Pot slump creates distressed opportunities

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Cannabis stocks have lost about a quarter of their value in the first half of 2020, compounding a 50 per cent drop in 2019.

The upside for investors? There’s never been a better time to do distressed deals, according to Codie Sanchez, managing director at private equity firm Entourage Effect Capital LLC.

Liquidity in the sector has been diminishing since the first quarter of 2019 but now that trend is “on steroids,” with private companies’ access to capital almost completely dried up, Sanchez said at a virtual conference hosted by Prohibition Partners last week.

“If you’re looking to invest, I’m not sure there’s a better time,” she said. “We’re working right now on three really large distressed deals that pre-COVID and the cannabis pullback we would not have been able to do.”

However, for distressed transactions to really take off, smaller operators will need to become more realistic about the worth of their assets.

“I’m not sure yet that all cannabis companies really understand what their valuations should be if they’re not operating at the highest level or public,” Sanchez said. “I don’t think we’re quite at the bottom for private companies yet.”

Graeme Kreindler, cannabis analyst at Eight Capital, agreed. Distressed opportunities “will not be in short supply,” especially among smaller players, but they’ll first need “to become more flexible in transaction terms, including higher proportions of share consideration and more realistic selling price expectations,” he said in a note published June 22.

There’s also a lack of available capital due to an ongoing reluctance among big institutional investors to touch the industry, Sanchez said.

She estimated there’s only a few billion dollars currently allocated to the cannabis sector by private equity and venture capital funds. “If it’s true there’s US$4.7 trillion of cash on the sidelines from institutional investors and retail investors,” she said, “we have a huge arbitrage opportunity from the moment we start to have some of those investors come into the mix.”

That may take U.S. legalization, or at least the big U.S. exchanges opening their doors to cannabis listings. But she’s happy to wait.

“For all of us that are building companies right now, I’m perfectly fine if we have another couple of years without legalization fully,” she said. “If we have a few more years before the investors in the institutional space want to get in, we’re going to make a lot more money.”

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