Business

“A Bright Spot:” Weed Investment Pros are Bullish

avatar Dan Mitchell / Jun 18, 2020

A pattern has emerged in the still-brand-new, still-precarious legal-cannabis industry: investors pour their money in, something happens to scare them off, and then they carefully step back in.

This is not unique to cannabis, said Emily Paxhia, managing partner at Poseidon Asset Management, during an online confab with other investors last week. “With emerging markets,” she said, “these types of cycles are not only inevitable, they’re necessary.”

She ticked off a few such instances. There was last year’s vape scare. Before that, then-Attorney General Jeff Sessions (R) rescinded the Cole Memo, an Obama-era directive that federal law enforcement should de-prioritize enforcement of pot laws in legal states. Cannabis stocks took a dive.

Even seemingly minor events can worry investors. “When Maureen Dowd ate a chocolate bar and freaked out in a hotel room [in 2014], capital ran from the space,” Paxhia said during the conversation, which was produced by CannabisLAB.

The companies in Poseidon’s portfolio, which include Flow Kana, PAX, and Sparc, are run mainly by “heads-down guys” who are prepared for unpredictable capital flights, she said. They were prepared when cannabis stocks started to tank in early 2019, and during the vape scare, she said. She said they’re prepared now for the deep uncertainty surrounding the industry today.

The pandemic itself still presents plenty of risk. But all the participants agreed that, so far, it’s nowhere near as bad as it might have been. This owes to state governments declaring legal weed to be an “essential” business.

The problem is that nobody knows how far the economy might sink, and what effect that might have on consumer demand. “I would now add social unrest and maybe even a constitutional crisis as potential risk factors,” Paxhia said.

The general consensus among the call’s participants: there’s still plenty of risk, but, the future looks promising. And it looks more promising the further out you go.

Even if a deep recession hits, “cannabis still stands out as a bright spot,” said George Mancheril, CEO of Bespoke Financial, a Santa Monica, Calif. firm that specializes in debt financing. Matt Hawkins, managing partner of Entourage Effect Capital, summed things up: “The cannabis industry is actually in pretty doggone good shape right now.”

Pressure on Government

Of course, these things are relative. And the business could be in much better shape. It’s still reeling from last year’s pot stock crash and vape crisis. And in California and other states, taxes and regulation remain onerous. But the main problem remains that cannabis is federally illegal. 

Many  industry insiders have said, the pandemic could accelerate that outcome at the federal level. Thanks to the shutdowns, “governments are hemorrhaging cash,” said moderator Jonathan Robbins, a Florida attorney who heads the cannabis practice at Ackerman LLP. “Is this an opportunity?”

Yes, the other panel members responded. Or anyway, it could be. State and local governments will be looking to tap all potential revenue streams. 

The same holds true for the federal government. The pressure is mounting, as Canopy Growth CEO David Klein said on CNBC this week. With each new legal MED or REC state, “You really bring in almost two more senators each time who are really going to feel compelled to not make criminals out of the people in their state.” He said he expects national legalization by 2022.

With “grass roots” support pretty well in place, “now we need grass tops support,” said Matthew Nordgren, founder and CEO of Los Angeles-based Arcadian Fund. He means legislators, but also institutional investors. “This is an industry with $16B in revenue [last year] but public companies have only 5 to 7% institutional support. It’s quite remarkable.” If that level of support ratcheted up by only a few percentage points, it “would change everything for the industry.”

It’s likely to be much more than a few points. The participants agree there’s a giant pool of capital waiting to be poured into cannabis. It’s waiting for the feds, and it might not take full legalization for that to happen. 

Even if cannabis merely became “quasi-legal” at the federal level, by passage of the SAFE Banking Act, that might be enough, Hawkins said. At that point, “Nasdaq will probably start listing companies,” and “institutional capital jumps in the game in a big way.”

Debt or Equity?

Investors want to know where to deploy their money. Meanwhile, business owners want to know where  should they get their money.’  

Debt finance specialist Mancheril thinks debt financing is the way to go. Bespoke’s business is booming, he said. Many equity investors have been spooked out of the market, and others, thanks to federal illegality, were never in it. 

Cannabis businesses are less inclined to dilute ownership than they had been during the rush to public markets of a couple of years ago, Mancheril said. So more of them are turning to debt financing even when interest rates are high relative to other industries. 

That was the case before the pandemic, Mancheril said, and it’s even more the case now. The big sales spike that accompanied the early lockdowns“resulted in our loans having a much shorter duration,” he said, thanks to the spike in cash flow. “There was a heavy wave of repayments.”

But then, when weed was declared essential, dispensaries sought more debt financing to restock and they sought more loans. It has resulted, Mancheril said, in the cannabis industry’s “biggest increase of debt since the third quarter of 2019.”

Equity investors might still be skittish, but they’ll still play a big role in the coming months as cannabis companies adapt to operating in a pandemic. “We’ve been pivoting since long before COVID and long before the vape crisis,” said Nordgren, whose firm specializes in growth-oriented equity investments. “We’re always pivoting.” 

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Dan Mitchell
Business columnist