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Management in Practice

Is Cannabis a Good Investment? 

As cannabis goes mainstream as a business opportunity, it’s easy to forget that just a few years ago, the industry was too risky for many investors. One company that got in early and has helped bring cannabis out of the shadows is Privateer Holdings, founded by Yale SOM graduates Brendan Kennedy ’05 and Michael Blue ’05. In an interview with Yale Insights, Kennedy says that cannabis will become more and more like other products as legalization expands, but that there are still huge risks ahead for the budding industry.

This interview was conducted at the Yale Business of Legal Cannabis Conference, a student-led event held at the Yale School of Management on February 16, 2018.

When Privateer Holdings was founded in 2010 by two Yale School of Management alumni, cannabis might have seemed like an odd market for a private equity firm to focus on. Only a quarter of states permitted some form of medical cannabis for residents. Recreational marijuana was legal nowhere in the United States. Using the plant medically was slowly catching on in Europe, but as an investment, cannabis seemed much too risky for large and institutional investors.

Eight years later, the landscape has changed fundamentally. More than 30 states have legalized medical cannabis, while 8 (plus the District of Columbia) now permit recreational use. The decision by Canada to legalize marijuana for recreational use has super-charged the development of a legitimate cannabis industry. Illustrating just how far out of the shadows pot has come, beer giant Molson Coors Brewing Co. formed a joint venture with a Quebec-based marijuana producer to develop cannabis-infused beverages.

Cannabis has even made its way to Wall Street. There have been a number of IPOs for Canadian companies such as Aurora Cannabis, Hydropothecary, the Supreme Cannabis Company, Namaste Technologies, and Canopy Growth Corp. Many have seen large jumps in their stock price as the legalization date approached.

Seattle-based Privateer Holdings has capitalized on the excitement. It is the majority holder in Tilray, which signed an agreement in September to provide cannabis for a medical study at the University of California San Diego. Tilray debuted on the NASDAQ in July at $17 a share; three months later, the price per share stood eight times higher. The surge has made it the world’s largest cannabis company.

Brendan Kennedy ’05, who founded Privateer with Michael Blue ’05 and serves as both Privateer’s executive chairman and Tilray’s CEO, said in a conversation with Yale Insights that the goal is for Tilray to one day be available in every pharmacy in the world. That may take a while, but with what’s going on in Canada, the U.S., and Europe, Kennedy said, the industry has reached a point where further legalization is inevitable. Eight years ago, very few investors were willing to invest in cannabis. When Tilray closed its most recent round of funding, he said, the majority were institutional investors.

“Over the next 12 months,” he said, “I predict that every major institutional investor in the U.S. will make an investment in this industry.”

Kennedy sat down with Yale Insights to discuss the state of the cannabis industry and how you bring something long dealt in the shadows into the light.

Q: Tell us a little bit about your company.

Eight years ago, I founded a company called Privateer Holdings, which is a private equity holding company that invests exclusively in the emerging cannabis industry globally. To date, we’ve raised over $200 million. We employ about 500 people in seven countries around the world. People tend to focus myopically on this industry in Colorado or California or Canada. It’s part of our fundamental thesis that we’re in the midst of a global paradigm shift around cannabis.

Q: How do you view the maturity of the industry? Do you find that private investors are concerned more with the short or long term?

It’s changed a lot over the last eight years. Our investors are very long-term focused; they’re very patient. All of our investors, certainly early on, were looking for a social return measured by ending harms caused by prohibition. A lot of the investors who are investing today in Colorado or Washington or in California are looking at a much shorter view. They’re looking for much faster returns from those more localized investments.

Eight years ago, it was a highly fragmented industry. No leaders, no standards. A lot of it was still hidden in the shadows. Part of our focus has been to bring the industry out of the shadows and into the light. The opportunities are different in different parts of the world, in that it’s still a very nascent industry in Colorado, or California, compared to Canada, where there are, I don’t know exactly today, but there’re a dozen companies that are public. There’s a potential that those Canadian companies end up being the consolidators of this industry at some point.

Q: What was it that made you think this would be a viable industry for a private equity firm?

We spent a lot of time initially just going around the world and talking to people, talking to cannabis cultivators and processors and retailers, dispensary owners, patients, pharmacists, physicians. Probably learned the most from the activists and the political campaigners. We came up with a thesis that cannabis is a mainstream product consumed by mainstream people around the world. Because of that, the end of prohibition is inevitable and brands will shape the future of this industry, just like any other industry.

We originally thought we would be building a venture capital firm that made typical passive investments in a lot of different companies. You couldn’t make investments like that eight years ago, because the companies, the people, the strategies weren’t sophisticated enough. We needed to actively manage the companies in our portfolio to help them navigate through the changes that were taking place.

One of the interesting things about the last election was that yes, Massachusetts and California legalized cannabis—very, very blue states. Purple states, Nevada and Maine, legalized cannabis. But then Florida, Arkansas, Montana, North Dakota—really red states—voters in those states voted overwhelmingly in favor of cannabis legalization. Cannabis on those ballots received far more votes than President Trump, who also won in those four states.

Q: What role do investors play in the maturation of the industry?

In the United States and most countries around the world, almost all the investors are private investors. They are high-net-worth individuals, family offices. We closed the first institutional investor into this industry back in 2015—Peter Thiel’s Founder’s Fund. That gave other smart investors permission to make an investment in this industry.

You’re starting to see institutional private equity firms, venture capital firms, some hedge funds and much larger institutions, make investments in this industry, in the United States and in legal markets outside the United States. Our last round, we raised a round of capital into Tilray, $60 million Canadian. There were 10 investors, and 9 of them were from the U.S. One was from Canada. They were all institutional investors, all 10, 9 of them had never made an investment in the cannabis industry before.

That’s the big change. Over the next 12 months, I predict you’ll see almost every major institutional investor in the U.S. make an investment in this industry.

Q: Under the Obama Administration, the federal government took a largely hands-off approach when it came to states that were legalizing cannabis. The Trump Administration has given indications it will be tougher on these states. How do you navigate the legal and regulatory landscape that is in such flux? How do you communicate to your investors that it’s still a safe investment?

It’s not easy. When he was on the campaign trail, President Trump said he’s 100% in support of medical cannabis and that adult use cannabis was a state’s rights issue. But then Attorney General Jeff Sessions rescinded the Cole Memo, which gave some guidance to U.S. attorneys around cannabis regulations in states that have legalized medical cannabis. So there’s a lot of uncertainty. When we look at deploying $100 million that we raised into the parent company and roughly $50 million into one of the portfolio companies, we’ll invest a vast majority of it outside of the United States, where there’s less risk, less uncertainty. Governments and regulators and politicians are trying to attract people like us—they want the jobs, they want the investment, they want the tax revenue from this industry.

It’s actually the exact opposite of what you see here in the U.S. You would think an administration that’s so focused on manufacturing jobs, in creating jobs here, would be focused on this industry. There’s over 150,000 people employed by this industry in the U.S., and you have an attorney general who’s a drug war dinosaur trying to deny people those jobs.

Q: What places outside the U.S. do you find are the best investments?

Canada was the first G7 nation to legalize medical cannabis. Germany was the second. In Germany, any doctor can write a prescription to any patient for any illness with insurance company coverage for cannabis products. Really different than anything we’ve seen in the U.S. or anything that we see frankly even in Canada.

Today, Tilray products are available in about 20,000 different pharmacies in Germany. That’s a massive opportunity. It’s two and a half times the size of Canada in terms of population and GDP. We’re investing heavily there. We have a license to cultivate in Portugal. We’re building a large facility there—not for Portugal; we actually won’t be able to sell our product in Portugal. We’ll just be able to produce it there. We’ll have tariff-free access to the European common market.

Q: Is Tilray your primary investment?

Tilray’s the medical brand we’ve invested in. We own the vast majority of that company. Although Tilray will bring some of our other brands to Canada this year when Canada becomes the first G7 nation to legalize cannabis for adult use. One of the other portfolio companies is a company called Leafly, which had over 50 million people use it last year, over 14 million people used it last month, to learn about cannabis, to learn about cannabis products and where they can buy them. Leafly operates in English, French, Spanish, and German.

Q: How do you invest in the medical side versus the recreational side? Is that ratio changing as time goes on?

There are roughly 30 U.S. states that have legalized medical cannabis and roughly 30 countries that have legalized medical cannabis. In 2018, we’ll add probably half a dozen more U.S. states and closer to 10 countries around the world that have legalized medical cannabis. In terms of adult use, legalization, you have nine U.S. states now, and two countries, Uruguay and Canada. In 2018, we like to say that two of the world’s largest economies are legalizing cannabis for adult use. January 1, California, the fifth- or sixth-largest economy in the world, legalized cannabis for adult use. California will be extremely influential in terms of brands and culture and the brands you see on TV and in movies and things like that.

Currently, about 80% of our investments are medical and about 20% are for adult use. We see that ultimately flipping over the next five years, to be 80% adult use and 20% medical.

“Any institutional investor that invests in alcohol needs to hedge that by investing in cannabis.”

Q: How important to the industry is legalization in California?

Roughly a quarter of the U.S. population now lives in a state that has legalized cannabis for adult use. Over 90% of Americans believe that medical cannabis should be legal, in poll after poll after poll. You can’t get 9 out of 10 Americans to agree on anything, but they agree on that. Over 60% of Americans believe that cannabis should be legal for adult consumption without a prescription.

I think California, in some ways, is a turning point. I think soon we’ll see states like Oklahoma and Missouri legalize cannabis, which will be the turning point. California and Massachusetts don’t really shock the world, because they’re very liberal places. But when you see Senator Orin Hatch from Utah talking about legalizing medical cannabis, that’s evidence of a paradigm shift in the U.S.

Q: What do you look for in a company that makes it a good investment for your portfolio?

We spend a lot of time learning about the people that manage the company. We spend a lot of time looking at risk management, how these companies operate and brand. For us to make an investment in a company, the brand needs to not be focused on a single state or on the U.S. It needs to be the type of brand that’ll work in multiple countries around the world. In most industries of this size, you wouldn’t be thinking about that yet.

Q: What are some red flags when you’re vetting a company that would make you back out?

The biggest one would be people who don’t believe that there are risks. You’d be surprised how many people who operate in this industry in the U.S. just don’t imagine that there are any risks from the federal government. I’ve spent a lot of time with large operators in Colorado who have a huge list of problems. Probably the biggest is with banking. Because cannabis is still illegal on the federal level, very few banks are willing to deal with them. People who operate in this industry in Colorado have tax problems with IRS code 280E. It’s just very complex. We spent a lot of time digging into how people operate and how people think about risk and how people manage those risks from a legal perspective. That’s one of the biggest areas of focus for us.

Q: How do problems with banks impact what you’re able to do?

We definitely have to deal with those issues. We have bank accounts here in the U.S. with banks that know us well. They know who we are. I’m very public about what I do for a living. It’s not like we’re going to hide the use of these funds. But everything in this industry is difficult. Eight years ago, hiring a lawyer was difficult. Hiring an accountant to do our finances or our taxes or an audit firm—all those things were harder. Simple “check the box” items in other industries became six-month projects. It’s getting easier, but it’s still really hard.

Q: As an outsider, you’d think that certainly in the beginning, a lot of the folks you came in contact with probably had experience in the black market. How does that impact your strategy?

There are a lot of people who have come to work for us from outside of this industry, the vast majority. We employ people from Microsoft and Amazon and Starbucks, T-Mobile, all sorts of companies, who are attracted to this industry. We do employ people who have operated illicitly. It’s okay if they’ve had a non-violent drug offense around cannabis; that doesn’t disqualify them from employment. Frankly, we need people who have deep knowledge of cultivation or processing of this product. It’s important for us.

And, if you’re thinking about transitioning a $200 billion industry from being an illicit industry to being a legal industry, it means bringing those people with you. You can’t suddenly disenfranchise all the people that’ve been operating in this industry over the last four years. You have to compel them to want to operate legally.

Q: Have things become more standardized? If you’re at a dispensary in Colorado or Connecticut, will a strain by one name be exactly the same? Is it difficult to impose standards on something that’s been underground for so long?

There are over 10,000 different genetics, or varietals, of grapes. With cannabis, we don’t know. It’s somewhere around 4,000 to 5,000, but there aren’t DNA databases of cannabis genetics yet. So, there is a lot of uncertainty. You are starting to see more and more testing—for genetics, but mostly for contaminants, to make sure that that product doesn’t have mold or mildew, microbials, or pesticides. Most of the illicit product available in New York City, even in California a year ago, was contaminated with pesticides. One of the benefits of legalizing this product is that people have access to a safer, more regulated product backed by companies that have suffered the consequences of not following the regulations.

Q: Why do you think the big intuitional investors will soon come into the market?

Many institutional investors invest in the alcohol industry, and we’re starting to see cannabis as a substitute for alcohol. Any institutional investor that invests in alcohol needs to hedge that by investing in cannabis. When Canada legalizes cannabis for adult use, alcohol sales in Canada will decrease. If you’re an alcohol investor, you need to hedge that. If you’re a alcohol company, especially a global alcohol company, you need to hedge the offsets and revenues that you’re about to face.

Q: Do you see alcohol producers as an obstacle for legalized cannabis? Is there a movement to try to block or hinder its spread?

It was one of the risks we identified eight years ago. We were very worried about how the alcohol industry would react. But Constellation Brands, a global alcohol company, made about a $200 million investment in a public cannabis company in Canada to do R&D around cannabis-infused beverages. Now, every global alcohol company is going to be looking at making an investment in this industry. You can see it in their SEC filings, where they list losses in alcohol revenue sales due to the emerging cannabis industry. These public companies are trying to figure out what their strategy is in response to cannabis.

Q: Will people soon be buying Bud Weed or something?

I think a lot of people, given the choice between alcohol with its side effects and a cannabis beverage, would choose a product that is lower in calories and doesn’t leave you with a hangover the next day.