Is the legal marijuana industry set for an M&A boom?

Is the legal marijuana industry set for an M&A boom?

Canadian Health Minister Jane Philpott’s cheeky use of April 20 – 4/20 in pot smokers’ code – to set a one-year timeline for legalization of recreational marijuana spells an important day for the marijuana industry as a whole. Shortly after the announcement, Canopy Growth Corporation, a diversified cannabis company growing and distributing to patients through several brands including Tweed Inc, Tweed Farms Inc, and Bedrocan Canada Inc, had risen as much as $0.35 (around 13.7%) by early afternoon. Supreme Pharmaceuticals, another medical marijuana producer was up more than 7% on the news.

The wild west isn’t so wild anymore

Canada isn’t the first in the North American market to make moves towards legalizing reasonable recreational usage – Oregon, Washington and Colorado have already passed laws, and California, Nevada, Massachusetts, Maine and Arizona are on track to do the same. If all goes as planned, nearly half of Americans will be able to use marijuana legally.

Obviously, the subject of marijuana prohibition has entered into the presidential debate, with Hillary Clinton and Donald Trump both opposing wide-scale legalization on a federal level, but agreeing that states should be free to make their own decisions surrounding medical and recreational use. Bernie Sanders advocates widespread legalization.

Up in smoke market

But here’s the rub in all of this. Legalization – recreational or health-driven – may signal the unshackling of an industry, but it’s not the starting gun.

The cannabis sector has been thriving for some time now and is anticipated to hit US$6 billion by the end of 2016. A study by ArcView market research pegs that number at $10.8 billion in legal sales by 2019. In its report “Medical Cannabis has high POTential: A joint biotech and tools Primer” Bank of America Merrill Lynch set an ambitious US$35 billion as the likely milestone for the market in 2020.

It seems an industry built around red-eyes and giggle fits is finally starting to mature.

Well, kind of.

To put it in perspective, the pet industry does about $60 billion in sales a year. But still, what has predominantly been viewed as a cottage industry is starting to gain the dynamics of a full-fledged market with mergers and acquisition activity to boot. It makes sense, given that all these tiny fringe businesses – ranging from cannabis-focused software providers and security companies to human resources firms and cultivators – are easy targets for bigger, well-funded corporations.

From a publicly traded perspective, there are plenty of hurdles. Regulations by the Securities and Exchange Commission stand to throttle listing activity with many dispensaries, growers and infused products companies opting to operate privately while the policy-makers figure out how all this is going to look.

But there are a few brave cannabis companies leading the pack.

On the NASDAQ, options are slim and include GW Pharmaceuticals, a U.K.-based biotech company with a cannabis-based epilepsy drug; Insys Therapeutics, an Arizona-based company edging into the same sphere; Cara Therapeutics in Connecticut, developing and commercializing marijuana-based pain relief drugs; and Pennsylvania’s Zynerba Pharmaceuticals – which developing and commercializing synthetic cannabinoid therapeutics.

Data from Viridian Capital and Research – a Cannabis-focused index made up of of 70 publicly-traded companies categorized in 10 sectors such as cultivation and retail; consumption devices and physical security data – saw 21 companies in its index complete a total of 33 acquisitions in the first three quarters of 2014. The index, which gained 147.1 per cent during that period, followed a strong 2013, when it climbed 146.6 per cent.

“We expect acquisition activity to grow for several reasons,” said Scott Greiper, president of Viridian Capital and Research in a press release. “Public companies are buying financial ‘meat on the bone’ to support current valuations; private companies want to ‘go public’ by being acquired by already public companies; and public companies are seeking to build out their IP and product portfolio.”

Predominantly, most of the country’s 350 cannabis-related businesses trade over-the-counter.

The Marijuana Industry’s first mega-deal?

In an all-stock acquisition last June, Tweed Marijuana Inc. acquired Bedrocan Cannabis Corp., creating the medicinal marijuana’s dominant leader with 25% of all registered patients and a collected production capacity of 6,500 kilograms, the largest in the country.

By September 2015, Tweed had re-branded under the aforementioned Canopy Growth Corp. As of today, its market cap stands at $263 million. Although the new entity’s market cap pales in comparison to GW Pharmaceuticals (worth $1.21 billion), the deal is no doubt the first of many mega-mergers to come over the half decade.

With the loosening of regulation in the space and an influx of players, redundancy is bound to fuel some healthy deal-making activity.

“Combining production facilities, giving existing patients more options, and diversifying supply are some of the potential synergies from two (producers) merging,” said Dundee Capital Markets analyst Aaron Salz in a note.

Some experts suspect massive global tobacco and pharmaceutical companies will swallow up fully legal Canadian producers leading to some transnational deal making. But at this point, how the market will look a decade from now is only speculation.

One thing is for sure: with prohibition on the outs, there’s no reason to expect the slight lull from the high times of the “potcom boom” of 2014 to burn out. Going forward, it’s easy to see how a vibrant industry rippled with startups could become a cloud of M&A smoke over the next ten years.