3 Cannabis Myths Debunked

3 Cannabis Myths Debunked

3 Cannabis Myths Debunked

The Paxhia, Managing Partners, Poseidon Asset Management | Dec 03, 2018

We’re closing in on our fifth year as Co-Founders and Managing Directors of a fund that’s dedicated to the cannabis industry. We’ve invested in over 47 companies in the space, across all sub-sectors of the industry as well. Over the five years, we’ve had questions upon questions upon questions that we’ve had to answer. Currently, there are three big myths, which we’d like to debunk.

Myth Number 1: Cannabis industry investing leads to immediate returns.

Right now, we’re experiencing a time of froth and exuberance in the market. The fact is that we’re meeting more and more investors- especially after spending time in New York and Chicago- where they think that if they just put money into especially that public market, that they’re going to immediately see returns. This has come up a lot recently, especially as it pertains to companies right before they go through a reverse takeover process, which is also affectionately known as an RTO up in Canada. People who jump in on those deals are jumping in on a high valuation that’s priced to perfection for the performance going forward. That’s concerning. New investors tend not to be aware of some of the logistical challenges of actually getting liquidity- which means the ability to actually trade and sell your stock.

While global news has really been quite positive for cannabis, there are still serious roadblocks. For context, in January of 2018, now Former Attorney General Jeff Sessions rescinded the Cole memos. Valuations appropriately did draw down- we saw capital retreat- when it had been coming in the space. Poseidon leaned in on that because we have been navigating these choppy waters of the cannabis industry for these five years, and so we kind of know what’s substantial, and what’s something to watch, and what’s an opportunity, frankly. And so we continued to invest through that time.

Moving forward through the year- right around June Canada announced federal legalization October 17th and it felt like from that moment on it was a mad rush- the sprint was on- and capital started flowing very handily into the industry.

This industry is very catalyst driven- especially in the public markets- and that means that anything that happens in the news, there’s a pretty direct correlation that the stock’s going to move based on that news. It’s not always that good news drives the stock up.

Obviously, it was great, great news to a lot of people investing in the space when Constellation Brands doubled-down on their investment to put $4 billion into Canopy Growth Corporation. That investment in particular led to a lot of exuberance but it fit the old adage, “buy the rumor, sell the news,” which meant did well.

A third catalyst was Tilray – a Canadian company – listing on the NASDAQ. There are a lot of interesting components to why that stock probably moves the way it does- which has to do with the float and some other mechanics of public stocks. It clearly went through the roof right away which we think was also an example of just how much appetite there is to participate in the industry through one of the better, more well managed exchanges instead of the OTC markets. Having said that- that stock has come back.

And so, immediate returns can’t happen with such a dynamic news cycle unless one has a unique interpretation of the word “immediate.”

This is a new world we’re living in where people expect the stock market to always go up and to the right, because it has for so long. We’re now experiencing some volatility, but it seems people have a pretty short-term memory about what it was like back in ’08, and what that looked like and felt like.

People seem to have a shorter-term window for investment – they’re looking to make quick returns on their capital. We’re in it for the longer-term, to see the building of an industry through – building companies – and then seeing the bigger exits that result in cogent investment in a nascent industry.

 

Myth Number 2: Old world cannabis perceptions currently apply.

In speaking with new investors who are looking at the space – one of the overwhelming two-part questions is inevitably, “how do you due diligence the people that are participating in the company and how do you make sure they’re not going to just be getting high all the time at work?”

Two things come to mind around this. The first is that you due diligence these companies a lot like you due diligence companies outside of the industry (including doing background checks) and talking with people who interface with the founders – both on a professional level and on a personal level. That’s just good diligence practice to get to know your founders – betting on them along with the concept and the market.

The thing that we’re always really open about is that sometimes in this industry – a founder may have a record because they’ve been participating in this industry before it was black and white legal in the state of operation. State regulations haven’t always been very clear. And of course it’s federally illegal. So people who have been trailblazers in this space have put themselves at risk way back when a lot of us were sitting on the sidelines. So a cannabis founder having a record is not necessarily something from which we’re going to run away. It’s something that we’re going to dig in on and try to understand. A criminal record in this industry, uniquely, might be bona fides. It may be an indication that you’ve been at this for a while. The investor then has to lean in and understand what actually transpired.

Another surprising question that we are still getting is something to the effect of, “Aren’t the founders always just getting stoned at the company?” What’s been remarkable to experience is how much the opposite is the case. The industry has been moving so fast for so long. It’s like a sprinting marathon- and these founders that we work with are some of the most dedicated and hard working people, and they don’t have the luxury of taking a time out for that while they’re at work. If the founder has a relationship with cannabis, it’s a functional relationship. We’ve reached another phase of this industry and no one is looking to put their business at jeopardy. They know it’s about go-to-market, they know it’s about scaling infrastructure. They know that this is their time to seize the moment.

 

Cannabis Myth Number 3: Exit opportunities are limited.

When we first looked into the industry in 2013 and officially entered into investing in the industry in January 2014. Understanding what the exit opportunities would look like was challenging to say the least. We had to draw nebulous comparisons – to technology, or health care, or consumer packaged goods – for exit opportunities to this space. There were no major market listings. There were a few highly speculative reverse mergers. But there certainly were no major brands investing in the space. So we had to kind of project what we thought the exit opportunities might be.

Having said that, an uninformed investor might look at today’s market and seen the large listed companies – the current valuations – and think, “I just have to pick the winner.”

That may be true. But there are fully three main thrusts of exit opportunities. One is in fact the public markets. But we’re so early on – who knows the true value of the current players? As the industry matures and potentially gains acceptance, and the NASDAQ and the New York Stock Exchange continue to open up, there will certainly be myriad opportunities for exit and others to enter and others to exit.

Hopefully players will have scaled and built their businesses to a revenue size, where it’s actually an appropriate place for them to be listing. So that’s one of the target places for an exit, and I do think that that is something that is absolutely in the cards for these companies.

A second option is that we’re now starting to see private equity funds with dedicated funds in the space- and just like in any other industry – private equity funds are certainly potential buyers of assets in this industry.

The third option is M&A, from either companies who are very similar, or maybe like a diversified hold co- and we’ve already started to see those exits.

So exit opportunities are very real, and they’re definitely starting to prove out. ,

It’s not a true question as it was when we first started. When we started, it was not clear if there would actually be a cannabis industry. Now the only thing that isn’t clear is the potential size of the cannabis industry.

Which brings us to another question we hear, “how could you possibly exit one of these companies?”

 

As an investor, if you’re concerned about the exit for your companies, then you should think about ways that you can get your capital out through cash flowing financial structure – such as royalties, or debt pieces, or mezzanine debt – because there are ways that you can get your capital plus a return out without necessarily having to have a massive exit that comes down to the mandate of the fund manager or how that investor is approaching this space.

 

And so, those are the three myths. Now that they’re debunked we can tell you one truth:

 

We’re simply traditionally investing in a hyper growth market.

 

Subscribe now to get every episode.

Cannabis Economy is a real-time history of legal cannabis. We chronicle how personal and industry histories have combined to provide our current reality.