With talk of a looming recession, many analysts predict that during a downturn there will be a short list of growth industries that can deliver a healthy return on investment. Cannabis is near the top of that list. In fact, spending on legal cannabis in the U.S. is expected to increase from the current $12.9 billion to $20.4 billion in 2022, according to New Frontier Data.
As investors aggressively pursue opportunities in the industry, the pace of consolidation continues to accelerate. We’re seeing an increase in buy-side due diligence inquiries that correlate with an increase in publicly reported acquisitions.
Among the investors pursuing deals are heavyweight players from big pharma, tobacco and liquor, as well as institutional investment companies like BlackRock. As legal issues get resolved and public support increases, the cannabis industry will become increasingly attractive to institutional investors. A recession in the U.S. could further push more investors into cannabis, chasing yield in the strongest growth market over the last few years.
Existing cannabis businesses, including large cannabis companies traded on the Canadian exchanges, further crowd the field of potential buyers. These businesses see acquisition as a fast way to build brand, expand market footprint, and raise their public market value. Regional players are also in the game, buying up smaller companies within their sphere of influence to increase their size and, ultimately, position themselves for their own lucrative exit down the road.
As M&A in the cannabis field heats up, here are five factors all buyers should keep in mind when looking for an acquisition target.
1. It’s not all about profitability
Many investors focus on revenue over profitability. Why? Because the successful companies of tomorrow are those that are grabbing market share and growing revenue today. That said, for more mature companies, profitability is a vital factor.
2. Technology is a competitive edge
The cannabis market is moving toward personalization, which requires more advanced technologies. For example, customers are wanting to place orders for cannabis with specified amounts of THC and CBD, as well as plants grown to their specifications. This means cultivators that can leverage agritech to produce designer cannabis will be increasingly popular moving forward. Advanced business systems are also important. Any acquisition target should have the fundamentals done right – such as proper software for sales, accounting, and logistics.
3. Valuations vary wildly from state to state
At this point, no two states are alike: a cannabis company in Oregon can have a different valuation from a similar company in Florida. That’s because Oregon has very low barriers to entry, and it’s relatively easy to get a business license for cannabis there. Florida, by contrast, grants a very limited number of operating licenses, which means that cannabis businesses there are significantly more valuable than those in Oregon. A license for a dispensary in Oregon today might sell for $50,000 to $100,000, whereas in Florida it could be as high as a few million dollars.
4. Professional management teams are essential
A cannabis company should have professional management in place – and many do. As an increasing number of executives from pharma and consumer packaged goods companies move into the cannabis industry, with them come honed, sophisticated business practices.
5. Operational efficiencies can lead to success
Like any successful business in other industries, a cannabusiness should have a set of standard operating procedures. This means, for example, that the company should be doing business with the right partners and suppliers to maintain continuity of supply and capacity to meet demand. It also means that the company has designed and implemented a series of processes to achieve its objectives and mitigate risk.
As many factors coalesce, the cannabis industry has sparked a goldrush mentality among many investors who want to stake a claim. But if you’re considering an acquisition in the field, you must first perform detailed due diligence and apply metrics specific to the industry. Properly understanding the acquisition target before the deal closes can ultimately ensure a profitable outcome.
Subject matter expertise
MAI, Principal, Valuation Advisory Services
Managing Principal – Real Estate, Cannabis Industries
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