Significant strides in legislation and cultural acceptance of cannabis use throughout the U.S. have paved the way for unprecedented mergers and acquisitions activity in the sector. According to Viridian Capital Advisors, a strategic advisory firm to the cannabis industry, a record $13.8 billion was raised by cannabis-related companies in 2018, a marked increase from the $3.5 billion raised by the industry in 2017. By all accounts, totals for 2019 are predicted to be even greater.
Deals, deals, deals
Multi-state operators are scaling in preparation for the eventual softening of regulatory restrictions on transport, access to financing and banking, and the opening of the national market. The consolidation activity touches growers, manufacturers, and retailers, but also industry collateral businesses, such as extraction and cultivation technologies, consulting (tax, legal, and financial), software, security, and packaging.
Deals attracting capital have often included acquisitions of licensed operators across state lines – essentially the simplest means of growing an enterprise in the face of uneven state laws and regulatory limitations on trade. More recent investments have included distribution and logistics firms, signaling that the build-out of a robust supply chain is underway.
Who else is buying?
It is expected that the next wave of buyers will be dominated by giants in the consumer product goods space. The food, drink, tobacco, and big pharma industries are gearing up to move in quickly once cannabis use is federalized. They can easily add cannabis to their broad product suites, and already have national manufacturing, distribution and retail infrastructure in place. In the words of Zachary Venegas, CEO of Helix TCS (OTC:HLIX), a leading software services provider in the cannabis space, “Once [cannabis] comes off Schedule 1, they’re coming.” This makes sense given the nation’s growing acceptance of cannabis generally: the potential for creating shareholder value for these maturing industries is massive.
Some have already come off the sidelines. Altria (NYSE:MO) (maker of Marlboro cigarettes) recently purchased a 45% stake in the cannabis company Cronos (NASDAQ:CRON) for nearly $2 billion. Earlier in 2018 Constellation Brands Inc., maker of Corona and Modelo beers, took a $4 billion stake in the Canadian marijuana grower Canopy Growth Corp. (NYSE:CGC), which makes cannabis-infused beverages and other products. These are two of several that are sure to follow.
What makes an attractive acquisition target?
So what does this mean for the small cannabis company? Industry players of all types may soon be under consideration for purchase. But according to Venegas, offering market share is not enough. “An acquirer is going to want a business that’s durable. They don’t want to acquire a business that, just by…throwing in an equal amount of money, they can…catch up or have the same business…” To be a viable target, the business must have a competitive advantage beyond its market share.
If a company is interested in being acquired, Venegas recommends taking a hard look at what the business offers. To attract buyers, and the advisory firms that represent buyers, a business must be clear on what it offers and how it accelerates a buyer’s growth in the industry. Venegas sums it up this way, “[The advisory firms] are advising you, but they’re only going to sell you once. They’re going to sell you to their long-term clients; they’ll do many deals with their buyers. They’ll only sell you one time.” Sellers must communicate their strategic value within the expanding cannabis landscape the first time because as the industry matures, there won’t be a second chance. Currently, competitive advantage in the cannabis space can take many forms. For example:
Technological solutions offered by ancillary companies (e.g., seed-to-sale trackers or customer relationship management firms) that address industry-specific challenges, such as regulatory compliance, can be key differentiators and will get more of a look from potential buyers. Venegas continues, “If you’re just a CRM – no compliance, no productivity – well, aren’t there other CRMs out there?” On the other hand, “If you’re…a CRM that markets exclusively to cannabis and you have an interface that’s tailored to cannabis, that’s powerful.”
As with most industries, expertise and deep experience in the cannabis business is not easily replicated. A seasoned management team that can lead the company through future sector stages, not to mention transform the company into a viable target in the first place, is worth just as much as good technology, and maybe more. “Your plans generally will hinge on the management team being able to navigate the future of the market,” Venegas asserts. “Technology might change…Trends emerge and disappear. But [it’s beneficial] if your management team is adept at…reading the signs of the future and correctly interpreting the next 3-5 years.”
Indeed, cannabis is a highly idiosyncratic but burgeoning industry, and securing a successful management team that has created a competitive advantage for its business is one of the strongest rationales for acquisition today.
Finally, what about capital?
While many smaller operators may not feel it, capital is not a scarce resource in the cannabis industry. Acquirers have it and the CPGs, when they make their entrance, will have even more. For small businesses in the cannabis space, spending too much time and resources raising capital can distract them from honing what competitive edge they may have. Says Venegas, “…some businesses spend all their time…raising that next bit of capital, and they start to lose the competitive advantage…”
These days Investment flows toward license holders – often to growers. But farther downstream and closer to the market, cannabis businesses must offer a competitive edge where the money can make a meaningful difference. As the influx of capital and M&A activity continues to grow, a sustainable competitive advantage will be harder to come by and more important than ever.
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