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The United States of Cannabis

January 12, 2021

Sharp's 2021 Industry Forecast

2020 was a hallmark year for cannabis, reaching annual revenue of $19.7B, a staggering 38% market growth over 2019. Amid nationwide industry shutdowns, cannabis was considered an essential service by most states, allowing doors to stay open and fundamentally altering public perception about legal cannabis. Meanwhile, five states passed meaningful reform, and, for the first time, a government bond to save jobs was backed by cannabis tax revenue.  During the back half of 2020, investors took note, and capital began to flow freely into the sector. 

Several promising scenarios lay ahead in 2021, including increased M&A activity, legislative progress on a state-level, and, perhaps most importantly, movement at the federal level.

M&A heats up

A loss of investor confidence in 2019that extended into the first half of 2020 caused a sharp contraction in M&A activity. Largely the result of untamed stock market volatility driven by the nebulous Canadian banking system, M&A activity contracted ~75% by volume, and capital raised decreased ~80% YoY in 2020. However, for the first time in the industry's brief existence, the lion's share of activity shifted dramatically to the U.S. in this long-time Canadian dominated industry. This trend bodes well for the fragmented U.S. cannabis industry as capital flows back into space.

Trusted public cannabis stock trackers, New Cannabis Ventures, show that cannabis equity markets bottomed out as the severity of the COVID-19 pandemic and its ensuing lockdowns set in. Ultimately, cannabis experienced a much-needed upswing when it was declared an essential service by every significant market outside of Massachusetts – a state that followed suit just two short months later.

Soon after, as positive earnings reports flooded the industry, cannabis quickly distinguished itself as a recession-proof growth industry. The market has been rallying ever since, successfully separating the wheat from the chaff. MSOs finally found religion and refocused their efforts around generating sustainable cash flows, and investors took notice. 

As investor confidence continues to ramp up, capital flows will pick up and exceed previous records set in years past, setting up cannabis for rapid consolidation. The industry is roughly twice the size by revenue that it was just two years ago, and its appetite for capital to build out infrastructure is nearly insatiable.  

As a result of state-by-state licensure, each MSO has to create a supply chain in each state they enter. Operators who can create density in the strategic states they enter will be rewarded for achieving scale and profitability.

As companies expand, they have two arrows in their quiver: organic growth through competitive licensure processes and M&A. However, the arduous and complicated licensure process will continue to make acquisitions the arrow of choice for the vast majority of MSO's looking to expand their footprint and satisfy investor demands for growth.

Thanks to rapidly appreciating stock prices, non-dilutive financing such as debt, and record levels of privately-placed equity, the industry is poised to defragment itself. Publicly-traded MSOs will be rewarded for scale and fundamentals, which will leave corporate development teams aggressively pursuing operators who can provide both.

 

New states join the cannabis club

Though underwhelming compared to the Green Wave of 2016, 2020 ushered five states - New Jersey, Arizona, Montana, South Dakota, and Mississippi - into the cannabis club.  

Had it not been for COVID-19, the number would likely be higher; lockdowns prevented signature gathering in several states, most of which now have their eyes set on 2022. With American views on legalizing cannabis reaching all-time highs, we expect the next wave to rival 2016.  

Of course, American views are not the only factor driving states towards cannabis legalization; many cash-strapped states are well aware of the largesse of cannabis tax revenue and are keenly interested in tapping that well to shore up state budgets. Moreover, the cannabis industry is a massive employment source in legal states; a fact politicians simply cannot ignore.  

We expect New Jersey's legalization to serve as a legislative catalyst in the Northeast as nearby politicians find their coffers empty and desperate for the tax revenue that New Jersey's adult-use program is projected to provide.

 

Federal progress

The election of a Democratic president, the re-election of a Democratic House of Representatives, and control of the senate shifting ever-so-slightly to the Democrats may lay the foundation for a path, albeit winding, towards federal legalization.  

The results of Georgia's run-off election spell the end of Mitch McConnell's reign as Senate Majority Leader. Not only can we expect cannabis-friendly bills to be introduced, but Democrats now have the majority control to vote them into law.

We expect this to accelerate impactful legislation around banking, the onerous 280E tax law, and states' rights. Regardless, the industry's tailwinds are blowing and should drive increased top-line, bottom-line, and scaling of cannabis businesses across the board.

That said, the incoming Biden administration has a robust legislative agenda, and it seems highly unlikely that full declassification of cannabis will be signed into law over the next 12-24 months.

 

What's the play?

Thanks to the factors mentioned above, the cannabis industry will dramatically grow revenue and drive more consolidation, as those with access to relatively inexpensive capital (the "haves")acquire those operators with attractive license portfolios but inadequate sources of capital (the "have nots"). Despite its uncertainty and volatility, 2020 helped the U.S. cannabis industry set the foundation for a prosperous decade of growth.

Perhaps the biggest story in cannabis in 2020 was the launch of Sharp Capital Advisors, a watershed moment ushering in a new and improved caliber of investment banking services to the industry.  

Sharp Capital has created a comprehensive, interactive map of the United States to track the cannabis industry's progress and provide valuable content to our cannabis ecosystem. We record what we learn every day as we talk to the top operators, investors, CPAs, and attorneys in the space. Every month, we will send out a newsletter, sharing what we've learned and what we think the play is for interested investors and entrepreneurs.

Buckle up folks; the green wave is looking more like a tsunami in 2021.

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Authors:
Stephen Miles
Rebecca Hawkinson