As support for federal U.S. cannabis reform continues to build, institutional investors are taking notice – and once they make the leap, investors already in the space are well positioned to reap the rewards.
In the next “two to three years,” federal rules are likely to shift in the U.S. that will open up cannabis to “widespread institutional investment,” said Jesse Pytlak, an analyst with Cormark Securities.
“The size of the opportunity in cannabis is massive,” he said. “It’s billions of dollars waiting in the wings, and, as barriers to investing come down, institutional investors will be ready.”
Riding the Institutional Wave
The entrance of institutional investors will likely boost the value of existing cannabis portfolios, offering solid returns to already building out their cannabis portfolios.
“When the large block of institutional money comes into cannabis, you’re going to see valuations in the U.S. pop – and we’ll see a major transfer of wealth and valuation from the Canadian names to the U.S. names,” said Brett Hundley, an analyst for Virginia-based Seaport Global.
“A lot of money we talk to now – whether its public or private – they’re looking to put funds to work in the private U.S. companies to get ahead of the curve.”
Doing so positions investors to potentially ride the wave of multiple valuation bumps, he said.
“When you invest in a private enterprise and take it public, that typically carries a value appreciation with it,” Hundley said.
“Then, when the broader-scale institutional wave comes, the hope is, you’ll see another bump.”
Valuations Will Reset
While valuations may run up in the short term after the flood of institutional investment, over time they likely will level out, said John Wagner, managing director at Colorado-based 1stWest Mergers & Acquisitions.
“Old-school firms use old-school traditional valuations when buying companies, and they will stay in those swim lanes no matter what they are buying, whether it’s a door lock company or a cannabis company,” he said.
“Look for more valuation discipline by larger and increasingly professionalized cannabis investment practices.”
According to Paul Rosen, CEO of Tidal Royalty Corp., a Vancouver, British Columbia-based investment group, Canadian investment banks that have been underwriting much of the cannabis activity in North America could be most impacted.
“The Canadian investment banks that have been covering the industry, for some there is a built-in economic incentive for them to make favorable calls on price targets,” he noted.
“They’re providing coverage for the same companies that they helped raise capital for – and the more that stock rallies, the more the brokers make.”
As U.S. institutions begin to consider the space, Rosen expects to see “deeper” analysis on cannabis operators’ performances and their proposed path to profitability.
“As more investors like Blackrock move in and we have more opinions weighing by investors who are judged on the quality of their picks, then we’ll really begin to better understand how to value these companies,” he said.
Early Institutional Movers
The cannabis industry has already seen some firms testing the waters:
- In April, vaporizer maker Pax Labs drew in big-name institutional investors to its massive $420 million raise, led by New York-based Tiger Global Management, San Francisco-based Tao Capital Partners and Prescott General Partners of Boca Raton, Florida. Tiger Global has also led fundraising rounds for California-based edibles manufacturer Plus Products and cannabis point-of-sale platform Green Bits.
- BlackRock, one of the world’s largest money managers, disclosed in regulatory filings that its funds have an $11 million stake in Curaleaf Holdings, a Massachusetts-based medical cannabis company. While the investment is small for BlackRock, which has nearly $6 trillion of assets under management, the stake is one of the first publicly disclosed investments by a major institutional investor into the U.S. cannabis space.
- Bank of America Merrill Lynch, one of the biggest American financial institutions, launched coverage of the cannabis sector. BofA Merrill Lynch Analyst Chris Carey initiated coverage of the broader industry and some of its market leaders: Aurora Cannabis, Canopy Growth, Cronos Group, The Green Organic Dutchman, Hexo Corp. and Supreme Cannabis. This isn’t BofA Merrill Lynch’s first foray into cannabis. Last summer, the bank helped finance global liquor giant Constellation Brands’ $3.8 billion investment in Ontario-based Canopy. It was the first time BofA Merrill Lynch financed a cannabis deal.
Investors and analysts say the flurry of activity points to one clear sign: Interest is quickly building.
The number of conversations Seaport’s Hundley is having with major U.S. investment banks and institutions has ramped up significantly in recent months.
“The long-only, big-money managers – the Fidelities of the world – they’re starting to do a lot more homework on the cannabis space,” he said.
While most major institutions have restrictions that prevent them from investing in U.S. operations, they’re now racing to get through the cannabis learning curve, Pytlak added.
“They want to know who these companies are and how the market is valuing these opportunities,” he said.
“Particularly in the last eight months, a lot of these managers are taking meetings with management teams of U.S.-based operators.”