Roll Ups Smoldering In US Cannabis Industry

Photo Credit: PEDRO PARDO

Even after a drug bust at his brewery in 2005 threatened his company, Lagunitas Brewing founder and CEO Tom Magee has proudly proclaimed his fondness for cannabis as a consumer.

He’s also a fan as a businessman. Lagunitas introduced a beer inspired by the event, Undercover Investigation Shut-Down Ale, and followed that up last year with cannabis-infused ale, SuperCritical, that was flavored by the fragrant oils from cannabis.

Supercritical lacks THC, the chemical that causes the euphoric high associated with marijuana, but Magee said it’s not hard to envision a future where “the molecule” can be found easily in broadly sold beverages, edibles and even consumer goods such as wallpaper and air freshener. He believes the only things slowing the push of global brands into the marijuana space as consolidators is that it remains illegal in the US under federal law, but “anyone who believes in this industry believes a 50-state solution is coming.”

And that solution will bring a wave of business consolidation, he said.

“Like any industry, I think being caught in the middle is a very dangerous place to be,” Magee said after his keynote talk earlier this month at the National Cannabis Industry Association Conference in Denver. “You can be small and artisanal … or you have to be a big player who can deliver on volume and the right margins.”

As it stands now, spreading legalization, maturing companies and growing investor appetites could spark up a flurry of M&A and capital raising for the cannabis industry in the coming years, according to industry executives and investors. The fact it remains federally illegal has mellowed deal-making, but there are already signs of a breakthrough.

The dollars have been flowing into ancillary services for a few years now, and the pace is picking up in that area, said Patrick Rea, CEO of investor CanopyBoulder. His firm has served as an incubator for cannabis-related businesses since 2012 and announced recently it would launch a $50 million VC fund for companies in the cannabis industry. It joins a handful of family offices and boutique VC firms popping up around the country, willing to be at the forefront of the growing industry.

The market has developed to the point where valuations are becoming clear, Rea said. Any businesses that touch the plant — growing operations, labs, distributors and dispensaries — are seeing offers of 1x last twelve months (LTM) revenue when they sell, unless they have a brand that contributes significant value, Rea said during a presentation at the National Cannabis Industry Association Seed to Sale Show in Denver earlier this month. Ancillary companies can see valuations between $3 million and $10 million when seeking an A round, while later rounds have typically valued companies between $10 million and $20 million.

According to Mergermarket data, globally there were at least 45 deals announced in the cannabis space totaling $1.69 billion in aggregate value in 2017. The vast majority of deal value came in Canada (17 deals, $1.5 billion) but a greater number of deals came in the US, though they were primarily much smaller deals (25 deals, $151 million). Some attendees at the NCIA event pointed to Viridian Capital Advisors data showing almost $3.5 billion invested in the industry globally, though that figure included debt and equity and had a broader definition of what constituted spending in the industry.

Andy Joseph, CEO of Apeks Supercritical, did not discuss details of the offers he saw while considering the sale of his botanical oil-extraction equipment company last year, but indicated it was underwhelming. He told Mergermarket in 2015 that he valued the company around $40 million. Apeks posted $13 million in sales in 2017 according to Joseph.

“Private equity was not valuing the company the way I did. And strategic buyers just aren’t willing to take the risk of investing in this space for the size of the opportunity right now,” Joseph said on the NCIA show sidelines.

He instead plans to look for joint ventures or partnerships with other equipment companies to create a large target, and he expects other companies to follow suit.

The federal issues still tamp down investors’ willingness to play. But many investors and executives in the space speaking to Mergermarket are cautiously optimistic that will change. That belief is rooted in simple math — about 95% of Americans live in a state with a jurisdiction where recreational or medical marijuana in some form is already legal, according to industry research group New Frontier Data. Recreational use for adults is already allowed in eight states and Washington, D.C., representing some 68 million people. One of those states — California — represents the world’s sixth-largest economy.

Magee said he believes legal cannabis will prove to be a much bigger market than craft brewing, where he made his mark. He sold Lagunitas to Heineken in 2017, saying it was a move that gave Lagunitas a long future, and noted during his presentation at the NCIA show cannabis companies will need to realize that “scale is what will keep you alive.”

In a brief meeting with reporters after his presentation, Magee said that he thinks the alcohol industry is a likely player to attempt a roll-up strategy of plant-touching businesses. But he also suggested THC could find a future as a component of consumer products if federal legalization happens.

Some companies are well aware of the opportunities – and challenges – that cannabis could create. Beer, wine and spirits company Constellation Brands last year bought a 10% stake in Canadian grower Canopy Growth for $190 million. And Denver-based Molson Coors said in its annual report filed 14 February that it now considers the cannabis industry a risk factor for its business, as customers could pass on beer and spend disposable income on pot.

Heineken executives also reached out to Magee for his thoughts on the cannabis business recently. He said the move surprised him because Heineken is headquartered in the Netherlands, well-known for allowing recreational marijuana use.