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The Bold Shall Conquer Cannabis

June 10, 2022
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COMMENTARY:
by: Anand Shahi, CFA, President, Bar Capital

Dow 30,000 is to the COVID-19 era as The Roaring 20’s was to the Great Depression. Perhaps the time-tested adage “Fortune Favors the Bold” inspired investors just a few short weeks ago, but it now seems so defunct that only fools would follow it. In the current “shelter in place” era, even liquid investors are largely standing by and waiting for the dust to settle. How then should these liquid investors adapt to the new paradigm and perhaps find attractive opportunities? We at BAR Capital believe in the following:

Fortune Now Favors the Liquid… the Liquid Should Favor the Bold… and the Bold Shall Conquer Cannabis

Investing in alternative investments such as cannabis is not without its risks and only sophisticated investors with large asset bases who have a long-term outlook should consider it. If those prerequisites are met, some would argue that the cannabis industry is the most attractive investment proposition it has ever been and offers greater opportunity for returns than any other industry today. BAR Capital’s main takeaways in the current COVID era are:

  1. Cannabis may now be significantly de-risked from both a cultural and regulatory point of view given its new ‘essential’ status.
  2. Valuations to some insiders seem the most attractive they have been over the past 5 years, but now in an industry that is far more mature and established with institutionally trained leadership teams.
  3. Cannabis to some investors is one of the strongest industries in the private alternative investment space. For diversification purposes, it may help portfolios mitigate risks from future shocks such as COVID over long-term performance periods.
  4. The key to investing in cannabis today is to select methods and companies that benefit most from the factors above. High-quality Private Equity funds along with direct companies that have brands with a
    global reach and can deploy capital for opportunistic growth.

First, from a risk perspective, it is truly amazing to see the milestone cannabis achieved culturally in recent weeks. Every single state without exception has deemed medical cannabis ‘essential’1. This cultural shift feeds into what is now a very stark reality for most governments. The fiscal deficits being accumulated over the foreseeable future are astronomical. Cannabis, as the highest-growth industry where high-tax rates can be absorbed, may become one of the few options for regulators to generate notable revenues. This fiscal necessity of cannabis is punctuated in the case of NY where Governor Cuomo is pushing forward legalization despite dealing with the largest outbreak of COVID in the USA.

Second, valuations were already discounted prior to the COVID crisis. BAR Capital has seen some deals that were priced down to 75 cents on the dollar previously now trying to raise funding at 45 cents. Valuations have not looked this good for cannabis investors since perhaps 5 years ago. In prior periods, companies led by inexperienced management coming out of the prohibition days of cannabis made many errors in judgment resulting in wasted capital and opportunity. At many cannabis companies, inept leadership has given way to veteran executives who are making wise strategic and operational decisions.

Third, investing in alternatives in the private space, although containing its share of risks, is one of the most effective ways to lower correlation in a portfolio comprised of public stocks, bonds and real estate assets. As stated in the CFA Institute and CAIA Association’s primer on Alternative Investments: “It is only through a dynamic approach to asset allocation (one that adjusts to new industries, securities, and other economic changes) that a portfolio can maintain good principles of diversification.” When an experienced investment manager looks forward on how to build a better portfolio to withstand future shocks through low correlation, we at BAR Capital believe they may have to look at cannabis as an ‘essential’ allocation option.

While it is true that currently there are many attractively priced assets out there across industries, in the case of the current crisis, even previously stable opportunities for return such as rental income (particularly from office spaces) is now being questioned as a reliable revenue model post COVID. The experience most companies and employees are currently gaining on the systems and protocols of remote working may lead to a potential downsizing of office space and ripple through the CRE market for years to come. Cannabis on the other hand, given points I and II above, may be de-risked, counter-cyclical, and potentially have a stronger return profile.

Finally, the method and companies to participate in continue to be keys to success in cannabis. We believe having a high-quality Private Equity fund in the portfolio is very favorable as it provides industry diversification, co-investment opportunities, and institutional information flow to the investor. When selecting direct investments, it is key to pick companies with strong brands, experienced management, and global reach. To date, many investors have allocated to a local dispensary here or a cultivator there but the fast maturing cannabis industry and favorable regulatory environment may bring stronger tailwinds to well-led brands that have a clear vision to conquer the global market.

In addition, companies with either cash on hand or a strong plan to deploy new capital on opportunistic expansion will likely outperform peers and industry growth rates over the next 5-10 years. For these reasons, we at BAR Capital believe now is the time for sophisticated and liquid investors to look at cannabis as ‘essential’ piece of their portfolio and for ‘best-in-class’ money managers and companies in cannabis to be bold and dominate the industry.