Pedro PalandraniOn September 19th, 2019, the Global X Cannabis ETF (POTX) began trading on Nasdaq. POTX seeks to invest in companies across the cannabis industry. This includes companies involved in the legal production, growth and distribution of cannabis and industrial hemp, as well as those involved in providing financial services to the cannabis industry, pharmaceutical applications of cannabis, cannabidiol (i.e., CBD), or other related uses including but not limited to extracts, derivatives or synthetic versions.
In recent years, public opinion and the global regulatory environment have generally shifted towards a more supportive stance on legalization efforts surrounding the growing and selling of cannabis and related products. As these efforts show signs of continuing across the US and around the world, additional regulated markets could enter the fray, bringing billions of dollars of potential revenue with them. In 2019 alone, global sales of legal cannabis are expected to reach $14.9 billion, rising 36% year-over-year, but still representing less than 9% of the total market.1,2 Given this momentous shift and the large potential market, companies operating lawfully across various aspects of the cannabis value chain possess high growth potential in this budding market.
In this piece, we discuss the state of the cannabis industry, including drawing parallels to the end of the alcohol prohibition era, analyzing how the market has changed in places like Colorado and Canada since legalization, additional potential markets for legalization, and the use cases for cannabis in medicinal and industrial capacities.
Cannabis Legalization Parallels Alcohol Prohibition Repeal
There are few instances where regulations shift so quickly and dramatically that multi-billion-dollar industries are formed virtually overnight. Yet one can look to the repeal of alcohol prohibition in the United States as an early precursor to the cannabis legalization efforts currently underway.
From 1920 to 1933, producing, importing, transporting, and selling alcoholic beverages was banned in the United States, costing the federal government an estimated of $11 billion in lost tax revenue and eliminating thousands of jobs.3 The subsequent repeal of alcohol prohibition in late 1933 quickly brought back buoyant economic activity. For the federal government, it meant $1.35 billion in alcohol-related taxes, representing half of the federal government’s total revenue in 1934.4 For the economy as a whole, the annual net social benefits were estimated to be $3.5 billion in today’s prices, or one-third of 1% of GDP in the 1934-1937 period.5 And after the repeal, thousands of workers found jobs in the industry again.6 The job multiplier effect allowed for creation of jobs in agriculture, retail-end of liquor industry (e.g. bars, restaurants), dispensaries and clerical-related jobs.
While just a handful of breweries and distilleries survived the prohibition era by switching their production to non-alcohol related products, these companies were ready to capitalize on the prohibition repeal and resume their position in the revamped industry. They possessed the specific machinery and expertise to quickly ramp up alcohol production and capture the growing market. The beer industry became regionally monopolized, as large companies took over small scale producers.7 Production of spirits was even more concentrated in the years following the repeal, with roughly four-firths of all distilled liquor made in the US being produced by four corporations.8
Post-prohibition, data on per capita consumption of alcohol suggests that alcohol use in the US increased after 1933, as the act was no longer illicit and social norms evolved.9
As cannabis becomes legalized in additional countries and states, we believe the post-prohibition era is an apt comparison for the potential growth of the industry. Searching for ways to boost economic growth and tax receipts, many governments are likely to consider taking a positive stance on legalization. Large established players with expertise and capital, are likely to take a commanding position in the global market, quickly entering new markets as they open and consolidating market share. And as regulations change, we expect consumer habits to evolve too, with stigmas associated with cannabis usage removed in recreational, medicinal, and health and wellness capacities.
The Impact of Legalization in Colorado
Since allowing recreational retail distribution of cannabis in 2014, Colorado’s monthly sales figures offer more recent insights into the potential growth trajectory of newly legalized markets. Recreational sales started at $14 million per month in 2014, growing to over $122 million by June 2019, representing a 48% compound annual growth rate (CAGR).10 In June 2019, Colorado reached combined monthly recreational and medical sales of $152 million, or a $1.8 billion annual revenue run rate.11 Total sales since legalization stand at roughly $6.8 billion.12
Colorado’s cannabis industry has generated meaningful economic growth and tax revenues. A Kansas City Fed study on the economic impact of cannabis legalization found that Colorado created roughly 18,000 direct jobs, boosted another 23% by spurring indirect employment from areas like construction, security, and legal services.13 Further, taxes on cannabis sales, which includes a 15% excise tax, 15% special sales tax, and a 2.9% state sales tax, have raised over $1 billion for the state since legalization, providing funding for school construction, local governments, and cannabis research.14
Beyond the economic success of legalization in Colorado, social attitudes towards cannabis consumption have continued their multidecade shift. Last year, 62% of Americans supported full recreational cannabis legalization, up from just 12% in 1969, and up from 54% in 2014 when Colorado first approved recreational use.15
The meaningful economic benefits, along with rising social acceptance, have played a major role in swaying policymakers from other states to support legalizing cannabis sales. While cannabis is still classified as Schedule I drug by the US Drug Enforcement Agency and subject to The Controlled Substances Act (CSA) at the federal level, 33 states have approved medical use and 11 states have approved both medical and recreational use. Other states like Ohio, Arizona, and Florida are considering introducing recreational cannabis legalization on upcoming ballots.
What’s been the (short, but promising) experience in Canada?
In October 2018, Canada achieved a milestone as the first G-7 country to fully legalize adult use of recreational cannabis. Since then, cannabis consumption has been on the rise, with 17.5% of Canadians reporting use, up from 14% a year ago, prior to legalization.16 In addition, sales of various medical and non-medical forms of cannabis increased 53% in the aggregate less than a year since recreational use was first allowed.
Post-legalization, Canada has emerged as the epicenter for the global cannabis industry. With a supportive regulatory environment nationwide, Canadian companies are uniquely able to build inventories and develop differentiated brands and products; an advantage that has catapulted many Canadian firms to become leaders in the space. Such efforts are part of many Canadian License Producers (LPs) plans to supply and serve international markets once regulations allow for the use of recreational cannabis, including in the US.
Currently, Canadian LPs may only enter the US by selling hemp or CBD products, which were legalized for cultivation and sale on December 12th with the 2018 Farm Bill. LPs have also acquired rights to control US companies once cannabis is legalized at a federal level. For example, Canopy Growth, which operates in the recreational cannabis market in Canada and in other legal medical markets around the world, announced on April 19th that it reserves the right to acquire the US based company, Acreage Holdings, for $3.4 billion, once cannabis is legalized at a federal level in the US.
Additional Potential Markets
We believe that today’s leading companies in the cannabis space are well-positioned to capitalize on the expected future growth of cannabis in pharmaceutical, health & wellness, and recreational products. As discussed earlier in this piece, the legal cannabis industry remains in its infancy, with an expected $14.9 billion in sales in 2019 relative to an estimated $166 billion total addressable market (TAM).17 As legalization efforts take place around the world, this should continue to grow the pie significantly for firms engaged in the legal sale of cannabis and related products. Mexico and New Zealand could be the next countries to legalize recreational cannabis; the former looking to propose the legislation in 2019 in order to reduce cartel activity in the country, and the latter with legalization plans by 2020, launching a referendum on legalization alongside general elections.
Beyond Recreational Use
Cannabis has many other uses outside the recreational space that represent further potential growth for the space. In the industrial space, hemp and its derivatives are increasingly used in building materials, plastics, textiles, paper, and fuel. In the medicinal space, research is still in its early stages of understanding cannabis, driving many pharmaceutical firms to begin clinical trials evaluating cannabinoid therapies for various diseases. With only one cannabis-derived drug being approved by the US Food and Drug Administration (FDA), the market remains a nascent one. GW Pharmaceutical is behind the development of this drug, Epidiolex, which treats seizures associated with Lennox-Gastaut syndrome and Dravet Syndrome, two rare and severe childhood-onset, drug-resistant epilepsy syndromes.18 GW Pharmaceutical is testing other drugs based on cannabinoids, but it is not the only company behind the opportunities in the medical cannabis space as can be seen in the table below. The breadth of indications encompasses neurological, psychiatric, immune, pain, gastrointestinal and other areas.
Conclusion
A trifecta of forces – regulatory overhaul, changes in public opinion, and a large, proven addressable market – makes cannabis an attractive theme in its very early stages. Early investors in the space can expect to experience high volatility as the theme takes hold, with new companies formed and developed, and public policy following a bumpy, unpredictable path, even if long term trends point to greater liberalization of cannabis regulation. Despite the potential risks we see vast opportunities in gaining broad exposure to the cannabis space as the nascent industry rapidly emerges.
Related ETFs
POTX: The Global X Cannabis ETF seeks to invest in companies across the cannabis industry value chain, including companies involved in the legal production, growth and distribution of cannabis and industrial hemp, as well as those involved in providing financial services to the cannabis industry, pharmaceutical applications of cannabis, cannabidiol (i.e., CBD), or other related uses including but not limited to extracts, derivatives or synthetic versions.