader in medical cannabis drug development, drug discovery, and research. Some problems with tax, political instability, and not being a member of the European Union. 
• Each country has its strengths and weaknesses. That said, I'll never put all my eggs in one basket. 
• Once the UN reschedules cannabis, the international medical market will explode, but this is not guaranteed in the short term. You'll want to be involved with companies in various countries before this occurs, or you'll be too late. 
• All this said, even if you're in the best country with the best laws, nothing is guaranteed. Companies fail there is fraud, deceit, misappropriation of funds. Governments can revoke and reassign licenses. Diversification is key. 
• International investments will require a long hold position. 

Let's talk about investment vehicles. Special Purpose Acquisition Companies (SPACs) have become all the rage on Wall Street these days. We've seen a few pop up in cannabis as well. What are your thoughts on SPACs as vehicles? How will they play a role in cannabis in the future?

• 
  SPACs are tremendous, and they've raised over $2 billion that's just sitting dry powder ready to go to work. Most of the SPACs created their investment thesis and mandates before coronavirus, and unfortunately for them, the market has shifted. So many are sitting on capital that they can't deploy. 
• I think some strategic SPACs for merging single state operators is a great opportunity. For example, in California, take a quarter billion dollars and rolled up as many licensed dispensaries as possible into a single company. That type of vehicle would be incredible as many operators are desperate right now, and there is no federal bankruptcy protection.
• Venture funds are another good candidate, but 70% of them have no idea what they're doing in the industry. Many have financial industry experience but don't understand cannabis and get distracted easily by shiny things. A few are doing pretty well. 
• Even considering the small fee structure, the right fund managers can make a difference because they know the space and access the proper deal flow. 
• Real Estate Investment Trusts (REITs) are also phenomenal because operational companies need property, fixtures, and equipment, and it provides investors with an asset-backed, much more secure investment. Additionally, licenses in many jurisdictions are attached to the specific parcel of real estate; therefore, operators must maintain their leases to stay in business. 
• There are also many direct private placements, private companies that need capital. Some are great opportunities, but I don't put all my eggs in one basket, as I said. 
• Many companies are going to fail, but we're not going anywhere. 
• I'm looking at the horizon friends, it's gray, it's shitty, and it's going to worsen. But the opportunities are vast. So find a good umbrella and do your homework.
  

Resources Mentioned

• World Health Organization (WHO) - Cannabis
• United Nations
• Single Convention on Narcotic Drugs, 1961 
• Convention on Psychotropic Substances, 1971
• International Narcotics Control Board (INCB)