Bay Street Bull – Summer 2017 – Miroslav Tomoski

The professionalization of pot is well on its way to becoming a major game changer in the world of business. Will Canada be the one leading the way?

Hovering on the edge of a major paradigm shift for decades, cannabis is now just one year away from entering a new era of legal recreational use in Canada. For the thousands who have been stigmatized through prohibition, the new regime will find them standing on the right side of the law for the first time since before the Great Depression. According to a 2017 Globe and Mail/Nanos Research poll, public opinion has shifted overwhelmingly in favor of legalization, with 68 percent of Canadians agreeing that a regulated
legal system is preferable to the black market.

The government’s announcement of a bill to regulate consumer sales, as well as an already booming medical system have paved the way for a more professional face for pot. A face which is now attracting a wider range of consumers and drawing new investments on a global scale.

This is the new cannabis and it wears a suit on the floor of the TSX. As Cam Battley, Executive Vice President of the medical cannabis giant Aurora, puts it, “People have come to understand that the days of ‘Reefer Madness’-type scares are over.”

With grow operations that would put cartels to shame, companies like Aurora are at the forefront of the transition from black market production to a legally-regulated system. These companies are also led by people like Battley, a scout leader, soccer coach, and a father who is sometimes referred to as the “squarest man in the business.” But his position as an executive at one of Canada’s largest licensed producers is indicative of a major shift in attitudes toward the industry.

“When I first got into this sector I was hesitant to talk about what I did,” Battley says. “These days I’m not hesitant at all, in fact parents from my scout troop and soccer coaching will take me aside and will talk about how [the cannabis industry isj changing.”

Battley’s experience is just one among a greater culture of openness around cannabis. Jon Liedtke, Director of the advocacy group Cannabis Confederation of Canada, found himself speaking about investment opportunities with family at Passover Seder.

“The culture is changing.” Liedtke says. “It’s becoming more professional due to legalization and regulations.”

Cannabis is now an ordinary part of Canadian life and culture, since the country has taken its time to nurture a steady transition from the black market. Canada has cracked the code with a world-class medical cannabis system and the commercial bedrock of ancillary businesses, which are lying in wait for a new legal structure.

Brands like Tokyo Smoke, a retailer in cannabis-related accessories, cater to the sophisticated smoker, from soccer moms to the average millennial. Everything down to the use of the plant’s biological name (cannabis), which most companies have adopted in favor of stigmatized black-market slang, is aimed at winning the hearts and minds that foster business relationships and make legalization possible.

Making Friends with the Man

The transition has not been easy and the new law, set to take effect on the July 1, 2018, will have some kinks to work out. After all, the business has been operating underground long enough to establish its own culture and expertise – all of which will have to be brought to the surface in order for a legal system to work efficiently.

“Canada has a rich and robust $8 billion in annual revenue black market. And they need to give consumers a reason to turn away from that market,” says Brendan Kennedy, CEO of Seattle-based Privateer Holdings, one of the first global investors in the cannabis industry. “It’s about bringing people out of the shadows and into the light, elevating the conversation, and creating jobs and opportunities within this new legal system.”

Nearly a decade ago, Kennedy was already reflecting on the inevitable end of prohibition. He saw an excellent investment opportunity in the industry, and went on to explore some of the world’s best bud in countries like Canada, Jamaica, Israel, and the Netherlands before returning to the US to launch Privateer.

“Banks are typically not first movers,” Kennedy says. “It’s about establishing relationships and trust so that investors realize that companies like ours exists, and people like us are part of this industry; we aren’t the ubiquitous cliché that people picture.”

Today, the cannabis industry’s ties to the world of finance have expanded beyond the private investment of a few brave firms to publicly-traded brands on the Toronto Stock Exchange. On April 5th, the TSX welcomed the world’s first cannabis themed Exchange-Traded Fund (ETF), courtesy of Horizons ETFS. This new bundle of stocks is known as Horizons Medical Marijuana Life Sciences (TSX: HMMJ) and is meant to offer a diversified and more secure method of investing in canna-businesses.

While the financial industry still considers it a volatile sector, those who know the business understand that cannabis consumers don’t always follow market trends. “It’s a high-growth industry that may also be counter-cyclical and immune to larger macroeconomic trends,” Kennedy says.

Uncertainty remains for those who are unfamiliar with a business that has spent nearly a hundred years in the shadows. But as a medical and consumer product, the demand for cannabis has a tendency to be inelastic and consistently higher than its supply, which makes its producers excited to see their product breaking some major institutional barriers.

“When you create an investment vehicle that your average investor can participate in without having to choose the individual stock, and investors are able to gain exposure to the industry in a more diversified yet simplistic way, it’s a really important step for the industry,” says Aaron Salz, Chief Financial Officer of Tokyo Smoke.

Since its initial launch HMMJ has hovered at around $10 after experiencing a spike (as most cannabis stocks do) around the unofficial marijuana holiday of April 20th. And while the hype around 4/20 has passed, many investors still see this as an opportunity to get in on the ground floor for what might someday be household brands.

“What it comes down to is people have an opportunity here to purchase huge amounts of stock in [future household names like] Bell, General Motors, or IBM at the beginning of their days,” says Liedtke, who is also the co-owner of Canada’s largest cannabis lounge, Higher Limits, in Windsor, Ontario.

Much more than a basket of Canadian companies, HMMJ is a global fund and Liedtke expects it to offer the best from cannabis businesses around the world.

Catching up to Canada

Before cannabis stocks go global, the rest of the world has to catch up with Canada. Today, only four of the 14 companies listed on HMMJ are based outside of the Great White North. Among them is International Cannabis Corp, a company based in Uruguay, which established the first nation-wide legal system in December, 2013.

Many countries are still hesitant to take that step and are waiting on the sidelines until the Trudeau government can prove that it works.

“What the Trudeau government has done is they’ve legalized cannabis the only way that they could. They had to go over the top in terms of restrictions and regulations because they had to be able to mitigate the voices of their opponents,” says Liedtke. “It’s restrictive, but it’s not restrictive to the point that people can’t get involved.”

For Canada’s neighbors to the south, what seems like a leap forward
for several states has been stifled by the fact that cannabis remains illegal federally. The opposing state and federal laws have left American canna-businesses to operate within a grey market that limits growth.

“In the US it is still extremely nascent,” Kennedy points out. “Things that are typical, check-in-the-box items for entrepreneurs are much more difficult. Whether it’s hiring a law firm or an accountant or getting insurance coverage.”

Operating largely through cash transactions, the eight American states and the District of Columbia that have entered the world of legal cannabis have done it in such a way that it’s difficult to pin down a consistent model.

“It’s definitely more of a wild west in states like Colorado where there are hundreds and thousands of growers and distributors and they’ve had to reel it in” says Salz, whose company also operates in the US. “Canada is doing the opposite and starting with a thoroughly regulated system that can be loosened over time.”

With American companies on a tight leash and a new Justice Department headed by vocal pot opponent, Attorney General Jeff Sessions, Canadian companies have been given the unique opportunity for a head start.

The Advantage of Canadian Capital

The Canadian approach has allowed its cannabis companies to professionalize rather than focusing on survival by navigating legal loopholes. It’s an inside-out approach, offering unprecedented access to institutional channels like financial backing, which is required to launch a successful business.

“The creation of shareholder wealth is simply undeniable,” says Battley. “When I joined Aurora in 2016, our market capitalization was about $70 million. Today it’s about a billion and we are listed on the TSX venture.”

Canada’s system is a prime example of the industry’s potential if it’s allowed to operate within a free market structure as opposed to single producer government-led programs in countries like the Netherlands and Uruguay. It’s a model that the black market has already proven can work, and one which the legal system has embraced.

“The genius of that is that it’s unlocked the economic potential,” says
Battley, “because there are now 43 licensed producers. There is competition, and competition drives innovation.”

With over 160,000 medical patients in the country – growing at a rate of 10 percent each month – and the recreational industry on the verge of legalization, the legal market is expected to bring in sales of $20-30 billion annually. (Though it’s difficult to predict just how much potential there is since a legal market on this scale is a world first.)

Still, Canadian companies have a history of giving way under international pressure. Companies like Nortel and Blackberry were pioneers of their day before collapsing under the competition of international giants.

“The question will be whether or not Canada is able to seize this
opportunity,” says Kennedy. “If you look at the 80s and 90s, I would have said the same thing about the Netherlands. In the 2000s, Spain and Jamaica had their opportunities as well and didn’t capitalize on them.”

But cannabis is not the tech industry and Canadian producers are the world’s cannabis giants; poised to grow stronger with the advantage that forward-thinking lawmakers have given them.

“I think you might even see the reverse of what happens in Canada,”
says Liedtke, “which is Canadian industries moving out of Canada, setting up offshore operations, and bringing that wealth back.”

Canada’s Going Global

International expansion has already begun. In addition to blazing the trail in the financial sector, Canada has become the first country to export their businesses around the world.

“We have a significant head start because we have the regulatory system in place and other countries do not,” Battley insists. “We’ve been able to access the capital that we need to grow quickly, and to spread out beyond our origins into other areas and other jurisdictions.”

Aurora has established international relationships with companies as far as Australia in order to conduct research on and cultivate medical cannabis. Other Canadian companies like Tilray, a BC-based medical producer owned by Privateer, have hosted governments from around the world and have been readying themselves for the legal market in Germany since the summer of 2016.

“You’ll see several other countries in South America like Uruguay
that will have a lower cost of production,” says Salz. “But when it comes to a sustainable advantage for Canadian companies, it all comes down to the intellectual property that we have a head start in developing and that are already being exported around the world.”

With licensed producers taking on a massive scale of production,
Canadian cannabis companies may grow so large that they become staples of the global industry. New production facilities like Aurora Sky in Edmonton promise to be the world’s largest and most advanced automated cannabis facility at 800,000 square feet (16 football fields), with an output of 100,000kg per year.

“The intention,” Battley says, “is to deliver the same level and quality of service as retail giants, such as Amazon.”

Yet the true potential is unknown since cannabis production extends
beyond what’s rolled in a joint or smoked in a bong. This includes the companies that will create innovative extraction technology, the jobs created from retail shops, cafés, and even unusual hemp products such as toilet paper.

“Beyond recreational sales, there is the pet industry where there are 11 million cats and dogs in this country alone and they can be transitioned off many medications that veterinarians prescribe and onto cannabis,” suggests Liedtke, pointing out the potential of cannabis for disruption.

All of which is to say that Canada is entering some seriously uncharted waters, while those at the forefront see clear skies ahead.

“I’ve never operated in an industry where I’ve rooted so much for my commentators,” says Brendan Kennedy.

So while the cannabis world’s eyes are locked on Canada, it’s time to show our friends abroad that a new world awaits where the maps once claimed: “here be monsters.”