Cannabis Analysts: Institutional Investors Still on the Sidelines

After a difficult 2019 and first half of 2020, capital has remained a key consideration for companies and investors focused on the cannabis market.

At last week’s online Prohibition Partners LIVE event, a panel of business analysts dished about the ups and downs of the cannabis industry and examined why easy access to funds has died for cannabis firms.

The group of analysts included: Owen Bennett, equity analyst with Jefferies; Kaumil Gajrawala, analyst with Credit Suisse (NYSE:CS); and Paul Gurney, analyst with BMO Capital Markets.

Where are the institutional investors?

For part of the talk, the panelists turned their attention to institutional investors’ lack of involvement in cannabis — despite constant whispers that they are interested in jumping in.

The Jefferies analyst explained that actual day-to-day institutional involvement at the moment is very small and is coming primarily from hedge funds. In his opinion, cannabis stocks won’t truly be tested until more established institutions pursuing long-term investments enter the space.

Bennett said there have been questions about the desired involvement of these larger groups due to the shaky nature of the industry. He explained that the sector has been ruled by easy money been doled out based on stock promotion, poorly designed projections from companies and lack of profits.

“Because money was easy there were a lot of companies in existence, and that still are, that shouldn’t even really be around,” Bennett told the web-based audience. “Those sorts of characteristics make it very difficult for a long-only institution to invest.”

And even as measurement metrics change and the sector becomes increasingly mature, one key factor remains: Cannabis is an illegal substance at the federal level in the US.

Gurney admitted to a fault in the system since, following the legalization of recreational cannabis in Canada, many expected a green rush and a legal US market 12 to 18 months after. “Here we are sitting 18 months later, and we’re no closer to a federally legal program in the US,” the BMO analyst said.

“Unless it’s federally legal, a lot of these institutions can’t invest,” Bennett added.

Growth-oriented investors versus value investors

Slower-than-expected growth and the stop-and-go in terms of legality in the US, the biggest market available, have also impacted other types of investors involved in the cannabis space.

Gajrawala said a large number of his clients felt like they were being left behind with the cannabis opportunity once the investment deal between Constellation Brands (NYSE:STZ) and Canopy Growth (NYSE:CGC,TSX:WEED) took place.

In retrospect, Gajrawala said that the two part investment agreement between the alcohol maker and the Canadian cannabis name should have served as the first signal for his clients to start to take notice — not as a sign of a rush in the industry.

The Credit Suisse analyst explained that cannabis has had to deal with growth-oriented investors and value investors, two groups that have different goals.

As he put it, growth investors evaluate an opportunity and its ability to expand, whereas value investors examine an industry and say to themselves, “This business is of a certain size … it’s worth a certain price and I want to buy it at some discount to that price.”

Gajrawala said the growth investors have left the industry for now, but once the cannabis space picks back up he expects to see them return.

When it comes to deals affecting investors who are typically outside the cannabis arena, Gurney said when his firm served in the Tilray (NASDAQ:TLRY) initial public offering (IPO), he saw firsthand the increase in interest due to the returns offered by the cannabis company.

Tilray went public in July 2018, and within the next few months its share price was near US$300 — an unprecedented and shocking event for cannabis investors.

“When you see returns like that it attracts everybody, people find a reason to invest in it,” the BMO expert said. Gurney noted that the Tilray case led various cannabis IPOs to also go up, which “creates all sorts of issues … people think the money is easy, they misspend it, they misallocate it and all sorts of people who shouldn’t be invested in the sector come in and hand it out.”

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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.