By Mitchell Baruchowitz, Kristin Fox and Glenn Taylor
When Cowen and Company released its report on September 12, 2016, titled “The Cannabis Compendium: Cross-Sector Views on a Budding Industry”, it confirmed the views of many across the cannabis industry. It was a welcome report as much of the analysis and metrics around investment in the space have been left to cannabis-specific analytics companies such as New Frontier. Cowen should be applauded for giving the emerging sector a thorough review and analysis from a more traditional public markets perspective. At the same time, because of the existence of a Canadian national health care law, larger investment firms in Canada have been far more active in both the public and private markets for cannabis companies and in many ways have helped drive the broader cannabis industry forward while the large investment firms in the U.S. have stood idle. This has led to a narrow channel for cannabis companies in the U.S. to exist publicly, primarily through reverse mergers to the Bulletin Board, and in the rare case, a Nasdaq listing. The effect of the Cowen report was no small thing. Equities directly relating to cannabis surged almost immediately and it is instructive to look at that surge to see what the future of cannabis is as it evolves and more companies trade publicly in the U.S.
For participants in the industry from the investment side, like our firm, Merida Capital Partners, Cowen’s report was a welcome validation of our perspective that the “infrastructure” of the cannabis industry offers an incredible long term growth opportunity as the industry surges forward. However, the Cowen report also showed the limitations that traditional financial channels in the U.S. have in assessing an industry that is among the most fragmented in history. The dizzying matrix of local laws, and the difference in both adult use laws and medical laws from state to state have created the most incredibly entrepreneurial ecosystem of private companies which cannot be captured by a research report, or a financial firm, which strongly focuses on public equities. Kush Bottles(KSHB), which was covered extensively in the Cowen report, now trades at something near 25 times their likely 2016 FY revenue. Granted, not many ancillary companies(i.e. companies that support cannabis business but do not touch the plant) have achieved even $8MM of revenue. And so with no judgments attached, the premium valuation on a company that made ~$32,000 in Net Income in the first half of 2016 is instructive about the types of multiples companies might see at points in time because of the macroeconomic facts of the cannabis industry and the difficulty in properly pricing its growth trajectory.
KSHB was not the only company to gain value aggressively since the Cowen Report. Massroots(MSRT), MCIG(MCIG), TerraTech(TRTC), American Cannabis(AMMJ), General Cannabis(CANN), Two Rivers(TURV), GreenGro(GRNH) and Cannabis Sativa(CBDS), Surna(SRNA) as well as many other companies, have moved up quickly since September 12. And for the most part, the cannabis sector, including even the largest company in the entire sector, GW Pharmaceutical (GWPH) are trading far in excess of traditional market metrics. Before going further, we want to make clear that in no way are we assessing the relative valuation of any company mentioned here or any public company in the sector. But our experience tells us that companies trading at 10, 25 or 50 times revenue or even more in some cases, are rare in the broader stock market over a sustained period of time. The list of such examples is long right now in cannabis. This is not to point out that these companies are overvalued, because we are not saying that at all. We want all of these companies to succeed and wish them nothing but good tidings. Rather we are highlighting that the market, and U.S. investors as a broader group, seem to be ready to embrace cannabis equities at higher valuations because the ecosystem of cannabis, be it health care, or retail consumer brands, or a grow consultancy, is going to grow faster than any sector of the market and will touch many traditional areas of traditional public equities. It is quite likely in fact, that these higher valuations will allow companies who are just developing to succeed as capital becomes easier to access through higher stock prices and better trading volumes. We do not believe that it is coincidence that this surge occurred right after the Cowen report was released.
The Cowen report merely opened investors eyes to the fact that the industry is moving forward quickly. And real companies are emerging from the early explosion of entrepreneurialism. Which brought a surge in the search for value in the sector which in turn drove buying in the aforementioned stocks and a long list of stocks not mentioned. The Marijuana Index(www.themarijuanaindex.com
) was at ~$76 when the Cowen report came out. It now stands at $144 but was as high as $165 on October 24. Why is this relevant to a private equity firm like ours? At Merida, we focus on the companies supporting cannabis businesses and their supply chains that have already jumped the “fragmentation chasm”. For us, this means cultivation equipment, technology, software and optimization tools that have achieved a significant amount of critical mass in their businesses. As the market now reflects, and we believe will reflect going forward, successful companies in the space will trade at valuations much higher today because of the underlying growth in the general cannabis sector. And with valuations moving up and the public attention on such the equities in the space, access to capital and the normalization of cannabis as an industry will accelerate which will bring more companies into the public space, and a further broadening of the equities investors can choose from.
That especially applies to the health care and life sciences sector which Cowen’s report spent the second half of its report on. As we constantly detail, cannabis is a widely diffuse industry and this also applies to the health care sector where small processors are developing formulations, medicines, and products that can all be accessed by patients without FDA intrusion. This will clearly change over time but by then, it is likely that traditional pharmaceutical or life science companies will look to acquire the most novel innovators. This has encouraged companies in almost every state to use sophisticated extraction equipment and precision tools, from companies like Waters Co.(WAT) to make pure cannabis oil and more refined products for patients to relieve everything from chronic pain or PTSD, to high-CBD/no-THC products addressing pediatric epilepsy.
We marvel at the inventiveness of the cannabis market and its operators every day and we believe investors will have a greater chance to invest in incredible companies on the private and public side as more attention is paid to deserving companies. Each and every company we listed, and the many we didn’t, who are publicly traded deserve credit for the pioneering nature of their effort, as they have brought to the broader market opportunities which have now allowed the financial markets to observe at least some small slice of the emerging industry.
We again applaud Cowen for the effort and work they put in to put that observation to paper, express it so well to investors, and for doing for the U.S. public cannabis stocks what many large firms are already doing in Canada: treating the industry with the attention and respect it now deserves. We look forward to reading a deep dive into approximately $1 billion in investment in this unique industry, to be released by New Frontier Data and its partners in January 2017, and gaining further visibility into post-election and post-California opportunities in this sector.
About the authors
Mitchell Baruchowitz is the Managing Partner of Merida Capital Partners, a private equity firm focused on cannabis infrastructure companies, and seats on New Frontier Data’s Board as one of its lead investors. Kristin Fox is the Editor in Chief of MJINews, has spent 25 years in the hedge fund industry, and is a member of the Advisory Board of both Merida and New Frontier Data. Glenn Taylor is the former Group President of Medco, which was sold to Express Scripts in 2013 for $29 Billion and is currently the Head of the Advisory Board of Merida.