Macro Battleship with Christopher Wood

A land grab is now emerging in the area of cannabis investing as legalization momentum gathers pace, resulting in the opportunity for corporates to invest in a brand new consumer market.


Cannabis Drawing Interest from Big Alcohol

On this point, it was interesting to read about a deal where Constellation Brands, a seller of liquor brands such as Corona beer and Svedka Vodka, will increase its stake in Canopy Growth, Canada’s largest publicly traded diversified cannabis company, from 10% to 38%.

Apart from the obvious desire of Constellation to secure a presence in a burgeoning new market, the interesting point was the valuation with the deal done at a 51% premium to the previous closing price valuing Canopy at 103x trailing 12-month sales. The company was not profitable last year. Canopy’s share price has since risen to C$61.5 or 131x trailing sales, according to Bloomberg (see following chart).

Canopy Growth share price and trailing price to sales

Canopy Growth share price and trailing price to sales

Source: Bloomberg

Similarly, it was also interesting to read that UK alcohol giant Diageo is also pursuing a deal with a Canadian cannabis company (see BNN Bloomberg article: “UK alcohol giant Diageo circling Canada for cannabis deals). Diageo has reportedly met with several Canadian companies in the past month to gauge their interest in a deal for a potential investment or collaboration to create new cannabis-infused beverages.


Canada is the Epicentre of Cannabis

Legalization in Canada is likely to be a catalyst for legalization elsewhere, particularly in America.

Certainly, Canadian quoted cannabis companies enjoy lofty valuations even though they are down 41% from their peak (see following chart). All of the large licensed producers are not yet making any money.

The reason that Canada is the epicentre of the cannabis story from an investment standpoint is, of course, because full-scale legalization is due to be implemented on October 17. When that historic event occurs, it is likely in this writer’s view to act as a catalyst for pressure for legalization to grow elsewhere, particularly in America.

At present 30 states in America have some form of a legalized cannabis program if medicinal applications are included, while nine of these states have legalized recreational use. But if a person buys a cannabis product in, say, Denver and then flies with it to Los Angeles, he or she is breaking federal government laws even though recreational use is allowed in both Colorado and California.

Bloomberg Canada Cannabis Competitive Peers Index

Bloomberg Canada Cannabis Competitive Peers Index

Source: Bloomberg

Why Marijuana Legalization Will Happen in the US

Why is legalization coming? First and foremost, unlike most areas of contention in divisive American politics, cannabis legalization does not appear to be a partisan issue. For example, more than 50% of Republicans support legalization (see following chart).

This writer also doubts that Donald Trump, himself not exactly a zealot, has huge problems with the issue; though the American president will certainly be aware, as are the cashed-up tobacco and liquor industries, of the commercial opportunities.

The cannabis market is estimated at more than US$50 billion, approximately the same size as the smartphone and wine industries.

The Marijuana Business Daily recently estimated that the US cannabis market is forecast to reach US$20 billion by 2022, up from US$6 billion in 2017, while the legal and illicit cannabis market is currently estimated at more than US$50 billion. This puts it around the same size as other consumer goods industries such as smartphones and wine though, for now at least, still below cigarettes and beer which are running at around US$80 billion and US$110 billion.

Poll: Support for legalizing marijuana use in the US

Poll - Support for legalising marijuana use in the US

Note: The latest figures are based on a poll done from 5 to 11 October 2017. Source: Gallup Polls

The Opioid Crisis — a Powerful Catalyst for Change

There are two other reasons why the call for cannabis legalization is gaining momentum in America. The first is the growing awareness of the reduced collateral damage from use of cannabis compared with alcohol, both for the individual concerned and for society at large since ‘stoned’ people do not tend to be violent.

But the second reason is more powerful. That is the dramatically increased awareness in America during the past two years of the country’s opioid addiction crisis in terms of the growing numbers of Americans addicted to ‘pain killing’ prescription drugs such as OxyContin.

Thus, Alan Krueger, former chairman of the President’s Council of Economic Advisers released a study in October 2016 that showed that nearly half of all prime working-age male dropouts from the workforce, comprising then nearly 7 million people, were on daily ‘pain killer’ medication (see Boston Fed Economic Conference paper: “Where Have All the Workers Gone?” [PDF]).

In practice this costly medication is often paid for primarily by Medicaid, America’s means-tested health benefits program. Yes, America does have a form of socialized medicine, however basic.

America’s opioid crisis has existed for some time, as have the rise of the non-participation rate in the labour force and the related stagnant level of household incomes. The US labour force participation rate has declined from a peak of 67.3% in April 2000 to 62.7% in August 2018, while the number of Americans not in the labour force rose to a record 96.3 million in August (see following chart).

But it only became a topic of media focus among East Coast and West Coast elites after the November 2016 election as explanations were sought as to how the people in the middle of the country, known as the flyover zone, could have elected such a person as Donald Trump. See, for example, a lengthy article on the opioid issue (Commentary Magazine: “Our Miserable 21st Century”, by Nicholas Eberstadt, February 15, 2017).

US labour force participation rate and Americans not in the labour force

US labour force participation rate and Americans not in the labour force - Sep 2018

Source: US Bureau of Labour Statistics

Faced with the choice between Americans being addicted to opioids, which are ultimately heroin derivatives, or having open access to cannabis, it is not hard to see which would be a better alternative in a society where there is now much greater focus on the fallout from ever greater wealth inequality, as indeed there is in the Western world at large, most particularly as “artificial intelligence” threatens more and more lower paying jobs.

In this respect, Aldous Huxley’s vision in Brave New World of a future society where the masses are living on soma might turn out to be a more accurate vision of the future than George Orwell’s 1984.

Certainly, no one should underestimate the ability of a legalized cannabis market to stimulate consumption by coming up with an attractive and diversified range of products. In this respect, where bottled water and premium coffee brands have gone, cannabis is likely to follow. But this is an area where Asia will definitely not be leading.

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

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