By Michael Apstein

The second half of 2019 saw a punishing devaluation of the publicly traded cannabis companies with drops of 60% or more after failures to meet performance expectations1. I hadn’t predicted it, but I had listened intently at the various canna-business conferences in 2018 and early 2019 as alternate predictions were made that the days of early stage and emerging cannabis companies were coming to an end2 – they simply wouldn’t be able to survive the cash power and marketing prowess of the large players – and nodded my head I didn’t believe it. I understood the thinking: at the time multi-national tobacco and beer companies had recently made multi-billion dollar commitments in the industry3, and publicly traded companies were using their stock price to acquire across categories of the sector from seed to sale. So the predictions of demise for early stage companies seemed well reasoned. Still, I wasn’t onboard. Experience has taught me entrepreneurs, and their small and emerging companies, are the lifeblood of almost every business sector for the simple reason that bigger companies rarely innovate4. They’re too busy making what’s currently selling, while small companies have to innovate to compete.

Following the 2019 stock debacle came stories the cannabis industry was in a crash5. The real data is the US cannabis industry total economic impact was up, not down, as much as 30%, 2019 over 2018. Evaluating dispensary sales plus the additional economic impact of dispensary sales, Marijuana Business Daily reported

$27.7 – $33.8 billion in 2018

$36.7 – $44.7 billion in 2019, and projected

$42.5 – $52 billion for 20206.

There is no economic theory for a crash when sales are up $8 to $10 billion a year, and is part of why those stock prices had a lot of recovery this year7. Nonetheless, the “crash” effect rippled through the industry, with private companies at every level experiencing a valuation reset. And that’s the big impact: a green rush mentality had driven even pre-revenue companies to Seed or Series A valuations of $10 million and higher; now we’re seeing the valuations at all levels in private placements are back down to earth, reflecting multiples or valuation theses we’d see in other industries.

The other concern I have when looking at the larger cannabis players is operational reality. Having led a couple of mid-market sized turnarounds, I believe most companies have a limited set of core capabilities, so I was never a subscriber to the cannabis vertical integration, or complete seed to sale model8. I simply don’t believe one company can be an excellent cultivator (of a finicky crop), manufacturer, build brands, master distribution and logistics, and ace merchandising and retail. I’d posit this is one of the significant underlying reasons for the missed performance targets in 2019 – trying to be good at too many things. Further, MSO (multi-state operator) sounds good, but cannabis interstate commerce remains illegal, so there are few of the standard efficiencies to be gained – no centralized manufacturing, regional distribution hubs, etc. In reality these are separately operating companies, state by state, with the only shared resources being top management and IP (intellectual property). The standout MSOs are really the ones who’ve gained a significant market share in their original home state. Notably, several have also begun divesting certain holdings towards a narrower focus of operations.

Before getting to the company sizes that capture my attention in cannabis because they have a dedicated singular focus (they have to), these are my assumptions about the cannabis marketplace, which are generally held by the industry at large.

· Having been declared an essential business during the pandemic in almost every state and locality where it is legalized9, combined with early indicators it is recession resistant10 (as beer and spirits have previously proven to be), suggest it’s a pretty good place to park during and following the pandemic, including whatever the post-pandemic economic fallout is.

· Its essential business status, as well as the meaningful tax base it can provide states and localities11 in a recessionary period, will continue to move the industry towards business normalization including broader access to banking12, and a reduction of bottlenecks in testing, distribution, and marketing.

· With cannabis legal in 34 states now, it’s only a matter of time – perhaps a couple of years or less – until there’s a schedule 1 drug reclassification at the federal level13, and the accompanying release from constrictive IRS tax code 280(e).

· At its core, cannabis is a CPG (consumer packaged goods) industry. Mature CPG industries tend to have 2 or 3 publicly traded multi-national companies at the top, then a couple large independents, and then a handful or so of companies in the mid-market space below them. This suggests the cannabis industry will see significant M&A consolidation at all levels of the market over the next few years14, likely in a more thoughtful way than was done with the easy stock price money prior to H2 2019.

· Value in CPG industries ultimately lies in IP – patents and formulations if applicable, then brand. Companies that have built innovative products and brand loyalty around authentic narratives have always been and will continue to be attractive acquisitions in CPG15.

The unknowns are which existing CPG players will enter the space and who will win. Beyond the beer (Constellation Brands) and tobacco (Altria Group and Imperial Brands) companies already in, big pharma, beauty, and supplements have all signaled interest. On a more immediate basis, while it’s easy to identify the publicly traded cannabis companies and MSOs in trouble, it’s more difficult to identify which of the current leaders are ultimately going to be the winning consolidators. Given these unknowns for the top players, I like early stage and emerging companies for investment, where their immediate future is more predictable, and the potential exists for creating traditional CPG value towards acquisition.

As I said at the top, small companies are where innovation happens. In cannabis, whether it is meaningful applications in health and wellness, new genetics in flower, or the next generation inhalation device, it’s happening at companies that need to raise early rounds. Also as stated earlier, valuations have met reality, which means a lower cost basis, equating to greater potential returns. Lastly, the legacy of the industry, a hardscrabble history, has trained its entrepreneurs to withstand crisis. The operators know running a cannabis business can be hard, and aren’t surprised by a finicky crop, or a nonsensical licensing requirement, or just about anything – they’ve seen it. What they are is innovative and resilient, big words for smart and tough. I find some of them well worth betting on.

It’s worth acknowledging I have the benefit of getting to directly see the strengths and weaknesses of legacy, early, and emerging cannabis brand companies every day through the work we do with them at PGP (Primary Growth Partners). We get the opportunity to see their execution against strategic business plans, as well as oversight of their marketing, legal compliance, and operational readiness. And we get to bring them a thoughtful, more traditional CPG approach to branding strategy including consumer segmentation and building emotional, limbic nerve based, customer loyalty – something that hasn’t been done much in the cannabis industry thus far.

Michael Apstein is the Principal Founding Partner at Primary Growth Partners (PGP). As a CEO and strategic business operator he has a track record of success in Health & Wellness and CPG including building two “Top 1000 Brands” in the US, and multiple companies to mid market revenue and exit. Recognized as a national branding and marketing expert, Michael has been profiled in the WSJ, Success, Money, and NBC’s Dateline. At PGP, Michael and the team fulfill mission critical roles for select legacy, early stage, and emerging cannabis companies as a hands-on stakeholder, mitigating risk with deep operating expertise. PGP works with investors seeking direct opportunities in early stage and emerging cannabis opportunities. Michael can be reached at michael@wearepgp.com or 424-303-6500.

1. The Single Biggest Issue With Marijuana Stocks Right Now, Sean Williams, The Motley Fool, October 21, 2019

2. Legal Weed Isn’t the Boon Small Business Thought It Would Be, Lester Black, fivethirtyeight.com, December 29, 2017

3. Cannabis Attracts Big Tobacco, Alcohol, and Pharma. Which Big Industries Will Join Next?, Kris Kane, Forbes, December 19, 2018

4. Why Large Companies Continue to Struggle with Innovation, Tendayi Viki, Forbes, November 4, 2018

5. Marijuana Madness Turns Into A Cannabis Crash, Jacquie McNish & Vipal Monga, Wall Street Journal, October 12, 2019

6. Chart: US marijuana industry’s economic impact could hit $80 billion by 2022, Eli McVey, Marijuana Business Daily, May 29, 2018

7. These Seven American Cannabis Stocks Have Advanced in 2020, Alan Brochstein, Forbes, June 7, 2020

8. Jack of All Trades or Master of One?, Joey Pena, Marijuana Business Magazine, March 2019

9. Marijuana’s big moment: Pot stores are essential businesses. Will legal weed go mainstream?, Trevor Hughes, USA Today, April 20, 2020

10. Is marijuana ‘recession-proof?’ Industry experts say yes – to a point – and alcohol might be a guide, John Schroyer and Bart Schaneman, Marijuana Business Daily, March 24, 2020

11. Cannabis Is A Tax Bonanza For States, Nick Kovacevich, Forbes, December 5, 2018

12. End the Cannabis Banking Problem, Rob Nichols, The Hill, February 18, 2019

13. US Federal Cannabis Reform Outlook, Jeff Smith, Marijuana Business Daily, January 22, 2020

14. Cannabis Outlook 2020: Consolidation to Take over Sector, Danielle Edwards, Cannabis Investing News, December 25, 2019

15. How CPG Leaders Are Using M&A to Bolster Growth, Peri Edelstein, Krishnakumar (KK) S. Davey, Aman Gupta, Seth Marcus, and Cara Loeys, Boston Consulting Group, April 17, 2019

Michael Apstein

Principal Founding Partner

Primary Growth Partners

info@wearepgp.com

424-303-6500

wearepgp.com

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