How COVID-19 Is Affecting Private Funding In The Cannabis Industry?

The year 2020 was already shaping up to be a brutal one for many privately funded cannabis businesses, and the nascent legal cannabis industry in general. The now idyllic promises from the “Green Rush” period seem childish in their naivete. The truth is, very few legitimate cannabis businesses have achieved sustainable profitability. Regulatory and tax costs are often a primary culprit, as is ostracization from the banking system and the ever-looming specter of dormant but ever-ominous Federal law enforcement risks. Top publicly traded cannabis stocks were already down 70% or more as coronavirus roiled many other stocks into comparable declines over less than a month. The broader market lost more value faster than at any other point in recent history. Something interesting happened to the long-hammered pot stocks, they started to go up.  

The market may be reflecting the simple reality that as a commodity, marijuana like other vices has counter-cyclical properties. Perhaps, it is also reflecting the incredible opportunity companies and investors strong enough to weather volatility will have the potential to capitalize on. 

Funding Terms Should Continue To Favor Investors

The balance of power between those seeking funding and those providing it already significantly favored the latter. This trend will only be accelerated by this crisis as will the demise of many weaker companies. Only the best managed and most established cannabis operators will be able to compete for capital. Those seeking capital to stay afloat, will likely not be able to find it. This is a net positive for institutional investors in the space who will enjoy an environment where they essentially get to dictate terms to their picks of the litter. Another factor that may bear down is that American cannabis companies will likely be excluded from Federal assistance. Having no backstop means they will be cutting deeper in terms of costs and employees than most American businesses, which again could turn out to be positive for investors. The lean and versatile organizations that survive this shock will likely be commercial forces to be reckoned with, and their investors will be well-positioned to capitalize handsomely.

That being said, the coronavirus crisis has led to a massive risk-off trade, and investment in legal cannabis is at the riskier end of the spectrum. Those who have not fled the space for safer waters will still have to shoulder risk, but will likely be able to increase their alpha significantly. 

Expect Quite a Bit of Trimming In The Cannabis Industry

Many cannabis businesses were already tightening their belts and improving their financial profiles in response to the general scarcity of capital. Leafly, Med Men, Green Bits, Greenlane Holdings, and Acreage Holdings have all engaged in layoffs or other significant cost-cutting measures. Leafly cut nearly 40% of its workforce in response to coronavirus. Also, expect a general tightening in the availability of capital dedicated to investing in cannabis. Generally, investors have tended to flee to safer assets in recent weeks. This will act to the benefit of the investors who do have the stomach and expertise to remain.

Cannabis Industry Consolidation Likely

Companies that have capital already and are not over-leveraged will benefit. Many with an insufficient buffer will likely become acquisition targets or cease to exist. Those who can innovate and respond to new market realities like changing consumer preferences due to the virus will succeed and stand out compared with those who do not. Larger players with unsustainable business models are no better positioned than smaller, well-capitalized players with steady customer demand.

Economic Reality Will Likely Increase Calls For Legalization

The Cannabis Industry is the fastest growing industry in the United States right now. It employs a quarter of a million Americans and pays them wages that are significantly higher than the median wage. When you factor in that state, local and federal tax revenue will all take a sharp decline with commercial activity, and gatherings banned the coronavirus epidemic may actually be creating tailwinds for federal legalization, which would be an incredibly bullish development for the US cannabis industry.

Cannabis Showing Countercyclical Resilience During Pandemic

It is an adage that vice does well during a recession. This has proven true with tobacco and alcohol during previous economic downturns. For the first time in a US Bear Market, cannabis is legal for medicinal or recreational purposes in a majority of states.  However, during the current downturn, other “vice” investments like casinos and entertainment have been obliterated. Cannabis stocks have been behaving inversely to the broader market, which indicates that so far in this crisis, cannabis is following the pattern of a “vice” commodity. In other words, cannabis sales can be expected to remain relatively steady compared with many other expenses during the anticipated economic downturn.  

The Bottom Line: The Outcome For Cannabis Depends on Severity of Virus and Associated Lockdowns

Like so many other industries, the cannabis industry is fraught with uncertainty. Many analysts on Wall Street and companies have refused to make earnings estimates due to the incredibly high levels of uncertainty. During an economic shock such as this one, the ultimate fate of the economy will be most tied to the outcome of the healthcare crisis surrounding the virus. Whether or not the anticipated strain on the healthcare system leads to the need for increased duration of lockdowns and even more draconian remedies remains to be seen. The outcome concerning how long and how severe the virus is in the United States will be the primary determining factor in the failure or success of many cannabis businesses. The longer this crisis lasts, the less will survive.

Most analysts do predict that since the root of this economic downturn was the virus itself and not underlying economic conditions that the recovery following containment will be swift. This may be true, but for many businesses, the difference of days and weeks in how long containment efforts of the virus takes makes the difference between having a business and not having one, between making payroll and making layoffs.

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