By: Rob Wertheimer 

Our thesis on cannabis is that a race is on. Canada’s early leaders have the chance to leverage regulatory window into global reach, but competition will increase sharply when the U.S. legalizes. Canada legalized ahead of all other major global countries (so far, it is in fact still the only one, along with Uruguay). That has provided Canadian companies with freedom to operate: capital raising, data into adult use trends, exports for medical use in other countries, time to innovate on product, plant genetics, delivery methods, and so forth.

The U.S. is the largest market likely to legalize soon, and that seems like a big catalyst for public Canadian equities. Instead, it might be better if the U.S. takes a little longer: the competitive risk from U.S. legalization is larger than the opportunity to sell in the U.S. for Canadian producers. At least, that’s the case today, with product and capacity brand new in Canada.

What cannabis investors may not realize is the remarkable change in the scale of venture capital/private growth investment in the U.S. and globally. Venture capital funding surpassed global IPO funding as a source of new capital for the first time in 2015, and unicorns (i.e. $1+ billion valued start-ups) are now common. Capital can now be raised more quickly and very substantially for early stage companies, a change from recent past.

The same is true in cannabis, despite its not fully-legal status in the U.S. More than 100 companies raised VC/private money in 2018 in the U.S., in more than 120 separate deals. For perspective, the number of companies raising private money in Canada was about 20, lower than the U.S. by a typical margin despite a more favorable legal environment.

Five years ago, about 40 U.S. companies raised money for cannabis, and a couple of years before that, effectively zero. Cannabis is rapidly becoming legal, but that kind of acceleration in investment isn’t unique to cannabis; we see it in lots of markets, including emerging industrial tech. VC funding has just been on a tear across markets.

Setting aside VC funding, the U.S. has the largest cannabis consumer market in the world, despite the quasi legal status. There is considerable expertise in growing, genetics, branding, and in some product differentiation as well. That expertise is constrained by the legal status of cannabis at the national level.

So as soon as the U.S. legalizes, we expect a flood of capital to enter the market, making the pathway to growth more difficult for existing companies. The flood will be larger and faster than investors expect, and the opening of the U.S. may be a better selling opportunity than a buying opportunity, depending on how far companies progress before the bell rings.

Aurora Cannabis (Overweight rated, top pick) and Canopy Growth (Neutral-rated) have the right urgency and strategy. Our initial view on this market has been that running fast is the right strategy, and Canopy and Aurora are ahead. Cronos’s relationship with Altria may yield rapid distribution in the U.S. when legalization comes.

Report Here