The growing global $344 billion legal cannabis market is maturing, attracting sophisticated capital and proving attractive for family office investors seeking returns, says Chrystal Capital Partners.
Kingsley Wilson (pictured above), investment partner and co-founder of the London-based entrepreneurial corporate finance and investment house, discusses the opportunities and shatters the myths in the alternative asset class with Geordie Hadden-Paton (pictured below), investment associate at CCP.
What’s driving the growth of the legal cannabis sector?
The global cannabis market is estimated to be worth $344 billion a year and split across the four core sub-sectors of adult-use, wellness (CBD products), medical and pharmaceutical. However, since global cannabis prohibition was agreed by the United Nations almost 60 years ago, virtually all current spend flows to the illicit market.
With prohibition coming to an end, country by country, and global legalisation unfolding, a new regulated industry is rapidly emerging. Family offices can now invest for the first time into medical cannabis companies operating under a legal framework and investors will capture the profits resulting from the conversion of this huge existing illicit market to legal and regulated ones.
The accelerating growth of the legal market is being driven by numerous structural tail winds, including:
Why are asset valuations currently so attractive given the growth potential?
Over the course of 2014-18, excitement surrounding the growth potential of the legal cannabis market resulted in a situation similar to the year 2000 dot-com boom. Euphoria drove significant ‘hot-money’ into the public and private markets and ultimately allowed many subpar management teams and business models to secure funding.
However, during the last 24 months, as individual company performances have underwhelmed and unrealistic forecasts have been missed, valuations have dropped significantly despite the sector continuing to experience strong growth. This has created a polarised market and a unique opportunity to invest in some of the best managed, fastest growing companies in the sector at highly attractive valuations. Similar to the progression post the dot-com bubble, and against the backdrop of Covid-19, where many sectors will struggle to generate any top line growth, many of the future winners in the global cannabis sector can now be backed at historically low valuations ahead of strong secular growth.
Why is the timing good now for family offices to invest?
Investors are often too early or too late to participate in the major value creation phase of a new sector. We have seen early investors in cannabis reap the benefits and then suffer the consequences of an overheated nascent market. However, the sector is now maturing and attracting sophisticated capital. This is the phase where we believe the most shareholder value will be created. Investors have the opportunity to invest into a fast growing, fragmented and undervalued market which is set to consolidate resulting in a significant appreciation of asset prices.
The growth potential has already been recognised by other large consumer sectors, such as pharmaceuticals, tobacco, alcohol and fast-moving consumer goods (FMCG), which have started to participate and position themselves in the sector. Examples include Constellation Brands’ (alcohol) $4 billion investment into Canopy Growth Corporation and Altria’s (tobacco) $1.8 billion investment into the Cronos Group. Endorsement by these blue-chip companies is a signal of the growth potential that lies ahead and a clear indication that family offices would be well advised to pay attention.
What is the possible upside potential for investors?
If we look at other large global consumer sectors such as tobacco, alcohol and pharmaceuticals, the companies operating in those sectors typically trade at 4-6x the annual global sales of that sector. In 2019, the global legal sales of cannabis totalled about $15 billion and the current combined market caps of listed cannabis companies is about $50 billion or 3.3x annual sales. If we look forward to the end of the decade, and a fully legal global market worth $344 billion per year, the market caps of the cannabis operators should equate to about $1 trillion. As such, we see more than $950 billion of shareholder value being created over the next decade making cannabis a must-own alternative asset class for family offices.
What’s the legality of investing in the cannabis sector?
The cannabis sector, by nature of the product itself, is one of the most highly regulated sectors in the world, akin to investing in the banking sector. Chrystal Capital has spent nine months working with the Guernsey Financial Securities Commission to allow Verdite to become the first ever regulated cannabis fund in one of the world’s most highly regulated jurisdictions. Every investment that Verdite makes must be compliant with both UK law and the laws of the countries in which the investee company operates. As such, Verdite represents one of the safest and most well-regulated investment vehicles through which family offices can participate in the growth of the sector.
Does Verdite have a differentiated investment strategy?
Over the past four years Chrystal Capital, the investment advisor to Verdite, has helped its family office clients deploy more than $210 million into a number of direct cannabis investment opportunities which have generated strong returns. However, direct deal-by-deal investing for family offices presents both a higher degree of risk as well as a significant drain on resources. Few family offices are structured, or have the resources, to conduct the same level of due diligence or have in-house sector and regulatory expertise as a professional fund.
In recognition of this fact, a family office has agreed to cornerstone Verdite Capital for $75 million and they have worked with us to create a fully regulated healthcare cannabis fund that will deploy a diversified investment approach to the sector. It is their opinion that this is the most effective way for family offices to participate in this growth sector at this juncture.
Verdite has a healthcare focus and will not invest in the adult-use segment of the market. The five-person investment team will screen the thousands of medical cannabis opportunities in the market and identify the best 10-15 investments across the healthcare cannabis value chain. The sub-sectors we see significant value being created in include genetics, extraction, synthetics, delivery devices, logistics, licensed pharmaceuticals and ancillary software and service providers.
Investments will be made across early, growth and late stage companies. Geographically, half the capital will be deployed in North America given it is currently the largest market, but Europe, with twice the population at 760 million, will receive 35% of the capital. We intend to lead most of the transactions as a growth capital provider, and a third of the fund will be held back to do follow on investments to compound the returns of the strongest growing companies.
What is different about the Verdite management team and advisory board?
The five-person Verdite team, led by myself, combines both significant cannabis knowledge and a demonstratable cannabis investment track record, with private equity and venture capital experience. The ability to thoroughly due diligence deals, structure investment terms with downside protection, advise at board level, create value in investee companies and ultimately position them for exit will be a critical component of driving return outperformance. Our team is also extremely well networked on a global basis with all the key stakeholders in the market for access to unrivalled deal flow and market knowledge.
Furthermore, Verdite has built an advisory board and panel of 11 of the cannabis industry’s most experienced individuals, such as Bruce Linton, founder and former chief executive and chairman of Canopy Growth, the largest listed cannabis company in the world, and Colin Stott, who spent two decades at GW Pharmaceuticals, the largest global cannabis pharmaceutical company. In addition, the five-person investment committee is steeped in private equity experience including Tim Farazmand, the former chief executive of the UK’s largest private equity business and former chairman of the British Venture Capital Association.
Why should family offices now consider investing into the sector via Verdite?
Cannabis is the next major global consumer market to establish itself. The conversion from illegal to legal sales offers a once in a lifetime opportunity for investors to participate at the ground level in high-growth undervalued businesses. Investing via Verdite brings the benefits of a seasoned cannabis and private equity team that has already deployed more than $210 million on behalf of investors into the sector and generated strong returns.
The Verdite strategy has been constructed to allow family offices to participate via a regulated vehicle, in a risk adjusted diversified strategy approach with a particular focus on downside protection, adding value to portfolio companies and positioning for exits to return capital to Limited Partners. Investors will also have access to co-investment rights to deploy further capital into the top performing portfolio companies to compound returns in the sector. With one family office having cornerstoned the fund for $75 million, we are currently marketing to other family offices to secure the remaining $25 million to reach a first close of $100 million in Q1 2021.
For further information, contact Kingsley Wilson, investment partner, at Chrystal Capital Partners.