Big things are afoot in the legal cannabis space. Following a year of many firsts, the biggest news looks to be the expected legalization of recreational marijuana by this coming summer in Canada. Should Canada move forward with the Cannabis Act in June and vote to legalize, it would become the first developed country in the world to do so, and only the second country overall behind Uruguay. And as things stand now, legalization looks extremely likely.
Meanwhile, growers in Canada have been busy expanding their production capacity as quickly as their balance sheets will allow. Growers like Canopy Growth Corp. (NYSE:CGC) and Aurora Cannabis (NYSE:ACB) appear fully capable, based on recent expansion updates, of producing in excess of 400,000 kilograms of dried cannabis per year when fully ramped up.
This expected legalization, capacity expansion, and shift in favorability toward cannabis among the public, has Wall Street and investors stoked, to say the least. Pot stock valuations have exploded higher by triple- and quadruple-digit percentages since the beginning of 2016 in anticipation of sales doubling or tripling on an annual basis over the next couple of years.
Why marijuana stock investors should be thrilled with Canada's expected legalization
But what if I told you that rapidly rising sales and even profits aren't the real reason why investors should be excited about Canada's expected legalization of adult-use weed. Instead, pot stock investors should be thrilled that legalization could put an end to, or at least reduce, the biggest issue they face: dilution. It'll do so by opening the door to financial institutions that've primarily been shut out of the industry.
The issue for banks is pretty clear: With the exception of Uruguay, marijuana is illegal in every other country around the globe. This means that financial institutions offering basic banking services to pot-based businesses could face two types of penalties. First, they could be fined by regulators in countries where cannabis illegal. The other possibility is banks could face criminal charges. These two concerns have pretty much kept financial institutions on the sidelines, despite the opportunity that servicing the weed industry presents.
However, that changed in February with legalization in Canada looking likely. Canopy Growth, the largest marijuana stock by market cap, completed a 175 million Canadian dollar offering (US$135.9 million) that was co-led by Bank of Montreal (NYSE:BMO) and GMP Securities. It marked the first time that one of Canada's five big banks dipped its toes in the water when it came to equity financing for the cannabis industry.
In an interview with BNN in December, Canopy Growth CEO Bruce Linton had this to say:
[The banks are] cautious about allowing debt instruments, they're cautious about allowing [employees] to give financial advice. I think you'll see, on about January 1st, 2018, a bunch of them pushing into the sector, and for sure by July, they're all there. I think that'll be the final normal business hurdle that we get over.
It's worth noting that while this interview was done in December with the expectation that adult-use sales would commence in July, that reality has been pushed back to August or September to allow dispensaries adequate time to get the product from grow facilities to retail stores.
Expansion could fuel mutualistic benefits for growers and banks
Legalization in Canada could allow for debt deals and lines of credit to become a reality, padding the pockets of large banks, while giving cannabis stocks the added flexibility they need to buy product, make acquisitions, expand the existing operations, and hire new workers. Assuming marijuana stocks do generate an additional $5 billion or more in annual sales from adult-use marijuana, long-term debt deals and short-term lines of credit needed by growers could be a welcome boost for a generally slow-growth banking industry.
Think about this for a moment: Even with Canadian growers already on pace for around 2 million kilograms in fully funded annual capacity by 2020 or 2021, most are still sitting on acreage that could be used for further expansion. Canopy Growth envisions a 5.7 million-square-foot growing operation when all is said and done. Meanwhile, Aurora Cannabis just announced the acquisition of 71 acres of land in Medicine Hat, Alberta, that'll soon house a 1.2 million-square-foot facility, to be known as Aurora Sun, which could be expanded to 1.5 million square feet in the future. There are plenty of expansion projects on the horizon that need financing, offering plenty of opportunity for banks, and perhaps reducing or slowing the dilution that marijuana stock investors regularly deal with.
Understandably, though, equity financing deals underwritten by major financial institutions like Bank of Montreal aren't a lock to stop dilution entirely. Opening the door to legalization may also mean additional bought-deal offerings, which are the scourge of pot stock investors because of the dilution they bring. The noted February deal underwritten by Bank of Montreal involved a common stock offering of more than 5 million shares of Canopy Growth, which dilutes the value of existing shares by making them less scarce.
It'll certainly be interesting to see how quickly Canada's big banks jump into the industry, as well as to what extent cannabis companies use basic banking services. Needless to say, the next couple of months are going to be very exciting.