The buzz around the cannabis business in 2016 reached an inflection point with medical marijuana companies raising more than $466 million on Canadian capital markets last year.
Two years into Canada’s commercial medical marijuana market, companies have investor attention. Several players raised millions of dollars in multiple rounds of financing. One launched an IPO on the Toronto Stock Exchange. Canada’s biggest marijuana company even hit a billion dollar valuation.
“It’s the biggest year so far and I expect in 2017 you will see a bigger year,” said Graham Saunders, head of capital markets origination at Canaccord Genuity, which led seven of the 22 capital raises in the sector last year.
The massive year for marijuana financing comes in anticipation of a legal Canadian recreational market, expected to be in place by 2019 and worth some $6 billion a year by 2021. It also came without the participation of the big banks, which refuse to finance marijuana companies for fear of reputational risk.
Many of the big banks have ties to the U.S., where medical marijuana remains illegal at the federal level, even though several more states voted to legalize pot during the November U.S. election. The disconnect sent more U.S. investors seeking exposure to the market north of the border.
“We can only finance things that are legal and the consumption of marijuana in Canada today is not legal. Medical marijuana is, but through our process and diligence, we can’t take the risk that it could turn out to be recreational,” said Daniel Barclay, head of investment and corporate banking at BMO Capital Markets. “No matter how much money we could make it’s not worth the risk or the issues.”
The reluctance among big banks to do business with marijuana players is indicative of “ a lack of understanding of the business,” said Neil Maruoka, lead marijuana sector analyst at Canaccord Genuity.
“One of the most significant components of a company’s valuation is its licence. You are not going to risk losing that by selling into an illegal market.”
Those risks haven’t stopped the big banks from eyeing future opportunities, meeting with players and waiting to pounce once the legal recreational market is in place.
The market is set to grow as just 2 per cent of licensed producer applications have been approved, with more expected ahead of the coming recreational market, Maruoka said.
At least eight Canadian marijuana stocks had returns in the triple digits last year, sparking talk about a bubble. Maruoka said that talk is overblown. “When we look at the valuations across the board, its beginning to price in the rec market, undoubtedly the rec market opportunity is so huge and it certainly hasn’t priced in 100 per cent of that as of yet.”
While the medical market is quite small, currently about 100,000 patients, it has the potential to reach about 700,000, Maruoka said. That demand accounts for about 200,000 kilograms of marijuana production each year, he added. “But there’s 450,000 kilograms that’s smoked annually in an illicit recreational market and the existing public companies are capturing some portion of that value because investors are looking ahead and saying, ‘This is coming.’”
In the meantime, the independent investment companies, well-versed in doing deals for riskier entrepreneurs and small businesses, are content to be reaping the revenues from being the only bankers in the market.
“The sector turned on fire” last summer after the federal government announced legalization plans in June, Saunders said.
In August alone, there were five big deals. Canaccord led a $23-million offering for Aurora Cannabis Inc., while GMP Securities and Dundee Capital Partners helped Canopy Growth Corp. raise $34.5 million. Clarus Securities led a financing for the same amount for Aphria Inc.
The November release of a long-anticipated task force report on legalization added fuel to the fire. One of the final deals of the year, the $60-million initial public offering of CanniMed on Dec. 29 led by AltaCorp Capital, was also one of the largest. CanniMed is now only the second marijuana company listed on the TSX main board. The other, Canopy, became the first pot company with a market value of more than $1 billion.
CanniMed CEO Brent Zettl said the company made the decision to go public as investor appetite improved and the reality of the recreational market became “galvanizingly clear” during the second half of the year. “The reality was that train was coming. We had to get bigger faster because we could just see that this was going to get bigger faster.”
Zettl had been in talks with National Bank about the financing around the same time that Royal Bank and Scotiabank announced they would no longer deal with marijuana companies, which “sent a chill down the spine of the banking industry,” he said.
He is frustrated by what he calls a “hypocritical approach” because they will trade marijuana securities but shy away from financing or even providing them with accounts. “It just infuriates me that the banks are saying ‘on the one hand we really can’t be helping you but on the other they are trading our securities though because it makes them money.”
AltaCorp has raised private capital for Zettl’s company since it was named Prairie Plant Systems and was the government’s official marijuana provider under a previous medical marijuana program enacted in 2000.
“Everything about the operation was as a standard pharmaceutical company which gave us great comfort in the product it was selling and gave us great comfort in the market,” said Jeffrey Fallows, managing director of investment banking at AltaCorp. CanniMed is its first client in the marijuana space, but after gaining “institutional knowledge” of the sector from the deal, Fallows is ready to ramp up its presence.
At Canaccord, Saunders said the market for marijuana financings is a once-in-a-lifetime opportunity perhaps not seen since the post-Prohibition period.
“The opportunity is extremely large for entrepreneurs and businessmen to go after this huge sector that’s being created.”
Marijuana sector deals have taken up about 90 per cent of his time over the last year, he said.
“And I don’t see that changing.”
Source via FinancialPost