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Even before the Georgia runoff elections turned the Senate blue, cannabis stocks had a good run to end 2020. The prospects of an expedited federal reform are growing by the day, and the potential for that to happen in the Biden administration is now a real possibility. Federal decriminalization would allow U.S. cannabis multi-state operators (MSOs) to list on major exchanges (GTBIF has already filed an S1) and allow major institutions to participate in the growth of the cannabis industry.
Despite the run in U.S. cannabis stocks, valuations are more than reasonable and do not reflect the healthy fundamental outlook or, more importantly, the end of prohibition. The end of prohibition will accelerate growth, improve profitability further, and boost the emerging M&A cycle. We continue to believe in all our Best Ideas prospects and do not segment them into tiers.
While we are mostly focused on the U.S. MSOs, CGC is also a Best Idea LONG with its clear visibility into the U.S. market through its investment in TRSSF and ACRHF. We believe that CRON is an underappreciated play on the U.S. market with $1.0 billion in cash ready to deploy on U.S. assets upon legalization. We are looking for the company to indicate how they will allocate that capital to get more aggressive on the name. APHA spent $400 million buying a craft brewer, and I suspect they would like to have that money back right now.
In the Hedgeye Staples vertical, we also have STZ as a second derivative play on U.S. legalization with its 38.6% ownership of CGC.
THE FIRST 100 DAYS
With Democrats in control of Congress and the White House, we see a clear path for expedited federal cannabis reform in 1H21 and possibly in the first 100 days of the Biden administration. Biden is set to reveal his stimulus package on Thursday. Will cannabis reform be weaved into the overall sweeping Democratic reform across the USA? The odds are growing in favor of the industry:
- The time is now; sentiment toward a more rational operating environment for the industry benefits both political parties.
- Cannabis lobbying is no longer a fringe issue but a political priority. With a Democratic-controlled Senate, this is now a live issue and could be part of the first significant piece of legislation from the Biden Administration to be released on Thursday.
- The lobbying efforts extend past the cannabis industry to other interested parties, like the alcohol industry, specifically BUD and STZ.
- Every significant banking association, including Visa and Mastercard, is lobbying for the SAFE Banking Act's passage because it makes sense and sound public policy.
- Recent comments from industry CEOs reflect an increased optimism that reform will be a 2021 event.
- With New York, Pennsylvania, Connecticut, and Rhode Island looking to go recreational in 2021, the industry's evolution out of prohibition could be complete.
Both industry and non-industry participants believe that the SAFE Banking Act is a likely scenario. SAFE Banking would allow cannabis companies to have, among other things, access to banks to process credit card transactions and access to bank debt, which would significantly lower the cost of capital.
The new Democratic Senate Majority Leader Chuck Schumer has stated he would put the MORE Act to a vote. Cannabis could be descheduled from the Controlled Substances Act via the MORE Act or similar legislation. Descheduling is also a clear catalyst to allow institutional capital to invest in the space, but more importantly, it would no longer subject MSOs to 280E taxes. Under 280E, MSOs are effectively taxed on gross profit so that descheduling would generate hundreds of millions in tax savings.
The MORE Act, which passed the House in 4Q20, has an uphill battle as both moderates and conservatives are not fond of the bill's taxing aspect, but that will likely be less of an issue in 2021. The bill would:
- Remove cannabis from the Controlled Substances Act
- Allow states to regulate cannabis sales
- Expunge cannabis convictions, tax sales, and reinvest in communities harmed by the War on Drugs
The STATES Act would:
- Allow states to regulate cannabis sales
- Explicitly recognize state-licensed cannabis companies as federally legal
The implications of all this suggest another, even more significant, run in cannabis stock as likely in 1H21.
TIME TO REVISIT THE COLE MEMO?
One thing stands clear to the cannabis industry; it can see significant upside from a clean perspective at the DOJ. With the Biden administration nominating Merrick Garland as Attorney General, the three main questions are:
- What is Attorney General nominee Merrick Garland's stance on cannabis?
- What is his perspective on the Cole Memo?
- Will Merrick Garland update the Cole Memo?
President-elect Biden has nominated Merrick Garland, a former federal appeals court judge, as his attorney general. Public information on Garland's stance on cannabis is scarce. However, in 2013, Garland sided with the DEA in a federal appeals case concerning descheduling. A medical marijuana advocacy organization, Americans For Safe Access, pushed to reschedule Cannabis to further medical research on Cannabis. In articulating his support for the DEA as they fought against the case, Garland said, "Don't we have to defer to the agency? We're not scientists. They are." At the time, some marijuana advocates commended Garland's deference to science. This instance, unclear as it is, appears to be the only public information available on Garland's stance on the plant.
With both Biden and Harris voicing support for various forms of cannabis legislative reform, it would seem likely that Biden's nominee for attorney general would be more agreeable to the cannabis industry than not.
COLE MEMO BACKGROUND
In January 2018, former U.S. Attorney General Jeff Sessions issued a memorandum to U.S. district attorneys which rescinded previous guidance from DOJ specific to cannabis enforcement in the United States, including the Cole Memo. With the Cole Memo rescinded, U.S. federal prosecutors were given discretion in determining whether to prosecute cannabis-related violations of U.S. federal law. This unsurprisingly created anxiety in the cannabis industry. On November 7, 2018, Mr. Sessions tendered his resignation as Attorney General at President Donald Trump's request.
Following Mr. Sessions' resignation, Matthew Whitaker began serving as Acting United States Attorney General until February 2019, at which point William Barr was appointed as the United States Attorney General. Mr. Barr was a former Attorney General under George H.W. Bush, with an anti-drug stance during his tenure. During his Senate confirmation hearing, Mr. Barr stated that while he disagreed with states' efforts to legalize marijuana, he would not go after marijuana companies in states that legalized it under Obama administration policies. He further stated that he would not upset settled expectations that have arisen due to the Cole Memo. Since this time, so much has changed for the cannabis industry and further reform is needed.
In June 2020, a federal prosecutor accused Mr. Barr of ordering "politically motivated" antitrust reviews of 10 marijuana business mergers, allegedly because he did not support their underlying business in the marijuana industry. According to some in the cannabis industry, at least one of those investigations reportedly resulted in the collapse of a proposed merger between two large cannabis businesses. If true, Mr. Barr's actions clearly reflected hostility toward the cannabis industry. We mainly assume that industry participants throughout 2020 were exceedingly cautious on what additional impact Mr. Barr would have had on U.S. federal government enforcement policy on cannabis. The industry's good news came when Mr. Barr resigned as Attorney General effective December 23, 2020.
At the heart of the matter is the industry operating without the guarantee that state laws legalizing and regulating the sale and use of cannabis will not be repealed or overturned, which also limits the ability for institutions to invest in the space. Until Congress amends the Controlled Substance Act (CSA) concerning medical and/or adult-use cannabis (and as to the timing or scope of any such potential amendments, there can be no assurance), there is a risk.
Now enter Merrick Garland and whatever stance the Biden administration will take on the cannabis industry. Given all that we know about the "Green Wave" continuing into 2021, it is hard to imagine that U.S. federal authorities will enforce current U.S. federal law. Instead, the industry's current setup suggests we will continue to see a softening from the federal government.
We would also not be surprised if we did not see an indication of the DOJ's stance on its direction it will take in the first 100 days of the Biden administration.
JUST THE BEGINNING
All of the above suggests that the end of Federal Prohibition is just the beginning of the opportunity to invest in the cannabis space. The catalysts upon legalization are apparent:
- MSOs uplist to major exchanges
- Institutional capital gets fully involved
- The Canadian LPs begin to invade the U.S. market and accelerate the M&A trade.
Naturally, the first beneficiaries of the first wave of institutional capital will be the largest, most liquid companies. They have strong fundamentals, footprints across critical states, and will likely be the first names to uplist to significant exchanges. We highlighted that GTBIF, a Best Idea LONG, has already filed its S1 and will probably be the first to go. Many of these companies have some of the best management teams and are thoughtful stewards of capital. Some of the more recent names we have added to the list also have significant upside for similar but different reasons. Notably, the companies on the LONG Bias List will also perform well in the current environment.
We also like two cannabis SPACs, CLVR and SBVCF, and we will have more to come.
The MSOS ETF is also a great way to play Cannabis, as it is the only ETF that provides exposure to US-only cannabis stocks. MSOS began trading on September 1, 2020, with over $2M AUM and now has over $409M AUM. We think the ETF is an excellent vehicle for gaining broad exposure to U.S. cannabis, including all U.S. names.
POTENTIAL CONCERNS DOWN THE ROAD
All things are coming up roses for the industry, but it would not be part of our process if we did not think of where the industry might face some challenges. Looking past company-specific issues, two industry matters need to be considered. First, understanding state by state supply capacity is a current priority, especially in limited license states. While demand currently exceeds supply, that will not always be the case. Second, interstate commerce will become a more significant concern post-legalization once its potential becomes a consideration for the industry.
In our first meeting with CRON CEO Mike Gornstein, back in 2019, he made a comment then which remains stuck in my head: "the commerce clause remains undefeated," meaning interstate commerce is inevitable for the industry. Interstate commerce's reality might be closer than we think if we are also right about legalization in the first 100 days of the Biden administration.
Several CEOs (mostly Canadian LPs) have also expressed some concern about investing capital in U.S. capacity, not knowing what the post-legalization industry will look like. Admittedly, I dismissed this more as a defense of the current strategy versus a real economic concern. It should be noted that Michael Auerbach, the founder of Subversive Capital (seed investor of Tilray), said growth outside of the core California market would be on an "asset-light" basis, noting some concern for how interstate commerce unfolds. Unsurprisingly, Tilray was one of the LPs that shifted to an asset-light strategy early in 2020. CRON executed an "asset-light" plan from the very beginning.
How interstate commerce will impact the 5-10 year investment lifecycle of the cannabis industry is one of the industry's biggest unknowns. President-elect Joe Biden's selection of Rhode Island Gov. Gina Raimondo (medical soon to be recreational state) as Commerce Secretary is essential for the industry. Ms. Raimondo has a venture capitalist background before being elected general treasurer of Rhode Island in 2011. Raimondo was elected governor of Rhode Island in 2014 and served as head of the Democratic Governors Association in 2019. During the presidential primary, she threw her support behind former New York Mayor Michael Bloomberg.
More to come in our Black Book presentation on 1/14.
