The Road to Recovery

By Dan Mitchell
Apr 16, 2020

It’s a time of intense activity for the cannabis industry. Dispensaries are retooling to offer or expand delivery services. Manufacturers are outfitting employees with personal protective equipment (PPE) to protect them from the novel coronavirus, as they scramble to secure their supply chains, or find new ones. 

But for all the madcap activity, the industry is largely moribund. Planned expansions have been shelved. Investments have been delayed. Hiring has slowed or stopped. Marketing initiatives – like those for now-canceled 4/20 events and trade shows — have been cut.

After a tough couple of years, everybody’s waiting to see what effect the pandemic, and the shuttering of much of the economy, will have on what was already a beleaguered business. The question now is: what will the industry look like after the crisis passes?

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A Mass Acceleration

Insiders predict it will become more consolidated, more “corporate,” and more disciplined. Some think this will make for a healthier industry. “Everything that was happening before the pandemic is being accelerated,” Roy Bingham, CEO of cannabis-data firm BDSA, formerly BDS Analytics, said. That means more mergers and acquisitions, more companies folding or being snapped up by bigger outfits, and the larger companies expanding their market share. 

As for the overall health of the industry, much depends on how long the crisis lasts. “We’re bearish on that” said Michael Boniello, managing director of Poseidon Asset Management a cannabis investment firm in San Francisco. “We think it could turn out to be an 18-month problem.” 

Other observers aren’t quite so pessimistic, but all agree that if the crisis continues for long enough, the current health of the industry — bolstered by most legal states declaring cannabis “essential,” and allowing it to operate — might be threatened. In the long term, however, everyone seems to agree: Cannabis has nowhere to go but up. 

After an initial spike in demand, retailers report sales have reverted back to about where they were before the pandemic struck, though it varies greatly from region to region, and even shop to shop. But the falling sales might be a bit of an illusion. It happened “largely because people had stocked up, buying twice as much on average as they were buying before,” Bingham said. “People are probably consuming more on average than they had been.” 

In other words, people hoarded for a few days when they thought the cannabis shops might close. But when their outsized stashes run low, they’re likely to start buying again. 

The situation seems to confirm leading analysts’ view that demand for cannabis is relatively inelastic: It doesn’t fall, or doesn’t fall much, during economic downtimes. It might even rise, as liquor sales tend to do during recessions. 

But even that can go on for only so long. If tens of millions of Americans remain out of work for months, cannabis could sink lower on people’s priority lists. “If we get to the point where it’s a choice between eating and purchasing cannabis, obviously, many will choose eating,” Bingham said. 

Boniello doesn’t think that will happen. He’s much more bullish on the industry’s future than he is about the current crisis. “Demand is going to be there no matter what happens,” he said. 

“I don’t think cannabis companies are recession proof”

That’s not the same thing as the industry being healthy, at least at first. “I think cannabis is recession-proof, but I don’t think cannabis companies are recession-proof,” Boniello said. Even if demand jumps, and remains high, he  expects the industry shake-out that accelerated last year to continue.

Before the pandemic, many companies were overleveraged, spending too much, and, especially beginning last summer, finding it hard to land fresh capital. That latter situation has worsened now that capital markets have frozen up across the economy.

Besides skittish investors, there’s also a logistics problem: nobody can go anywhere. Investors “can’t meet teams, they can’t do due diligence, they can’t put boots on the ground,” Boniello said.

Even so, he says there’s been an uptick in interest from investors, particularly family offices and to a lesser extent venture capitalists. Even some institutional investors, who had been particularly spooked at the end of 2019, are expressing interest again in non-plant-touching companies. They might not be able to do anything about it immediately, but many have said they’re ready to start plunking money down once the economy opens up. 

Indeed, some might be banking on the pandemic to speed up the “Darwin phase” that the industry was in before the virus, Boniello said. Once the weaker players are shaken out, the thinking goes, better bets will be easier to spot. Many of them, he added, are waiting to see “whether this is a three-month problem, a six-month problem, or an 18-month problem.”

“A watershed moment”

Investors are also waiting to see what federal and state governments might do. Cannabis’ “essential” status is widely believed to have saved the already-weakened industry from devastation. But it might end up doing more. “It was a watershed moment for cannabis,” Justin Ort, a portfolio manager for Measure 8 Venture Partners said. “It is creating more acceptance, it’s helping remove the stigma, and it might push lawmakers toward reform.” 

By “reform,” he mostly meant the removal of cannabis from the U.S. criminal code, where it is designated as a Schedule 1 narcotic. Until that happens, or at least until there are changes in banking access, the cannabis industry will continue to have to work within unique artificial constraints. 

Whether that might happen before the crisis has passed is uncertain, but reform advocates think the “essential” designation is likely to accelerate the industry’s path to normalization. The economic downturn will also likely make at least some state and local governments more pot-friendly, Ort said. “Governments are going to become really desperate for tax revenue.”

As with federal action, much-hoped-for reforms in California will likely be put on hold. The nation’s largest pot market has been stymied by high taxes and by a lack of licenses issued by local governments. As a result the illicit market comprises more than three quarters of the pot business in the state. 

Industry advocates had been hoping the state legislature would address both issues this year, and several different bills have been floated. It might still happen, but it appears unlikely. The legislature has streamlined its business to deal with the pandemic, and for the next few months it will be working only on the state budget, which must be completed by July. 

Normally, any kind of bill can be – and often is – attached to the budget legislation. But this session, lawmakers are allowed to consider debate on just three non-budget issues: the pandemic, wildfires, and homelessness.

Advocates hope that if cannabis issues can’t somehow be shoehorned into the budget debate, they’ll at least be taken up by the end of the year. By then, “there will be a need to create jobs in the state, and a need for local revenue,” Max Mikalonis, a cannabis lobbyist with K Street Consulting said.

He also hopes the U.S. Congress will be moved to take up legalization or decriminalization. “It took the Great Depression to spur the end of prohibition, he noted. “Maybe something similar will happen with cannabis.”