Business

The cannabis industry is evolving, but does that mean a market turnaround is coming?

Posted November 15, 2019 4:13 p.m. EST

— North American cannabis companies are slogging their way through another rough earnings season.

On Thursday, it was the industry leaders' turn to take their licks. Canada's Canopy Growth and Aurora Cannabis' stocks were rocked as their financial performances again missed expectations amid ongoing market weakness in Canada and beyond.

Those companies and others that tried to live up to sky-high valuations and overly optimistic projections are being greeted by stark realities: New cannabis markets take time to develop, and ongoing regulatory limbo only fuels uncertainty.

While some cannabis businesses are hopeful of a market rebound -- one even has its sights on a new public listing -- some investors say that an industry reset is more likely to come first.

"There needed to be a cleansing process of companies that are real and not real," Matt Hawkins, managing partner of private equity fund Entourage Effect Capital, said in an interview with CNN Business.

The North American cannabis industry is in the throes of an evolution that will favor the financially fit.

Those who follow the industry closely say there will be bountiful opportunities for companies that have strong cash and capital positions. The cheaper valuations and operational flux could result in asset fire sales or entire businesses landing in the bargain bins.

"This happens in new asset classes; it happens in emerging markets," said cannabis investor Tim Seymour, founder of Seymour Asset Management and manager of the Amplify Seymour Cannabis ETF.

Public cannabis companies initially were rewarded for expansion-heavy strategies that required cobbling together businesses and licenses to form vertically integrated operations across different US states, provinces and countries.

The capital markets are no longer rewarding that strategy, Seymour said.

The North American Marijuana Index, which tracks leading cannabis industry stocks, traded around 115 on Friday, a nearly 60% drop from six months ago.

Private companies are feeling the pinch too when it comes to cash and valuations. Companies across the board are scrutinizing their operations for inefficiencies, focusing on financial fundamentals rather than spending for growth's sake, and evaluating what works and what doesn't.

This period of corporate upheaval, deals gone south, and companies retrenching is a healthy reality check for the industry, said Evan Eneman, chief executive officer of MGO-ELLO Alliance, a provider of business advisory and investment banking services.

"There are a lot of moving parts right now; but overall, the view from a macro standpoint is very positive," Eneman said.

Canada's flower-heavy market soon will have a more diverse selection of cannabis products, which industry analysts expect will draw more consumers from the black market. In the US, more states are adopting cannabis-friendly laws, and hemp and hemp-derived products are gaining some regulatory clarity, although the elephant in the room remains the US Food and Drug Administration's much-awaited guidance on cannabidiol (CBD) products.

Cowen analysts this week raised their outlook for the US cannabis industry, projecting potential sales of $85 billion by 2030, up from previous forecasts of $80 billion.

Earlier this month, bucking a trend, the CEO of ManifestSeven (M7) sent a note to investors saying that the company would dust off its application for the Canadian Securities Exchanges and finalize the listing in the coming weeks.

"This is a conclusion of a cycle that was somewhat inevitable," Sturges Karban, M7's chief executive, told CNN Business in an interview. "This is really the beginning of the true build of the industry."

While there's hope the ongoing evolution generates a turnaround in the flailing cannabis public markets, several cannabis investors who attended Kahner Global's Cannabis Private Investment Summit on Nov. 5 in San Francisco say the public markets doldrums are far from over.

"I would run the other direction; the markets right now, they're frozen," said Entourage Effect's Hawkins. "My reaction is, 'good luck.' I don't really know the upside of [a public listing] right now."

Any lasting resurgence in the cannabis public markets likely will take the involvement of institutional investors who are waiting for some semblance of certainty in US federal regulation, he said.

The investment approach in cannabis could start to shift away from the Canadian public market, said Joyce Cenali, chief operating officer and managing partner of Big Rock Partners, a San Francisco firm that invests in privately held cannabis, media and hospitality companies.

"Certain investors will reset towards privates with a future exit outcome on a more diligent exchange such as NASDAQ or the NYSE, and/or via acquisitions from existing public companies, notably in the [consumer packaged goods] space in America," she said.

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