An executive summary of Life Sciences Thematic Research.

Amidst speculation over the timing of re-scheduling, it is easy to lose sight of the long-term investment opportunity cannabis presents. In the US, US$30bn in state-legal sales would need to more than triple to reach the value of the current market inclusive of illicit sales, and in Canada, six years into legalization the market is still growing double-digits y/y. In “The Future of Cannabis” series, we invite investors to think about how the industry might look like years from today. As the industry grows, it could mature to resemble regulated-product sectors such as tobacco and alcohol. What would this mean for valuations and business models?

Part 1 of our series draws parallels between cannabis and tobacco, and Part 2 with alcohol. Part 3 explores other variables and scenarios of how the global cannabis industry could evolve and where US and Canadian companies might intersect.

Highlights:

Tobacco Lessons
The tobacco industry provides a framework of how the Cannabis industry might look like in the future. If Cannabis follows tobacco’s footsteps, we could see (1) consolidation into global oligopolies, (2) outsourcing of cultivation to focus on manufacturing, marketing, and distribution, and (3) margin and ROI expansion. As of 2020, five tobacco companies made up 82% of cigarette sales globally, up from 43% in 2001. Top tobacco companies increased their avg. EBITDA margin from ~17% 40 years ago to ~41% in 2023 (vs ~21% for MSOs today). 

Will Cannabis Look Like Tobacco? 
Cannabis and tobacco products are derived from a commoditized natural plant, attract repeat purchases conducive to brand loyalty and demand inelasticity, and face burdensome regulations and taxes. These characteristics make it hard for smaller players to compete. We think an oligopolistic “Tobacco scenario” could occur in cannabis, but this would be a multi-year long process since the conditions necessary for consolidation are still lacking. In Canada, we think wholesale distribution would need to be privatized for consolidation to accelerate; in the US, we see meaningful consolidation starting only if and once interstate commerce is permitted.  

A Valuation Exercise 
What sort of multiple would top cannabis companies command today, assuming they survive a shake-out period and cannabis economics eventually converge with tobacco (in terms of margins and market share concentration)? Were a tobacco-like consolidation to occur over the next 15 years, we find that leading MSOs/LPs—those handful of companies among the long-term winners—would find support for an EV/EBITDA multiple of over 40x (think about a ~US$10bn EV in the US and ~C$420mm EV in Canada, and note that this excludes international markets). Our analysis has two key takeaways: (1) Tier 1 MSOs/LPs may command an extremely large valuation premium over the rest of the sector as they could accrue most of the sector’s long-term value creation; and, abstracting short-term trading dynamics, (2) long-term investors should place outsized emphasis on market leadership, strong fundamentals, and management teams with long-term orientation.