Canada has become ground zero for cannabis business in recent years, with Canadian companies like Canopy Growth Corp. and Aurora Cannabis Inc. drawing headlines for sky-high valuations, high-profile acquisitions, partnerships with mainstream companies, and international expansion plays. Much of this hype is justified, as Canada moves swiftly towards becoming the largest country in the world to legalize the production and sale of marijuana for adults when legalization takes effect this July.
But some of the hype is just that—hype. It’s worth looking at what Canadian cannabis companies have going for them, and where the hype may be getting in the way of gaining a clear perspective.
Canadian companies have a huge competitive advantage over their American counterparts, due largely to marijuana being legal and regulated at the federal level in Canada, whereas American businesses must operate only in state-legal environments while being viewed by the federal government as large-scale drug traffickers. Companies in the United States face hurdles that don’t exist for Canadian businesses, including the 280e provision of the IRS tax code, which effectively taxes American cannabis companies at rates substantially higher than businesses in any other industry. American cannabis companies also face substantial hurdles accessing simple banking services, with many banks charging $5,000 a month or higher just to open a basic bank account.
Meanwhile in Canada, cannabis businesses have full access to capital markets, with an ability to access institutional lending and public markets. This has led to Canadian companies being extremely well capitalized. Canadian companies are clearly the dominant leaders in the global industry, and have much going for them in the worldwide cannabis markets. These companies enjoy a first-mover advantage as the first large cannabis companies in the world. This has not gone unnoticed by traditional industries, as evidenced by major global alcohol producer Constellation Brands’ $190 million investment in Ontario-based Canopy Growth, and tobacco company Alliance One’s recent purchase of majority stakes in two Canadian marijuana companies.
These Canadian companies are using their access to relatively cheap capital to build massive greenhouse and indoor production sites across Canada. Canopy alone is currently licensed to grow over 1 million sq. ft. of greenhouse canopy space. And many of these companies are making noise internationally, with Tilray (a subsidiary of Privateer Holdings) building out more than 100,000 sq. ft. of greenhouse along with outdoor fields in Portugal, and Aurora Cannabis building out 1 million sq. ft. of greenhouse production in Denmark.
These companies have been rewarded with sky-high valuations, particularly those on the public markets. The three largest publicly traded Canadian companies—Canopy Growth, Aurora Cannabis, and Aphria Inc., which all trade on the Toronto Stock Exchange—currently have market caps of approximately $4.9 billion, $3.4 billion, and $1.8 billion, respectively. Privateer Holdings, the privately held parent company to Tilray, recently completed a $100 million capital raise at a valuation of more than $600 million, according to TechCrunch.
Valuations justified?
This all begs the question, are Canadian companies overvalued and overextended? These valuations make little sense when viewed against these companies’ revenues. In no other industry could a company like Canopy Growth have a $4.9 billion valuation—more than 98 times its reported lifetime revenue of $46.8 million. Aurora’s valuation is over 220 times its reported lifetime revenue. These valuations are not being driven by current or even near-term projected revenue, but by speculation that these Canadian companies will eventually dominate the global cannabis industry. These companies have generated tremendous investor excitement by positioning themselves to be the dominant players when Canada fully legalizes for adults this summer, and by building out large-scale production facilities that can export into newly emerging medical cannabis markets in Europe, markets that are inaccessible to American companies that are in violation of federal law.
Look under the hood, and these assumptions may be shakier than these companies would like investors to believe. Yes, Canada will be legalizing for adults later this year. But Canada’s entire population is only 36 million people, 3 million less than California alone. According to BDS Analytics, California is expected to be a $5 billion market in 2019, nearly $6 billion less than valuations of the top three Canadian companies.
On the international markets, it is uncertain whether Canada will truly be the dominant global player on the export market. Canada hardly has the climate and conditions for large-scale greenhouse agriculture. There is a reason that the largest greenhouse vegetable producers in the western hemisphere are located in California, Arizona, Mexico, and Latin America. These same conditions will allow cultivators in those areas to produce cannabis at a fraction of the cost of similar-sized greenhouses in Canada. Meanwhile, Latin American countries are starting to allow large-scale cannabis production, with Colombia in particular making moves to be a large-scale exporter in the western hemisphere.
Even in Europe, production in wealthy EU countries like Portugal and Denmark may have a hard time competing when areas with lower labor costs and better agricultural climates—such as Turkey, Albania, and North Africa—eventually embrace large-scale production.
There is no doubt that today Canadian cannabis companies enjoy a substantial competitive advantage, and they may well use that advantage to maintain their position as the dominant global players into the future. These companies may use their first-mover advantage to purchase companies in the United States and elsewhere and become large consolidators of the industry. But for those who are truly bullish on Canada, they should be aware that significant risks exist.
