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We still have three weeks remaining in 2021, but it’s pretty clear that after entering the year with so much price momentum and strong fundamentals, cannabis stocks are likely to end the year lower. The New Cannabis Ventures Global Cannabis Stock Index, down 20.7% year-to-date, is on track to have posted three declines in the last five years:
Coming into the year, we shared 9 potential drivers of a continuation of the big rally in last year’s 4th quarter, many of which played out, including expanded access to capital, several companies going public, an increased pace of M&A, expanding institutional and retail ownership and more states legalizing. At the same time, our outlook for some reforms at the federal level, market-share gains from the illicit market, more legalization outside of North America and improvement in the Canadian market missed the mark.
With respect to the positive outcomes, the most important was the expanded access to capital. Debt has become more available to cannabis operators at a lower cost and for longer terms, and we have also seen the pool of available sale-leaseback capital expand as well. This expanded access to capital has reduced the need for companies to issue equity as they add capacity ahead of states that are legalizing and scale within their existing states of operation.
Two top MSOs by revenue went public this year, Ascend Wellness and Verano Holdings, but the big story was the addition of many ancillary names. In fact, the expansion of the ancillary space led New Cannabis Ventures to launch the Ancillary Cannabis Index in the spring. Supporting expanded access to capital, two mortgage REITs, AFC Gamma and Chicago Atlantic, went public on the NASDAQ, and NewLake Capital, which does sale-leaseback transactions went public as well.
M&A was big in both Canada and the U.S., and market consolidation will likely drive growth in the future. Two publicly traded Florida operators were bought, Liberty Health and Bluma Wellness, and Trulieve bought one of the largest MSOs by revenue, Harvest. TerrAscend has the pending acquisition of GAGE Cannabis. The list of acquisitions of private companies is quite long as well, as all of the major MSOs were quite active. GW Pharma was acquired, and in Canada there was tremendous consolidation, including the purchase of Supreme Cannabis by Canopy Growth and several purchases by HEXO Corp, including Redecan, 48North and Zenabis. Valens and IM Cannabis purchased smaller publicly traded LPs as well. Sundial bought retailer Inner Spirit and has the pending acquisition of Alcanna, which controls retailer Nova Cannabis. We also saw consolidation in the CBD space, with High Tide, Valens and Village Farms making acquisitions. We also saw continued investment by Canadian LPs into the U.S. with the non-equity purchases, including options acquired by Canopy Growth for Wana Brands and Cronos Group for a minority stake in PharmaCann, and convertible debt and warrants in MedMen acquired by Tilray.
The investor base broadened this year. Very early in the year, when MSOs were raising capital through the sale of stock, many of them reported expanded institutional ownership. As the year progressed, institutions continued to invest in Green Thumb Industries, per public disclosure, and have been active in private placements for ancillary names, like Dutchie. Institutional investors are increasingly figuring out how to invest in the space, even with many obstacles to doing so. Perhaps more of a factor has been the growth in AdvisorShares Pure US Cannabis ETF, which we highlighted in our outlook. So far in 2021, the ETF has seen its number of shares expand 627%, and it now has assets in excess of $1.1 billion. The ETF has allowed more investors to access direct cannabis operators.
Our view that the elections in November 2020 would catalyze other states to legalize has certainly played out. In 2021, Connecticut, New Mexico, New York and Virginia have all moved to legalize for adult-use, moves that will fuel industry growth for many years ahead.
With respect to federal reforms, this year has been disappointing. At the time we shared our outlook, Senate control wasn’t yet known, but we argued then that, even if the Democrats did win the two Georgia elections, full legalization in the near-term was unlikely. Instead, we hoped that some reforms could take place, but the Democrats failed to grab the low-hanging fruit as they embraced a flawed strategy of trying to craft all-encompassing legislation that was dead on arrival.
In 2020, the legal cannabis market was able to take share from the illicit market as the pandemic paved the way for online ordering and curbside pickup or delivery. We had expected more gains in 2021, but it’s not clear that has been the case. The slowing growth across most markets, especially in the western markets, some of which have seen year-over-year declines for the past few months, suggests these gains were transitory to some degree.
We had expected to see Israel and Mexico legalize for adult-use this year, but this didn’t materialize. It is encouraging that both could still do so. Of course, Germany appears to be moving in that direction as well. We had suggested that focusing beyond North America would be more important in 2021, but it’s not clear that it was, as these international markets continue to develop slowly. At the same time, the largest publicly traded cannabis company, Curaleaf, did focus more on Europe, making a $286 million acquisition.
The Canadian market has grown in 2021, but its year-to-date growth has been slower than expected at 55% through October. The largest LPs have lost market share in the highly fragmented market as well. The year has seen continued write-downs of inventory and production capacity, but the market remains under pressure with respect to pricing. Additionally, derivative products continue to be a smaller part of the market than we expected. According to Hifyre, flower and pre-rolls account for more than 72% of the overall retail sales in Canada, down from about 74% a year ago.
In our year-ahead outlook last year, our crystal ball didn’t reveal five key events, a mix of positives and negatives, that we believe were very important for cannabis investors:
New Jersey Delays
New Jersey voters approved adult-use last November, and the state was expected to launch its program by mid-year. We still don’t have a date, and this delay has been quite detrimental for the several MSOs that operate in the state’s medical market. The delay is a reminder that implementations in the cannabis space tend to take longer than expected.
Trulieve Acquires Harvest
While we expected a lot of M&A this year, we were very surprised by this one given the overlaps in Florida and Pennsylvania. Harvest was able to keep all of its Florida dispensaries and its grow but was forced to divest its license (it got $50 million selling to Planet 13). Pennsylvania didn’t force any divestitures. This transaction suggests that over time, the industry may be able to consolidate more quickly than expected as regulators become more accommodative.
California Pricing Plunges
The falling prices in California were probably the biggest surprise of the year and have inflicted substantial damage on not only the operators but the ancillary companies as well. Pure-play cannabis operators in the state have been among the worst performing stocks this year, and many of the largest ancillary stocks are highly leveraged to this market. WM Technologies, for example, had to write off $2 million (5% of revenue and 20% of adjusted EBITDA) in receivables from California operators in its Q3. Most of the MSOs have little exposure to the state, so this factor didn’t have as much impact on the broader sector.
Republican Federal Legalization Legislation
We have long argued that cannabis legalization and reform is a bipartisan issue, but we didn’t expect that a new Republican representative would introduce federal legalization legislation. We think Nancy Mace’s States Reform Act takes a much more practical approach to federal legalization than what the Democrats put forward (lower taxes, less FDA involvement) and are encouraged that a dialogue may commence about how to best tax and regulate at the federal level.
How Low MSO Valuations Would Become
2021 had a mix of positives and negatives, but one would assume, based on the price action for many of the MSOs, that there is some huge problem ahead, like lower revenue or a federal government crackdown. Of course, neither of these are the case. With the retreat of prices while the forward outlooks advanced, the valuations of the largest MSOs have plunged. A year ago, we discussed the forward valuation of GTI as a proxy for the large MSO group being very reasonably valued. Then, the stock was trading at 6.5X 2021 projected revenue and 18.8X projected adjusted EBITDA. Despite hitting projections and having excess cash on the balance sheet with strong growth projections, it trades at about 4.4X 2022 projected revenue and 12X projected adjusted EBITDA. GTI appears to be very inexpensive, but most of its peers have even lower valuations by these metrics. We detailed just how cheap the MSOs appear to be at our premium subscription service 420 Investor last week.
The cannabis industry is still young, and predicting its future remains a challenging process. For the most part, 2021 played out in line with our expectations as the industry continued to make substantial progress. Still, though, the price action was terrible. We look forward to weighing in on our expectations for 2022 in a few weeks, but we remain optimistic that the strong growth and maturation of the industry will continue in the year ahead.
The Valens Company continues to provide a select group of Canadian LPs and brands with custom manufacturing, cannabis processing, formulation, product development and testing services, but it has also dramatically increased its own proprietary brands and capabilities following several acquisitions that have helped it become a leading cannabis consumer packaged goods platform, including Citizen Stash, Verse Cannabis and LYF Food Technologies as well as Green Roads, which also has allowed the company to enter the U.S. as it evolves its focus and global reach.
After listing on the NASDAQ last week, shareholders can now benefit from greater access to liquidity, increased corporate visibility and a broader investor base.
Get up to speed by visiting the Valens Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.
New Cannabis Ventures publishes curated articles as well as exclusive news. Here is some of the most interesting business content from this week:
- Exclusive: Agrify Rapidly Expands Its Cannabis Growing and Extraction Solutions
- Cannabis REIT Chicago Atlantic Raises $100 Million in NASDAQ IPO
- Cresco Labs Closes $80 Million Acquisition of Pennsylvania Operator Laurel Harvest
- Exclusive: How the Cannabis Industry Is Embracing the CPG Model
- Exclusive: Illinois Adult-Use Cannabis Sales Increase 61% in November to $121 Million
- Exclusive: Jushi Holdings Adds Capital and Talent to Support Continued Strong Growth
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Alan & Joel