March 20, 2020

Coronavirus Update: Cannabis Industry

INDUSTRY OVERVIEW

The supply chain has seen disruptions due to its heavy concentration in China. Manufacturing of key components to the industry, including vape equipment, LED lighting, packaging and laboratory equipment, have been concentrated in China historically.
Stock market volatility is impacting the industry’s access to capital. The industry requires access to debt and equity capital in order to survive.
The closure of state courts means delays in setting legal precedent and legislative decisions impacting the legality of cannabis at local levels.
Prior to the virus pandemic, hemp was in oversupply. As much of that production originated in China, the surplus is no longer growing at the same rate.

MARCUM VIEW

The coronavirus pandemic is having the effect of shutting down many parts of the U.S. economy. The fledgling cannabis industry is more vulnerable than most due to a number of factors.

Challenges:

Demand

Cannabis is commonly used in social settings. Furthermore, users commonly share paraphernalia, which could have the impact of spreading the coronavirus. In addition, social distancing/isolation could have a negative impact on the demand for cannabis.

Supply Chain

As noted above, China is an integral part of the cannabis industry supply chain. The entire supply chain from China has either been shut down or significantly disrupted.

Access to Capital

Many cannabis companies are not yet cash flow positive. They need access to both debt and equity capital to survive. Since early last year, many cannabis company valuations have been hampered by illiquidity in the capital market for cannabis. There was already a lack of equity capital in the industry due to the decline in valuations. Debt funds and other structured types of debt/equity were starting to fill the void. The recent dramatic stock market declines may have the impact of drying up the availability of any types of capital.

Legalization

Pre-coronavirus, there had been a continued push at the federal and state levels for legalization. However, many state courts are closed for now, and the federal government has more pressing current priorities than cannabis issues.

On a Positive Note:

Oversupply

There has been an oversupply of hemp largely attributable to China, which is a predominant exporter. The current hold on exports may help U.S. producers reduce their inventories and stabilize prices.

Reliance on Chinese Manufacturing

The cannabis industry, like others in the U.S., is waking up to the risks of having too much of its manufacturing and pieces of its supply chain with one country. This could encourage companies to find U.S. suppliers and help grow the domestic manufacturing base.

Consolidation

The cannabis industry was already in a state of consolidation, with significant M&A activity occurring throughout the country. Many companies in the industry fall into one of three categories—acquirers, targets, and those preparing to raise their own capital. A common theme among all three types is the need to put the financial house in order so as to complete a successful transaction. This includes financial reporting systems, internal controls, tax returns prepared and filed, and audited financial statements. The current environment only exacerbates those needs, as we may see a rise in distressed M&A transactions.

The Cannabis industry team at Marcum LLP is well versed in supporting companies through these difficult times.