After Constellation Brands: What’s next for the Canadian Cannabis Sector?

The marijuana industry is worth as much as $35 billion per year. As legal restrictions are eased, will this mean M&A activity? 

This quarter has been abuzz with activity for the Canadian cannabis sector.  The provinces continue to roll out their distribution plans, and in November, Health Canada tabled its proposed regulatory framework.  In the private sector, Aurora Cannabis launched a hostile takeover for CanniMed Therapeutics, and Aphria announced a landmark agreement to supply medical marijuana to Shoppers Drug Mart.  But while all of this is exciting news, the biggest watershed moment occurred in October, with Constellation Brands’ $245 million investment in Canopy Growth.  This investment by the $42 billion company behind brands like Corona, Modelo, and Mondavi may be a harbinger of things to come, the pivotal point from which large strategic investors outside the cannabis sector gain a foothold by investing in Canada’s nascent industry.

High Times for Canadian Cannabis

It’s an exciting time for cannabis in Canada. There’s still some uncertainty as regulatory frameworks get hammered out, and the Senate embarks on what promises to be a lengthy debate of Bill C-45.  In addition, while capital is still flowing, according to Health Canada, there are currently 79 Licensed Producers (“LP’s”), more than a quarter of whom have some sort of listed profile or reporting issuer status, and there is not as much capital available to new entrants.

The Canadian Marijuana Index (Past 3 Months)

Alexis Levine, a law partner at Blakes, and co-lead of the Blakes Cannabis Group, expects that the latter dynamics will drive a couple of trends.  The first is demand for alternative sources of capital, whether in the form of royalty financing, or debt financing, which is becoming a reality for more established LP’s through credit unions, agri-lenders, dedicated debt funds, and a small number of banks. Mr. Levine also expects to see considerable consolidation in the space, some of which may come through strategic investment or acquisition, particularly once cannabis is legalized at the recreational level.

Mr. Levine believes that there will be strategic interest in situations where a prospective investor sees the potential to contribute distribution, product, or agricultural expertise.  He also points out that, as the number of cannabis consumers balloons from the current 150,000 to estimates of 4-9 million once recreational cannabis is legalized, the possible scarcity in product could be perceived as an opportunity for strategic investors with the expertise to scale existing operations.

Cross-Border Cannabis Investment

Josh Kappel, Law Partner, Vincente Sederberg LLC

Josh Kappel, a law partner at Colorado-based Vincente Sederberg LLC, a firm with a long-established cannabis legal practice, agrees that consolidation will be a driving trend, and expects more cross-border strategic investment in the Canadian sector.  While Mr. Kappel is currently seeing former executives from different alcohol companies investing in California’s cannabis industry, he believes that large multi-national corporations will be more comfortable investing in Canada, “and using that as a launch pad for the world, as Canada does not have the legal risk [of the US].”

The “legal risk” that Mr. Kappel alludes to stems, of course, from the disparate treatment of the cannabis sector by the US federal government relative to many of the states.  While there is an overarching federal pronouncement of illegality, many states have legalized cannabis for medical use, with California first out of the gate in 1996.  In addition, some states, including Colorado, Washington, and California, have legalized adult recreational use as well.

As a result of these divergent laws combined with the substantial head start enjoyed by US medical cannabis producers, cannabis companies in states such as California and Colorado will often have significant sales, intellectual property, and track record relative to their Canadian counterparts, but will have far less access to capital.

Canadian Capital Flows into U.S. Cannabis Industry

Several Canadian companies have ventured into this complex US market, including the aforementioned Aphria, and CannaRoyalty, whose US assets include operations in California and Washington.  Afzal Hasan, Head of Corporate Development and General Counsel for CannaRoyalty, explains why the company pursued US cannabis investments:

“Three years ago, when CannaRoyalty was founded, there was a significant difference between the state of the cannabis industry in Canada relative to the US. In Canada, projects that were being pitched were greenhouses and indoor grows – construction projects that weren’t going to generate any revenue for a long time, whereas there was an opportunity to invest in US businesses that were already active and thriving.  We saw an opportunity to raise capital in Canada and invest that capital in revenue-generating US businesses.”

With medical marijuana legalized in more than 30 states (including 2 pending), the economics of the industry have developed to a point where, despite the rhetoric of the current administration, it would be a difficult and painful sector to shut down.  According to a recent New Frontier Data report, by 2020, the legal cannabis industry will create more than a quarter of a million new US jobs, exceeding those created by manufacturing, utilities, or government.  With economic benefits accruing from cannabis sector job creation and tax revenues, it is not surprising to hear from Mr. Hasan that on a state level, CannaRoyalty has received a warm reception.

A Complex Regulatory Environment in the U.S.

Hasan cautions, however, that navigation of the US federal issues is complex, and requires ongoing counsel from legal experts to maintain compliance with the many federal departmental announcements that carve out operating space for cannabis businesses.  Further legal expertise is required to allow for more efficient taxation in the face of US tax code provision 280e, which restricts the deductibility of cannabis business expenses.

In the future, with an (always) inevitable change in administration, the benefits of investing in the more mature US cannabis industry may prove to be considerable. Mr. Hasan acknowledges that currently, however, strategic investors like Constellation Brands are more likely to look to the Canadian market.

And as for his view on the Constellation Brands investment?  “It’s a great development for the Canadian cannabis industry generally,” Hasan says.  “As the Canadian industry is at a nascent stage, a positive development for a significant player is a positive development for everyone in the industry.”


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