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Toronto Stock Exchange Issues Warning to Cannabis-Related Companies

October 31, 2017

In yet another sign that legalized cannabis is going mainstream, the Canadian cannabis industry has now lived through its own “Black Tuesday” moment. On October 16, the Toronto Stock Exchange announced that any cannabis-related companies that are violating US federal cannabis laws—by, for example, selling or growing cannabis in the United States—might be “delisted” from the exchange. Or in the words of an exchange spokesman, “If you’re violating federal law, you’re out.”

On October 16, the Toronto Stock Exchange announced that any cannabis-related companies violating US federal cannabis laws might be “delisted” from the exchange.

The response was swift and predictable. By Tuesday, shares in Aphria, an Ontario-based cannabis producer with operations in Florida and Arizona, had plunged by 13%. Calgary-based Maple Leaf Green World, which is pursuing a medical cultivation operation in Nevada, saw prices fall by 10%. Even Canopy Growth, Canada’s largest licensed cannabis producer, which has no US operations, suffered an 8% decline in its share price.

To be clear, this was not a market meltdown. The selloff was fairly narrowly contained—only around two dozen of the Toronto Stock Exchange’s 1,498 listed companies, or “issuers,” are directly involved in the cannabis business, and only four of those have significant U.S. operations (which, by the way, is perfectly legal under Canadian securities law).

That’s a small fraction of Canada’s 69 publicly traded cannabis-related companies, most of which are listed on the Toronto Stock Exchange’s main rival, the Canadian Securities Exchange (which is not threatening any delisting action). Further, industry insiders note that the exchange’s parent company, TMX Group, hasn’t reached any firm decision on delisting, but is still in the process of reviewing companies’ operations.

An Impediment to Investment?

Still, the timing of TMX’s announcement wasn’t ideal. With Canada’s recreational market set to open in just eight months, cannabis companies are scrambling to ramp up production to meet consumer demand that, by most accounts, will significantly exceed supply. To fund that growth, cannabis firms are hungry for investment. Aphria, for example, had just raised $80 million by selling 11 million new company shares only days before the TMX announcement.

The move by the Toronto Stock Exchange underscores the financial uncertainties that still plague Canadian cannabis despite by federal legalization.

More broadly, the move by the Toronto Stock Exchange to review its members’ cannabis risk underscores the financial uncertainties that still plague Canadian cannabis despite by federal legalization. Like any emerging new sector, Canadian cannabis is hungry for capital to fund its rapid expansion: the emergence of mega-scale farms and proliferation of new consumer products simply wouldn’t have happened without billions of dollars of investment.

And, clearly, one of the main reasons so much capital has flowed to Canadian companies is that sector enjoys a relatively low level of political risk. Because legalization has been a federal process—with medical cannabis legalized in 2001 and adult-use starting this spring—investors in Canada have much less concern that, say, a grow operation approved by a provincial government will run afoul of federal authorities. That confidence has allowed Canadian cannabis firms to draw on a much wider array of capital sources.

And, critically, it has also given Canadian companies important advantages over their counterparts in the United States, where federal prohibition continues to scare away most banks and traditional investors from the cannabis business. Instead, American cannabis firms are forced to rely heavily on private “niche” investors, who typically demand a much higher rate of interest in return for the higher risk of a federal crackdown.

Canadian firms, by contrast, can not only get private investment at lower rates. They can also raise capital by going public—issuing shares and listing them on Canada’s three stock exchanges: the Toronto Stock Exchange (TSX) and the TSX Venture Exchange, both of which are run by the TMX Group, and their rival, the Canadian Securities Exchange. Currently, the 69 publicly traded cannabis firms on Canada’s exchanges have a combined market value of $8 billion CDN.

The advantages of public finance go beyond access to cheaper capital—publicly traded firms also get a big boost in business credibility.

The advantages of public finance go beyond access to cheaper capital: because “going public” is such a heavily regulated process, with lots of government oversight, publicly traded firms also get a big boost in business credibility. That credibility in turn makes it easier for public companies to attract potential partners to, for example, add new product lines or expand into new markets.

“Everyone in the cannabis business globally knows who [the publically traded companies] are,” says attorney Hugo Alves, an industry veteran who now runs the investment firm Wheaton Cannabis. “And so everybody wants to do business with them.” Case in point: US beverage maker Constellation Brands, maker of beverages such as Corona Beer, has just announced a whopping $245 million investment in Canada’s Canopy Growth.

The Pressure of Going Public

If there is a downside to “going public,” it’s that these companies are now under substantial pressure to keep their investors happy, and their share prices high,by rapidly increasing their revenues and profits. That pressure in turn pushes firms to constantly seek out new ways to boost profits—by adopting the latest cost-saving growing technology, for example, or by expanding into a new product line or consumer market.

Are High-End Vapes Worth the Expensive Price Tag?

This dynamic has huge benefits for the cannabis industry as a whole, in that it accelerates innovation and growth. But the companies themselves are under constant pressure to find “the ‘next thing,’” says Wheaton’s Alves. “The next iteration of cannabis technology or know-how or products or brands–‘What is out there that I can add value for my shareholders?’”

The accelerating hunt for shareholder value has helped motivate Canadian cannabis firms to expand their presence internationally.

And that search is at the heart of the current tension at the Toronto Stock Exchange. This accelerating hunt for shareholder value has helped motivate Canadian cannabis firms to expand their presence internationally. For example, some companies are working with partners in Germany, which also has a growing medical market.

But the most tempting foreign market, of course, is south of the border, in the United States. The burgeoning US medical and adult-use markets offer Canadian companies, with their access to cheaper financing, the chance to generate higher revenues and profits than are possible at home.

Further, by partnering with a company in Colorado, Washington, or some other cannabis-friendly state, Canadian firms can gain valuable market experience in consumer products, such as edibles, that generate high profits, but aren’t yet legal at home. By the time those products are legal in Canada—perhaps as early as July 2019—these early-movers “will already be well down the path to having an entire product line,” says one Canadian industry consultant.

But, adds the consultant, given the ever-present of risk that the US federal government will crack down on state-legal cannabis companies and seize their assets—a risk that has jumped measurably with President Donald Trump’s appointment of the old-school drug warrior Jeff Sessions as Attorney General—the strategy of investing south of the border is “a bit of a house of cards.”

Case in point: Because the Canadian cannabis sector is now such a respectable place for investors, it is attracting a lot of foreign capital, including from the United States. Big American investors that were reluctant to put money directly into state-legal cannabis ventures have been piling into Canadian companies. Because some of those Canadian companies are partnering with US operators, US investors may feel they’ve found a way to invest in the US market indirectly, without the risks of doing it directly.

But that, too, is a strategy that could fail if the Trump administration decides to crack down on state-sanctioned cannabis operations, warns Bruce Linton, CEO of Canopy Growth, which has avoided US investments.

“If you’re sending your money up to Canada and then we take your money and send it back to a place where you couldn’t have made the investment yourself, we’re kind of doing indirectly for you what you couldn’t have directly done yourself,” says Linton. “And that really isn’t going to be a good idea going forward, because I’m pretty sure the current government of America is not looking to make it easier to produce and distribute cannabis than it was under the prior administration.”

Risks & Rewards

What all this means for Canada’s publicly traded cannabis firms—and Canadian cannabis more generally—is still unclear. Canadian security regulations don’t bar Canadian firms from investing in the United States. In fact, in a statement issued the same day as the Toronto Stock Exchange’s announcement, the Canadian Securities Administrators said cannabis-related companies were merely required to fully disclose to investors any potential risk they faced in the United States due to the Trump administration’s more hostile attitude toward state-legal cannabis.

It’s still up the individual stock exchanges to determine how much risk they’re willing to tolerate.

That means it’s still up the individual stock exchanges to determine how much risk they’re willing to tolerate. The TMX Group has given little indication as to how it will determine whether to delist any of its members. Some observers think an outright delisting is unlikely, given how lucrative cannabis has been for the exchange: because cannabis companies’ shares are frequently traded, they generate large commissions for the exchange.

“At the end of the day, the exchange is a business,” says Wheaton Cannabis’s Alves. “And they don’t want to lose a significant active issuer.” In fact, rival Canadian Securities Exchange has offered to list any firms that TMX delists.

In other words, one could say that the sky is not yet falling on publicly traded Canadian cannabis. And, indeed, two weeks after the initial crash, share prices for Canadian cannabis firms were starting to recover.

Yet some Canadian cannabis companies remain skeptical of the American market.  Canopy Growth’s Linton, for example, readily admits that he could be making a lot more money if were willing to absorb the political risk of operating south of the border. But until America’s federal prohibition ends, he says, the risk posed by a potential crackdown—or even some impolite attention by America’s most famous Tweeter—outweighs the potential short-term gain. As Linton wryly notes, “I’m not sure I want to be on the wrong side of those 140 characters.”

And so far, the market hasn’t punished Linton’s cautious approach. Canopy Growth’s stock, which took a major hit after the TMX announcement two weeks ago, is now trading at an all-time high.

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Paul Roberts

Paul Roberts writes about business, technology, and natural resources. His work has appeared in The Los Angeles Times, The Washington Post, The (UK) Guardian, National Geographic, Rolling Stone, Harper’s, and other national publications. His latest book, "The Impulse Society," was published in 2014. He lives in Washington state.

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