M&A Is Coming to Cannabis. And That's a Good Thing.
Despite being a relatively new industry, cannabis is quickly moving through the well-trodden industry life cycle: from fragmentation to consolidation in the form of mergers and acquisition.
This is good news for small businesses and private investors. A company's long-term success directly correlates with how fast it can move up the consolidation curve. In a mature industry, two or three companies often make up 70 to 90 percent of the market.
And market ownership isn't achieved always through slow, steady growth but rather through brand alliances and M&As. That's why small business survival is dependent upon making choices that prepare their companies to either acquire or be acquired. Last year alone, startups raised $4 billion in cannabis, and this forward thinking is key to their exit strategies.
Let's take a look at where the market is now and where it's going.
What the Canopy-Acreage merger means.
Over the past five years, we've seen numerous exits in our portfolios, including big names like Acreage and smaller ones like Form Factory and Ebbu. While these M&As have resulted in nice rewards for the founders and investors, they've also come with complications. For example, the recently announced merger between Canadian company Canopy Growth and the U.S. company Acreage is, at this point, only a "right to buy" deal. What does this mean? Because cannabis is legal in Canada, Canopy Growth can trade on the New York Stock Exchange. But if it acquired Acreage today, it would own an illegal business in the U.S. and be prohibited from trading.
The $3.4 billion dollar deal means $300 million to Acreage shareholders now, with the remainder contingent on the legalization of marijuana in the U.S. at the federal level. This agreement has opened a door for similar M&As across the industry. In fact, it may be a model. We expect many cross border transactions to follow suit. That door just may be blown off its hinges when legalization occurs.
Consumer Packaged Goods make a cannabis play.
Most of the mergers and acquisitions happening recently are from MSOs (multi-state operators) and license aggregators making acquisitions, but as we know cannabis companies aren't the only ones looking to take advantage of growth trajectories to make a profit. Many of the world's largest CPGs are already investing. Constellation Brands, the owner of Corona, Modelo, and Black Box Wine, dipped its toe in the water with a small investment in Canopy Growth, then quickly jumped all the way in, purchasing 35 percent of the company. Recently they announced they might buy as much as 50 percent of the company, despite less than desirable performance of their own stock following the previous purchase. Altria, the owner of Marlboro, has also taken the leap and invested big in cannabis, putting nearly $2 billion into the Cronos Group. InBev, owner of Budweiser, is working with Canadian giant Tilray, on cannabis-infused non-alcoholic drinks.
What this means for small companies.
Many think that this consolidation signals the end of small businesses and craft cannabis. Do all of these large players mean that small companies and startups no longer have a place in cannabis? I'd argue the opposite. Innovation will continue to be a driver in the industry, and startups will continue to be the driver in that area. But the startups that scale quickly and reach critical mass will have VC backers and are more likely to be snapped up in an M&A at the first sign of high growth. Long-term success correlates with the speed at which a company can scale from startup to M&A. This is one of the reasons that we like to invest in the private side -- it gives the ability to get bought out early and benefit from the arbitrage between private companies pre IPO.
Looking to the future, expect investors to focus on growth and consolidations:
- More rollups, specifically multi-state operators and license aggregators
- Medical biotech and cannabis plays
- CBD and hemp CPG space
- Cannabis infused beverages
The cannabis industry isn't going away, and neither is the wave of mergers and acquisitions currently on the horizon. The next three to five years will either see more rapid growth through federal legalization or the ongoing creative investing we are now seeing, with an eye to the future.