Cannabis - The Cole Memo Lives

Friends – in case you missed it, William Barr, AG nominee, testified at his confirmation hearing yesterday that he’ll go back to the Cole Memo guidance that Jeff Sessions rescinded (but really didn’t do much about). Indeed, he said that he’s not going to go after actors complying with state laws, and, although he doesn’t personally support Cannabis legalization, he recognizes that the Federal/state conflict doesn’t make any sense (gee!) and wants Congress to take action.  (link to article)  

Good news!  The path to Federal legalization just got a wee bit clearer, the industry just got a wee bit more legitimized, and (perhaps?) the window for Cannabis businesses to figure out their post-legalization positioning just got a wee bit smaller.

Now we just need our elected officials to do, well, something.

Excelsior!

Written by: Marc Hauser

Hemp is Growing Like Weeds

Friends – the hemp bonanza just hit second gear.  Within the past 24 hours, we learn that:

  • Tilray is partnering with major US branding conglomerate, Authentic Brands Group (link) (and this on the heels (pun!) of Green Growth partnering with DSW (see my blog!)

  • Canopy is investing over UIS$100mm in hemp extraction in New York (link)

  • The FDA is cracking down on hemp-based CBD for consumption (link; see, also, my blog!)

So two of the largest Canadian Cannabis companies are now making inroads into the US, taking advantage of their head start, bringing along cheaper capital and branding firepower, and partnering with national CPG companies who have the scale to quickly bring product to market in places this industry never dreamed of (well, I did dream of a CBD knish truck).  At the same time, the FDA is doing what it said it would, clarifying (limiting?) the scope of the hemp opportunity (and destroying my dream).  Now that hemp is legal, and professional/institutional capital is flooding into the market, the industry will quickly start to rationalize.

I’ve speculated that hemp will be a test case for what happens when Cannabis becomes federally legal.  True, the Cannabis market today is very different from the pre-legalized hemp market (speculative capital, national scope, larger brands, consumer-based, maturing(-ish) markets).  Nonetheless, we can see how hemp-based CBD is quickly becoming a mainstream product (or, at least, there is a lot of money betting that it will be).

Excelsior!

Written by: Marc Hauser

Tilray's Stock Lockup

Friends, a note about public stock.  Tilray (which you may have heard of) announced that its largest shareholder, Privateer, which owns about 76%(!) of Tilray’s stock, won’t immediately sell when Privateer’s lockup expires next week.  (link)

(If you know what this means, skip this next paragraph)

When a company goes public, its stock is “registered”, which basically means that shares may be freely sold to other investors without restriction (it’s what allows me to go on e-Trade and buy shares of Bigfoot Project Investments (OTC:BGFT)*).  To be registered, a company needs to do things like file information publicly (BGFT's filings).  When a private company IPOs, its larger shareholders and management are customarily “locked up” from selling by the underwriters (the bankers paid handsomely for the risk of selling the IPO shares to brokers) for a period of time (180-360 days), so that the buying public (brokers) has confidence that the major ownership and management teams aren’t cashing out on day one.**  So when that lockup expires, those shares may then be registered and also sold to the public***.  The market’s concern is that a huge pile of stock will then flood the market and depress the stock price (supply>demand).  On the other hand, it means that there’s a lot more stock to go around for trading, getting rid of the dreaded “overhang”, so in the longer term, it’s a generally good thing for the markets and liquidity.  TLDR: lockups release more stock for trading.

When a single shareholder owns 76% of the stock of a publicly-traded company, that’s a really large overhang on the float (which also causes expensive short borrows (link; see also my blog!))  Plus, the single shareholder entity here is headed up by the CEO of the issuer.  So, when Privateer announced that it wouldn’t flood the market to quadruple the number of shares freely traded, the markets responded by bidding up the stock price (and squeezing the shorts even further). 

I’m guessing the main reason for this decision is that it’s just not that easy to sell that much stock without annihilating the stock price.  Shares can be sold as “block trades” in large chunks to big investors, but those are negotiated deals and take time to execute and there aren’t as many institutional investors (e.g., mutual funds, pensions) that will want to take large bites of a highly-volatile stock (more likely hedge funds).  There can be a “secondary offering” through an underwriter, but that’s expensive and underwriters take a cut.  Or they can sell the shares over (a very long) time.  This requires small trades over a long period, which are hard to keep quiet, but help maintain the stock price.  In the meantime, there are ways for the owners to get some liquidity – say, borrowing from a bank against those shares, or lending them out to short sellers (which, yes, is weird for a management owner to do, and some issuers don’t let their management/board do this).

So, this move is good for prices, but also a mixed blessing for the markets.

Excelsior!****

*This is a real company, and it’s amazing (not investment advice).

*At times, they sell some shares into the IPO, but that’s still typically limited.

***I’m skipping some steps to keep this from getting too boring.

****I’ve gotten a few comments about this signoff.  I stole it from Longfellow’s Excelsior.  Stan Lee apparently did too.

Written by: Marc Hauser

CBD Markets

Friends – well, one of the proverbial shoes has dropped (and you thought the Cannabis business had enough puns).  Green Growth Brands, which has sort of been in the news lately (see my blog!), is now putting its hemp-based CBD products in DSW stores: LINK.

I’ve speculated recently about the newly-legal hemp-based CBD market (see my blog!), as has everyone else on earth.  What’s notable to me is that DSW is a very mainstream store.  It shows that the addressable market isn’t just high-end spas – it’s the big box retailer targeting the suburban shopper who wants a product at a reasonable price, the millennial looking for purported health benefits (LINK) etc. CBD is even more of an unknown product to Americans than THC (I’m guessing not too many people smoked hemp in high school to get the CBD medical benefits), so, like the Cronut™, they want to try it out and see what all the buzz (pun!) is about. 

The wave is only beginning.

Excelsior!

Written by: Marc Hauser

Cannabis and Public Sentiment

Friends – passing along two OpEd pieces written recently that highlight a challenge and opportunity for the Cannabis industry.  Both are written by the same author, Alex Berenson, and they appeared in the NY Times and the Wall Street Journal: LINK LINK (both behind paywalls).  New York Magazine does a good job of raising the same skeptical eyebrows that I raised when reading these and their claims of connections between Cannabis and violence: LINK

Berenson’s minor jeremiad should not be dismissed, however.  Having grown up in the “Just Say No” generation (I still remember the very special episode of Diff’rent Strokes” in which Nancy Reagan guest stars to ply her message to the TV-viewing youth of America)*, there is still a part of me that finds it simply odd reconciling that message with the fact that Cannabis possession/use is now legal in some form in a majority of states (and growing). 

As the Cannabis industry seizes this delicious moment of legitimization, acceptance, and market opportunity, it shouldn’t forget that there are plenty of skeptics out there.  And whether those opinions are based on misguided facts, bad science, or simply fear, those opinions should be respected and appropriately addressed.  This means a strong focus on education, solid (but fair!) consumer protection regulations, credible product claims**, and more research.  Consider what’s happened with the rapid rise of the vaping industry and the regulatory backlash they’re now facing – granted, it’s not a perfect analogy (not even a good one), but while trends continue to rise for Cannabis acceptance in this country, there’s still a large minority that needs to be convinced.  In other words, the Cannabis industry shouldn’t overplay its hand. 

Excelsior!

*Yes, I’m old enough to have watched Diff’rent Strokes when it was originally broadcast; however, I’m not old enough to make a Reefer Madness reference here.

**Which also has the added benefit of avoiding lawsuits!

Written by: Marc Hauser

Interstate Trade in Cannabis

Friends – two interesting articles to share that make a point on markets.

https://www.marijuanamoment.net/oregon-marijuana-could-be-exported-across-state-lines-under-proposed-bill/

https://www.nytimes.com/2019/01/02/us/buying-legal-weed-in-california.html (behind a paywall)

The NYT article is more general about the state of the cannabis market in California and the struggles of those compliant players against the black market.  It notes the interplay of the giant surplus of raw materials in California playing into downward pricing pressure, the fact that heavy taxation (which the recent 280E decisions sure don’t help) counters that, the supply chain regulations, and the  difficulty in getting consumers to shift their habits to buying legal products (which I still think is inevitable as brand awareness matures and people get more used to knowing exactly what they’re buying, but then again, I’m just a lawyer).  In other words, what else is new in California?

Note the claim by Gavin Newsom from 2016 that 80-90% of California’s product ends up out of state.  Now, that’s an uncited statistic from before the laws really changed in California.  And, it’s coming from a politician.  But, let’s assume for a moment that’s true (I’ve heard similar claims anecdotally, but that’s not saying much) and that’s California is flooding other states with cheap(er) cannabis. 

Turn then to the other article and the news that Oregon is (re)considering allowing legal export of Cannabis products.  Based on what the article says, it’s not clear if the proposed bill has legs, but let’s say it does pass.  Then you’ll have a scenario where Oregon producers export into other legal states, opening up other delicious markets to Oregon brands without the need for cumbersome licensing/production agreements.  Interstate commerce! 

This is generally how markets work in the US.  A state could attempt to block import, but it’s generally quite unlawful for a state to unduly limit the import products from another state (I can’t wait for the 2025 Bar exam questions on the interstate Cannabis trade and the dormant commerce clause (lawyer inside joke)), but then again, Cannabis isn’t a Federally-legal product, so who knows what that Federal court lawsuit would look like. 

However, this could create another markets kerfuffle with larger companies pressuring their state lawmakers to follow suit and allow for export (see, e.g., the 2016 lifting of the ban on US export of oil/gas), opening up legal markets nationally, giving MSOs the ability to quickly scale (if Oregon indeed passes this bill, and I were an MSO, I’d make sure to get licensed in Oregon real fast), putting yet even more pressure on the smaller, local producers who now have to compete with national and regional brands, not just local/statewide brands, consolidating and stratifying the market even further.

Excelsior!

Written by: Marc Hauser

Public Information in Cannabis Markets

Friends, happy new year to you all.  The only prediction that I’m going to make about this coming year in the Cannabis industry is that it’s going to continue to be bonkers and fun.  Beyond that, don’t be looking to a lawyer for advice on where the industry is going.

Not much has happened in the past week or so from a deal/capital/legal markets perspective (not surprising!), although Green Growth Brands’ press release from Monday is worth reading:

https://www.greengrowthbrands.com/press-releases/2018/12/31/green-growth-brands-reaffirms-commitment-to-takeover-aphria-inc/

I wrote last week about this hostile takeover strategy (LINK) and got a lot of interesting feedback, which is best left out of email (as the old lawyer saying goes, “the ‘e’ in ‘email’ stands for evidence”).  The latest press release from GGB has some interesting tidbits:

  • The press release (as best I can tell) was issued at 3:04pm ET on Monday, before trading ended for the day.  Typically, you issue a press release containing material news outside of market hours (mostly due to exchange rules), so that investors have time to digest it.  Also, it’s worth noting that this was filed on the afternoon before a market holiday.

  • They try to address the related party concerns that were highlighted by critics of the deal in the press (e.g., LINK).  GGB’s CEO also was on Bloomberg making similar points: LINK.  Related party issues get into fiduciary issues, which is why they’re such a hot button for regulators, investors, and, well, everyone.  Under US securities law, the rules are different for a management buyout (relative to a third-party buyout)– when an insider (CEO, director, 10% owner) is taking their own company private, they’re presumed to have insider information (because they do).  So, there’s a lot more scrutiny, a lot more disclosure, a lot more pressure on the independent board (who then hire their own advisors), a lot of opinions on price (valuation fight!), and a plethora of plaintiffs’ lawyers suing everyone anyway.  I’m definitely not saying that this situation is an insider transaction (I don’t know).  Instead, this is a good example of the fact that information and misinformation runs markets, and that business news is imperfect, no matter how hard the journalists try to get it right, and then layer dueling press releases on top of that (including those from short sellers).  It’s one of the reasons that tender offers are highly regulated – to try to control the information flow to investors, among other things – and why these are typically not launched through press releases.

  • They talk about the going-forward strategy and reaffirm their intent to launch a bid.  It’s not every day you see a smaller company take over a bigger company, where the target shareholders will control the venture after closing.  Again, a bold move in a market that is defying conventional public markets strategies.

  • There’s still no actual tender, nor a timeframe on when the tender is going to be launched.  As I said in my last email, it’s unorthodox (though I can’t say unprecedented because I just don’t know for sure) to launch a tender offer by press release first (a friend in Canada confirmed (but not giving legal advice!) that it’s not typical there either, and also that you don’t get do diligence the target in a hostile takeover).  GGB seems in the last paragraph of the release to be pushing Aphria hard to get Aphria to come to the table.  We’ll have to wait and see if that happens, and, if not, if/when GGB launches the tender.   To grossly misquote someone, they’ll face off against each other out in the street, down in Cannabisland. (I’ll be here all night)

Excelsior!

Written by: Marc Hauser

Hostile Takeovers in the Cannabis Markets

Friends – another milestone today for the Cannabis public markets with Green Growth Brands’ announcement of a (possible) hostile bid for Aphria.  As you may recall, Aphria’s sort of been in the news lately for a short seller making some allegations about Aphria’s Latin American transactions (my blog post on this). Well, someone’s been paying attention and is now going to try to take advantage of Aphria’s hammered stock price by announcing the launch of a (possible) hostile bid for Aphria’s stock…..

https://www.bloomberg.com/news/articles/2018-12-28/pot-producer-aphria-spurns-2-1-billion-hostile-green-growth-bid?srnd=deals

Here’s GGB’s press release: link

Here’s Aphria’s response press release: link

A bit of capital markets background for those of you who never saw Wall Street.  A hostile takeover is where a buyer makes an unsolicited bid for a public company and the target rejects the bid.  Under US securities laws and caselaw (and I’m making the assumption the same is true under Canadian securities laws, though I’m definitely not a Canadian securities lawyer, and, by the way, none of this is legal advice), the target’s board has a duty to consider the bid (and they usually reject the first bid – never take the first bid).  If it’s rejected, the potential acquirer can launch a “tender offer”, meaning they send lots of paper to the shareholders generated by expensive lawyers and investment bankers and financial advisors trying to argue that the bid is fair, and then the target sends lots of paper to the shareholders generated by expensive lawyers and investment bankers and financial advisors trying to argue that the bid is not fair, and then they send paper proxy cards in pretty pastel colors asking the shareholders to vote for or against the bid.  And then the securities lawyers sue everyone.  Companies have ways of limiting hostile takeovers, like “poison pills” and “golden parachutes” and “white knights” and “the knish defense” (okay, that last one isn’t real, but I’ll invent it some day).

This announcement is great for two reasons, both of which I’ve discussed before.  First, it’s another example of the Cannabis public markets becoming like all other public markets.  Second, it’s necessary consolidation in the MSO marketplace.

What I’d like to focus on, though, is different. 

First, what’s interesting to me is that GGB didn’t actually launch a tender offer – they issued a press release about their possible intent to launch it.  Sure, they talked to Aphria’s board and all, but nothing has actually been done yet other than filing a press release (apparently, 6 hours (!) after they approached the board), and now it’s all over the financial press.  Nothing’s been filed with the Canadian authorities, and the press release doesn’t say when that’ll happen.  GGB’s press release also says that they might not even make the offer if they uncover anything materially adverse about Aphria. 

Typically, a bidder starts a takeover by publicly filing a nice, lengthy document with the SEC outlining the bid in heavy detail.  Sure, if GGB decides not to actually launch the tender, there may be some short-term investor blowback, but all they’ve done is state a possible intent to maybe launch a potential bid.  Or not.  I’m continually mystified by the way the Cannabis public markets are so heavily reliant upon, and driven by, press releases. 

Second, GGB is going to get this done with a C$300 million brokered financing, meaning they’re going to raise additional cash from public shareholders to finance it in part.  They note that GGB “expects that certain of its existing shareholders will commit to backstop” that C$300 million raise.  (a backstop is a firm commitment from an investor(s) to make any investment that other offerees won’t)  It’s something to launch a hostile takeover bid without having your financing tied down – public shareholders approving a takeover bid usually like to know that closing is certain, let alone likely.

Third, note this statement from the Bloomberg piece quoting GGB’s CEO, Peter Horvath:

While Quintessential’s allegations are “something to be concerned about,” the transaction, if successful, would take at least three months to complete, Horvath said. “In that time period, we should have an understanding if there is any overhang at all.”’

 

When is Aphria going to actually get to diligence if the allegations are legit?  The “hostile” part of “hostile takeover” sort of makes it seem like Aphria isn’t going to all of a sudden freely open its books and answer the kinds of questions to which, usually only, governmental authorities get answers.  It’s not every day you see someone acquire a company that has fairly serious allegations about financial fraud hanging out there, where the bidder is going to assume all of the regulatory risks and shareholder lawsuits if they’re true, but not actually knowable until after closing. 

Having been deep in the trenches of public deals for years and watching how the press/public views/skews them, I admit that it’s easy for me to sit out here from lovely Napa, California, starting at the mountains, writing about the curiosities of Cannabis capital markets, and that there’s so much we don’t know about GGB’s approach – they’re clearly advised by top-notch professionals, and they’ve got a substantial board and management team with serious experience.  Nonetheless, there is so much about those same capital markets, and the Cannabis business overall, that defies (disrupts?) convention, and that’s not always a good (or bad!) thing.

All the best for a healthy and prosperous 2019.

Excelsior!

Written by: Marc Hauser

Recent Cannabis Cases - 280E and Bankruptcy

Friends!  Wanted to alert you to two very recent court cases – tax and bankruptcy – that impact the Cannabis industry and the way it does business.  Some fun reading for the short work week between holidays.

Management Companies and 280E

First, an opinion of the US Tax Court from December 20th that seems to put a fork in the 280E “management company” structures that many Cannabis companies have been using.  As I learned early on in my long, painful career as a deal lawyer, tax influences everything, and this opinion highlights that lesson.

For those not familiar, Section 280E of the Internal Revenue Code bars deductions of expenses for businesses trafficking in a controlled substance.  In short, the “management company” structure seeks to, well, structure around this limitation by having the license-holding entities (cultivation, production, distribution) contract with a management services entity that doesn’t hold a license or “touch the plant”, but instead only provides services to those licensed companies (e.g., holding the lease and providing employees).  The theory has been that, since the management company is only providing services, it’s not trafficking in Cannabis and therefore may take Federal tax deductions. 

TLDR: the US Tax Court rejected outright the defendants’ arguments that the management company wasn’t engaging in “trafficking in controlled substances”.  The Court noted that, among other things, the management company employees were directly involved in the purchase and sale of Cannabis, and the only difference was that the licensed entity held title to the Cannabis while the management entity didn’t.  The result of this is that the management company is fully-taxed, without the right to take deductions due to 280E, and its flowthru members were charged with the additional income (plus a penalty).  To make the point, the Court said that these “tax consequences are a direct result of the organizational structure petitioners employed”.

https://www.ustaxcourt.gov/USTCInOP/OpinionViewer.aspx?ID=11855

Going forward, Cannabis companies should consider, among other things:

  • How does the apparent death of the “management company” structure change the economics of my business?

  • Should I continue to use flowthru (S corps and LLCs taxed as a partnership) entities at all?

  • What does this mean for my “management company” returns filed for prior years that claimed deductions?

  • Should I trust any structure that claims to avoid taxes?

  • Why does it seem like, every other day, there’s another roadblock to positive EBITDA?

My suggestion (not legal advice!) - make sure to discuss with your favorite lawyer and/or tax professional.   

Everything in business and law is about balancing risk (certainly something this industry knows well), but when it comes to specialized areas like tax, you want the most sophisticated advice you can get* to fully understand the nature of that risk and make a truly informed decision.  Ventures were set up by Cannabis business owners using the “management company” theory without appreciating that the structure itself hadn’t actually been tested or considered by the IRS.  To quote Homer Simpson: “I agree with you Marge .. in theory.  In theory, Communism works!”

Bankruptcy

Our second contestant today comes from the US Bankruptcy Court in Colorado (thanks to Jason Rosell, a bankruptcy lawyer at Pachulski Stang Ziehl & Jones LLP, for altering me to this**).  The case, In re Way to Grow, Inc., Case No. 18-14330 (MER) (Bankr. D. Colo. Dec. 14, 2018), involved an indoor hydroponic and gardening-related supplies company filing for bankruptcy protection (which is under Federal law).  Federal law makes it a crime to distribute “equipment, chemical, product or material which may be used to manufacture a controlled substance ... knowing, intending, or having reasonable cause to believe, that it will be used to manufacture a controlled substance”.  The Court rejected the debtors’ petition to file for bankruptcy because the debtors were selling, and would continue to sell while in bankruptcy, equipment directly to the Cannabis industry.  What’s notable about this case is that the debtor wasn’t a Cannabis company – it was an equipment manufacturer selling goods to Cannabis grower.

Although it had been clear in the past that a Cannabis company wouldn’t be able to take advantage of Federal bankruptcy protections, this decision broadly expands that limitation to companies servicing the Cannabis industry.  When the next recession hits, and companies touching the Cannabis industry are distressed, how will that play out?  My guess – it’ll be ugly and messy, and there will be many trade creditors to equipment companies taking haircuts and becoming owners.

Excelsior! (and happy new year)

*And, of course, it goes without saying, from your deal lawyer as well...

**See, above, my point about seeking out sophisticated advice in specialized, highly-regulated areas of law.

Written by: Marc Hauser

FDA Nixes CBD in Food

Friends, wanted to call to your attention a statement from the FDA that came out yesterday about CBD and food products.  In short, the FDA is saying that CBD (and THC) in food is still not legal under FDA rules, even though hemp-based CBD is now itself legal.  This runs the gamut from supplements (nutraceuticals!) to beverages.

https://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm628988.htm

The FDA is focused on the fact that CBD is an active ingredient, and like any other active ingredient that’s added to food products, the FDA gets to regulate that, and they’re not going to allow for now (although they say they’re evaluating it).  They’re also focused on false claims made about the benefits of CBD, similar to any other consumer product.

For one thing, this means that’s it’s highly unlikely that the State of California will change its ban on adding CBD to food/beverages any time soon (I suppose my CBD knish truck concept will have to wait).  It also puts a wrench into plans that beverage companies might have been looking forward in the past week weeks to offering these products in the US (although, other hemp-based products like seed oils may be added, so maybe a hemp seed knish truck?).  However, it creates yet another disconnect in the marketplace, with some companies allowed to use CBD in their products today (e.g., skin care), leaving others (e.g., wine, beer, knishes) having to wait to get that marketing benefit.

This also seems to me to be a good indication of how regulatory agencies are going to react to Cannabis legalization down the road.  Nothing will happen quickly and federal/state/local authorities are going to regulate it just like they regulate other consumer products.*  That, of course, won’t stop investors from pumping too much capital into the industry too soon, as if the industry were fully mature in terms of regulation, infrastructure, supply chains etc.  I suppose that keeps service providers like me in business, however, which is nice.

Excelsior!

*Not a political statement about regulation.

Written by: Marc Hauser

Cannabis Market Moves

Friends – another day, another seismic shift in the industry.  If you haven’t seen it yet this morning, AB InBev announced a strategic deal (US$100mm) with Tilray to develop non-alcoholic THC and CBD beverages up in Canada.

https://www.newcannabisventures.com/tilray-and-ab-inbev-to-invest-up-to-100-million-in-cannabis-beverage-venture/

A few thoughts on this (none of which constitutes legal advice, let alone business advice): 

  • As I’ve said in the past, the Cannabis industry is progressing towards becoming like the wine and beer industries – a handful of large players at the top and lots of small niche-y players at the bottom. 

  • This kind of strategic partnership makes total sense to me.  Successful cannabis companies realize early on that there’s a reason that businesses hire/solicit expertise from other disciplines, both internally (HR/finance/marketing) and externally (outsourcing things like logistics) – not everything can be or should be developed anew.  Why not tap into and leverage the global expertise of a giant, successful alcoholic beverage company to grow and scale?

  • There’s nothing to say that smaller cannabis companies can’t do this either, particularly for the niche-y players who have a specific product/service that isn’t easy to duplicate and can bolt easily onto a larger company.

  • A bit surprising to me that there haven’t been more outright acquisitions of cannabis companies up in Canada.  Yet.  Could be the valuations, while the large beverage/tobacco/pharma companies are waiting for a downturn to snap up non-US companies at a discount with their lower cost of delicious capital.  Could be that their boards are reluctant to dive in whole hog at this early point in the legal cannabis industry’s history.  It’ll be interesting to see what happens over the next 6-12 months with US-based CBD companies and whether CPG companies (healthcare/pharma/neutraceuticals (one of my favorite portmanteaus)) take the same approach of partnership or outright acquisition and integration.

  • It puts more pressure on companies in the US across the size spectrum to figure out their long-term strategy before legalization hits.  Going back to my handy wine/beer industry analogy, the “turf war” (to anonymously quote a friend at a large cannabis company) among the national companies will only continue to accelerate so that there’s enough breadth/market share to be attractive to large beverage/tobacco/pharma, for either strategic partnership or outright acquisition. 

  • I’m guessing that you’ll see more consolidation in the middle market, which, well, there’s plenty of currently.  These are attractive targets for larger companies to quickly acquire licenses and access to local supply chains.  As the cannabis industry morphs over time and becomes less fragmented (see, e.g, the wine/beer market), it’ll be more challenging for middle market companies to distinguish themselves and gain national presence/share/distribution (ibid.).

  • Small companies will have to figure out what they want to be when they grow up, and how they will be able to stand out in a very crowded marketplace.  Walk into any dispensary and already you can see how many products there are that are difficult for the average consumer to distinguish.  Then walk into a wine shop – it’s not that different.  Certainly, in both instances, that’s where the staff adds real value; however, over time, with national players expanding their brand presence, the cannabis market will become much less fragmented than it is right now, and they’ll have better access to national distribution.  So the small company will have to be nimble and specialized – sort of like a cult wine or a craft beer.  Investors in those companies will be asking the same questions that they always have – what’s different about you and how can you scale – but the scale question will need to shift.

  • US-based beverage/tobacco/pharma companies will need to figure out their strategies for when cannabis is legal, and also what they’re going to do about legal hemp-based CBD.  Moves like this InBev deal mean that the larger companies are already figuring out how to position themselves.  Smaller companies can start today to build relationships within the US and do their due diligence to discover whether, if, and how they want to play in the cannabis market.

Excelsior!

Written by: Marc Hauser

Cannabis Lending

Friends, I’m confident you saw the news about Tilray signing a deal with Sandoz for global distribution of medical cannabis.  Indeed, the transformation of the industry continues to accelerate.

But instead, I’d like to call your attention to two smaller deals recently announced.

http://www.abladvisor.com/news/15390/chiron-completes-25mm-transaction-for-u-s-cannabis-producer  (thanks to Seth Freeman at GlassRatner for tipping me off to this news)

https://www.newcannabisventures.com/terrascend-lines-up-75-million-credit-facility-to-fund-u-s-cannabis-acquisitions/

Debt!  And not the convertible kind.  Working capital term, revolving, and equipment loans issued by non-bank lenders.  The kinds of loans that other businesses get all the time from banks.  There’s little info about the first one (the press release doesn’t even announce the name of the borrower – only the name of the shop that shopped the deal).  The TerrAscend is an interesting loan, in that it’s made by an affiliate (JW Asset Management, its largest investor), and the terms are not cheap (8.75% coupon, 1% fee), but generally in line with current high yield offerings.  And one of my friends has been arranging equipment loans for the industry for a while (he didn’t ask me to plug his business).

This is all good for the industry – traditional debt isn’t dilutive and thus produces leverage.  As companies get past the Series A and grow their asset base, they’ll want to find sources of capital that don’t erode the capital structure.  It does require that asset base, and although it’s hard for a lender at this point to put a lien on assets like licenses and flower, things like equipment, leasehold interests, contracts, and intangibles can all be solid collateral.  Leverage, when used wisely, can be a powerful tool – it’s what drives the private equity industry.

This is also good for investors – it’s another way to play in the industry while hedging the risk of pure equity investments.  Plus, at least for now, the borrower can’t file for bankruptcy (another feature of current Federal law). Throw in an equity kicker and that’s good eatin’.

Excelsior!

Written by: Marc Hauser

CBD Opportunities and Risks

Friends, from this lawyer’s perspective*, serious money is about to flow into the (imminently) legal CBD market.  See, e.g.:

https://www.newcannabisventures.com/village-farms-international-to-aggressively-pursue-hemp-and-cbd-opportunities-following-u-s-federal-legalization/

Village Farms (not a client) is a Canadian produce company and they’re viewing this opportunity as a “nutraceutical phenomenon”**.  Anecdotally, other non-cannabis companies (CPG, institutional investors) are scrambling to enter the (imminently) legal CBD market.

This presents yet another whiplash-inducing opportunity and risk for the industry.  For companies that have both CBD products and THC products, do you spin out the (imminently) legal CBD product line, to take advantage of mundane things like bank accounts and lending, tax deductions, traditional institutional capital, and interstate commerce?  Among the many things to consider:

  • Branding – are the two businesses going to share the same brand name?  If so, how does that relationship work to keep the legal CBD business legal?

  • Local Rules – how quickly will local regulations on CBD use (such as those in CA) change to open up how you want to use the product?

  • Taxes – can you split off the legal CBD assets in a tax-efficient manner? (not a 280E question – a traditional tax question)

  • Structure – how is the legal CBD business going to be owned?

  • Strategy – once you’ve got the CBD business separate, what’s your plan to compete?

In other words, yet another day in the Cannabis business.

*As usual, this is definitely not legal advice.

**I don’t know what that means.

Excelsior!

Written by: Marc Hauser

Yuppies and Cannabis (and CBD)

Friends, sharing today a recent article from the Washington Post style section about yuppies using cannabis again.  Putting aside the author’s questionable choice to revive the term “yuppie”, this kind of style section article highlights the mainstreaming of cannabis in the US.  I think that the article does a nice job of capturing the cognitive dissonance in the minds of people who grew up during the time when the term “yuppie” was actually used and were subjected to the Just Say No/DARE campaigns of that era. 

https://www.washingtonpost.com/lifestyle/style/i-dont-feel-like-im-doing-something-wrong-yuppies-have-discovered-weed-and-they-like-it/2018/11/30/dd2b7240-e90c-11e8-a939-9469f1166f9d_story.html?utm_term=.ddf204c8d63c

It shows the challenge and the opportunity for the industry at this moment in time. 

Speaking of challenge and opportunity, as you likely know, the Senate signed the 2018 Farm Bill, moving the industry one step closer to finally being able to sell hemp-based CBD fully legally.*  It’ll certainly cause more work for us lawyers as companies move to split out their hemp CBD businesses, which then would be able to take advantage of such quotidian things as tax deductions and bank accounts, and then raise capital on those businesses.  This is because, I suspect that, once CBD is legal, the floodgates will open and US-based CPG companies will start to put CBD in everything to capture market share, and traditional institutional capital will finally start to fund deals.  This will put pressure on the smaller players, who will need to find ways to distinguish themselves into a more niche market, or else consolidate. 

 This isn’t different from other markets**, which is another way that this industry is (almost) like any other consumer product (which is a good thing). This process should provide a good test case for much of what’ll happen when Cannabis is legalized – how large CPG companies react, how the financial system reacts, how the regulatory agencies react, how plaintiffs’ lawyers filing consumer products claims react, how investors react.

 *yes, I know that the CBD industry takes the position that CBD is already fully legal based on the existing Federal agency regulations.  I won’t comment on that because, as the disclaimer says below, this email isn’t legal advice….

**as I’ve noted to many of you, every day, this industry looks like the wine industry to me

Excelsior!

Written by Marc Hauser

Cannabis and Securities Law

Friends, sharing a good article from MJBizDaily with further perspective on Aphria. 

 https://mjbizdaily.com/aphria-cannabis-stock-plunging/

The article also points to a recent notice issued by the Canadian Securities Administrators (the Canadian securities regulators) warning against misleading/unsupported promotional activities. This comes on the heels of a recent CSA warning about a lack of sufficient disclosures by public Cannabis companies.  This is all also true for US companies, both public and private – companies and boards have duties to their securityholders* and there are very tight rules about sales and disclosures.

 https://www.securities-administrators.ca/aboutcsa.aspx?id=1752

 These help underlie the point that easy money isn’t easy. 

*Well, unless they’re waived because they’re a Delaware LLC and they’ve got a good corporate lawyer drafting the documents….

Excelsior!

By: Marc Hauser

Level Brands Announcement

Friends, as a corollary to my most recent email, Level Brands announced a deal to acquire cbdMD for stock (~$65mm based on 2018 $3.2mm of revenue and $353,561 loss through August, plus a five-year earnout for an additional 15.525mm shares, but I’m not writing today about valuations).  Level Brands owns a bunch of wellness brands, including a licensing deal for CBD products.

What’s interesting about this deal is that one of the closing conditions is the passage of the 2018 Farm Bill with descheduling of CBD (CBD generally, not just hemp-based CBD).  Although the cannabis industry hasn’t been shy about selling CBD products, now that there’s a possibility of legalization, someone (a lawyer, perhaps?) apparently now sees a risk to the industry and/or the market if the bill passes without CBD legalization.   http://ir.levelbrands.com/node/6901/html

Also, since I have your attention if you’ve made it this far, the Wine & Spirits Wholesalers of America are still in support of cannabis legalization, which is good.  What’s notable about this story, which has a copy of the group’s talking points, is that the group is (unsurprisingly) opposed to vertical integration.  This is, in my opinion, going to be a giant lobbying battle that no one is really focused on yet – whether the three-tier system is replicated in cannabis post-legalization.  It’ll be fun to watch. https://www.marijuanamoment.net/major-alcohol-association-briefs-congress-on-marijuana-legalization/

Excelsior!

Written By: Marc Hauser

Cannabis Stocks

Friends, for those of you who’ve been receiving my spammy musings for a while, and for the subset of you who actually read my spammy musings, you may recall that I made a comment a while back about how the Cannabis industry achieved a somewhat dubious milestone when an activist investor targeted a public Cannabis company.  Well, the markets hit another fun milestone today: Ontario-based Aphria is the target of a short seller attack today, which caused Aphria’s stock to plunge (trading down 20% as I write this). 

(Short selling, for the uninitiated, is simply a way for an investor to bet that a stock price will go down.  The short seller is supposed to borrow the shares to make the short, and pays a fee to the lender of the shares.  Generally, the borrow cost has been high for Cannabis stocks, due to, among other things, the demand for these stocks.)

The fund put out a report attacking Aphria’s Latin American transactions.  Aphria responded accordingly that the allegations of the short seller are “false and defamatory”.  In my opinion, this is good news.  Not for Aprhia, perhaps, but for the Cannabis public market, which is looking more and more like the rest of the stock market.

For those of you in California, today’s the day when the BCC is supposed to issue its revised proposed regs.  Something to tide us all over while we await passage of the 2018 Farm Bill.

Excelsior!

By: Marc Hauser

Capital Markets Continue to Shift and Develop in The Cannabis Space

Friends, once again, the capital markets continue to shift and develop in the cannabis space.  In other words, it’s a weekday.

In the past two weeks, we’ve seen a major public company reduce and reprice their offering in response to market movements: https://mjbizdaily.com/marijuana-firm-medmen-scales-back-financing-appoints-interim-cfo/?utm_medium=email&utm_source=mjbiz_daily&utm_campaign=MJD_20181120_NEWS_Daily_11202018&elqTrackId=A25B5812550E3D302DAE5F24E8902F66&elq=caea0b4add5e4b3a8f21e560766efe39&elqaid=834&elqat=1&elqCampaignId=543

We’ve seen one of the larger institutional players announce the upcoming launch of a second fund at US$100 million: https://www.greenmarketreport.com/altitude-investment-closes-30-million-fund/

We’ve seen a US$14 million PIPE deal by a cannabis-focused hedge fund: https://www.newcannabisventures.com/navy-capital-invests-14-7-million-in-marimed/

 What does this mean, beyond the fact that I’m pretty good at cutting-and-pasting stories that are based on press releases?  It’s probably too early to call it a trend, since the cannabis markets seem to be evolving by the minute, but these deals appear to confirm what I heard in Vegas a few weeks ago: cash is king (or, as my former boss liked to say, “Liquidity is Value”).  As speculators finally start to recover from their collective hangover and share prices react to broader market trends, operating companies taking on investment are coming to prefer cash over stock. Investors are starting to fill that need for cash by raising bigger funds to write bigger checks (just like in the rest of the private equity world).  Just wait until someone figures out how to place real leverage into these deals…..

Excelsior!

By: Marc Hauser

Juul, Cannabis, Then an Even Bigger Deal for Big Tobacco?

Friends, a report in Bloomberg today about Altria potentially investing in JUUL.  Who knows how real this is*, but if it’s true, it’s yet another example of how US companies are finding ways to establish a foothold and get exposure to the Cannabis industry (however indirect)** without causing their boards or general counsels to have a conniption.

 Excelsior!

 *(yes, some folks at Altria and JUUL know, but it’s a rhetorical question posed for editorial emphasis)

**(yes, I know that JUUL is for tobacco, not Cannabis)

Juul, Cannabis, Then an Even Bigger Deal for Big Tobacco?

Excelsior!

By: Marc Hauser

MJBizCon Recap

Friends, it was good to see many of you in Vegas for the lollapalooza that was MJBizCon.  A number of thoughts and observations from my trip:

  • Just about everyone I talked to is still mystified at the current state of the capital markets in the cannabis industry, particularly the public markets.  I heard the word "bubble" used a lot, but then I heard a lot more people counter that argument.  There did seem to be general consensus that the strategy of issuing more stock to get another all-stock deal done to issue more stock to get another all-stock deal done etc. is probably not sustainable.  What seems to me to be more sustainable is tapping the public markets for truly strategic and measured growth, not just relentless roll-ups.

  • Then again, Acreage Holdings just listed with a $2bn+ valuation.  

  • But what's interesting is that, even if this first real wave of public markets activity does correct, the industry itself is strong and growing like crazy and likely won't care, so it'll be a case study to watch how investors and buy/sell side activities adjust if/when that happens.

  • To paraphrase Rick Ross, everyday we're hustin'.  Everyone who wasn't there to look at all of the equipment on the expo floor (if you didn't go, this was a real, honest-to-goodness trade show, and the expo was mostly equipment and services, with relatively few brands) was making connections and finding deals.  Even the investor luncheon - there had to be 1000 people in the room listening to industry folks talking about investment opportunities in the industry.

  • Cash is back.  More vehicles are being formed and raised to put cash out the door, as operators are coming to realize that stock consideration comes with risk, and as more traditional (non-Cannabis) PE investors come into the market and want to write bigger checks and don't want to hold SAFEs (because, why would they?).

  • That's also because Series A/B rounds are on fire.  Operators in the industry are now large enough that they've grown past the seed capital stage and hitting up friends and family. (hence the real need for sophisticated/experienced charming deal/capital markets counsel such as yours truly to help them develop, structure, and make that pitch...)

  • PE funds being raised are still being funded by individual investors, not really yet with any traditional institutional investors (unsurprisingly).  One fund I spoke with noted that they've got 99 people in their new fund - they have to stop at 99 for boring securities law purposes - and the average check isn't relatively (to traditional PE funds) large.

  • Lots of focus on Senator McConnell and the 2018 Farm Bill, which (if you believe what a politician says before they actually do it) is now almost certain to include industrial hemp. Investors are very much eyeing the potential in hemp-based CBD with the anticipated passage of the Farm Bill, particularly if it really does, once and for all, clarify that it's legal (few operators seem to appreciate and/or care that the legality of hemp-based CBD is not as certain as they think it is).

  • Lori Ajax, Chief of the CA Bureau of Cannabis Control, finally gave some public guidance (after relentless public questioning) that the newly-proposed regulations weren't intended to eliminate white label products. We'll see what happens there, but she suggested that no one should change their current practices yet (this is not legal advice).

  • I personally didn't see any dreadlocks or tie dyes at the expo, and instead saw lots of khakis and sensible shoes. Another example of the fact that cannabis is moving towards being like any other business with a giant trade show and people doing regular business things. (not a judgment on dreadlocks or tie dyes - more likely to be found at The Emerald Cup)

  • That being said, Vegas brings out some odd ones.  Waiting for coffee at a stand at NYNY, an older gentleman in front of me asked if they could grill his bagel. No, not toast it (that was an option he declined) - grill it.  I'm 99.99% certain this was a sincere request.  

Looking forward to seeing you all there next year, and definitely sooner than that. 

Excelsior! 

By: Marc Hauser