The cannabis landscape

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The Canadian cannabis market now sits on the verge of a seismic shift as Canada is on track to federally legalize adult-use cannabis this summer. This has already enticed investors to pour billions of dollars into cannabis companies, attracting adjacent industries, from tobacco to alcohol to pharma. This activity is the harbinger of developments to come with the next two waves of adult-use legalization near: dried leaf and oils later in 2018 and an expanded product range in 2019.

 

Deal mania

More than 100 licensed producers (LPs) already exist in Canada with hundreds more awaiting government approval. Most continue to function as startups despite being in operation for several years. Notwithstanding a lack of strategic focus, the LPs have been handsomely rewarded in capital markets.

 

Regulatory rule books

The medicinal and adult-use market segments will operate separately with oversight from Health Canada. Most provinces and territories will set up exclusive distribution channels for adult-use cannabis through their liquor control boards. Health Canada has announced new federal commercial licences to replace the Access to Cannabis for Medical Purposes Regulations (ACMPR) with a new set of production, processing and sales licences that will allow greater flexibility for all types of cannabis companies.

As a result, provinces/territories have created a unique marketplace with its own regulatory requirements. The new federal commercial licences will likely devalue the core ACMPR licence and allow for greater intermediation along the value chain.

Visit here to view more information on the PwC cannabis series.

Strategic moves

While governments develop the legal and governance frameworks, LPs have been pushing ahead with several strategic initiatives.

Numerous LPs are positioning for the medical market, establishing supply agreements with pharmacies and product development arrangements with pharmaceuticals. This strategy sees LPs working with patients and physicians on education initiatives and with health-care institutions and universities to fund research.

It’s anticipated there will be a supply shortage when the new cannabis marketplace opens. Most LPs are aggressively expanding their production capacity to meet demand requirements – encouraged by investors. The shortfall will likely last only six to 12 months, partly because Health Canada is quickly licensing a number of new producers. Over the long term, cannabis supply will almost certainly exceed demand.

Initially, LPs will be challenged to differentiate their products, as Health Canada currently restricts branding activities and is hesitant to allow new product forms/formulations. For now, most producers are aiming to stand out by offering a variety of cannabis strains. Some are also trying to develop brands that register as “premium” products.

LPs are also pursuing supply agreements with provincial liquor boards. To succeed, they will need the right resources and tools to develop, submit and update the data these provincial bodies require.

The liberalization of foreign medical cannabis laws may help producers avoid a potential market glut in Canada and pursue more attractive economic opportunities overseas. The risk here is that too many Canadian LPs are trying to become global corporations before establishing sustainable domestic businesses, opening the door to complications down the road.

 

The future

The cannabis market will evolve quickly, propelled by seven connected drivers of change:

1. The new licensing regime proposed by Health Canada and the provinces will remove the need for ACMPR licences and allow greater flexibility in the business models of cannabis companies.

2. Expanding regulations around cannabis product forms/formulations will enable companies to create a wider variety of products.

3. The market’s growing sophistication will see profit margins move away from growers to value-add operations that include the extractors, and the processors who use the cannabis buds and oils to create foods, drinks, creams and other innovative products.

4. As the market becomes more established, institutional investors will step in and expectations will change. Companies will be under greater pressure to deliver profits. Those that prove unable to adapt could be pushed towards mergers or acquisitions.

5. Well-financed participants from adjacent industries will boost competition in the marketplace and raise the standard of products and services. With so many emerging players, LPs will be forced to move away from a vertically integrated business model.

6. The gradual internationalization of both the medicinal and adult-use cannabis segments will offer successful Canadian LPs lucrative expansion opportunities. The export market will bring new challenges, and companies will find partnerships and/or joint ventures essential for success.

7. In the medicinal market segment, there will be an increase in research and development to understand the effects of cannabinoids, leading to greater physician awareness and support for cannabis therapies. As such, insurance companies will begin to offer improved medicinal cannabis coverage and businesses will design new cannabis formulations targeting specific therapeutic areas and conditions.

 

On the horizon

Oversupply of raw cannabis and increasing competition

Canada’s cannabis market is going to find itself transformed before being fully developed. An oversupply of raw cannabis, together with the arrival of well-established businesses from neighbouring industries, will force the sector to accelerate its consolidation.

 

More stringent investor expectations

As cannabis players look to separate themselves from the pack via acquisitions, investors have been largely supportive of the perceived “winners,” providing the requisite equity for high-priced deals. The challenge will be to meet investor expectations and deliver on deal value. Investors will hold management accountable to ensure that the integration is completed quickly and is ultimately accretive to the company.

 

Emergence of new players

Health Canada’s proposed licensing regime will allow for variations on the current LP business model. Companies will be able to focus on the discrete areas of the value chain to compete and ultimately win. This will drive these players’ allocation of resources towards creating a compelling competitive advantage against the current LPs.

This process demands that businesses take the time to understand what sets them apart from competitors and how to best leverage that difference. It may also result in redeploying capital to build or enhance capabilities and systems to support sustainable growth.

 

Beyond the horizon

These market issues will, in our opinion, lead to the following outcomes:

1. Industry consolidation

2. Business model redesign

3. Capability and system enhancement

4. Bankruptcies and restructurings

The net result will be a drastically different market landscape than today. We predict tomorrow’s industry will have fewer larger players but an abundance of niche companies offering specialized products and services.

 

Taking the right steps

There are actions businesses in the cannabis sector may consider to respond to market forces and prepare for the outcomes described. For example:

• Formalize a focused strategy

• Identify the requisite capabilities and systems to deliver on the strategy

• Understand the core value proposition and how to leverage it

• Invest in deal integration for any acquisitions to capture all synergies and deliver on deal value

• Acknowledge the need for appropriate financial controls and have them in place for compliance with all regulatory requirements

• Have the right tax and accounting structures in place for all jurisdictions in any international expansion

• If restructuring becomes the only solution, find the right partners to maximize shareholder value and put the company in a position to succeed

 

A window of opportunity

While Canada’s federal and provincial governments have been developing the framework for an adult-use cannabis market, businesses and investors have already built much of the contents. Once all the legal, regulatory and oversight elements are finalized and the doors are opened to adult-use consumers, the market will evolve quickly.

 

The full article is available at pwc.com/ca/cannabis

This publication is made available by PricewaterhouseCoopers LLP (PwC) for educational purposes only as well as to give you general information and a general understanding of the cannabis landscape, not to provide specific financial, investment or other advice. By using this publication you understand and agree that there is no client relationship between you and PwC, or any of its member firms. The publication should not be used as a substitute for competent financial, investment or other advice from a professional services firm.

If you are interested in learning more about opportunities in the cannabis sector, and hearing a panel presentation that Business in Vancouver is hosting on July 12, check out BIV's Business Excellence Series: Legalizing Cannabis at the Vancouver Club.