According to a press release sent out last week, Complex Biotech Discovery Ventures (CBDV) has expanded their testing capabilities considerably with the new addition of a vapor/smoke analyzer. CBDV is a licensed cannabis and psilocybin research laboratory embedded in the University of British Columbia, led by CEO Dr. Markus Roggen.
Dr. Markus Roggen, Founder of Complex Biotech Discovery Ventures (CBDV)
The ability to analyze vapor and smoke is a relatively novel concept for the cannabis space, but has been utilized by the tobacco industry for years now. In the early days of adult-use cannabis legalization in the United States, stringent testing regulations for contaminants like pesticides were adopted out of a fear for what would happen when consumers ingest toxic levels of contaminants.
One of the common refrains iterated throughout the industry over the past ten years was that there just wasn’t enough research on how different contaminants affect patients and consumers when burned and inhaled. We still don’t know too much about what happens when someone smokes a dangerous pesticide, such as myclobutanil. Beyond just contaminants, the new technology allows for companies to measure precise levels of cannabinoids in vapor and smoke, getting a more accurate reading on what cannabinoids are actually making it to the end user.
The smoke analyzer at CBDV
This new development coming from our neighbor to the north could lead to a breakthrough in the cannabis lab testing and research space. CBDV claims they can now analyze cannabis material with a much more in-depth analysis than basic compliance testing labs. The new technology for analysis of smoke, vapor, plant material and formulations allows companies to thoroughly understand their materials in each stage of the product formulation process, all the way to product consumption.
Beyond just smoke and vapor analysis CBDV also offers NMR spectroscopy, metabolomics, nanoparticle characterization, computational modeling and other testing services that go far beyond the traditional compliance testing gamut.
“Our new services offer comprehensive insights into plant material, extracts, end-products and even the smoke/vapor by using state-of-the-art analytical instruments,” says Dr. Roggen. “By understanding the chemical fingerprint of the material, cannabis producers can eliminate impurities, adjust potencies, and optimize extraction processes before wasting money and resources on producing inconsistent end products. As a chemist I am really excited about adding NMR and high-res mass spectroscopy to the cannabis testing offerings.”
Multi-state operators (MSOs) are on the rise in the United States, navigating complex regulatory frameworks to drive profitability through economies of scale and scope. C21 Investments is a vertically integrated cannabis company with operations in Nevada and Oregon; traded on the Canadian Stock Exchange (CXXI) and on the OTCQX (CXXIF). The company recently secured a commitment from Wasatch Global Investors, JW Asset Management (Jason Wild/TerrAscend) and CB1 Capital Management (Todd Harrison) who, in addition to C21’s CEO, provided an equity commitment for repayment of all convertible debt.
We spoke with Bruce Macdonald, Chairman of C21 Investments. Bruce joined C21 in 2018 after reviewing the company as a personal investment and getting to know the senior management team. Prior to C21, Bruce had a long and successful career in finance and capital markets at one of Canada’s largest banks.
Aaron Green: Can you give a brief overview of C21?
Bruce MacDonald: C21 is a cannabis company that has operations in both Nevada, and in Oregon. Oregon is fundamentally a wholesale business, and we recently announced a divestment of some non-core assets in the state. Our cash cow and where we currently see our best opportunity for future growth is our Nevada operations. We run a seed-to-sale business in the state with two dispensaries doing about $35M a year in revenue, with a 40% EBITDA Margin, and servicing 600,000 customers.
Aaron: Can you tell me about a little bit about your background and how you got involved in a cannabis company?
Bruce: I spent 37 years working for RBC in the capital markets business. I started as a floor trader, back when there was such a thing as a floor, and over the years held a number of positions, ultimately working my way up to Chief Operating Officer of the bank’s global capital markets division. Throughout my time, I built a lot of businesses, which was why C21 and this opportunity was so interesting to me.
My involvement in the cannabis sector was a bit of an accident, but it’s turned into a passion. It actually found me. I was an investor in the C21 IPO. I sat down with management to understand the investment and given my experience, they asked if I would consider becoming a member the Board. Since joining the Board, my involvement has been primarily focused on strategy and the financing side of the business. While I certainly didn’t anticipate it, it’s turned into a 24/7 gig and a challenge I am thoroughly enjoying.
Bruce Macdonald, Chairman of C21 Investments
Aaron: Can you tell me about the history of C21 becoming a MSO? Did you start in one state?
Bruce: While this history predates my time at the company, my understanding is that as a Canadian company, we had first mover advantage to be able to access public funding and get established in the US cannabis space. As part of that, the team at that time reviewed approximately 100 different properties. Because we were based out of Vancouver, the focus was primarily the Western states like Washington, Oregon, Nevada and California. Arizona wasn’t in the game yet. The first transaction C21 did was in Oregon, with a company called Eco Firma. In all, there were four acquisitions in Oregon, and one in Nevada. In fact, it was the investment in Silver State (Nevada) that was by far the most meaningful. As far as our Oregon assets are concerned, we have worked hard to integrate and streamline them into an efficient operation.
So, when I joined the Board, we were just completing the paperwork on the acquisitions, and finalizing our strategy and business plan to go forward.
Aaron: Today there are a number of MSOs. How does this more crowded market impact your value proposition; how do you think about gaining and maintaining strategic advantage?
Bruce: It’s important first to start with strategy. From a strategic perspective, we had the advantage of being the first operator in Nevada with Silver State. Sonny Newman, our CEO, started the business back in 2013. We run a seed-to-sale business so we have a deep knowledge of all aspects of the operation and really know the Nevada market. In fact, 70% on a dollar volume basis of the 700 SKUs that we sell are products that we manufacture. It’s a critical piece of our strategic advantage.
What I would say is our most important strategic advantage is the fact that C21 is a stable, self-sustaining operator. What I mean by that is we’re one of the few businesses that actually makes money. This is what really allows us to be strategic and disciplined in our approach to growth. For example, it’s been more than 18 months since we did our last capital raise and that’s by choice. Every decision we make is through the shareholder lens and focusing on delivering value to customers and shareholders.
Looking at our value proposition, simply put, it comes down to four things – the right products, at the right price, in the right location, with the right environment. Some people might call this motherhood, but there’s a lot of work that goes behind each of them.
Great quality products, that’s table stakes. You have to be a top-notch grower and generate quality products that people demand if you want to build a loyal customer base. Right price – to some it sounds like just putting the right sticker on the package – it’s not. It’s all about making sure you are efficient in your operations because to be profitable, you have to be a low-cost producer to deliver on a lower price promise. Tons of work has gone into our operation around being a “right price” business.
Right location is another important element of our value proposition. We wanted to build a loyal customer base which for us meant focusing more on locals than on tourists. This is why Sonny positioned the dispensaries on commuter paths.
The last key factor is having the right environment to sell our products. In Nevada, the company ended up building fit-for-purpose dispensaries rather than fitting ourselves in a strip mall. We cater to over 600,000 clients a year. Now we’re doing 10,000 curbside pickups a month. With that type of volume, logistically speaking you need ample parking, a well-lit exterior so people feel safe, and of course, great curb appeal. These factors are essential in maintaining a loyal customer base.
Aaron: Tell me more about Silver State Relief and why it has been so successful?
Bruce: I think what you’re really asking for is: what is Sonny’s secret sauce? There are a few ingredients that go into it. As I highlighted, it was a purposeful decision to build a business with a loyal customer base focused primarily on locals. That needs product, price, and convenience. Sonny lives in the Reno area, which is one of the main reasons Silver State is located up North.
Critical to success has been the culture of the organization. Let’s start with the company being nimble and I’ll give you an example. The early days of the pandemic included the complete shutdown of dispensaries. We went from serving over 1500 customers a day in our stores to the next day being told that we could offer delivery only. Within a week, we were able to pivot and had lockboxes, regulatory approvals and a delivery capability. When you look at our Nevada operation, we ended up with just a 10% dip in our revenues for the quarter, even though we had to live through six weeks of delivery-only and then a phase of curbside-only.
Another key element of the culture is our laser focus on cost management. We’ve talked a little about cost management, but it’s absolutely critical, especially in the context of the high cost of capital that we see in this sector. Add to that the punitive tax impact of 280e where federal tax is applied to gross margins which means SG&A and interest are non-deductible expenses for tax purposes. So, to enhance our profitability, we are intent on having the lowest SG&A of the public cannabis companies. We’re also among the lowest in interest expense. That whole drive for efficiency has given us a formula and a mantra that has allowed us to have a stable business with significant cash flow. We get to make strategic decisions — not hasty or desperate ones — and focus on what’s good for the shareholder.
Aaron: How was C21 capitalized?
Bruce: We did a $33M raise on the RTO of a listed shell company. That was how C21 was established, and then signed contracts with the Oregon and Nevada properties.
Aaron: I recently saw a press release about expanding the Nevada cultivation. Can you give me some more details?
Bruce: We announced that we are tripling our capacity within our existing 100,000 square foot warehouse facilities. We’re going to build out another 40,000 square feet, and we currently use 20,000. That’s the tripling. Expanding our cultivation was clearly the next logical step in our growth story. This should yield us an additional 7,500 pounds of high-quality flower. We can do this very cost effectively with about $6M in capex, and we anticipate funding the project internally. We will still leave another 40,000 square feet of expansion capacity as market needs justify.
This announcement was significant, but I don’t think it was fully understood by the market. Just to play with some numbers, 7,500 pounds of flower has a wholesale market value today of about $17M. It will cost us approximately $2M in incremental operating expense to add these additional grow rooms. We already pay the rent, so we just need to pay for the people, power, fertilizer and product testing. When you do the simple math, we see this as a big win for shareholders and extremely accretive on an after-tax basis.
Historically, we always used to grow more than we needed, but with the increase in demand that’s going on in the market, we now run at a flower deficit. In the near term, this build-out will allow is to meet our current retail needs, with the balance that we will sell on the wholesale market. Ultimately, this positions us well on a seed-to-sale basis to support our plans to extend our retail footprint in Nevada.
Aaron: It sounds like the decision was made based on both revenue growth and supply chain consolidation?
Bruce: Yes, and just the pure profitability of it! You can’t get a bigger, better bang for your buck from spending $6M to generate $17M with ongoing operating costs of $2M.
Aaron: The next question here is about the recent note restructuring and, and how the debentures was restructured. How’d that come about and what is the advantage now of having gone through that process?
Bruce: This all fits into our medium-term growth strategy. For C21, the first thing we focused on was getting our house in order to ensure that we were efficient and profitable. We knew we needed to have a scalable machine to grow. The second step, which the debt restructuring relates to, was around fortifying our balance sheet. To support our growth plans, we needed to have a solid foundation.
Our balance sheet had two things that needed fixing. One was that we had an $18M obligation coming due to our CEO. The effect of the restructuring extended this obligation over the next 30 months at favorable terms. Additionally, $6.5M of convertible debentures were reaching maturity in January of 2021. And while the debentures were in the money and theoretically would convert to shares, we didn’t want to take the risk that our stock price could drift a bit and all of a sudden there could be significant cash required for redemptions. We’ve seen a lot of companies suffer significant unwanted dilution when their debentures get out of control. So, we approached Wasatch, Jason Wild’s JWAM and CB1 Capital, three seasoned investors, who provided a backstop whereby they would purchase any shares not taken up by people though the conversion of their debentures, so that we would be able to pay any debenture holders back cash with the money we would receive as the investors took shares. In exchange for providing this backstop, C21 gave them an upside participation in the form of warrants. I think it was absolutely critical to get this in place. And it’s phenomenal to have these three names in our corner. We couldn’t imagine better partners.
Aaron: So, what’s next for C21?
Bruce: I hope you are getting the feeling that here at C21 our objective is to play the long game. That means we make measured decisions with the interest of shareholders top of mind. We’ve worked hard in 2020 to get our house in order, fortify our balance sheet, and generate significant cash flow. I think we’re clocking in at around $12M in trailing annual cash flow, which interestingly, is about the same number that Planet 13 is doing. That’s obviously a fantastic result for a company with $150M of market cap.
“We are working with urgency to break the back of these sector economics.”When we think about our medium-term growth strategy, we will continue to make our decisions through a cash flow and earnings lens rather than hype and flash. While we will remain opportunistic with respect to strategic alternatives, the core of our expansion is going to focus on where we already have a proven track record: Nevada. We’re big believers that to achieve long term success, you have to own your home market. And what I mean by that is today we’re about 5% of the Nevada market. Owning your home market looks more like a 15% share. That is our focus. I think we’ve shown that our disciplined approach delivers results – results such as having top five metrics in Net Income, Cash Flow and EBITDA Margin, across the range of public companies that we can see.
I think it’s key we’re getting noticed. We talked about the strategic investors, but we’re also one of the 17 plant-touching companies that’s in the MSOS ETF. So, we’re going to follow our clear growth trajectory, focused on the bottom line and delivering for shareholders. If you look under the hood right now, you see a 10% cash flowing company, which is a pretty rare bird in our industry. We’re excited about where we are.
One thing I haven’t touched on in great detail is our plans for expanding our retail footprint. How do you grow in the dispensary space? Aaron, I think what’s key here is looking at the expected return relative to the cost of capital. For example, if you targeted buying a dispensary with $20M in revenues, and are able as we are, to generate 25% in after-tax cash based on those revenues, then once optimized, it would generate $5M in earnings. An asset like this is going to trade at roughly one and a half times revenues. So, you’re going to have to pay $30M. For the people that have been going out and borrowing money at 15%, their annual cost would be $4.5M. We’re not going to give four and a half to the moneylenders, it just doesn’t make sense for shareholders. We are working with urgency to break the back of these sector economics. It is something we believe will be afforded to companies with stable earnings and profitability such as ours. Of course, no deal’s a deal until it’s on the tape, but we are very hopeful that we have cracked the code ahead of SAFE Banking to get capital costs down. This is just a little bit of an inside look into our thought processes.
Aaron: Okay, awesome. All right. That concludes the interview.
Editor’s Note: This piece is an excerpt from Marguerite Arnold’s Green II: Spreading Like Kudzu. Click here to buy the book.
THC as of February of 2019, certainly in the recreational sense, was not much seen in either Switzerland or much of Europe. Even in Holland, the coffee shops were getting more regulated along with the supply chain for them. In Spain, the cannabis clubs thrived in a grey area. But outside of these two very narrow exceptions, the biggest, most valuable part of the cannabis market (medical and THC) was just as fraught with similar kinds of issues. And those were occurring not in Spain, Holland or even Switzerland, but just across the border, in Germany.
In fact, the real news on the industry side in Europe, as it had been for the past few years, was not the consumer CBD market, however intriguing and potentially valuable it was in the foreseeable future, but the medical, and “other” cannabinoid universe that included THC. And the real triggering event for the beginning of the European march towards reform was certainly influenced by what happened both in the United States and Canada as much as Israel. Where it landed first and most definitively was not Holland, circa 2014, or even Switzerland or Spain soon thereafter, but rather Deutschland.
Green II: Spreading Like Kudzu
The Canadian market without a doubt, also created an impetus for European reform to begin to roll right as German legislators changed the laws about medical cannabis in 2017. But even this was a cannabis industry looking to foreign markets that they presumably knew were developing (if not had a direct hand in doing so, including in Berlin, come tender-writing time).
Divorced from inside knowledge about moving international affairs, why did Germany – certainly as opposed to its certainly more “liberal” DACH trading partner Switzerland- suddenly turn up in the summer of 2016 as the “next” hot thing for Canadian cannabis companies?
The answer is in part political, certainly economic, and absolutely strategic.
Germany is in the EU, unlike Switzerland, and is a G7 country.6 It also was, by 2016, certainly much closer to legalizing federally authorized and insurer-reimbursed medical use cannabis. This was because sick patients had by this time successfully sued the government for access (including home grow). And the government, citing concerns about the black market and unregulated cannabis production (see Canada) wanted another option.
Not to mention was a market, certainly in 2016, helped with a little CETA inspired “juice.”
The international trade treaty between Canada and the EU (if not the other big treaty, the pharmaceutically focused Mutual Recognition Agreement (MRA) with the U.S.) has been in the back of the room throughout the entire cannabis discussion during the expansion of the Canadian industry across Europe. It is still unclear at this writing if the juxtaposition of CETA and the start of the Canadian cannabis trade had anything to do with lengthening the process of the German cultivation bid – but given how political the plant had also become, this was at this point more than a reasonable assumption to make.
As a result so far at least, since the beginning of the real German cannabis market in 2016 (namely the beginning of an import market from not just Holland but Canada) and Europe beyond that, Canadian companies have played an outsize role (starting with bankrolling operations in the first place). The growth of the Canadian market as well as developments within it absolutely spawned if not sparked the change if not beginning of the changeover within Europe by starting, of all places, with Germany.
Marguerite Arnold, CIJ contributor and author of Green II: Spreading Like Kudzu
But again, why Germany? And why the coalescence of the industry as well as other Euro hot spots outside its borders since then?
There are several explanations for this.
One is absolutely timing and strategic positioning.
Germany had, since 2015, begun the slow process of dealing with the medical cannabis issue on a federal basis, informed if not greatly influenced not only by what was happening in events abroad in Canada and the U.S. but also Israel. At home, there was also pressure to begin to address the issue. Albeit highly uncomfortably and at least in the eyes of the majority of centrist legislators, as far at a distance as possible.
Namely, patient lawsuits against insurers began to turn in favor of patients. Technically, between the turn of the century and 2016, patients could buy cannabis in pharmacies with a doctor’s prescription in Germany. But it was hugely expensive and beyond that a cumbersome process. Only 800 patients in fact, by 2017 had both managed to find doctors willing to prescribe the drug and could afford the €1,500 (about $1,700) a month to pay for it.
Everyone else, despite nobody’s willingness to admit it, found their supplies in the grey (non-profit patient collective) or black (street and largely criminally connected) market.
Günther Weiglein, a patient from Wurzburg, a small town in Bavaria, changed all of that.
In 2015, he won his court case against his insurer, claiming that even though he qualified as a patient, he could not afford the cannabis for sale in pharmacies. With that, he and a few patients temporarily won the right to grow their own (with permission).
Weiglein is the epitome of the German “everyman.” Blond, stocky and in his fifties, he has suffered chronic pain since a devastating motorcycle crash more than two decades ago. He has also taken to the cannabis cause with a dedication and singularity of purpose that sets him apart even from most other patient activists (in Germany or elsewhere). He is fiercely independent. And not afraid of expressing his desire for a “freedom” that has not yet come.
However, in 2015, there seemed to be several intriguing possibilities.
Indeed, at the time, it seemed possible, in fact, that Germany seemed poised to tilt in the direction of Canada – namely that patient home grow would be enshrined as a kind of constitutional right.
However, it did not turn out that way. Desperate to stem the pan European black market, which is far more directly connected to terrorism of the religious extremist and Mafia kind in these waters and to avoid a situation where Berlin became the next Amsterdam, the German parliament decided on a strange compromise.
On one level, it seems so predictably orderly and German. If cannabis is a medicine, then Germans should be able to access the same through national health insurance.
In fact, however, the process has been one that is tortured and has been ever since, not to mention compounded the difficulties of just about everyone connected to the market. From patients to producers.
“In practice it has so far not evolved quite so smoothly.”Here is why. The government decided that, as of passage of a new law which took effect in March 2017, the German government would regulate the industry via BfArM, the German equivalent of the American Food and Drug Administration (FDA), and issue formal federal cultivation licenses.
This makes sense from a regulatory perspective too. Cannabis can be used as a medical drug. Even if its definition as a “narcotic” – even on the medical side – leaves a lot to be desired.
This is especially true on the CBD part of the equation. It is even more particularly relevant for those who use THC regularly for not only chronic pain, but as an anti-convulsive or anti-inflammatory agent.
However unlike Canada, the German federal government also chose to revoke patient grow rights while mandating that insurers cover the cost of the drug if prescribed by a doctor. In practice also spawning a specialty distributor market that is still forming.
All very nice in theory. In this abstract world, these rules make sense for a pharmacized plant if not drug beyond that. This is the route all other medicines in Germany take to get into the market if not prescribed in the first place.
In practice it has so far not evolved quite so smoothly. Indeed, while understandable for many reasons from stemming the black market to setting standards, this rapid switch from patient or collective grown cannabis to requiring patients to interact with both a doctor and a pharmacy (beyond the insurer) with no other alternative also creates its own serious problems. For everyone along the supply chain. But most seriously and problematically for both patients and doctors.
After a slow start following a disappointing 2019, M&A in the cannabis space closed 2020 with a bang, with more than $600 million in deals announced immediately following the November elections. Prospects for the New Year are expected to continue the explosive year-end trend with a backlog of nearly $2 billion in deals heading into 2021. The COVID-19 pandemic boosted sales of cannabis products, and election results opening up five new states to legal cannabis use and possible federal regulatory reform are further boosting prospects. Analysts now predict the U.S. cannabis market is poised to double by 2025.
Growth is expected to be led by multi-state operators who have achieved scale, cleaned up their balance sheets and stockpiled dry powder for roll-up acquisitions. Cannabis companies raised nearly $134 million in the two weeks before Election Day, a 185% increase over the same period last year. Most of the money flowed to multistate operators. In addition, the biggest stocks by market capitalization saw a roughly 20% bump ahead of the election and now are trading at record volumes, providing plenty of stock currency for further acquisitions.
Among the headline acquisitions last year:
Curaleaf continued its multi-state expansion with two of its largest acquisitions – the all-stock purchases of its affiliated cannabis oil company Select and of Grassroot, another MSO player. Curaleaf is now the largest cannabis company in the world based on annualized revenues, with annualized sales of $1 billion and operations in 23 states and 96 open dispensaries. Curaleaf also raised $215 million privately last year end for further expansion.
Close behind, Aphria and Tilray announced in December that they will merge, creating what they say will be the largest cannabis company in the world with an equity value of roughly $3.8 billion. The combined entity will have facilities and offices in the U.S., Canada, Portugal and Germany. The deal is expected to close during the second quarter of this year.
Also in December, Illinois-based Verano Holdings LLC unveiled plans to go public at a $2.8 billion valuation through a reverse takeover of a Canadian shell company. That deal followed the announcement that Verano will merge with Florida-based AltMed.
In addition, publicly traded New York cannabis firm Columbia Care signed a definitive agreement last month to acquire Green Leaf Medical, a privately held Maryland-based cannabis manufacturer and retailer, for $45 million in cash and $195 million in stock. The acquisition is expected to close this summer. Including Green Leaf’s inventory, the Columbia Care will operate 107 facilities, including 80 dispensaries and 27 cultivation and manufacturing facilities. Columbia Care also took advantage of cannabis fever last year by raising $100 million privately.
Also in December, Ayr Strategies announced it would acquire Liberty Health Sciences, one of the largest cannabis companies in Florida, for $290 million in stock, as well Garden State Dispensary, a New Jersey marijuana company for $41 million in cash, $30 million in stock and $30 million in the form of a note. This follows Ayr’s $81 million acquisition of an Arizona medical marijuana operator in November. Voters approved marijuana use in Arizona and New Jersey in November. Ayr has completed a string of acquisitions in Nevada, Massachusetts, Pennsylvania, Arizona, Ohio and, upon the closing of December’s deals, New Jersey and Florida.
Not all cannabis companies will rely on acquisitions, however. Trulieve, as an example, has focused its efforts on Florida and organic growth. It remains to be seen whether a multi-state approach fueled by acquisitions or a single-state organic growth model will prove the more lasting. Growth and profitability in the short term likely will continue to be hampered by limits on economies of scale due to federal restrictions and differing state laws.
In light of the maturing industry and the 2019 bust, the valuation model for acquisitions in the cannabis space is evolving from one based on sales, typically associated with emerging growth industries, to a more mature industry model based on profits or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Most cannabis MSOs have stabilized and generate positive EBITDA, which justifies the evolution away from a sales-driven model.
From a legal standpoint, the same limitations that have vexed the cannabis industry for years will continue to challenge deal makers until there is greater clarity on the federal front. Institutional investor reluctance, financial industry constraints, haphazard state regulation and the unavailability of federal forums such as national copyright and trademark registration will continue to be issues for acquirers and their lawyers in the space.
Acquisition agreements will continue to have to address the federal Damocles’ sword should expected relaxation of federal enforcement under the Biden administration and further legislative relief does not materialize as expected. Although the U.S. House in December passed the “Marijuana Opportunity Reinvestment and Expungement Act” (MORE) to remove cannabis from the Controlled Substances Act, the Senate did not take up the bill in 2020 and it will have to be re-introduced in 2021. Notably, the MORE Act does not affect existing federal regulation of cannabis, such as the Food, Drug and Cosmetics Act, under which the FDA has limited the use of CBD in certain products despite hemp being removed from the Controlled Substances Act in 2018.
The cannabis M&A market is moving into a more mature phase, as MSOs will be choosier in their approach rather than continuing the land-grab mentality of years past. Due to improved financial strength, 2021 should see these MSOs continuing to expand their footprints either within existing states or new ones. Although uncertainties abound, further consolidation and expansion through add-on acquisitions is likely to continue apace in 2021, providing plenty of opportunities for deal makers and their lawyers.
Editor’s Note: This is an excerpt from chapter ten of From Seed to Success: How to Launch a Great Cannabis Cultivation Business in Record Time by Ryan Douglas. Douglas is founder of Ryan Douglas Cultivation, a cannabis cultivation consulting firm. He was Master Grower from 2013-2016 for Tweed, Inc., Canada’s largest licensed producer of medical cannabis and the flagship subsidiary of Canopy Growth Corporation.
Cultivation businesses should consider specializing in just one stage of the cannabis cultivation process. The industry has focused heavily on vertical integration, and some regulating bodies require licensees to control the entire cannabis value chain from cultivation and processing to retail. This requirement is not always in the best interest of the consumer or the business, and will likely change as the industry evolves. Not only will companies specialize in each step of the value chain, but we’ll see even further segmentation among growers that choose to focus on just one step of the cultivation process. Cannabis businesses that want to position themselves for future success should identify their strengths in the crop production process and consider specializing in just one part.
Ryan Douglas, former Master Grower for Tweed and author of From Seed to Success: How to Launch a Great Cannabis Cultivation Business in Record Time
Elsewhere in commercial horticulture, specialization is the norm. It is unlikely that the begonias you bought at your local garden shop spent their entire life inside that greenhouse. More likely, the plant spent time hopping between specialists in the production chain before landing on the retail shelf. One grower typically handles stock plant production and serves as a rooting station for vegetative cuttings. From there, rooted cuttings are shipped to a grower that cares for the plants during the vegetative stage. Once they’re an appropriate height for flowering, they’re shipped to the last grower to flower out and sell to retailers.
Cannabis businesses should consider imitating this model as a way to ensure competitiveness in the future. In the US, federal law does not yet allow for the interstate transport of plants containing THC, but the process can be segmented within states where vertical integration is not a requirement. As we look ahead to full federal legalization in the US, we should anticipate companies abandoning the vertical integration model in favor of specialization. In countries where cannabis cultivation is federally legal, entrepreneurs should consider specialization from the moment they begin planning their business.
Cultivators that specialize in breeding and genetics could sell seeds, rooted cuttings, and tissue culture services to commercial growers. Royalties could provide a recurring source of income after the initial sale of seeds or young plants. Contracting propagation activities to a specialist can result in consistently clean rooted cuttings that arrive certified disease-free at roughly ¼ the cost of producing them in-house. This not only frees up space at the recipient’s greenhouse and saves them money, but it eliminates the risks inherent in traditional mother plant and cloning processes. If a mother plant becomes infected, all future generations will exhibit that disease, and the time, money, energy, labor, and space required to maintain healthy stock plants is substantial. Growers that focus on large scale cultivation would do well to outsource this critical step.
From Seed to Success: How to Launch a Great Cannabis Cultivation Business in Record Time
Intermediary growers could specialize in growing out seeds and rooted cuttings into mature plants that are ready to flower. These growers would develop this starter material into healthy plants with a strong, vigorous root system. They would also treat the plants with beneficial insects and inoculate the crop with various biological agents to decrease the plant’s susceptibility to pest and disease infestations. Plants would stay with this grower until they are about six to 18 inches in height—the appropriate size to initiate flowering.
The final stage in the process would be the flower grower. Monetarily, this is the most valuable stage in the cultivation process, but it’s also the most expensive. This facility would have the proper lighting, plant support infrastructure, and environmental controls to ensure that critical grow parameters can be tightly maintained throughout the flowering cycle. The grower would be an expert in managing late-stage insect and disease outbreaks, and they would be cautious not to apply anything to the flower that would later show up on a certificate of analysis (COA), rendering the crop unsaleable. This last stage would also handle all harvest and post-harvest activities—since shipping a finished crop to another location is inefficient and could potentially damage the plants.
As the cannabis cultivation industry normalizes, so, too, will the process by which the product is produced. Entrepreneurs keen on carving out a future in the industry should focus on one stage of the cultivation process, and excel at it.
On December 16, 2020, Aphria Inc. (TSX: APHA and Nasdaq: APHA) announced a merger with Tilray, Inc. (Nasdaq: TLRY), creating the world’s largest cannabis company. The two Canadian companies combined have an equity value of $3.9 billion.
Following the news of the merger, Tilray’s stock rose more than 21% the same day. Once the reverse-merger is finalized, Aphria shareholders will own 62% of the outstanding Tilray shares. That is a premium of 23% based on share price at market close on the 15th. Based on the past twelve months of reports, the two companies’ revenue totals more than $685 million.
Both of the companies have had international expansion strategies in place well beyond the Canadian market, with an eye focused on the European and United States markets. In Germany, Aphria already has a well-established footprint for distribution and Tilray owns a production facility in Portugal.
About two weeks ago, Aphria closed on their $300 million acquisition of Sweetwater Brewing Company, one of the largest independent craft brewers in the United States. Sweetwater is well known for their 420 Extra Pale Ale, their cannabis-curious lifestyle brands and their music festivals.
Once the Aphria/Tilray merger is finalized, the company will have offices in New York, Seattle, Toronto, Leamington, Vancouver Island, Portugal and in Germany. The new combined company will do business under the Tilray name with shares trading on NASDAQ under ticker symbol “TLRY”.
Aphria’s current chairman and CEO, Irwin Simon, will be the chairman and CEO of the combined company, Tilray. “We are bringing together two world-class companies that share a culture of innovation, brand development and cultivation to enhance our Canadian, U.S., and international scale as we pursue opportunities for accelerated growth with the strength and flexibility of our balance sheet and access to capital,” says Simon. “Our highly complementary businesses create a combined company with a leading branded product portfolio, including the most comprehensive Cannabis 2.0 product offerings for patients and consumers, along with significant synergies across our operations in Canada, Europe and the United States. Our business combination with Tilray aligns with our strategic focus and emphasis on our highest return priorities as we strive to generate value for all stakeholders.”
As a strange year heads to a final, painful finish, there have been some major (and some less so) changes afoot in the global world of cannabis regulation. These developments have also undoubtedly been influenced by recent events, such as the recent elections in the United States, state votes for adult use reform in the U.S. and the overall global temperature towards reform. And while all are broadly positive, they have not actually accomplished very much altogether.
Here is a brief overview of the same.
The UN Vote On Cannabis Despite a wide celebration in the cannabis press, along with proclamations of an unprecedented victory by large Canadian companies who are more interested in keeping their stock prices high than anything else, the December 2 vote on cannabis was actually fairly indecisive.
Following the WHO recommendations to reschedule cannabis, the UN voted in favor of the symbolic move. Despite removing cannabinoids from Schedule IV globally, a regulatory label designed for highly addictive, prescription drugs (like Valium), the actual results on the ground for the average company and patient will be inconclusive.
The first issue is that the UN did not remove cannabinoids themselves, or the plant, from Schedule I designation. This essentially means that countries and regions will be on the front lines to create more local, sovereign policies. This is not likely to change for at least the next several years (more likely decade) as the globe comes to terms with not just a reality post-COVID-19, but one which is very much pro-cannabis.
In the meantime, however, the ruling will make it easier for research to be conducted, for patient access (for the long term), and more difficult for insurers to turn down in jurisdictions where the supposed “danger” of cannabis has been used as an excuse to deny coverage. See Germany as a perfect example of the same.
It is also a boon for the CBD business, no matter where it is. Between this decision and the recent victory in Europe about whether CBD is a narcotic or not (see below), this is another nail in the coffin for those who want to use semantic excuses to restrain the obvious global desire for cannabinoids, with or without THC.
That said, the vote is significant in that it is a test of the current trends and views towards big issues within the overall discussion, beginning with decriminalization and a reform of current criminal and social justice issues inherent in the same. The Biden Administration, while plagued with a multitude of issues, beginning with the pandemic and its immediate aftershocks, will not be able to push both off the radar. Given the intersection of minority rights’ issues, the growing legality of the drug and acceptance thereof, as well as the growing non-partisan position on cannabis use of both the medical and adult use kind, and the economy, expect issues like banking to also have a hope of reform in the next several years.
Cannabis may be taking a back seat to COVID, in other words, but as the legalization of the industry is bound up, inextricably, in economic issues now front and center for every economy, it will be in the headlines a great deal. This makes it an unavoidable issue for the majority of the next four years and on a federal level.
Prognosis in other words? It’s a good next federal step that is safe, but far from enough.
The European Commission (EC) Has Finally Seen The Light On CBD
This combined with the UN rescheduling, will actually be the huge boost the CBD industry has been waiting for here, with one big and still major overhanging caveat – namely whether the plant is a “novel” one or not. It is unlikely as the situation continues to cook, that Cannabis Sativa L, when it hits a court of law, will ever be actually found as such. It has inhabited the region and been used by its residents for thousands of years.
However, beyond this, important regulatory guidance will need to fall somewhere on the matter of processing and extraction. It is in fact in the processing and extraction part of the debate that this discussion about Novel Food actually means something, beyond the political jockeying and hay made so far.
Beyond this of course, the marketing of CBD now allowed by this decision, will absolutely move the topic of cannabinoids front and center in the overall public sphere. That linked with sovereign experiments on adult use markets of the THC kind (see Holland, Luxembourg and Denmark as well as Portugal and Spain right after that), is far from a null sum game.
Legal Challenges Of Note
The European Court of Human Rights
Against this changing regulatory schemata, court cases and legal decisions remain very important as they also add flavor to how regulations are interpreted and followed. The most important court case in Europe right now is the one now waiting to be decided in the Court of Human Rights at Strasbourg regarding the human rights implications of accessing the plant.
Beyond that, in Germany, recent case law at a regional social benefits court (LSG) has begun to establish that the cannabis discussion is ultimately between doctors and their patients. While this still does not solve the problem of doctor reluctance to prescribe the drug, barriers are indeed coming down thanks to legal challenges.
Bottom line, the industry has been handed a nice whiff of confidence, but there is a still high and thorny bramble remaining to get through – and it will not happen overnight, or indeed even over the next several years.
Dr. Markus Roggen is a chemist, professor, cannabis researcher and founder & CEO of Complex Biotech Discovery Ventures (CBDV). Founder & CEO of Ascension Sciences (ASI), Tomas Skrinskas has been at the leading edge of transformative healthcare technologies, including computer assisted surgery, surgical robotics and genetic nanomedicines, for over 15 years.
Leading researchers from the cannabis industry – Dr. Markus Roggen (Complex Biotech Discovery Ventures) and Tomas Skrinskas (Ascension Sciences) – highlight the challenges facing the industry’s current compliance testing standards and the opportunities emerging from the latest developments in nanotechnology and advanced analytical testing. Here are the key insights from the discussion.
What are the current compliance testing requirements for cannabis products? Are they sufficient in ensuring safety and quality?
In the current landscape, Canada’s compliance testing requirements are clearly laid out in the form of guidance documents. Specifically, for pesticide testing, cannabinoid concentration content in products, heavy metals, etc. Compliance testing can be roughly divided into two categories: 1) establishing the concentrations of wanted compounds, and 2) ensuring that unwanted compounds do not exceed safety limits.
In the first category, cannabinoids and terpenes are quantified. Their presence or absence is not generally forbidden but must stay within limits. For example, for material to be classified as hemp, the THC concentration cannot exceed 0.3 %wt., or a serving of cannabis edible should contain below 5 mg of THC. The second category of compliance testing focuses on pesticides, mold and heavy metals. The regulators have provided a list of substances to test for and set limits on those.
Are those rules sufficient to ensure safety and quality? Safety can only be ensured if all dangerous compounds are known and tested for. Take for example Vitamin E acetate, the substance linked to lung damage in some THC vape consumers and the EVALI outbreak. Prior to the caseload in the Fall of 2019, there were no requirements to test for it. It’s not only additives that are of concern. THC distillates often show THC concentrations of 90% plus 5% other cannabinoids. What are the last 5% of this mixture? Currently, those substances have not been identified. Are they safe? There is no concrete way to determine that.
The aforementioned guidelines have the best intentions, but do not adequately address two key obstacles the industry is currently facing: 1) what happens in practice, and 2) what can easily be audited? Making sure people follow the requirements is the challenge, and it comes down to variability of the tests. Testing has to happen on the final form of the product as well as every “batch,” but there is little guidance on how that is defined. With so much growth happening in the industry, how are these records even tracked and scrutinized?
And finally, there’s the question of quality. How do you define quality? Before establishing quantifiable quality attributes, it can’t be tested.
If compliance testing is insufficient, then why aren’t more cannabis companies testing beyond Health Canada’s requirements?
Compliance testing has always been focused on the end product, THC and CBD levels, and consumer safety. As long as cannabis companies are testing to determine this, doing further testing means added costs to the producer. There is a rush to get cannabis products to the new market because many consumers are eager to buy adult use products such as extracts or edibles, and quality is not the biggest selling point at this very moment.
However, there are unrealized advantages to advanced analytical testing that go beyond Health Canada’s requirements and that offer greater benefits to cannabis producers and product developers. Producers often see testing as an added cost to their production that is forced upon them by the regulators and will only test once the product is near completion. For cannabinoid therapeutics and nutraceuticals, advanced analytical testing is critical for determining the chemical makeup and overall quality of the formulation. This is where contract researchers, such as Ascension Sciences, come in to offer tests for nanoparticle characterization, cannabinoid concentration, dissolution profiles and encapsulation efficiency.
A lack of budget and awareness have prevented cannabis companies from advanced analytical testing. However, testing that goes beyond lawful requirements is an opportunity to save money and resources in the long term. This is where companies, like Complex Biotech Discovery Ventures (CBDV), offer in-process testing that provides a deep characterization and analysis of cannabis samples during every stage of product development. If tests are conducted during production, inefficiencies in the process are revealed and mistakes are spotted early on. For example, testing the spent cannabis plant material after extraction can verify if the extraction actually went through to completion. In another case, testing vape oil before it goes into the vape cartridges and packaging allows producers to detect an unacceptable THC concentration before they incur additional production costs.
Which methods are the most successful for cannabis testing?
The most effective method is the one that best determines the specific data needed to meet the desired product goal. For example, NMR Spectroscopy is paramount in assessing the quality of a cannabis sample and identifying its precise chemical composition.
HPLC (liquid/gas chromatography) is the most precise method for quantifying THC, CBD and other known cannabinoids. However, if a cannabis extractor wants to quickly verify that their oil has fully decarboxylated, then an HPLC test will likely take too long and be too expensive. In this case, IR (Infrared Spectroscopy) offers a faster and more cost-effective means of obtaining the needed data. Therefore, it ultimately depends on the needs of the producer and how well the testing instruments are maintained and operated.
What’s next in analytical testing technology? What are you working on or excited about?
In terms of compliance, regulations to standardize the testing is the hot topic at the moment. For nanotechnology and nanoparticles, the big question now is what is known as the “matrix” of the sample. In other words, what are the cannabinoids, and what else is in the sample that’s changing your results? The R&D team at Ascension Sciences is in the process of developing a standardized method for this to combat the issues mentioned earlier in the interview.
The smoke analyzer in CBDV’s lab
Ascension Sciences is also excited about characterizing nanoparticles over time to determine how cannabinoids are released and how that data can be transferred or made equivalent to consumer experiences. For example, if a formulation with quicker release, faster onset and better bioavailability is found in the lab, product development would be more efficient and effective when compared to other, more anecdotal methods.
At CBDV, the team is working on in-process analytical tools, such as decarboxylation monitoring via IR Spectroscopy and NMR Spectroscopy. CBDV is also looking at quantifying cannabis product quality. The first project currently in motion is to identify and quantify cannabinoids, terpenes, and other compounds present when vaping or smoking a joint using a smoke analyzer.
A lack of budget and awareness have prevented cannabis companies from testing beyond what’s required by Health Canada. Compliance testing is designed to ensure safety, and for good reason, but it is currently insufficient at determining the quality, consistency and process improvements. As the above factors are necessary for the advancement of cannabis products, this is where further methods, such as advanced analytical testing, should be considered.
There is an ineffable logic to the pace of reform these days. Nowhere is that clearer in both the success of voter reform measures in the United States (along with timelines for implementation baked into the language of the same) and developments internationally. No matter that New Zealand decided to take a recent punt on the issue, there are other forces moving elsewhere that have the potential to be far more consequential – and in the short term.
Israel Announced Its Intent To Create A Recreational Market in 2021
There is little news anywhere as consequential as that of the oldest medical market finally succumbing to the inevitable. Namely, Israel has announced that it will allow an adult use market to begin operations probably by the third quarter of 2021. That said, don’t hold anyone to a deadline in the days of COVID-19, which will just as surely have not passed by then.
However, this development means that the entire conversation has moved up a notch – because the Israelis have so much research on the plant at this point.
For this reason, the tiny country is likely to have an outsized impact on the entire discussion – along with conveniently timed medical exports to the world.
Luxembourg Will Initiate Its Recreational Market Shortly Thereafter
It is likely not insignificant that the Israelis announced their intent to begin an adult use market just ahead of the long-announced Luxembourg flip – now on the agenda of the Green Party domestically for several years.
The strategic location of Luxembourg in both the European market as well as the much larger financial one now interested in the vertical cannot be understated. Indeed, the country has already played an outsized role in the development of the medical market here due to the contretemps over the clearing of stock trades in the German market as of 2018.
The double whammy of good news from both markets will also create a buzz internationally that is sure to drive other conversations forward – even if it is to study how both countries approach the issue. And, more to a point, how they differ from Canada, including regulation of their equity markets.
Combined with a more regulated market in Holland and presumably continued “experimentation” in Denmark, and by the end of next year, adult use reform will have hit the continent and in no small way.
Does This Mean The Sudden Potential of Adult Use Everywhere?
As 2020 has shown, in spades, just about anything can and frequently does happen. However, do not expect many more countries to move into the recreational column for the next several years.
Whatever the UN does or does not do about cannabis at the next meeting of the WHO, cannabis the plant remains a Schedule I drug internationally. This means that, for example, import and export of the same across borders, even in Europe, is likely to be problematic and for some time to come – let alone its international travel across say, the Atlantic.
Further from the law enforcement and financial security (namely money laundering) perspective, there are big issues that have to be dealt with finally, internationally, that so far have not – and under the guise of “medical reform.”
For that reason, in other words, do not expect Germany, much less France or even the UK to suddenly switch gears. And remember that both Luxembourg and Israel are small countries.
Bottom line? Adult use reform is here to stay, and will increasingly show up on the map. But the more “blanket” reform, still driving the entire discussion, is broadly, and globally, medical.
While the 2020 Presidential election didn’t exactly end up in a clear landslide victory for the Democrats, there is one group that did well: the cannabis industry.
The results clearly show that the expansion of cannabis is a recognizable part of today’s society across the United States. States like New Jersey, for example, partly thanks to New York and Pennsylvania—which already allow the use of medical cannabis—traffic will start to force the state of New York’s hand and that’s a big chunk of the population of the Northeast.
If the question of legalization was on the ballot, it was an issue that overwhelmingly succeeded in delivering a clear mandate. Adult use of cannabis passed handily in Arizona, Montana, South Dakota and as mentioned above, New Jersey, and was approved for medical use in Mississippi and South Dakota.
With only 15 states remaining in the union that still outlaw the use of cannabis in any form, the new reality for the industry is here. All of these outcomes show promise as the industry’s recognition is growing.
Election outcomes and the position of the average American on cannabis
Americans are definitely understanding, appreciating and using cannabis more and more. It is becoming a part of everyday life and this election’s results could be the tipping point that normalizes the adult use of cannabis. It is becoming more widely understood as an effective and acceptable means to help manage stress and anxiety, aid in sleep and general overall wellbeing.
Voters in New Jersey overwhelmingly passed their adult use measure
This image of cannabis is aided by the many different forms of consumption that exist now: edibles, transdermal, nano tech, etc. No longer does a consumer have to smoke—which isn’t accepted in many circles—to get the beneficial effects of cannabis.
Knowledge expansion is going to move these products across state lines and eventually, the federal government will have to take notice.
Do Democrats and Republicans view cannabis through the same lens?
Cannabis is and will always be state specific. Republicans in general tend to be a little bit more cautious and there are a lot of pundits who believe that as long as the Republicans control the senate, there isn’t much of a chance for federal legalization.
President-Elect Joe Biden & Vice President-Elect Kamala Harris
There is some hope, however, that the industry will get support from the Biden administration. While President-Elect Biden has been on record as being against legalization of cannabis at a federal level, even he will eventually see that the train has left the station and momentum continues to build. In fact, Biden’s tone has changed considerably while he running for president, adding cannabis decriminalization to the Biden-Harris campaign platform.
Ultimately, how cannabis is viewed from each side of the aisle matters less than how it is viewed at the state level.
Cannabis reform under Biden
Biden had an opportunity to legalize cannabis federally in the U.S. during the Obama administration and it didn’t happen. It’s clear that the mandates of the Biden-Harris administration are going to be overwhelmed by current issues, at least in the beginning: COVID-19, the economy and climate change, to name but three.
What will be interesting is if the Biden-Harris administration goes to greater lengths to decriminalize cannabis. For example, cannabis is still a Schedule 1 drug on the books, which puts it in the same class as heroin. Biden couldn’t unilaterally remove cannabis from all scheduling, but his government could reschedule it to reduce the implications of its use.
This could, however, create more problems than it solves:
“It’s generally understood, then, that rescheduling weed would blow up the marijuana industry’s existing model, of state-licensed businesses that are not pharmacies selling cannabis products, that are not Food and Drug Administration-reviewed and approved, to customers who are not medical patients.
Biden rescheduling cannabis “would only continue the state-federal conflict, and force both state regulators and businesses to completely reconfigure themselves, putting many people out of business and costing states significant time and money,” as Morgan Fox, chief spokesperson for the National Cannabis Industry Association, said in an email on Monday.” (Source)
In reality however, there is little chance that Biden will spend any political capital that he has, particularly if the Senate remains in Republican control, dealing with the legalization of adult use cannabis.
What needs to happen for legalization to become a reality
Outside of the law, if Trump suddenly decided to legalize adult use cannabis before leaving the White House, the states would still need to agree on issues such as possession, transportation, shipment and taxation.
It’s clear that further normalization of cannabis use is required—which will likely take a good couple of years—in order for it to become as understood and as simple as wine, liquor or cigarettes.
Beyond that, it’s Congress that dictated that cannabis be illegal at the federal level and it will have to be Congress that makes the decision to change that. Even the Supreme Court has been reluctant to get involved in the question, believing this to be an issue that should be dealt within the House.
What does all of this mean for investment in the cannabis industry?
Cannabis should be part of most long-term investors’ portfolios. Like a group of stocks in a healthy market with the right balance sheets, cannabis is an expanding industry and growth is there.
Whether or not this is specifically the right time to invest, it’s always important to evaluate each stock or each company individually, from the point of view of the merits of the investment and investment objectives, as well as risk tolerance perspectives.
There isn’t any unique or special place to buy into the cannabis industry, unless it is connected to some new real estate or other opportunity that is COVID-19 related. This moment in time isn’t really any different from any other when it comes to the opportunity to own some cannabis stocks. It’s always a good time.
The short term returns of this market shouldn’t be speculated upon. There are just way more factors than the fundamentals of a company that will affect the short-term play. The country is in a transition of power, in addition to much international change taking place that can also contribute to returns in the short term, making speculation unhelpful.
The cannabis market in 2021
The cannabis industry is likely to continue to expand and grow with the select companies acquiring more and more and getting back to their cash flow. Some companies will slowly be going out of business and/or will be acquired by others going into a certain consolidation period of time. Whatever the outcomes in specific tourism dominated markets, the industry as a whole can really go in one direction.
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