Mid-year Review

2019 has been a tale of two tapes for global cannabis, with first-quarter strength ceding its gains to a second-quarter retracement. The volatility in individual names was fierce, with the average cannabis stock losing 41% from its YTD high-water mark through the end of Q2. A five-year chart of global cannabis puts these recent swings in perspective.

*BI Global Cannabis Index 2015-present

*BI Global Cannabis Index 2015-present

Investor concerns ranged from New York’s and New Jersey’s inability to find legislative solutions to the uncertainty surrounding the FDA’s stance on CBD. With some recent M&A deals involving U.S. multi-state operators stalling during review by the Department of Justice, the notion of duration risk— the time until regulatory reform arrives, stateside revenues scale and clinical trials come due—loomed large as several high-profile Canadian LPs stumbled through clumsy quarters.

There were several positive strides, too; Illinois’s legislative legalization was a significant milestone that provides a road-map for other states. Cannabis-friendly legislation began to move through Congress, with multiple bills addressing research, banking and deportation; and growing support for legal adult-use in Mexico could soon bookend the U.S. borders with legal cannabis.

It’s been our view that global cannabis will be a 2020 story that begins to price into markets in the back-half of 2019. If that proves true, the recent pullback should represent a superb opportunity to accumulate our forward vehicles at attractive price points. Our analysis is based on several top-down assumptions.

1. International

The UN released its Office of Drugs and Crime: 2019 World Drug Report in June, which called for incarceration alternatives for cannabis-related offenses, an approach criticized by many as being “not comprehensive or transformative enough.” This report was issued one month after the World Health Organization (WHO) had released its recommendation that the UN reschedule cannabis from the more restrictive Schedule IV to the less restrictive Schedule I.

The WHO also had recommended that CBD not be placed under international drug control, as the substance was found to have no psychoactive properties and no potential for abuse or dependence. We expect global CBD usage to increase dramatically over the next 48 months and further expect CBD to be a major healthcare disruptor that catalyzes both social adoption and the eventual legalization / decriminalization of cannabis.

International markets have taken longer to develop than many anticipated; we view this as a positive development for our U.S. portfolio companies (it provides time for them to develop domestic operations and build the scale needed to better compete in new market expansion) and a net-negative for Canadian companies (as their competition builds competitive scale). We view the developing medical programs of Australia, Germany, South America and the U.K. as proxies for international medical market growth.

2. Federal

In a late-June note to clients, Cowen Research opined that “this Congress is likely to enact cannabis legislation though we believe it is more likely to be narrow bills like the SAFE [Banking] Act on cannabis banking than broader bills to legalize cannabis at the federal level.” We agree, as Treasury Secretary Mnuchin, Attorney General Barr, and Federal Reserve Chairman Powell each have previously stated, the inability of compliant U.S. operators to access banking has created significant public safety issues that must be addressed.

While the current political climate doesn’t appear to support a comprehensive legislative solution for cannabis, we expect this topic to gain steam into next year’s Democratic primaries and the 2020 general election. We remain of the view that cannabis could emerge as the Trump Card for the administration; with every democratic challenger running on this issue, it wouldn’t surprise us if POTUS moved to own one of the most bipartisan issues in generations before the ballots are cast. If he frames this issue as a States’ rights issue that should not suffer from Federal interference, he could simultaneously appeal to his voter base at the same time that he delivers a blow to his opponent’s pro-cannabis platform.

3. State-level adoption

Eleven states and the District of Columbia now have legal adult-use, while 33 states allow for legal medical-use. All told, eight of the ten most populous states have significant cannabis programs, including California, Illinois, Michigan, New Jersey, Florida, New York, Pennsylvania and Ohio. Early analysis by election strategists view Michigan, Florida, Pennsylvania and Ohio as key swing states for the 2020 election, and using cannabis as a tool to win over these States could bode well for the President’s re-election chances.

Developments of note include:

Alabama — Gov. Kay Ivey (R) has indicated that she would consider signing a medical cannabis bill if it's tightly controlled and limited.

Alaska — Lt. Gov. Kevin Meyer (R) signed new regulations into law on March 12 that will allow Alaska residents to consume cannabis at licensed dispensaries later this year.

Arizona — Activists and cannabis businesses in the state are seeking to launch a campaign to get marijuana legalization on the ballot in 2020.

Arkansas — A House bill (HB 1972) was introduced on April 1 that would decriminalize small amounts of marijuana.

California — On June 14, California's Senate Health Committee approved a bill regulating CBD in food products; we believe this will emerge as the trend in state-sponsored CBD regulations for food and drink.

Connecticut — Gov. Ned Lamont (D) has signaled support for marijuana legalization and would likely sign such a bill if it reaches his desk, per Cowen Research.

Georgia — On April 17, the governor signed a bill into law that allows in-state production and sale of low-potency medical marijuana oil.

Maine — On June 28, Gov. Janet Mills (D) signed a bill creating a framework for legal marijuana sales.

Maryland — Gov. Larry Hogan (R) signed a bill into law legalizing edible medical marijuana products on May 13.

New Jersey — On July 2, Gov. Phil Murphy (D) signed legislation expanding the state's medical cannabis program.

New Mexico — Legalization will be added to the legislative agenda in 2020.

New York — On June 21, state lawmakers sent Gov. Andrew Cuomo (D) a bill to expand marijuana decriminalization, while the Senate approved hemp legislation.

Texas — On June 10, Gov. Greg Abbott (R) signed a bill allowing the production and regulation of industrial hemp and legalizing CBD. On May 24, the Texas House advanced a bill (HB 3703) to the governor's desk expanding the state’s medical marijuana program for additional medical conditions

Source: Cowen & Company.

Source: Cowen & Company.

4. Clinical Demonstration

We expect that clinical trials will emerge as a major catalyst in pushing adoption rates higher, and we’ve been eagerly awaiting the results for our bio-pharmaceutical companies.

Corbus Pharmaceuticals continues their advancement of developing and commercializing medicines that improve the health of people affected by inflammatory, fibrotic, and metabolic diseases. Their main candidate, Lenabasum, is currently undertaking 3 rare disease programs, with data expected in 2020; Phase 3 data is expected for Systemic Sclerosis and Dermatomyositis, as is Phase 2 data for Cystic Fibrosis and Systemic Lupus Erythematosus.

The GWPH Epidiolex roll-out continues apace. GWPH reports that 7,600+ patients have received Epidiolex prescriptions, and 90% of all US lives are covered by insurance; they expect launches in France, Germany, the UK, Italy and Spain next year. GWPH also is in Phase 3 trials for Tuberous Sclerosis Complex and MS spasticity; and is in Phase 2 trials for Rett syndrome, neuropathic pain, Epilepsy (CBDV), Autism spectrum disorders, Glioblastoma multiforme and Schizophrenia.

Two of our Australian canna-biotech companies are helping to lead the scientific development of cannabinoids. Botanix Pharmaceuticals recently completed the world’s first randomized clinical study to establish the mechanism of action of CBD in skin disease, and a new study showed that BTX 1801 is effective against a range of problematic human and animal bacteria. Zelda Therapeutics, for its part, expects Phase 2 results for insomnia and Phase 1 results for opioid reduction in the fourth quarter.

What if?

The question is of course begged: what if we’re too aggressive with our timeline? What if the retail traders that currently dominate the landscape create another emotional extreme, such as what we saw in December? What if the institutional adoption, clinical validation and regulatory arbitrages are further out on the horizon than we anticipate?

While each of our investment verticals have unique parameters, we skew heavily toward U.S.-based companies that our models suggest are too cheap; by our pen, we’re buying growth companies at value multiples. In November, we saw a similar disconnect across valuation metrics and we shared our work to help demonstrate our thought process.

Data is as of 28 June 2019.

Data is as of 28 June 2019.

While the complex is volatile, our view remains that:

• We’re in the early stages of a secular bull market for global cannabis,

• This will phase from cultivation to consumer-packaged goods to efficacy-driven solutions and sustainable industrial use-cases, and

• A myriad of financial products, ETFs and dedicated funds reside on the other side of banking reform.

Between here and there, we will continue to lay in wait for an efficient market and attempt to use price to our advantage. As always, please don’t hesitate to contact us with any thoughts or questions.

Todd Harrison
Chief Investment Officer
CB1 Capital Management



midyear review.jpg
todd harrison