Trends Watch: Cannabis Investing

May 13, 2021

By Elana Margulies-Snyderman 

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Robert Sciarrone and Juan Pablo Martinez, Principals, Measure8 Venture Partners.

What is your outlook for investing in cannabis via alternative investments?

Since November 2020, seven additional U.S. states have passed adult-use legislation, including New York, New Jersey, and Arizona. We’ve also seen significant liberalization overseas in countries like France, the U.K. and Germany. As long as barriers to entry remain, and jurisdictions continue to liberalize globally, we expect to see outsized return potential from private alternatives. This industry is still very “new,” and we believe the best innovators across the value chain may be yet-to-exist.  

Where do you see the greatest opportunities and why?

Two areas of focus for us in 2021 are genetics and tech, ancillary services.

When we say genetics, most operators point to a unique portfolio of cannabis “strains.” But our outlook on this subsector revolves around cultivation cost reduction, genetic/genome mapping, and big agriculture application. Due to expensive practices adopted from the black market, cannabis is very expensive to grow today at around $500-$700/lb on average across the U.S. We believe cannabis is ultimately an ingredient for formulated products, where this cost will need to be reduced to under $100/lb; innovative genetics strategies will be an integral part of achieving these milestones.

With over 3,500 dispensaries in the U.S. alone, there is a vast opportunity for SaaS businesses solely focused on servicing shops and consumers. The “big tech” names we are used to hearing dominate marketplace and SaaS opportunities in traditional industries are unable to play the cannabis sector to compliance issues at the federal level. This creates a blue sky scenario for private cannabis tech companies, increasing prospects of large IPOs/acquisitions down the road.

What about the greatest challenges?

Current U.S. cannabis operators face a number of challenges: They pay a crazy amount in federal taxes (IRC Sec. 280E), are profoundly regulated at the state level, have no protection under federal law, no access to the U.S. capital markets and can't even have a checking account at a federally chartered bank. Despite all of that, the industry is witnessing explosive growth with companies generating hundreds of millions of dollars in positive EBITDA. It directly employs over 275,000 people in the U.S. and generates billions in tax revenue. As the industry (and tax revenue opportunity) grows, we believe the government will face increasing pressure to support cannabis banking, financial services and a repeal of IRC Sec. 280E.

IRC Sec. 280E prevents U.S. cannabis companies that are compliant with state laws from reducing taxable income, leading to tax rates of well over 70% for the cannabis industry. Any regulation to alleviate this issue would substantially increase cash flow. The currently proposed SAFE Banking Act is aimed at reducing some of these operational challenges that operators face running all-cash businesses and give better access to banking and credit cards but has not directly addressed IRC Sec. 280E.

What keeps you up at night?

Nothing. I sleep like a baby with THC gummies. But actually, the explosive growth of the industry is what keeps me up. I’ve personally been shocked by how fast the more mature markets are growing. Everyone is talking about Illinois and Michigan (and yes, It’s easy to be impressed by states still on the early part of the growth curve), but look at Colorado and Oregon in 2020 during the pandemic. Colorado did $226m in July alone according to the U.S. Census Bureau’s Business Dynamics Statistics data, which was approximately 35% growth over the previous year. Oregon did $106m in July, 45% growth over the prior year. We thought these markets were mature and steady-state, but this growth makes you question where the ceiling is (both in those states and nationally). Even Nevada is seeing record sales and that economy was more shut down than any in the nation.

We see the same trend internationally. In Germany, around 120,000 patients were treated with medical cannabis. Germany is the largest market in Europe and 120,000 represents only 0.1% of Germany population. In Florida, 3% of the state’s population are medical cannabis patients. 3% of the 83 million German population equals 2.5 million patients. By the way, the average cannabis expenditure per patient is €500 per month putting the industry potential at over €15 billion just in Germany.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper LLP.

 

About Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.