2018 may very well go down as the most game-changing year on record for the legal cannabis movement. While other milestones, such as Uruguay becoming the first country worldwide to legalize recreational marijuana, and California becoming the first state to OK the use of medicinal cannabis for compassionate-use patients in 1996, will go down in the record books as big events, nothing quite compares to Canada becoming the first industrialized country in the world to give the thumbs-up to adult-use marijuana.
When Canada officially waves the green flag on recreational marijuana on October 17, it'll be opening the door to perhaps $5 billion in annual sales. This will come atop the revenue that growers, processors, distributors, and retailers, are already bringing in from domestic medical marijuana sales and exports to foreign countries where medicinal weed is legal.
The first wave of legalizing cannabis: Capacity expansion
Having expected that the Cannabis Act would pass for months -- i.e., essentially since the federal government worked out a two-year tax-sharing agreement with all but one province (Manitoba) in December -- growers have been busy expanding their production capacity at a breakneck pace.
For instance, Aurora Cannabis (NYSE:ACB) entered 2018 with a peak production forecast of just north of 100,000 kilograms per year. Since then, it has:
- Acquired Saskatchewan-based CanniMed Therapeutics in an $852 million deal.
- Purchased Ontario-based MedReleaf in an all-share deal for $2.5 billion -- the largest pot deal in history.
- Partnered with Alfred Pedersen & Son in Denmark on the Aurora Nordic project, which will span roughly 1 million square feet and yield 120,000 kilograms annually once existing greenhouses are retrofitted for cannabis production.
- Announced the construction of a 1.2 million-square-foot facility in Medicine Hat, Alberta, which should yield 150,000 kilograms annually when at full capacity.
All told, Aurora Cannabis now anticipates that it'll produce in excess of 570,000 kilograms annually, once at full capacity. The rest of its peers have similar stories to tell, with capital being poured into organic, acquisitive, and partnered production growth. In the coming months to roughly two-and-a-half years, all of these projects designed to boost output should be complete.
Now, the second wave: Building brands
However, the capacity expansion craze is beginning to wind down. This isn't to say we won't see pot stocks announcing acquisitions, partnerships, or organic builds, so much as to suggest that not every single marijuana stock will be doubling their production capacity within a 6- to 12-month timeframe.
Instead, it's the dawn of a new era in the legal marijuana landscape: brand-building.
Now that growers have laid the foundation for ample supply in the months and years that lie ahead, they need to find ways to attract loyal consumers and/or secure long-term supply agreements with retailers or provinces. Generally speaking, the easiest way to do that is by having a portfolio of well-known, diversified, brand-name cannabis products.
How do we know that the switch has been flipped on brand-building? Look no further than Canopy Growth Corporation's (NYSE:CGC) mammoth reach for Hiku Brands, the owner of the Tokyo Smoke, DOJA, and Van der Pop cannabis brands in Canada.
Canopy Growth agreed to acquire Hiku in an all-share deal, with 0.046 shares of Canopy Growth being exchanged for each share of Hiku. This valued the deal at approximately $205 million and caused Hiku Brands to terminate its existing merger agreement with WeedMD since Canopy's offer was clearly superior. Canopy has advanced Hiku the 10 million Canadian dollar breakup fee triggered by the company's action to walk away from the merger with WeedMD.
What makes this roughly $205 million acquisition such a head-scratcher is that despite having a national retail presence and a portfolio of lifestyle cannabis brands, Hiku is barred from selling recreational cannabis out of its shops in Ontario -- unless Premier Doug Ford alters the existing law in the province. This means Canopy Growth paid a boatload of money to purchase a company with 10 locations in Manitoba, and licensing applications in Newfoundland and Alberta. That's pricey!
This stock has written the blueprint on cannabis branding, thus far
However, Hiku's nosebleed valuation explains why MedMen Enterprises (NASDAQOTH:MMNFF) has been able to command a billion-dollar-plus valuation despite having just 16 stores in three states, which includes three that are in development in Nevada. Although, to be fair, investors might simply be jumping the gun and assuming that MedMen can stick to its word of having 50 retail cannabis shops open by 2020, as well as take advantage of a partnership with Cronos Group to bring its brand north of the border.
MedMen, which CFN Media pointed out has been referred to as the "Starbucks of weed," is looking to transform the way consumers purchase marijuana. It aims to normalize the experience of purchasing cannabis, as well as control the entire process, from seed to sale.
You see, in addition to its 13 operating retail locations, it also owns a growing number of cultivation sites. Since marijuana can't cross state lines in the U.S. -- that's one of the stipulations of keeping the federal government off of states' backs, since it remains a Schedule I substance -- this means MedMen needs grow facilities, processing, and distribution networks in each of its three operating markets. But by controlling the seed-to-sale supply chain, MedMen should also be able to boost its margins and create a unique buying experience for the consumer.
Still, is MedMen really worth nearly $1.5 billion because of its branding? While there's no question that MedMen holds clear advantages over retailers in its operating markets, the company is also going to be spending big bucks on opening new locations over the next two or three years. That would mean MedMen is still a long way away from being profitable.
At some point, investors are going to stop looking at marijuana stocks with blinders on and start looking for genuine fundamental progress. I'm not entirely certain when we're going to see that from branding giant MedMen, or from the likes of Hiku Brands, even with the deep pockets of Canopy Growth in its corner. That makes brand-building companies an exceptionally high-reward, and high-risk, investment at this time.