Part 6: Capital Markets, M&A, and Beyond

See Capital Markets, M&A, and Beyond Panel here.

The Burns & Levinson 2019 State of the Cannabis Industry Conference concluded with a final panel, covering the current status of the industry’s capital markets and M&A transactions; finishing off with a look into the future.  The discussion centered on the effects of the industry’s recent nosedive earlier this year and how that has played out in the various related financial markets and asset classes.  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, which those in the industry should be aware of in the coming months, as they adjust to the fluid capital landscape on the horizon.

The cannabis industry is one that is continuously plagued by public sentiment, for better or worse, as seen over the past several days, with public cannabis 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 intraday deltas in excess of 1,000 bps.  Over the past several months, the public sentiment and along with it, company valuations, have diminished in drastic fashion, 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 have been hard hit by the recent retreat of the cannabis market, 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 suffered a degree of “guilt by association” that is endemic in the industry, exacerbating the recent capital crunch and piling on financial 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 cash-rich balance sheets.

While Dan and his team are currently focusing on becoming self-sustaining, so as not to require injections of outside capital during this period of low valuations, many other operating companies on the sell-side are seeking to avoid cash deals, if possible.  The panelists noted a recent trend in the M&A market of sellers (usually in strategic acquisition or mergers) opting to receive buyer equity in lieu of cash, in efforts to mitigate the losses resulting from their selling in a down market.  The thinking there being that (a) both seller and buyer valuations are currently depressed in proximate magnitudes and (b) the seller will be able to ride the expected upward rebound of equity market pricing and the possibility to divest itself of the buyer equity after valuations have recovered.  Even though a 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 size.  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 normally invest in the industry.

Whether directly resulting from (i) the current softening of the cannabis market, (ii) recent policy and regulatory reforms, or (iii) 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 funds have been dipping their toes into the industry of late.  Admittedly, this increased interest may, at least in part, be driven by the current state of the general economy, including recent drops in interest rates and a dearth of committed LP funds available to such investors, in turn stimulating increased appetite for investments in non-traditional industries, as sponsors continue to search for yield.  However, the panel pointed out that the currently diminished valuations in the industry have likely played a significant role as well, making the industry now appear to be too good to keep overlooking.  While more and more existing private funds explore entering into the industry (often in the form of ancillary businesses, at first), the panel indicated that a number of financiers have been raising LP investments for marijuana specific private equity funds, many of which will begin to come online within the next two quarters.

While the recent cannabis market crash has sent many investors and operators reeling, the resulting shake up in the industry and adjustments to the capital markets are signs that the worst may be over, as the pendulum is set to begin 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, anticipating an increase in industry sentiment that will lift the value of their holdings.  Despite the current downward pressures on the industry and the difficulties in locating well priced capital, there is hope for the future.  The capital markets panelists were seemingly unanimous in their consensus that a fresh injection of capital, along with a complimentary increase in M&A activity, is due to arrive shortly.  Leading the charge, a vanguard of newly raised, industry specific, private equity funds are expected to come online in the next few months, with significant arsenals of dry power ready to be deployed.  In tandem, existing finance shops that have been toying with the idea, will begin to enter the space in growing numbers, enticed by the presently discounted valuations.