The Canadian Cannabis Industry: Enter the Giants
Guest Post by Michael Black, Director Consulting & Deals at PwC Canada
The entrance of Constellation Brands in the cannabis industry has broken the insulation around cannabis companies—it is now incumbent upon the industry to embrace and prepare for the forthcoming wave of disruptive entrants that are better capitalized, more mature and better recognized than existing LPs.
The cannabis industry is on fire. The combined market cap for public companies is over C$8.5B, provincial governments are preparing for the legalization of adult-use and, given that most governments are pursuing some version of a government-led model, licensed producers (LPs) are identifying and securing supply agreement opportunities to lock in market share and stabilize revenues.
Amidst all this industry activity, a giant has officially entered the industry. In case you missed the press release, Constellation Brands and Canopy Growth Corporation have announced that they are forming a strategic relationship that will see Constellation provide broad support in the areas of consumer analytics, market trending, marketing and brand development, in addition to both parties collaborating to develop and market cannabis-based beverages for the adult-use market (where legal).
This announcement should not come as a surprise to anyone. With the explosive growth of the commercial cannabis industry, industry titans, whose products are close relatives to cannabis, have watched its development very closely. However, until this point, the stigma, reputational risk and uncertainty surrounding adult-use frameworks have largely kept them on the sidelines, waiting to see how the market would evolve. Additionally, most multi-national companies have significant US operations that could be put at risk if they were to enter an industry that is federally illegal in the US.
This calculus has obviously now changed. Whether Constellation has found a unique legal structure to protect their operations, or the wave of legalizations for either adult- or medical-use at the state level combined with the growing international acceptance of cannabis has cleared the path, it is now clear that corporate giants can pursue this burgeoning industry despite cannabis remaining federally illegal in the US.
Who (else) could enter the cannabis industry?
While many large players in adjacent markets are already eyeing the cannabis industry (e.g., fertilizer suppliers, digital security providers, etc.), the most disruptive entrants will be:
- Tobacco companies;
- Alcohol companies; and,
- Pharmaceutical companies.
Taken collectively, large tobacco, alcohol and pharmaceutical (TAP) companies represent every significant permutation of cannabis—both adult-use and medicinal—in the market.
The Tobacco Industry
This industry is the closest analog to the current cannabis industry given its involvement in growing, processing, shipping, marketing and distributing tobacco products. It is important to note that the tobacco industry similarities largely end at dried leaf and vaporized products, which is the most basic form of the cannabis business. Despite the decline of the tobacco industry in recent years due to the massive public awareness campaigns on the adverse health effects of smoking, industry players remain quite large with significant political, financial and brand capital.
The Alcohol Industry
As we’ve seen with the Constellation / Canopy partnership, alcohol companies aspire to become significant players in the cannabis industry. Currently on the market, there are two primary forms of cannabis beverages: (1) infused beverages where cannabis oils are infused with a mixed drink base; and, (2) brewed beverages using cannabis. Regardless of form factor, alcohol companies have the experience and know-how to market psychoactive products while navigating a strict regulatory landscape.
The Pharmaceutical Industry
To some, the pharmaceutical industry may seem an unlikely entrant to the cannabis industry; however, I would argue that these companies have the most disruptive potential. While alcohol and tobacco companies have enough capital to consume the entire adult-use industry and the know-how to rapidly professionalize and enhance it, pharmaceutical companies have the ability to transform and revolutionize the medical market into something unrecognizable from today.
The foundation of Canada’s current legal cannabis industry (i.e., under the ACMPR) is focused on medical patients. These patients have access to dried leaf products and a limited selection of oil products (e.g., drops, capsules) due to strict Health Canada regulations surrounding product formulation. Despite some preliminary experimentation by pharmaceutical companies with cannabinoids (e.g., GW Pharma with Sativex and Epidiolex), the future of the medical market lays in the development of innovative forms and delivery technologies for botanical products / extracts. This innovation will provide physicians with the dosing precision and quality assurance, in addition to the corresponding educational materials and dosing guidelines, they are accustomed to from other pharmaceutical products to increase responsible prescribing patterns. These innovations will likely serve to disrupt, if not replace, the existing product spectrum available to medical cannabis patients.
How could these players enter the market?
When a company is looking to do something new (e.g., enter a new market, introduce new capabilities, etc.), there are generally three ways it can accomplish this:
- Buy an asset;
- Build the infrastructure; or,
- Partner and create contractual agreements.
Buy an Asset
As the Canopy / Constellation announcement showed, buying into an existing asset is the quickest entrance into the cannabis industry. For those unfamiliar with the terms, Constellation acquired a 9.9% minority investment in Canopy Growth in exchange for CA$245M – this represents a massive investment into both the cannabis industry and a single LP. Despite the significance of the investment, it does not necessarily indicate that players should anticipate similar blockbuster deals in the future. Canopy Growth is the largest legal cannabis company in the world and has a track record of creating shareholder value through M&A activity and press releases. At a recent cannabis conference, one of the speakers (quite accurately) claimed that this industry trades on sentiment, and Canopy Growth has captured investor sentiment better than any other.
In the future, asset acquisitions will still likely include some minority stakes in the remaining big players (e.g., Aphria, Aurora, MedReleaf, etc.) – how could they not given that these companies represent the most mature and experienced options of the ~3 year old industry – however, there are a number of smaller players that represent similar opportunities at a significantly reduced price. In fact, the industry should expect some whole-company / majority acquisitions in the near term. After all, aside from the large LPs already mentioned in this article, Constellation could have bought either a majority stake or the entire company of every other company on the Canadian Marijuana Index for the same sum. Given that any large TAP player could effectively purchase every single public entity for the equivalent of 2-3 years’ profit, capital is readily available and not a barrier to whole-asset acquisitions.
It is also important to remember that an investment from large TAP companies would primarily serve to expedite their acquisition of an ACMPR license (i.e., to produce and / or sell cannabis). Because marketing is not currently allowed under the ACMPR and the brand development that has occurred to date – while impressive given the confines of Health Canada’s regulations – cannot compare to what these large players can bring to bear, the argument that these large corporates are buying a ‘market position’ or ‘preeminent brand’ is likely exaggerated.
Build the Infrastructure
While large corporate players can buy an existing asset that holds a Health Canada ACMPR license, it is equally feasible for these players to build their own operations. The capital cost is relatively small to them (ranging from $15-40M depending on the type of facility being built and whether it is a new build or a retrofit) and they presumably have experience with large capital projects. The downside to TAP companies is that the process is long and cumbersome for new applicants to the ACMPR. Even with Health Canada expediting applications to offset potential supply shortages upon adult-use legalization, it may still take 12-18 months to procure the required approvals, build the facility and cultivate two batches of cannabis before initiating sales.
So far, we have not seen any announcements that the big TAP players are pursuing this route, but given the financial difficulties some pre-ACMPR applicants are experiencing (i.e., burning significant cash while awaiting final Health Canada approval), it is feasible to expect that a large player could swoop in, save the development and ultimately accelerate the process of building a wholly-owned facility.
Partner with Contractual Agreements
The third path for TAP companies to enter the Canadian cannabis industry is through partnership with existing players. This avenue is attractive for companies that do not want the operational responsibilities associated with owning an LP. To date there has been a number of partnerships announced between cannabis companies and large players:
- Teva Pharmaceutical Industries—a generic drug manufacturer—announced in November 2016 its partnership with Syqe Medical to market and distribute Syqe’s medical cannabis metered-dose inhaler.
- Apotex—the largest Canadian generic drug manufacturer—has partnered with CannTrust to develop innovative medical cannabis products.
- PharmaChoice—a member-owned cooperative national pharmacy chain—announced in March 2017 its pharmacist education and distribution agreement with CanniMed.
As the market continues to evolve, these types of agreements will become more prevalent and will likely be combined with some ownership over cannabis cultivation and manufacturing operations. Additionally, there are many variants of these agreements that could be leveraged by companies – for example, a TAP company could acquire an LP’s assets and then contract the operations to a reputable vendor.
How long before they storm the gates?
These companies are here. There have been a number of partnerships announced globally and I’ve personally participated in conversations with a variety of players planning their market entry strategy. With the adult-use market opening up on July 1st, 2018, the entry of large TAP companies will only accelerate in the coming months.
It is important to remember that these entries are long-term plays for these large corporates; however, it is unlikely that they will enter the market and control it overnight. For example, Constellation executives are quoted as securing the deal as the precursor to identifying markets with growth potential to capitalize when cannabis is “legal at all government levels.” Given that Constellation has stated they wish to develop a cannabis-infused beverage, this investment will (likely) not start generating revenue until July 2019 when the government has proposed to make infused products legal in Canada.
Despite the long-term nature of TAP investment theses, and relatively slow initial entry to the space, if LPs do not prepare today for their entrance, they will be left behind.
How can existing companies prepare for this opportunity / inevitability?
LPs must first and foremost develop a distinct, competitive and defensible value proposition that is attractive to a large corporate. The way to do this is through a robust and coherent strategy (as I discussed in my last LinkedIn article) that articulates their market positioning and value proposition to customers / patients.
Second, LPs must professionalize their operations. While this is underway and happening very rapidly, it isn’t fast enough. During the due diligence process, TAP companies are going to quickly identify any financial, operational and / or legal deficiencies that could be a red flag and sink the deal.
Third, TAP companies are looking for an existing corporate and strategic network that can be built upon and enhanced through the transaction. Going back to the Canopy / Constellation transaction, it is clear what attracted Constellation to Canopy in the first place: they were the largest player in the market with (possibly) the only recognizable brand in the market and they have an initial platform of brands upon which to build. Future transactions are going to look at the capabilities and value drivers LPs bring to the acquirer—excluding the ACMPR license that is quickly becoming a commodity as Health Canada expedites processing—and these must be articulated as part of the mutual value proposition.
Finally, LPs are the current experts in the cannabis industry. Part of this means articulating a roadmap for the future development of the industry. As part of any value proposition to potential large acquirers, LPs must highlight activities and milestones that will not only win in the market but also elevate and evolve the market to reach its full potential. This could include: future M&A and / or divestitures to specialize and / or disintermediate the value chain; R&D activities to enhance the product value proposition and / or educate the market; or, more broadly, market entry and expansion strategies to build the global cannabis industry.
Final Thoughts
It comes down to this: Canadian cannabis companies are at the forefront of a burgeoning industry with the opportunity to build a both a robust domestic industry as well as shape the future of the global industry. Despite this opportunity, everyone must remember that this nascent industry and its associated companies are relative peanuts to the corporate giants who will enter. With the entrance of Constellation, cannabis companies now must acknowledge the new calculus in the industry and ensure they properly prepare to realize the current opportunity in front of them.
Disclaimer: The views and opinions included in this article are solely my own and do not necessarily represent the views and opinions of my employer.
About the author:
With over 6 years of strategy consulting experience, Michael Black works directly with C-suite executives, business owners, Boards of Directors and Management teams in business strategy development.
Michael has a proven ability to adapt and apply lessons learned to enhance organizational performance and has worked with clients in various industries, including: medical cannabis, pharmaceutical, technology, professional services / law firms, private equity, TMT as well as retail financial services.
Prior to his career at PwC, Michael worked for Monitor Deloitte (Deloitte’s Corporate Strategy Practice) in Toronto, focused on advising mid-market clients on innovative ways to achieve organizational growth.
Michael holds a Master of Business Administration and Bachelor of Science (Biochemistry, Molecular Biology and Music) from Dalhousie University.
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