Introduction
On October 17, 2018, the Cannabis Act came into force in Canada, establishing a comprehensive legislative scheme governing the licensing, production, distribution, and sale of cannabis and related products for recreational use. Canada’s nascent recreational cannabis industry has faced its share of growing pains, but there is reason for optimism moving forward. Statistics Canada estimates that the illicit market for cannabis was worth approximately CDN$5 - $6 billion (US$3.79 - $4.55 billion) in 2015, while a 2018 Deloitte report suggests that the total Canadian cannabis market could generate up to CDN$7.17 billion (US$5.44 billion) in sales in 2019. If the sales figures forecast by the Deloitte report are achieved, that would put the cannabis market on the same footing as both the Canadian wine industry and the Canadian spirits industry.
Excitement surrounding legalization has led to a flurry of capital markets activity in Canada, resulting in billion dollar market capitalizations for several Canadian cannabis companies traded on the Toronto Stock Exchange (“TSX”), as well as the one Canadian cannabis company that currently trades solely on the NASDAQ.
Investor optimism is not fueled exclusively by the market potential that exists within Canada’s borders; rather, international opportunities represent a significant growth target. A 2018 report published by CIBC suggests that the global cannabis market could reach approximately CDN$25 - $30 billion (US$18.96 - $22.75 billion) in 2020. The U.S. could play a significant role in the global cannabis economy, as a study conducted by the Brightfield Group estimates that Canada and the U.S. will account for more than 86% of global cannabis sales in 2021.
Although cannabis is currently legal for recreational use in ten U.S. states and for medical use in 33 states and the District of Columbia, cannabis remains a Schedule 1 narcotic under the U.S. federal Controlled Substances Act. This classification has prevented Canadian cannabis companies from entering the U.S. market. Although cannabis may be exported from Canada for medical or scientific purposes under the Cannabis Act, an export permit may be refused if such exportation would contravene the laws of the country of import, or if such exportation would not comply with the permit for importation issued by a competent authority of the country of import.
Notwithstanding these obstacles, enthusiasm regarding the U.S. market was on full display when Tilray Inc.’s shares jumped 28.95% on the same day it was reported that the Canadian cannabis producer had received approval from the U.S. Drug Enforcement Agency to export cannabis to California for a clinical trial.
What does this mean for U.S. cannabis companies?
U.S. stock exchanges are regulated by federal legislation and, as a result, you will not find any pure play U.S. cannabis companies listed on the major American stock exchanges. Similarly, the TSX and its affiliated TSX Venture have taken the position that companies with operations or investments in the U.S. cannabis industry will be in violation of the listing requirements of their exchanges and thus subject to de-listing.
However, Canada’s more junior exchange, the Canadian Securities Exchange (the “CSE”), has welcomed Canadian and U.S. cannabis companies alike, listing 116 companies that operate in the cannabis industry, as of the date of this writing. Rather than prohibiting issuers with ties to the U.S. cannabis industry, the CSE has taken a disclosure-based approach, requiring its issuers to disclose the extent of its activities in the U.S. and the risk that its activities present from a U.S. legal standpoint.
Investor response to CSE listed cannabis companies has been extremely positive, with investors showing a particular appetite for companies offering exposure to the U.S. cannabis market. While historically being considered a “third-tier” Canadian stock exchange, the CSE is gaining notoriety, attracting industry-leading U.S. cannabis companies that have been denied access to more traditional exchanges.
For example, in May 2018, MedMen Enterprises Inc., a leading cannabis retailer in the U.S., began trading on the CSE at an implied value in excess of US$1.6 billion and on November 16, 2018, filed to raise CDN$75 million (US$56.88 million) via bought deal. In October 2018, Curaleaf Holdings Inc., a vertically integrated cannabis cultivator and retailer, closed a private placement on the CSE which raised approximately US$400 million, implying a valuation close to US$4 billion. The most recent debut on the CSE was that of Acreage Holdings, a multi-state cannabis producer that boasts former House Speaker John Boehner and former Canadian Prime Minister Brian Mulroney as board members. Acreage Holdings began trading on the CSE on November 15, 2018, shortly after raising US$314 million in a private placement, implying an enterprise value of approximately US$2.1 billion.
How are U.S. cannabis companies becoming listed?
The most popular approach to listing on the CSE by far is the reverse takeover, or “RTO". RTOs involve the entity acquiring a publicly-listed shell or dormant company to pursue listing. RTOs are typically completed by way of a statutory amalgamation or arrangement and may require approval of each company’s shareholders, depending on the structure of the transaction and constating documents of the companies.
Compared to an IPO, RTOs are generally less time consuming and expensive and do not necessarily need to be accompanied by a concurrent equity financing—although MedMen, CuraLeaf and Acreage Holdings each completed private placements connected to their respective RTOs.
Another primary driver of expediency in RTOs is that they do not require regulatory review by securities regulators, and rather only require approval of the stock exchange. While a document with prospectus-level disclosure is still a requirement, eliminating the review of the securities regulators is one less obstacle to face in an RTO process.
Looking forward
There has been growing support to amend federal cannabis laws in the U.S. On June 7, 2018, Senators Cory Gardner and Elizabeth Warren introduced the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act in Congress, which would amend the Controlled Substances Act to make it impossible to prosecute individuals and corporations who are in compliance with U.S. state laws on cannabis. A companion bill was introduced on the same day in the House of Representatives by Representatitives Earl Blumenauer and David Joyce.
The STATES Act would not remove cannabis as a Schedule 1 narcotic, meaning that cannabis would remain federally illegal. However, the STATES Act provides that compliant transactions would not be considered trafficking and would therefore not result in the proceedings accompanying an unlawful transaction. With this distinction in mind, it remains unclear what impact the STATES Act, if passed, may have on the willingness of U.S. stock exchanges and federally regulated banks to participate in the U.S. cannabis industry.
While much uncertainty remains with respect to the long-term outlook of the U.S. cannabis market, there appears to be a significant appetite among investors to participate in this burgeoning industry. As of right now, the most attractive way for U.S. cannabis companies to capitalize on this enthusiasm and to access capital markets is to look north of the border, where the CSE awaits with open arms.