Has Big Cannabis Lost Its Buzz? Marijuana Stocks Suffer As Markets Experience A Correction

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It’s no secret that the legal cannabis industry has been taking it on the chin lately, with stock prices falling after years of very high valuations, almost never justified by companies’ fundamentals.

But what triggered the correction? Why was everyone excited one day and crying “overvaluation” the next?

There is no one element we can attribute the correction to. Numerous issues plague the weed world.

Among the biggest challenges the industry currently faces are the “vaping crisis” and its aftermath, reports of rampant counterfeit products flooding the market, and the uncertain Senatorial fate of the Secure and Fair Enforcement (SAFE) Banking Act – a bill that would protect federally-insured banks that serve the cannabis sector.

Even more vexing than these external issues are the unintended problems caused by business leaders and companies under-delivering on ambitious promises. Not to mention the numerous cases of corporate malfeasance, and recanted mega-deals that are sending shudders through the cannabis investment community, as evidenced by the steep fall in stock prices.

For a nascent industry trying to establish solid market footing and legitimacy among investors and analysts, recent financial blunders risk poisoning the pot for many. If the once high-flying cannabis market is amid a correction, what can be learned from the past to establish a more even-keeled course for the future?

When prompted about the issue, Scott Greiper, president of Viridian Capital Advisors, explains the industry is undergoing a “necessary and healthy” re-calibration. And this is affecting both the business side of things and the capital markets.

“The mania around the ‘legalization of weed’ and the resulting embrace of public cannabis stocks that drove unsustainable valuations, is returning to a fundamentals-based approach for investors and acquirers,” he says. “Execution, real governance, accretive acquisitions and profitable growth matter, and those companies that drove growth and targeted acquisitions without underlying investment rationale are paying the price.”

Jeff Siegel, co-founder and managing editor of socially-responsible investing community Green Chip Stocks and author of the best-selling book “Investing in Renewable Energy: Making Money on Green Chip Stocks,” agrees. He points out that margins matter, revenues matter, and losses matter.

“It didn’t seem that way for the first few years because it was a virtual land grab,” he continues. “But debt obligations ultimately come due. Eventually, shareholders want to see a path to profitability, and they also want to see less cash burns and nonsensical acquisitions, where they end up paying far too much to get far too little.”

But, he notes, this is a situation we’ve seen before: it’s not exclusive to the cannabis industry. Similar things have happened in energy markets, in tech, in cryptocurrencies, etc.

As a result of this, “the flow of capital that had been on a seemingly limitless upward trajectory, is now scaling back and being allocated to those companies that can meet the operating metrics described above,” Greiper adds. For him, this spells good news for companies that have experienced management teams that have built business in high-growth, highly regulated industries, and bad news for inexperienced management teams that are operating businesses for the first time in the cannabis industry.

As states paved the way for legalization in the United States, the promise of big cannabis to deliver significant returns spurred a period of ambitious business planning. Many entrepreneurs entered the market anchored to aggressive MSO plans predicated on quickly establishing and sustaining multiple recurring revenue streams, with forecasted transactions that had yet to execute fully.

Now, with stocks quickly losing ground and access to additional capital in both public and private markets, these companies are coming up short on the revenue front. This impairment leads to businesses that cannot secure the funding necessary to bring their ambitious plans to fruition.

As the market resets, larger LPs and MSOs are quickly burning through cash reserves while waiting for a rebound – and one that is by no means guaranteed, at least in the short term.

Let’s take a look at a few examples.

‘Troubled Times, You Know I Cannot Lie’
A good one to start with is that of MedMen, one of the most visible and high-flying cannabis retailers. In 2018, the company announced its intention to exponentially expand its operations with the purchase PharmaCann, in a mega-deal valued at $682 million in stock.

That deal was terminated late last year, along with MedMen’s CFO.

Company leaders said they were abandoning the agreement to instead focus on driving shareholder value by deepening expertise rather than widening MedMen’s reach in a rapidly evolving cannabis sector. This process also included the firing of 40% of its staff just a few weeks ago.

As a result of this turbulence, MedMen’s stock lost approximately 80% of its value in the past 12 months.

Another example is presented by Alefia Health, which terminated a long-term wholesale cannabis supply agreement with Aphria last year, after revealing that the latter had failed to live up to the obligations of its contract. Aphria objected to the characterization, while share prices for both companies fell on the news.

Most recently, Harvest Health & Recreation filed a lawsuit against Falcon International, seeking to terminate a previously agreed-upon merger. The former alleged the latter had failed to disprove claims about operating illegally, transporting marijuana across state lines – a federal offense.

Even OG cannabis operators are not immune to current market fluctuations.

Harborside, a company founded by one of the most prominent faces of the cannabis legalization movement worldwide, Steve DeAngelo, has also lost more than 80% of its value since it started trading in Canada on June 10, 2019. Not even its status as a pioneer in the legal cannabis industry, with a track record that dates back to 2006, a strong reputation, vertical integration, and over a quarter of a million registered customers, could save the company from the bearishness of equity investors.

But companies resist, focusing less on capital markets, and more on making their operations and overall businesses more robust. For instance, Harborside explained it’s weathering the capital crunch storm by placing its focus on growing and strengthening its presence in California, investing in cultivation technology, and expanding retail opportunities.

Similarly, Nevada’s Planet13 Holdings, is well-positioned in terms of business strategy and transparency.

A vertically integrated multistate operator, Planet 13 owns the world’s largest dispensary, just steps from the Las Vegas Strip. The company is responsible for almost 10% of Nevada’s monthly cannabis sales. It should be noted: the state that is projected to lead per-capita cannabis spending in the next five years.

To bolster investor confidence, Planet 13 provides a rich array of data, including store traffic and sales averages with monthly granularity. This level of disclosure helps investors accurately predict quarterly performance, providing them with assurances that are rarely seen in other industries.

But again, the company’s stock has been suffering, albeit less than most others. The shares rose by 33% in the last year, and by roughly 21% in the last month, even in spite of the volatility they experienced in the last quarter of 2019.

Understanding The Retreat
The fact that cannabis stocks have retreated from their highs in recent months should not come as a complete shock. The promise of an entirely new consumer market coming online drove an initial wave of inertia and interest. But novelty wore off.

That enthusiasm was (and will continue to be) tested as the realities and complexities of migrating an entire industry from the illicit sphere to the regulated world came to bear.

How the industry responds is a chapter yet to be written. For some, the lessons learned today will result in stronger organizations adhering to more rigorous standards tomorrow. For others, it could spell the end. If so, expect to see consolidation and vertical integration as dominant, entrenched players with sound fundamentals absorb their less-well-off cousins.

Cannabis may be a new industry with a new swagger, but the rules that govern success in public markets remain true. Businesses that adhere to the fundamentals of transparency, operational excellence, and focus can weather any storm.

By means of conclusion, Greiper comments, “We are in the midst of a Darwinian ‘Survival of the Fittest’ where there is a growing gap between those companies that will attract needed growth capital at reasonable valuations, and those that will have to do down rounds just to survive.”

It is his belief and that of his partners that the cannabis industry is “at a point where there is almost an inverted yield curve, i.e., where public valuations have corrected so severely that they are not trading too much higher than private market valuations. This ‘arbitrage’ will ultimately attract investors back to the better managed, better performing cannabis stocks.”

Moreover, the underlying strong growth in sales of legal cannabis across legal states, the evolution of medical states to adult use, and the addition of new legal states in the November 2020 election cycle, will provide support to the investment rationale for investors in the cannabis industry, he ends.

“Momentum on the policy side remains strong, and demand is still nowhere near being met,” Seigel concurs. “So yes, it’s actually a good thing that we’re now seeing the laggards get pushed out, leaving only the strong to survive. This ultimately makes for a stronger market.”