This year hasn’t been kind to many industries. For cannabis, it’s been a bit chaotic, but the industry was already bracing for change heading into 2020.
Throughout 2018 and 2019, there was a rush by cannabis companies to grab market share across the country, a feat that was often complicated by the fitful pace of state legalizations. To expand as much as possible, many cannabis transactions were done for licensing rights, in addition to buying up the assets themselves. The past several years have been something of a race for regional consolidation, in anticipation of potential national consolidation if cannabis were to become federally legal.
The tide started to turn late last year, as M&A deal flow began to hinge on profitability and liquidity instead of market share. A handful of big deals would be canceled, including MedMen’s $862 million acquisition of PharmaCann. The shift in focus turned out to be a sign of things to come.
Perhaps more than many industries, the cannabis sector will likely see a tectonic shakeout. Many expect the current downturn will be the death knell for hundreds of small cannabis businesses. Larger, sturdier companies now have the opportunity to acquire upstarts for cheap, often below $10 million. And there will be lots of smaller cannabis companies struggling to survive.
While it certainly helped that eight states deemed cannabis stores to be “essential,” and another 20 states did the same for medicinal cannabis, the bigger problem has been liquidity. Cannabis companies that “touch the plant” are ineligible for federal stimulus money, thanks to the still-illegal status of their product in federal eyes—a status that also prohibits them from taking bank loans. As a result, many companies have been forced into bankruptcy or have had to lay off the bulk of their employees.
The only options left have been white-knight acquirers or risk-hungry investors. Like many industries, though, economic uncertainty was top of mind, which brought Q2 deal activity to multi-year lows. The PitchBook Platform shows only 30 cannabis deals done last quarter across the U.S. and Canada, compared with more than 100 in Q1 2019.
Whether that slow pace is sustainable is another question. Prior to the coronavirus outbreak, the cannabis industry topped the list of sectors in need of consolidation. Hundreds of smaller companies—from growers to manufacturers to distributors—can be found across the continent, but ultimately only a dozen or so major companies will be able to compete. On top of the need to consolidate, the cannabis industry is still a growth industry, and keeping up with growth expectations is a major hurdle in the middle of a pandemic. The industry should count its lucky stars it was deemed essential by so many regulators.
Now the real challenge begins—to become profitable, not only to survive but also to reap the potential benefits of federal legalization. At the moment, cannabis companies don’t have many places to turn for help. Better days are ahead if they can figure things out this year.