Trends Watch: February 21, 2019

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.

This week, Elana talks with Jon Trauben, Partner, Altitude Investment Management.

What is your outlook for cannabis?

Over the past year we have watched the global legal cannabis market grow, change and begin to mature.  We believe in the long-term growth of the industry: Altitude’s strategy rests on the premise that the evolution of the legalized industry should continue to provide compelling global investment opportunities.  As the trend toward U.S. legalization evolves, we anticipate the increasing globalization of the cannabis market; companies finding new sources of capital; traditional industries continuing their expansion into cannabis; M&A and consolidation ramping up; and medical research opportunities accelerating.

The passage of the 2018 Farm Bill legalized hemp nationwide by classifying it as an ordinary commodity and removing it from the Controlled Substances Act.  While still in a somewhat gray area due to the involvement of the Food and Drug Administration, this has set the stage for an expanded focus on cannabidiol (CBD) products and medical research as acceptance of cannabis for its health and wellness benefits accelerate.

Globally, England, Thailand, and South Korea have legalized cannabis for medical use, and we believe that trend will continue.  In the E.U., specifically, the main shift in policy is centered around providing medical cannabis.  In total, there are now 14 European countries where medicinal cannabis is legal in some form: half of the 28 countries that make up the European Union.

As the cannabis industry matures, more companies will require significant growth capital to fund product, service, and geographic expansion.  Multi-jurisdictional cannabis companies continue to access the public markets in both the U.S. and Canadian stock exchanges and companies are being rewarded for scale.  However, in recent months, we have seen a great deal of volatility in the equity markets with cannabis stocks trading down between 20-40% and then strongly rebounding.  We believe that cannabis companies will have increasing access to private and public capital, in step with deregulation.

Scale is becoming more and more important for cannabis companies to prosper as the industry goes through its own evolutionary cycle.  We believe it is going to be more difficult for smaller players to compete cost-effectively against larger players.  Increased competition will create the need for consolidation and M&A, and in that process distressed investment opportunities will surface. 

The receding of prohibition, perceived or real, will also drive increased investment and entrance from traditional industries into cannabis companies.  With diminishing sales in traditional categories, numerous household names in alcohol (Constellation Brands), tobacco (Altria) and beverage industries (Coca-Cola) either launched into the cannabis industry or considered the idea rather publicly.

What types of investments are you eyeing?

Altitude looks to take advantage of investing in the early formation stage of the industry which is subject to significant inefficiencies and limited availability of capital.  We purposely cast a wide net and chose not to eliminate any vertical or promising opportunity.  Altitude’s portfolio consists of some of the leading firms spanning the North American cannabis industry with concentrations in five general verticals including (1) operators, brands, distribution; (2) compliance-related; (3) advertising, marketing, media; (4) agtech and (5) data.

The portfolio construct is primarily driven by our focus on the industry as a whole -- investing in strong management teams and business strategies of companies that will be foundational to this emerging industry but also keeping in mind a portfolio that could weather the many unknowns in the industry including, but not limited to, regulatory impact, timing of federal legalization and directionality of how the industry will mature.

We have sought reasonable valuation entry points taking advantage of illiquidity and inefficiency due to the existing federal prohibition. As the cannabis market matures, we believe that Altitude’s portfolio companies will benefit from a rapidly growing global market, continued relaxation of prohibition, and the acceptance of cannabis as a medical, health and wellness, and adult-use recreational product.

We continue to cast a wide net and look for companies and investment opportunities that are foundational and scalable in nature that can build significant market share, recognized and leading products, brands and services with strong customer loyalty and those with sticky customer relationships.  Further, we are looking for companies with niche-industry expertise that provide tailored solutions for this highly regulated industry and that are looking to build long-term enterprise value and where we can have appropriate corporate involvement.

Who will the major players be?

We see major players developing all of the primary verticals in the industry.  For example, the U.S. multi-state operators should continue to consolidate the state-by-state vertical integration strategy.  The Canadian public companies are the current unicorns in the industry, and they will likely continue to raise capital via offerings and strategic investments from non-cannabis industry companies looking to gain exposure and/or hedge their own market share.  They will likely use this capital to expand globally to establish early dominant positions country by country.  Certain service companies will likely emerge as key to the industry in the areas of cultivation specific to this high-value crop, SaaS tech solutions, advertising and marketing strategies and data.  Further, there may be some disrupters on the horizon as companies’ progress on strategies to produce cannabinoids via yeast, algae or other biological hosts vs. from the plant.

Overall, the incumbents in many cases already exist and will likely need growth capital to pull away from their competitive set.  The maturing industry is starting to provide indications on what may win in terms of verticals, strategies, companies and geographies.  These winning entities will need growth capital to truly pull away from their competitive set.