"Marijuana prohibition is just the stupidest law possible… Just legalize it and tax it like we do liquor."
- Morgan Freeman
Back in the early days of Hedgeye, I was called in regularly to write the Early Look. I was made famous 'in my mind' by Keith's book (Diary of a Hedge Fund Manager) by writing a bullish Early Look note in March 2009. I'm going to write another bullish note, but it's on a topic I could never have imagined until a few years ago. It's also a bullish view that many people will disagree with on principle, but that's okay, too.
I was born in the early '60s, making me one of the few boomers at Hedgeye. I'm one of four siblings, a sister and two brothers, eight and nine years older than me. Growing up in the seventies was an exciting era to be a teenager with two older brothers. I was a punching bag for my brothers but could do no wrong in the eyes of my parents, which may have made things worse. I have one brother who can dominate the Thanksgiving dinner table, but he also kept my parents on their toes. Every family has tales of growing up, and with Thanksgiving around the corner, we should all be grateful for what we have.
One particularly amusing tale of growing up in the Penney household in the '70s was when my oldest brother gave my mother a few "seeds" to grow in her greenhouse. Mom was very active in the local garden club. She took great pride in nurturing her son's seeds to cultivate. That was until she hosted the Garden Club for lunch when she learned that the beautiful budding plant that her son gave her to grow from seeds was the Marijuana plant. Needless to say, that day did not go well for my brother; mom now tells the story with a smile. (Sidenote – guess how many times we have retold that story at the Thanksgiving table over the years?)
I was asked recently on Twitter if I have any "experience" in the cannabis space. My answer was I was born in the '60s and have two older brothers. I was not even a teenager when The Controlled Substance Act (CSA) was signed into law. The CSA was signed into law by President Richard Nixon in October 1970. The CSA provides "a mechanism for controlled substances (added to or transferred between schedules) or decontrolled (removed from control)." The CSA places all substances which were in some manner regulated under existing federal law into one of five schedules. This placement is based upon the substance's medical use, the potential for abuse, and safety or dependence liability. In determining into which schedule a drug or other substance should be placed, or whether a substance should be decontrolled or rescheduled, certain factors are required to be considered:
- Its actual or relative potential for abuse.
- Scientific evidence of its pharmacological effect, if known.
- The state of current scientific knowledge regarding the drug or other substance.
- Its history and current pattern of abuse.
- The scope, duration, and significance of abuse.
- What, if any, risk there is to the public health.
- Its psychic or physiological dependence liability.
- Whether the substance is an immediate precursor of a substance already controlled under this subchapter.
We just passed the 50th anniversary of the CSA, and there are now 15 states with recreational marijuana programs, and another 22 states have Medical programs. I'm not asking what your belief is on those factors listed above, or should the CSA be changed because it will be changed; the question is, when and how can you profit from it!
My conservative estimate is that the ten largest U.S. Cannabis companies in the U.S. will generate $5.5 billion in revenues in 2021, up from $3.3 billion in 2020. Because of the CSA, this multi-billion dollar industry effectively operates in prohibition, with the obvious comparison to the alcohol prohibition in the 1920s. Prohibition made it federally illegal to produce, import, transport, and sell alcoholic beverages, but consumers were safe from prosecution. Today, the cannabis industry does not have access to federal banks, which results in a significantly higher cost (capital & expenses) than it should be for an industry as big as it is.
The recent election suggests that we are at a point of no return on the prohibition of marijuana. It's just a matter of time before a real change in Washington occurs. Consumers have long changed their attitude toward legalization, passing the 50% mark in 2014, and now it stands at better than 66%. Therefore, this past election cycle's most significant shift was more about the substantial increase in Federal lobbying by the cannabis industry.
In 2019, federal lobbying expenses totaled nearly $11 million, up 206% from the 2018 level and just under 1% of the ten largest company revenues. I don't have the final 2020 numbers, but if we hold that math to 2021, Federal lobbying spending by the cannabis industry could be upwards of $30-40 million in 2021, with at least a similar amount in 2022. This suggests that by the mid-terms, the cannabis industry will have spent close to $60-80 million lobbying to have marijuana removed as a schedule one drug from the CSA. Can that level of spending change a few Republican votes in the Senate? Time will tell!
Following the money makes being long, high-quality names in the U.S. cannabis industry a once in a lifetime opportunity. I don't have enough time in this Early Look to expand on how profitable the industry is, but the best run companies have Gross margins in the high 40's low 50's and EBITDA margins in the 30-40% range, growing top-line 50-100% for the next few years and building a defensible moat. Understanding that most large institutions cannot invest in the space for legal reasons gives us little guys an extraordinary investment opportunity.
Function in disaster; finish in style.
Howard
