By Alan Brochstein
The global media frenzy surrounding the opening of Colorado's legal marijuana market in early 2014 set off a bull market of magnitude that is rarely seen. By my measure, the stocks that represented the cannabis space went up by more than 600% on average in ten weeks, with several 20-baggers. The rally was fueled by a mismatch between a flood of interested investors looking to get in on the "Green Rush" and the limited number of companies to buy. Ironically, none of the companies that benefited from the bubble made a single dime in Colorado. In fact, most of these companies weren't particularly leveraged to the emerging growth of a legal cannabis at all.
A year and a half later, the market has suffered a brutal downturn, losing over 90% of its peak value. At the same time, though, the industry itself has advanced dramatically, with Colorado exceeding expectations, Washington progressing and Alaska and Oregon about to implement legal use for adults. In 2016, California and Nevada voters will get a chance to weigh in. Additionally, medical marijuana program adoption continues to proliferate across the country. The "Green Rush" is very real.
Now that pre-season or perhaps even the first inning is over, I believe that we are getting closer to a market that could attract long-term investors. Before I address the many positive dynamics, I want to point out that the current market isn't quite there. First, the stocks are almost entirely on the OTC. Second, the vast majority of the 300+ publicly-traded companies look to be opportunists at best and not reflective of the real industry. Finally, federal illegality remains a huge challenge for the industry, particularly with respect to banking and taxation issues, and it also creates a risk that many investors don't want to assume.
Despite these challenges, I have seen some improvements on several fronts this year. First, quality is improving, as there have been a couple of companies go public through the S-1 route (rather than via reverse merger). The new Reg A+ could pave the way for more legitimate companies to enter the market as well. Second, at least some of the marijuana companies are actually in the marijuana business, with several holding state licenses to grow or dispense. Additionally, technology plays are emerging. Finally, the political landscape has improved, with an historical piece of legislation, the "CARERS Act", introduced earlier this year into the Senate. It is clear that medical marijuana will be a topic of discussion in the Presidential election next year.
For those investors who are interested in the theme, there is a federally legal cannabis market that may be more attractive for now: Canada. The country rolled out a new medical marijuana program in April, 2014, and, despite a slow start, it is now showing strong growth. The government has awarded a limited number of licenses, and several of the licensed producers trade publicly (mainly on the TSX Venture). There is also an investment company that owns stakes in several of the private companies. Investors have the opportunity to invest in revenue-generating marijuana producers in a program in its early days, and I expect the growth will be torrid, with an outside shot at full legalization in the next few years offering a nice call option as well.
The get-rich-quick market of 2014 came and went, but it appears to me that we are now moving towards a more sustainable investment opportunity in the public markets. Institutional and high net worth investors are moving into the market, as several private deals in excess of $10mm have closed. The transition from a black market to a legal one will likely afford investors and entrepreneurs tremendous financial opportunities in the years ahead.
Editor's Note: Alan Brochstein, CFA, began his career as a bond trader in NYC in 1986 with Kidder, Peabody and worked with CS First Boston and Criterion investments until transitioning to equities as a analyst/portfolio manager in 2000. In 2007, he began AB Analytical Services, where he provided research and consulting to several investment advisors while also becoming one of the most popular contributors at Seeking Alpha. In 2013, Alan launched 420 Investor, an online community focused on publicly-traded companies in the cannabis sector.
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