The bubble has officially burst when it comes to the global cannabis market, and at this point many pot stocks are already on the road to bankruptcy.
It may be hard to picture now, but the cannabis industry was in a vastly different position during the halcyon days of 2018.
Investors were clamouring to get in on the green rush and cash was being poured into the sector courtesy of private equity firms, VC's, and multinational corporations.
However, by the end of 2019 a storm was brewing, as the hype arounds cannabis began to wane, and investors became increasingly concerned about the industry's lack of profitability.
Licensed producers over-invested heavily in facilities to grow cannabis, but not in making the high-value products that will appeal to a greater number of people. In the last six months of 2019, expectations had been building around retail earnings, namely that they were going to justify the huge capital expenditure these companies had made and the investment they'd asked for to pay for them. MMJ Group Director, Mike Curtis
This was further compounded by the gradual realization that recreational legalization would be slower to arrive than expected in the US—and several other jurisdictions—which significantly impacted numerous company's future revenue guidance.
And once the "Vape Crisis" began to rear its ugly head in September, it became clear that the honeymoon was officially over.
This led to a severe capital crunch—making it virtually impossible for cannabis companies to secure further financing—and soon the writing was on the wall; pot stocks without cash in the bank or a pathway to near-term profitability would be facing bankruptcy in 2020.
Unsurprisingly, this "Black Swan Event" caused the Horizons Marijuana Life Sciences ETF to decline by approximately 39% last year—even as the S&P 500 rose by roughly 29%—and former juggernauts like MedMen (CSE:MMEN) suddenly found themselves caught in an inescapable death spiral.
Unfortunately, this was just a dress rehearsal for the arrival of the COVID-19 pandemic, which has ravaged global markets and annihilated the market cap of the cannabis industry's biggest players.
Even titans such as Canopy Growth (NYSE:CGC)—which had already lost $9 billion in value during 2019—saw their market cap shrink by a further $5 billion as of March 2020. As a result, the company expects to incur a pre-tax loss of approximately $700-800 million in Q4 2020, which follows a net loss of $375 million for Q3 2019, and a staggering $1.28 billion loss that took place during the June quarter last year.
In fact, the company recently announced that it will be ceasing operations across three continents in an attempt to stop the rot, although at this point it may already be too late.
Canopy Growth will now shutter its indoor facility in Yorkton, close down all operations in South Africa and Lesotho and cease cultivation operations in both Colombia and Springfield, New York.
The company will also be eliminating 85 fulltime positions—which will primarily come from its now defunct Columbian operations—along with temporarily furloughing 200 retail workers due to the government ordered shutdown of dispensaries.
"When I arrived at Canopy Growth in January, I committed to conducting a strategic review in order to lower our cost structure and reduce our cash burn," Canopy Growth CEO David Klein said.
"I believe the changes outlined today are an important step in our continuing efforts to focus the company's priorities and will result in a healthier, stronger organization that will continue to be an innovator and leader in this industry."
And it's a similar story if we turn our attention to Aurora Cannabis (NYSE:ACB), which has lost 92% of its value since March 2019, thanks to a series of disastrous missteps and blunders which saw the company fail in its bid to become the peak production market leader.
At the same time, Aurora has been burning cash at an alarming rate—which is a highly troubling sign in the middle of a capital crunch—and also recently elected to put its 1-million-square-foot Exeter facility up for sale, effectively stripping away more than 425,000 kg of annual output capacity.
This barrage of negative news caused investors to begin fleeing the pot stock in droves, and by mid-April Aurora's share price dropped by another 13%, after news broke that the company would be selling off $350 million in stock to maintain its listing on the New York Stock Exchange (NSYE).
"Our focus today continues to be on financial discipline across the entire organization. We are taking appropriate actions to strengthen our cash position and maintain financial flexibility as we navigate through the current environment," Aurora Executive Chairman Michael Singer said
"As Aurora drives towards generating positive free cash-flow, we are confident that our shareholders will be supportive of our further actions to solidify our balance sheet and position the Company for success."
While this move was intended to reverse Aurora's downward trajectory, it only served to hasten its decline by drawing further attention to the company's massive cash burn, which caused many investors to re-consider their position on the one-time rival to Canopy Growth.
Aurora's decision to pursue share consolidation was also seen as further evidence that the company is officially dead in the water, following a stunning fall from grace which caused its share price plummet from $9 USD last year to just 0.70 by April 2020.
Has the Cannabis Bubble Burst?
Although this may sound like an apocalyptic scenario, the industry-wide downturn was likely long overdue, as stock valuations have been on a constant downhill slide—barring market spikes caused by the legalisation of recreational cannabis in Canada and the passing of the 2018 US Farm Bill—for almost two years.
And while the arrival of COVID-19 certainly hasn't been kind to cannabis company valuations, the cold hard truth is that most pot stocks were probably going to have a tough time in 2020 regardless of the global investment slump.
If you look at the sector from a historical perspective, the year after a bubble has burst tends to be mildly positive — that's 2020 — and the oversupply and over-capitalisation is being integrated. The year after is when an industry kicks and the businesses that survive become highly profitable. Now we're in the fun times when we can figure out who the winners will be. MMJ Group Director, Mike Curtis
However, it seems increasingly likely that 2021 will be a rebound year for the cannabis industry—once the coronavirus pandemic eases and markets begin to rally—but the path to profitability won't be easy.
We're going to see a wave of cost-cutting measures, layoffs, and bankruptcies as the invisible hand of the market moves to separate the wheat from the chaff.
The emergence of the coronavirus pandemic may even prove beneficial to some pot stocks—as long as they use this time to scale back non-essential expenses and re-position their commercial strategy—once the market finally begins to bounce back.
Unfortunately, the sector is going to be ruled by a dog eat dog mentality until investor confidence begins to rise again, and it looks like smaller cannabis companies are going to weather the brunt of the storm. As a result, we've already seen several cannabis companies file for bankruptcy over the last two months, and it looks like the bloodbath is only just beginning.
The Kentucky-based hemp cultivator GenCanna Global was the first to fall, after it filed for Chapter 11 bankruptcy protection in response to serious liquidity issues.
This was followed less than a month later by news that CannTrust—which was once the largest LP in the Canadian market—had finally given up the ghost, after being dogged by a series of class action law suits and continuing fallout from the discovery of its disastrous illegal grow-op in 2019.
Another pot stock that's showing worrying signs is Harvest Health & Recreation (CNSX: HARV), after the company recently offered an $100 million non-brokered private placement at 60% of the value its shares were trading at just 8 months ago.
A few weeks later this was followed by the announcement that the company's planned $850 million acquisition of Verano Holdings was being scuttled due to the radically altered market conditions that have emerged in response to the coronavirus outbreak.
"This deal was struck in a much different time, when the market rewarded empire building over positive cash flow. Today, companies need to focus on generating positive cash flow to survive and prove out a viable business model to investors." Marijuana Business Daily equity analyst Mike Regan said.
While Harvest's recent activity is hardly encouraging, the bloodletting may be a necessary step for the company to stay afloat during the economic shutdown, as a recent report from Investment bank Ello Capital estimated that the company had less than seven months of funding left prior to the offering.
Similarly, Aurora Cannabis and Canopy Growth Corp were both pegged to run out of cash within a year if their current burn rate continues.
This means that bankruptcy may be the only option available for early-growth stage cannabis companies that were already struggling with liquidity issues pre-coronavirus, as there will likely be few opportunities on the field for acquisitions and mergers—due to the cash-strapped position most pot stocks are in—for the remainder of the 2020 financial year.
Survival of the Fittest
Luckily, this could actually end up strengthening the cannabis industry in the long term, as an extinction event of this scale will likely end up wiping out the pretenders and also-rans that have alienated investors with pie in the sky valuations and commercial strategies that favour aggressive expansion over material profitability.
Then, once the herd has been thinned and the dust has settled—and investors finally identify the bottom of the market—the pot stocks that have demonstrated they can go the distance are expected to experience a sudden surge in value, provided they cut costs enough to become sustainable in the near term.
Cannabis is a more volatile industry than most, with higher levels of active trading causing a larger downturn in response to COVID-19 but also a more powerful recovery in response to market upticks. Investors predicted that cannabis firms would lose revenue e.g. due to restricted movement and general economic slowdown. They may now be reacting to the increase in cannabis sales as well as the current general uptick of the market. Prohibition Partners Managing Director, Stephen Murphy
An example of this can be seen in the Canadian cannabis company Aphria (NYSE:APHA), which has seen its share price decline by almost 70% over the last 12 months, despite recording a profit for three out of the last five financial quarters.
The most commonly held explanation for this discrepancy is that the company is still suffering from guilt by association—after being lumped in by investors with other under-whelming pot stocks—despite a series of consistently strong earnings reports.
Narrowing the playing field will not only help to weed out the pot stocks that have little to no long-term viability, but also shine a spotlight on those that have been outperforming their peers.
Additionally, the upcoming cavalcade of bankruptcies should allow some cannabis companies to pick up valuable assets for pennies on the dollar, as many businesses are looking to unload any non-essential holdings in an attempt to bolster their war chest.
Evidence of this trend was already visible by the start of April, when Ohio-based cannabis retailer Green Growth Brands (CNSX: GGB)—which operates the largest chain of mall-based CBD kiosks in the US—placed its CBD business into receivership.
Like other underperformers, Green Growth made the decision to sell off its range of CBD body-care products and retail chain in response to a disappointing Q4 2019, when it incurred a dismal $35.9 million loss.
The CEO of Green Growth Brands, Peter Horvarth, attributed the decision to "overhead costs" and "constraints on liquidity", and stated the company aims to provide greater value to investors by focusing on its dispensary operations in Florida, Massachusetts and Nevada.
"While we're currently in the process of selling the CBD business, we're extremely proud by how we grew this business from a mere idea to products that have reached over 300,000 consumers in just nine short months," Horvarth said.
"We're proud of the CBD business we created, [but] it's important to reiterate that our core business has always been the multistate cannabis business."
Although the company initially planned to sell its CBD assets to the BRN Group—while retaining a 20% stake in the business—this plan has been temporarily delayed due to the coronavirus pandemic.
CannTrust Holdings is also in a comparable situation, after a potential acquisition by Aphria fell through, despite the company's impressive 450,000 square foot cultivation footprint.
Most of these deals are unlikely to go through until the current market turmoil is resolved—and capital becomes less scarce—but once things return to normal it's going to be a feeding frenzy, as the surviving cannabis companies move to cannibalize those that have fallen by the wayside.
"Marijuana and hemp investors shifted their focus from wanting companies to grow at all costs to demanding companies sell or shut down noncore or money losing assets, focus on core operations and articulate a near-term path to profitability," Marijuana Business Daily equity Analyst Craig Behnke said.
"We believe it's a necessary, but painful, step the industry has to take in order to thrive in the long term."
Unexpected Side Effects
Aside from a radically re-shaped cannabis industry—with a greater focus on profitability rather than expansion potential—2021 also may provide a much-needed boost to the marijuana legalization movement, as federal and state governments look for options to address the budgetary deficit caused by the COVID-19 pandemic.
Sadly, Australia will most likely miss out on this—as the Coalition government has historically opposed previous drug reform attempts—although it may be possible depending on how strongly the economic hangover from the coronavirus outbreak is felt.
However, it's a completely different story in the US, where government officials in several jurisdictions have already begun considering the idea, including Oklahoma lawmaker Scott Fetgatter, who recently floated the legalization of recreational cannabis as a way to address the growing unemployment rate, along with a downturn in oil prices that has straddled taxpayers with a debt of more than $220 million.
A legalised cannabis system could provide a much-needed stimulus during the potential downturn. Pioneering regions like Canada and some US states have charted much of the course towards a responsible system of cannabis control and the lessons learned about what works and doesn't work in licensing systems, compliance, standardisation and retail logistics, can be applied – and applied at speed. Prohibition Partners Managing Director, Stephen Murphy
While Fetgatter's proposal was initially met with pushback, it may become an increasingly attractive proposition to Oklahoma's citizens, as the state's debts are expected to balloon by an additional $250 million within the next 12 months.
"With the current situation with oil prices being down, COVID-19, the economic impacts from those things, I just am wondering if it wouldn't be a good idea to have a discussion in the legislature about a full access program adult use over 21 alongside our medical program," Fetgatter said.
"Colorado brought in $300 million in tax revenue and license fees last year in the state coffers. In the first year we legitimately could see $100 million a year in increases rendered to the state of Oklahoma."
But don't get too excited, as lawmakers are unlikely to pursue this route while grappling with a "once-in-a-century" health crisis.
For evidence, investors need look no further than New York Governor Andrew Cuomo's recent decision to jettison recreational legalization from the 2020 state budget, despite the $15 billion deficit that is expected to be caused by coronavirus fallout.
"It's not likely. Too much, too little time," Cuomo said.
While this may have been disappointing news for cannabis enthusiasts, New York legalization activists conceded that their plans would have to be put on hold, as government officials would be hard-pressed the find the time needed to hash out a regulatory framework for legal adult-use sales in the middle of a pandemic.
Once the infection rate starts to stabilise—and governments turn their attention towards economic recovery—we may start to see a renewed push for recreational cannabis as a way of replacing the billions lost during the 2020 recession.
In fact, a recent report from Prohibition Partners argued that the untapped economic potential of the cannabis market is analogous to the era of alcohol prohibition that took place in the US during the Great Depression.
"Cannabis presents a similar opportunity which could now be leveraged by governments globally. Markets that harness the economic power of the cannabis industry have demonstrated societal and infrastructural benefits," the report stated.
"Colorado and Washington reported US$303 million and US$400 million, respectively, in cannabis-related sales taxes in 2019."
"Legalisation represents an easy-win for any government looking to build an industry with high revenue potential. Cannabis is by no means a new product and there is no question about the demand globally."
This pot stock could reach new heights in 2020 due to Coronavirus
The COVID-19 pandemic is showing no signs of slowing down, and as global markets enter meltdown many cannabis companies are feeling the effects of capital crunch.
While the market crash will continue for some time, it represents a golden opportunity for investors who are capable of riding out the volatility until share prices rally.
Luckily, one pot stock has developed antimicrobial drug that can already treat two superbugs while limiting their ability to develop antibiotic resistance.
Investors can also start picking up shares at rock bottom prices, as global investor sentiment continues to dampen thanks to COVID-19.
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