In the infamous words of Freddie Mercury, “another one bites the dust.” In the early days of legal cannabis – a short six or seven years ago – investors came to our firm for guidance. They were proud to boast of their status as “medical cannabis investors.” But I was always left wondering what they really meant by that designation.
When I hear “medical cannabis,” I think of UK-based, GW Pharma. In other words, products and companies that fall within the pharmaceutical regulatory lane. In my mind, a “medical cannabis investor” would be someone investing in a country’s medicinal cannabis program or scientific research. More often than not, these folks coming to our firm during the legal industry’s infancy had invested in dispensary franchises across California. Does that really classify that as medical?
To me, what these investors were doing was akin to investing in a chain of liquor stores, rather than the medical advancement of the cannabis industry. The common lexicon we use for the marijuana and cannabis businesses is sometimes at odds with the regulatory frameworks that govern them. These investors weren’t much interested in all of that. They were moving quickly and had a bit of investor FOMO (fear of missing out). In some ways, their strategy has been flawed from the get-go.
It involved fast-moving companies, much like the dot com boom of the late 1990s. The next phase involved the belief there are only so many assets in a given industry and investors need to acquire as many of these as possible to control market share. This disregards revenues and actual business functionality. You can almost reduce the whole cannabis investment strategy to this – shoot first, ask questions later.
That strategy combined a hard-charging mentality with the notion that companies can assemble entire global cannabis supply chains in real-time with unproven assets, within an unclear regulatory framework, and with little idea where these supply chain components would be located. All this was designed to operate in a post-prohibition environment and folks wanted to be positioned for when prohibition ends. But as I’ve written previously, that may not happen any time soon.
For the most part, cannabis investment has been driven by tremendous speculators operating in unclear environments to capitalize on extraordinary valuations and value creation opportunities. But in the U.S., cannabis with more than 0.3 percent THC by dry-weight marijuana remains an illegal Schedule 1 substance. While there are viable alternatives to these investment strategies, we simply haven’t seen them yet.
In fact, we’ve seen failures on such a large scale, like the fall of MedMen, that it’s becoming increasingly clear that current strategies aren’t working. We’ve seen multi-state operators take on enormous finance costs to obtain lending in this environment. We’ve seen Canopy Growth out of Canada rise and fall. We’ve seen the downfall of businesses like CannTrust, Wayland, Invictus, GenCanna, and Suntrand.
MedMen’s recent failures were documented by Chris Roberts who suggests that its fall reveals “everything wrong with the cannabis industry.” The case study reveals lavish spending, high salaries for executives (unsupported by even projected revenues), and luxuries befitting a Fortune 500 company.
Isn’t the rise and fall of these companies simply the kind of natural selection that happens in any emerging marketplace? When these companies falter and then take steps toward downsizing, reducing staff, layoffs, and retooling executive positions, doesn’t that create distressed assets?
I can’t think of an industry that hasn’t thrived when distressed assets become available. In fact, many industries, particularly emerging ones, are built on distressed assets. The value lost by prior operations doesn’t necessarily take value away, but rather, puts value in the right place. The assets themselves, including human capital, never truly leave, but get moved around to other smarter operators with more foundational and business expertise.
I recently read that MedMen lost 95% of its value. But was that value ever there to begin with? When you split up holdings due to operational failures and businesses are sold for parts, it creates opportunity, not failure, on a large scale. The fall of the aforementioned companies doesn’t reflect a loss to the regulated cannabis marketplace, but an evolution.
It’s only natural that when a company has very little cash on hand, negative operating cash flow, is unable to obtain institutional lending, and is saddled with the burdens of 280e compliance (for the marijuana side of the industry), there will be growing pains.
Sometimes, the sum of the distressed parts, when sold off and liquidated, can equal greater value. The marijuana industry doesn’t have access to bankruptcy protection. Therefore, reorganization bankruptcies that might be available to nearly every other industry remain unavailable to marijuana operators. In theory, this gives marijuana businesses “breathing room” in the event that cash becomes tight. And we saw cash become extraordinarily tight even before COVID-19.
These growing pains represent evolution and growth, not failure. It isn’t easy to correct them, but the opportunity exists on such a notable scale that folks are certain to give it another shot and assemble the pieces accordingly. When businesses fail, such as MedMen, it brings the industry, its lenders, and investors back to fundamentals.
It’s precisely these fundamentals that were lacking in the cannabis space from day one. Not because of the capability, experience or education of the people running the businesses, but because of the frenzy in the capital markets. And that came because investors knew so little about the industry that they insisted on applying the same methodology, manner, and strategies that had worked in other businesses. They didn’t work here.
Hopefully, the fall of cannabis industry titans has refocused investors and investment to embrace foundational business principles. That means not focusing on promoting revenue streams at the moment, but having a long-term view. The right executives and leadership need to be in the right place to make the right things happen. That will necessarily dovetail with consumer demand, which the initial industry buildout had far exceeded.
Recalibrating focus toward revenue generation is what this industry has sorely needed for years. But again, nothing’s been lost. The human capital remains, as do the assets, along with consumer demand. Perhaps, these distressed assets will get picked up and mobilized in a profitable fashion by the next wave of cannabis aggregator investors — demonstrating the evolution of an emerging market surrounding the world’s most powerful and versatile plant.
If investors continue to learn the industry and take strategies back to basics, they’ll be poised for what we’re all waiting for – the fruition of the true global cannabis economy.