Cannabis stocks surged on the final trading day of 2019 — but the sector's gains couldn't reverse substantial losses in a year that started off strong but ended in a flurry of disappointed investors, restructured deals, and layoffs.
Although cannabis companies and investors are anxious to leave 2019's challenges behind them, a fresh start in a new year and decade warrants a look back on the lessons learned in the last 12, turbulent months of 2019.
RINGING IN A BULLISH YEAR
One year ago at this time, cannabis stocks were riding high. On the heels of the kickoff of adult-use sales in Canada and the legalization of industrial hemp via Congress' Farm Bill, investors were ecstatic. Canadian cannabis giants surged to all-time highs, which fueled a flurry of massive M&A. Harvest Health & Recreation and Verano Holdings; Curaleaf and Cura Partners; and Cresco Labs and Origin House were among those companies to negotiate close to $1 billion deals. Canopy Growth and Acreage negotiated a blockbuster merger agreement valued at $3.4 billion and contingent on federal legalization. Investors were irrationally exuberant about cannabis companies, regardless of their underlying fundamentals — kind of like in the early days of technology — and companies took advantage.
"I think there were definitely people that were opportunistic about valuations who weren't necessarily long term players per say, but looking at short term profit generation," said Hershel Gerson, managing director and CEO of cannabis investment bank Ello Capital. "It was a little bit like musical chairs, where people were financial engineering quick returns for themselves, which potentially were at the detriment of the retail investor."
Months later, the situation looks quite different.
After a rout that rattled the cannabis sector throughout the summer and into fall, publicly traded cannabis companies like Canopy Growth ($CGC), Cronos Group ($CRON), and Aurora Cannabis ($ACB) all closed the final trading day of the year up more than 12 percent. But it wasn't enough to reverse the substantial losses the sector suffered throughout the course of the year.
Canopy, Cronos, Aurora, and Tilray ($TLRY) fell 21.5 percent, 26.1 percent, 56.4 percent, and 75.7 percent respectively in the last 12 months. ETFMJ Alternative Harvest Exchange Traded Fund ($MJ), which tracks a basket of cannabis stocks, finished the year down 31.4 percent and down more than 55 percent from its March high.
The last few months of 2019 introduced cannabis companies to some harsh realities of the business world. Strapped for capital after the summer's market rout, layoffs hit the industry. High profile California companies Canndescent, MedMen, Flow Kana, Weedmaps, and Eaze announced what the Sacramento Bee called an "epidemic" of job cuts in attempts to cut costs.
Other companies walked back ambitious funding rounds or looked to more creative means of fundraising, once more conventional means — the Canadian capital markets, for example — proved to be less viable. Trulieve was one of the many companies this year to ink sale-leaseback agreements — or financing deals in which companies sell real estate to a Real Estate Investment Trust (REIT)t, like Innovative Industrial Properties ($IIPR), and lease it back for a fixed term. Trulieve's two deals were worth an estimated $60.5 million. CEO Kim Rivers told Cheddar she opted for that type of arrangement on her cultivation facilities because she got “the best terms that are available right now” for her cultivation facilities.
Innovative Industrial Properties is one cannabis company that has thrived amid the general disarray of the rest of the industry, consistently appearing on analysts lists of top picks in the cannabis sector.
Those megadeals announced at the beginning of the year? Many have been renegotiated. One deal, the $682 million acquisition agreement struck between MedMen and PharmaCann, was called off altogether.
SO WHAT CHANGED?
Much of what drove investor exuberance at the start of the year was the untapped potential of major cannabis markets, like California and Canada. But hindsight is 20-20, and investors then could not have foreseen how a confluence of strict regulation, stubborn black markets, and growing pains would serve to derail markets on which many companies had bet their futures — and their financial projections.
"In my mind, it's pretty simple. We had companies basing their projections on a conversion rate from the black market to the legalized market that failed dramatically. A lot of that is due to states like California that put regulatory handcuffs on companies," said Matt Hawkins, managing director of Entourage Effect Capital.
Disappointing sales and spendthrift habits translated to even more disappointing earnings — especially for those companies that went public prematurely for lack of other liquidity options. Investors got cold feet. Companies acted quickly to rectify poor earnings, shuffling leadership, like former Canopy Growth CEO Bruce Linton who was ousted in July and Aurora's Cam Battley who stepped down just recently, and introducing aggressive plans toward profitability.
Then came the vape crisis, which introduced more uncertainty into an already shaky market just as quickly as it sickened and killed U.S vape users.
But with the bottoming of the market seemingly in the rearview mirror, it's not all bad news for the cannabis industry. Many view 2019's market adjustment as a natural and needed response to the irrational exuberance and overly inflated valuations of the early days of 2019.
"As sophistication and more fundamentals come into the industry, people are re-evaluating the proper valuation at which these companies should be trading. This happens in many industries — its happened in tech, it's happening right now in all the dtc and disruptors related to delivery," Ello Capital's Gerson said. "Most of the time it was done in a private market context we are just seeing it in the public market because the funding source required a public vehicle to get the money to fund the industry."
And while 2020 should offer redemption for some cannabis stocks, experts don't expect the pain to end once the clock strikes midnight on Jan. 31. In 2020, continued weakness in the industry will fuel need-based M&A and creative financing, and winning companies will gradually emerge from the ongoing shakeout. Those lessons the industry undoubtedly learned this year will prove invaluable to the winners: companies with strong fundamentals, good leadership teams, and pathways to profitability.
And with a big year for cannabis politics ahead, things might just be looking up for the nascent cannabis industry.