Cannabis Businesses Learning from the Dot-com Bubble

The dot-com craze has provided a number of lessons for emerging cannabis businesses seeking opportunities in an industry gaining legitimacy across North America.

Over the past several years, cannabis has been the single most talked about industry among North American investors and for good reason. The historic legislative breakthroughs for legal cannabis have created numerous opportunities and no small amount of excitement. Investors who have been in the game for a while, however, probably remember that this isn’t the first time an exciting industry has come seemingly out of nowhere and generated massive buzz and speculation. Much like the mania that ensued during the dot-com bubble, the trend towards a global cannabis market is offering both opportunities and challenges to new companies on the market.

Legal cannabis businesses and investors have something that many of the dot-com stakeholders probably could have used: the benefit of hindsight. Investors can look to previous bubble cycles to find indications of where cannabis markets might be on the timeline while seeking out companies with solid foundations. Meanwhile, cannabis companies can ensure their staying power by adopting proven business models.

Cannabis businesses entering the US market

At this time, there are 11 legal adult-use cannabis states in the US as well as 22 additional medical cannabis states for a total of 33 with medical access. The US cannabis market was worth US$11.3 billion in 2018 with a compound annual growth rate of 14.5 percent forecasted up to 2025, according to data from Grand View Research. That’s already a huge market considering that US cannabis companies are operating within a fragmented marketplace without the ability to conduct business across state lines. Data by Barclays Investment Bank suggests that if cannabis was nationally legal in the US today, the market would be worth approximately US$28 billion, and could be worth as much as US$41 billion by 2028.

While federal legalization is not expected to occur anytime soon, the upcoming US election in 2020 could bring the conversation to the national stage. In the meantime, some of the country’s largest markets are already providing ample opportunity. Specialized cannabis companies have an opportunity to establish themselves as leaders in a given segment within their states of operation, leveraging that foothold when the national market opens up.

It’s important to note that the timeline for a cannabis bubble is not quite as linear as it was for the dot-com bubble. Regulatory reform is happening on its own timeline in each country, and so is the corresponding market development. Canada is far ahead of the curve in this regard, for example — the Canadian cannabis bubble has already burst, dragging down major licensed producers. In the US, on the other hand, the market can’t reach critical mass until the full country is open for business, and at this time there is no way of knowing exactly when that will be. The US cannabis market is already large, but the real boom and the true opportunity for value could be yet to come.

“To use a baseball analogy, US cannabis isn’t even in the first inning yet, and the Major League still isn’t established. In Canada, we led the industry and exhausted the over speculation on unsustainable business models that crashed into short-sighted regulatory barriers,” Karl Kottmeier, president and director of cannabis producer Chemistree Technology (CSE:CHM,OTCQB:CHMJF), told Investing News Network. “Now, the US can learn from the bursting Canadian bubble and build on sound business principles in a massive market with many years of double-digit growth ahead.”

The dot-com bubble

The dot-com bubble was a product of the internet’s explosion into mainstream popularity in the 1990s. In previous years, most consumers had yet to buy their first computers, meaning the internet was the exclusive domain of computer scientists in university basements. By 1994, however, the general public was beginning to catch onto the role the internet would come to play in our daily lives. By 1996, companies like Netscape and Yahoo! were suddenly worth billions. Internet-based companies flooded the NASDAQ, raking in huge amounts of cash from IPOs. Unfortunately, investors only had an idea of what the internet was becoming and jumped on dot-com stocks hoping to grab a piece of the online revolution.

By 2001, however, few of these dot-com companies had turned a profit. In the early days of the bubble, all a company needed for a successful IPO was a brand and enthusiasm. Some of these spent the bulk of their capital on marketing rather than developing a product and as a result, had no proprietary technology or any value proposition to speak of.

In the excitement of the internet boom, many investors assumed that any company with a web-based business model was destined for success, but they forgot to ask themselves some of the basic questions about a company’s fundamentals. Investors weren’t asking how long it would take for a company to translate its operations into a profit, whether there was a place in a crowded market for yet another company or whether a company was trying to do too much and spreading itself too thin.

The bubble burst in 2002, with most of these companies disappearing as quickly as they had sprung up.

Cannabis businesses emerge as essential

Today, the hype is all about cannabis. Even without national legalization, the US cannabis market is the biggest in the world thanks in large part to California. Long-standing stigmas about recreational cannabis consumption are quickly disappearing and the medicinal value of cannabis is becoming increasingly recognized. The explosion of non-psychoactive CBD products is allowing the cannabis market to reach an exponentially broader consumer base. Cannabis is booming and, just like with the explosion of the internet, investors have wanted in. Cannabis companies brought in more than US$13.8 billion in investments in 2018.

The emergence of the coronavirus and designation of cannabis operations as “essential businesses” in many parts of the United States has caused many to speculate that national cannabis legalization could be next. In addition to its newfound legitimacy, the potential revenue opportunities presented by legal cannabis could provide states with the opportunity to replace revenue likely lost due to the coronavirus.

The sudden proliferation of the internet has also created opportunities for new business models and revenue streams such as e-commerce and digital advertising. These spaces were initially wide open and companies rushed to fulfill the demand. The legalization of cannabis has created new spaces as well, including cultivation, distribution, extraction and the manufacturing of consumer packaged goods like edibles and topicals. Cannabis companies are flooding in to grab these opportunities.

There are some clear parallels between the cannabis boom now and the dot-com bubble then. Both were the result of significant breakthroughs, a technological breakthrough in the case of the dot-com boom and a legal one in the cannabis space. Both saw a massive rush of companies looking to establish themselves in new and emerging industries and both have seen a corresponding rush of investors looking to finance them. Just like with the dot-com boom, there could be a time when the market can not sustain all of the cannabis companies that have popped up.

Cannabis businesses adapting to market conditions

When the dot-com bubble burst, it clearly wasn’t the end of the tech industry or the internet. A few of the companies that originated during the boom period took a hit but ultimately came out stronger than ever. Companies like Google (NASDAQ:GOOGL) and Amazon (NASDAQ:AMZN) survived and went on to become ubiquitous tech industry behemoths. What separated these companies from the competition was that they were doing something unique, had valuable properties and were well-capitalized to weather the storm and acquire other struggling but sound businesses.

Likewise, cannabis companies with valuable assets, high-quality products, capable leadership and solid long-term plans for growth are expected to be the most likely to stick around when the booming US cannabis industry eventually levels out. Basic business fundamentals are still key. Companies with a clear focus on one part of the industry reduce their risk of facing unsustainable operating costs and can find quicker paths to profitability. Companies that try to grow too fast, however, could find themselves in a difficult position if market dynamics change. For example, Washington-based cannabis producer Sugarleaf initially set up a comprehensive production and processing facility in the early days of the Washington cannabis market. The company was successful in establishing its brand, but could not come up with the capital necessary to sustain operational growth.

Recognizing the opportunity, Chemistree negotiated the acquisition of Sugarleaf for only US$1.2 million, along with the global rights to the Sugarleaf brand outside of Washington state. Chemistree has since updated the facilities and arranged for a new operator to hold the license and operate the assets with more stable financial support. According to Washington i502 data, Sugarleaf’s monthly sales have increased by 239 percent following Chemistree’s takeover.

“Cannabis investors should look for clear and easy-to-understand business models that focus on a single segment of the market. Management experience and focus will establish a foundation for value creation and eventually, when the time is right, open the doors to larger opportunities,” says Kottmeier.

US companies, in particular, should have a growth plan in place in order to capitalize on the potential shift to a fully legalized national cannabis market. As for cannabis investors, it’s up to them to find the companies with these strong foundations while avoiding the ones that are trying to coast on a booming market.

Takeaway

The dot-com bubble serves as a valuable cautionary tale of the dangers of speculation in a booming market. There are hundreds of cannabis companies looking to find their place in the US market as it develops. While not all of these will succeed, the forward-thinking, well-capitalized companies with a clear understanding of the industry could have the best chance at long-term success.

This article was originally published by the Investing News Network in January 2020.

This INNSpired article was written according to INN editorial standards to educate investors.

INN does not provide investment advice and the information in this article should not be considered a recommendation to buy or sell any security. INN does not endorse or recommend the business, products, services or securities of any company profiled.