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The U.S. Marijuana Frenzy

October 1, 2018 / Federico D'anna

The recent surge in the price of Tilray, the biggest Canadian-based marijuana company listed on Nasdaq, has attracted the attention of several investors in the industry. The controversial sector has been historically characterized by a high perceived risk due to its unstable legal position, yet things are starting to change.

Starting early this June, markets have displayed an increasing degree of comfort following the declarations of U.S. President Donald Trump’s “probable” support of the STATES Act, an extensively discussed bipartisan bill proposed by Senators Cory Gardner and Elizabeth Warren which would exclude legal state-licensed marijuana businesses from the Controlled Substances Act.

Approval may have a significant economic impact on the sector. The demand for marijuana, taking into consideration both the legal and illegal markets, today accounts for 52.6 billion dollars, generating this year close to two billion dollars in tax revenues from 12 billion sales. The size is already impressive, but it is worth noticing that the market has been growing at a solid 33% each year since 2016 and now rivals American spending on firearms and ammunition.

Yet, what spurs investors to pour billions of dollars in an industry that could potentially become illegal overnight? The answer, yet again, is political power. Although the Democrats have always been the party more in favor of legalization, recently the Republican party, who until now had been completely adamant to change, does not seem to shun this new source of revenue. As a result, politicians on both sides have been speculating over the benefits of the pot industry, analyzing the impact that all these figures could have and already have had on the accounting balances of the administrations. According to Pew Research Center, in fact, 60% of Americans think marijuana should be legal. In addition, after a brief period of fear following Attorney Jeff Sessions’ announcement to rescind Cole Memo—which had, until then, de-prioritized the use of public funds to enforce cannabis prohibition—investors are starting to become more comfortable with the US market.

American cannabis is attracting a broad pool of capital. The top-performing stock on the BI Canada Cannabis Competitive Peers index is iAnthus Capital Holdings Inc., which owns and operates cultivators, processors and dispensaries in six states. The company has gained 37% since July, accounting for a 155% growth this year. The pot retailer Medmen Enterprises came out the gate in May on the CSE with a private placement of two billion dollars. The prospects show that in aggregate, the US pot industry could reach a value of 50 billion, matching the current demand of the market, luring capital away from Canadian companies and toward American businesses.

Pulling the curtain, we see that behind the pot frenzy there is a simple economic and political explanation. As analyst Matt Bottomley said, “The businesses there are real cash-flowing businesses that are vertically integrated compared to what we’re seeing in Canada, meaning from seed to sale they own all the economics”. Indeed this gives an incredible advantage in terms of flexibility of supply, cost advantage, profit margins and, ultimately, growth prospects that are hard to ignore. American companies are therefore now expecting an increase in their valuation at the expenses of a down-rating of their northern relatives.

The bottom line though remains a lack of a national conversation and federal support. Democrats have missed out on the opportunity to own the issue back in 2016. During the elections in fact, Hillary could have picked up where Obama had left with the Cole Memo and championed full legalization in the wake of a consensus of 70% of millennials (a particularly misrepresented group at the election) and strong party which already in 2010 could claim 54% of his members supporting full legalization. But things did not proceed in that direction as a more politically-correct position instead was pursued. As Republicans start to align with this position, and given the overwhelming public support, it is likely President Donald Trump will not lose this chance to strengthen the odds for his re-election in 2020. Since 2016, Trump has pledged to leave marijuana legalization up to states and there are talks of his probable support for the STATES Act.

Looking into the midterm elections, there are few industries better positioned than this one. If the results lean on the left, there is hope for a pro-cannabis federal bill to be produced, yet good news might even come from the right side anticipating a possible removal of marijuana-hostile Attorney General Jeff Sessions. The momentum is going and the frenzy has already been picked up, yet it is reasonable to expect incremental interest in the industry as we get closer to the elections.

The market is currently showing a strong buy signal all over, gains are impressive, and the variety of offers is really massive allowing investors to find what suits best their funds. As the analysis suggests to join the market, the time frame to make this decision might be very narrow.

Looking into the midterm election, almost every share is extremely bullish as expected, with all this attention coming from the strong belief from market participants that some sort deregulation process will happen on November 6. GW Pharmaceuticals, one of the largest players in the industry with a market cap of 4.75 billion, has been on a wild climb since April (61% since 04.01.198) and has gained an astonishing 20.57% in the last eight days (09.17.18). The bullish sentiment, however, is likely because all this information has already been priced in by the participants.

There are three possibilities. The first and most probable one is the bull case, where Trump declares marijuana legal at the event. In this, we will continue to see a bull until November 5th, a squeeze play at the top if the event is positive, and afterward a correction as most likely the market will over-price the event.

In the base case, we see a weaker bull, where if geopolitical issues interfere and Trump declares weaker expectations of a marijuana legislation—perhaps taking a similar stance like in his election—he leaves it to the various states. In that case, we see a possible revision of marijuana counters in states which have traditionally taken anti-marijuana stances and most likely a continued bull in states where state legalization is highly probable.

Finally, in the bear case, Trump holds back on the decision, and we see marijuana counters all across the board tanking. Currently, a mid-bull/base case can be seen happening. Given its legalization is one of the possible watersheds of his re-election, grabbing hold of this vital opportunity could very well pave the way for his re-election. Conversely, due to the incredibly tedious nuances that surround the idea of marijuana legalization, we see him possibly taking a more measured stance. The play is most likely to involve either going bull now and taking a bet on the 6th November legalization state bid or hold and wait for a correction to go in; even if the states don’t legalize at the moment, we see Trump taking a positive stance on marijuana leading to his candidacy for re-election.

The situation can be summarised in a few wise words: “If the War of Kuwait has taught investors something, now might be time to treasure past experiences and be aware of the dangers of scheduled appointments with the market.”