It would be an understatement to say that the COVID-19 pandemic impacted transactional activity for buyers and sellers across a range of industries, the hemp and cannabis merger and acquisition (“M&A”) space being no exception. In particular, the current period of COVID-19 volatility in the hemp and cannabis space is marked by numerous consequential outcomes, namely: (1) a sharp decline in the number of deals; (2) decline in capital raises; and (3) overall decline in market valuations.
First, there has been an overall “precipitous decline in hemp and cannabis M&A,” as recently stated by Scott Greiper, president of Viridian Capital Partners (“VCA”). According to VCA, there were 94 hemp and cannabis M&A deals in the first quarter of 2019, and there were 19 such deals in the first quarter of 2020, representing approximately 80% fewer deals on a quarter-by-quarter comparison. At the micro level, there were 25 M&A deals in March 2019 as tracked by VCA, and there were 5 such deals by March 2020, yet another 80% decline in deal count. These numbers roughly match those released by Mergermarket, a leading provider of business intelligence and research. According to Mergermarket, there were 110 M&A transactions in the first half of 2019 compared to a paltry 27 such deals announced by the end of March, which represents approximately 75% fewer transactions. The overall decline has affected total cannabis M&A deal value, which has spiraled downward from $9.2 billion in 2019 to just $325 million by the end of March 2020. The Exchange Traded Managers Group, LLC and ETF Managers Group, LLC (together, “ETFMG”) Alternative harvest exchange-traded fund (“ETF”) (NYSE:MJ), an ETF tracking the performance of certain cannabis-related investments, reports a 40% decline year-to-date. However, it should be noted that there are some small pockets of M&A activity. For example, Emerald Organic Products, Inc. (OTC:EMOR), a health sciences company, announced on March 27, 2020 that it signed a Plan of Merger Agreement with Bonsa Health, a digital pharmacy entity capable of same day delivery of prescription medications anywhere in the United States, for a 51% controlling stake in the latter.
The brief optimism surrounding the Bonsa Health merger is overshadowed by the grim overall negative trend in cannabis deal count. VCA, which shares the results of M&A deal tracking through a proprietary tool on its website at the end of every week, had the following figures for the last three weeks, namely the weeks ending June 12, June 19, and June 26, 2020, as seen below:
- Week ending June 12, 2020: This week was the most active week to-date for cannabis M&A in 2020, with 3 M&A transactions compared to 9 in the prior year period. The largest M&A transaction for the week was Charlotte’s Web Holdings, Inc. (TSX:CWEB) closing the acquisition of all the issued and outstanding subordinate shares of Abacus Health Products Inc., the total consideration being $76.7 million of Charlotte’s Web common shares. Due to this transaction, Charlotte Web’s portfolio in the Topical Products category has enlarged. It should be noted that all 3 M&A acquisitions for the week were on behalf of public companies, which has been the reality in 90% of cannabis M&A transactions announced this year. It appears that public companies, owing to their fund raising ability, have become dominant purchasers (especially of private companies) in the cannabis space. Of the 3 acquired entities, 2 were private, and 1 was public. The 3 buyers came from 3 different sectors, specifically Hemp, Investments & M/A, and Cultivation & Retail.
- Week ending June 19, 2020: This week saw 2 M&A deals compared to 8 for the same period in the prior year. M&A remains significantly below the levels seen in the first and second quarters of 2019, but there appears to be a slight uptick in weekly activity. A healthy guess would be that this is driven by a multiweek increase in capital raising and stock price performance of public cannabis companies, also the most dominant acquirers in the space. The largest M&A transaction was IGNITE International Brands, Ltd. (“IGNITE”), a global consumer packaged goods and lifestyle brand, announcing the closing of the remaining issued and outstanding equity securities (a 90% acquisition) of Ignite Distribution, Inc. As a term of the transaction, IGNITE issued an unsecured promissory note for $3.35 million, with an annual interest rate of 10% and maturing on June 11, 2022. For both M&A deals, the acquisitions were by public companies, which account, to-date, for 90% of the M&A cannabis transactions in 2020. The 2 buyers came from two different sectors, specifically Cultivation & Retail, and Infused Products & Extracts.
- Week ending June 26, 2020: There were no M&A transactions, which is down from 7 in the prior year period. This week marks the third week in the preceding 5 weeks with no M&A activity. Due to constrained capital availability, many companies have canceled previously announced acquisitions to focus on cash production in their existing operations. These substantial amounts of capital could potentially be deployed in the second half of 2020, which is when increased M&A activity is to be expected.
Second, while the impacts of the COVID-19 global pandemic are pronounced with regards to pure M&A activity, the cannabis capital raising space has not gone unscathed. In a recent interview with Adam Pope, an associate in the Business Development department of Canopy Rivers, a venture capital cannabis firm, Mr. Pope had the following comments on changes in the types of companies raising:
“…In 2020, prior to March 16, the top three deal verticals for which we’d received pitches were consumer products, production and cultivation, and retail and distribution. Since March 16, though, 37% of the pitches we’ve seen have been from software and technology companies. Broadly, software companies have fared relatively well during the economic downturn, and many “pick and shovel” companies—like Shopify in e-commerce—are helping businesses pivot by offloading cost centres to specialists which can help grow their business. Cannabis software opportunities could potentially be more pervasive post-COVID as they are less capital intensive and could draw more significant investor interest during global macroeconomic uncertainty.”
These comments are supported by analysis from VCA regarding capital raises on a week-ended basis, which, along with M&A information, is available through the same proprietary tool mentioned above. VCA had the following figures for the last three week-ending periods:
- Week ended June 12, 2020: For the first time in 2020, there were more dollars raised, as well as a higher average tranche size, compared to the same weekly period of the prior year. There were 7 capital raise transactions totaling $73.8 million compared to 12 capital raise transactions total $71.8 million for the same period in 2019. Average tranche size appears to have increased, with $10.5 million for the week ended compared to $6 million for the period in the year prior. This week appears to have been an outlier active week for both aggregate dollars raised and number of transactions. The largest capital raise was for MediPharm Labs Corp. (TSX-LABS), a Canadian producer of pharmaceutical quality cannabis oil and concentrates, which raised $37.82 million (Canadian) in private placement of 2 series of unsecured convertible notes. Of the 7 capital raises, all were closed by public companies, which matches 2020 data. So far this year, public companies account for 82% of all capital raises compared to 66% for the same period in 2019. Public companies currently account for 91% of total dollars raised compared to 72% for the same period in 2019. It would appear that a recovery in cannabis stocks is fueling competition among public companies to seek both debt and equity financings. As between equity and debt capital, equity-based capital comprised 4 of the 7 transactions, and a convertible debt-based financing comprised the remaining 3.
- Week ended June 19, 2020: As expected, there was a downturn in activity. There were 3 recorded capital raise transactions totaling $59.6 million compared to 9 transactions totaling $158.8 million during the same weekly period in 2019. Perhaps in part due to the Charlotte’s Web M&A transaction for the week ending June 12, 2020, average tranche size for the week ending June 19, 2020 was $19.9 million compared to $17.6 million for the same weekly period in 2019. The largest capital raise was for Charlotte’s Web, which had previously closed its announced aggregate gross proceeds to the company of 77,625,000 (Canadian). Some 11,500,000 units of the company, at a price of $6.75 (Canadian) per unit, were sold pursuant to the offering, including the full exercise of the over-allotment option by the underwriters. Of the 3 capital raises, all were closed by public companies. As between equity and debt capital, equity-based capital raises comprised all three capital raise transactions, which is the first time in 2020 that no debt raising was reported as part of total capital raises.
- Week ended June 26, 2020: This week, there was a higher dollar volume but few aggregate number of transactions compared to the same weekly period in 2019. There were 5 recorded capital raise transactions totaling $32.5 million compared to 13 transactions totaling $235.4 million for the same weekly period in 2019. Average tranche size was $6.5 million this week compared to $18.1 million for the same weekly period in 2019. The largest capital raise involved Aurora Cannabis, Inc. and Alcanna Inc., who jointly announced a short-form prospectus offering for aggregate proceeds of $27.6 million (Canadian). Aurora sold 9.2 million shares at $3 (Canadian) per share, exiting its 23% stake in Alcanna, and also agreed to cancel 1.75 million Alcanna warrants with exercise prices of $15 (Canadian) for no consideration. Of the 5 capital raises, all were closed by public companies. As between equity and debt capital, equity-based capital raises comprised 4 of the 5 transactions, as well as 91% of the proceeds raised. It appears that debt financing has drastically declined as a percentage of total capital raised since the major multistate operators completed several large debt financings immediately prior to the COVID-19 pandemic.
Third, there has been an overall decline in market valuations. According to Adam Pope:
“We have seen an adjustment to round sizes and overall valuations. Valuations are decreasing and we’ve heard during pitches that smaller round sizes is not only an effect of current conditions in the capital markets, but an effort from startups to close more quickly and ensure they have enough cash to weather the current storm. From a venture capital perspective, this means that runway has become increasingly important. We are critically analyzing how long a company may survive on a smaller round, as well as their ability to raise additional capital during or post-COVID-19. Startups we’ve talked to also appear to be adjusting their use of proceeds. Many cannabis startups, which were originally proposing short-term high growth strategies, are now adjusting to strategies designed for slow, sustained growth.”
Mr. Pope’s comments mirror a recent Law360 report detailing multiple planned financings that were canceled, and interviews with investors who are slashing previous valuations of their potential targets by more than 50% in some cases from before the pandemic. One such example provided is of a Santa Cruz, California cannabis manufacturing company that was ready to receive $10 million from an investment fund right around the acceleration of COVID-19’s spread in the United States. According to the report, the fund investors pulled the $10 million, leaving nothing for the company’s planned investment. The impact on valuation is particularly pronounced for the cannabis industry, which, largely shut out of traditional bank loans, depends almost entirely on private investment.
Without a doubt, the current COVID-19 pandemic and related economic fallout has wreaked havoc on the total number of cannabis deals, capitals raises, and market valuations. However, to the degree a silver lining exists, the current M&A situation offers a unique moment for those investors comfortable with risk. The cannabis industry has long been home to certain investor-friendly deal structures, such as asset-backed loans connected to equity, warrants, and high interest rates. Additionally, cannabis investors may also be given control over major company decisions, especially with regards to dictating control rights. This unique moment in time may allow existing cannabis investors to exhibit more opportunistic behavior, especially compared to newer investors, who may not have come to terms with the inherent risk profile present in the cannabis and hemp space.
As you are aware, things are changing quickly and there is no clear-cut authority or bright line rules. This is not an unequivocal statement of the law, but instead represents our best interpretation of where things currently stand. This article does not address the potential impacts of the numerous other local, state and federal orders that have been issued in response to the COVID-19 pandemic, including, without limitation, potential liability should an employee become ill, requirements regarding family leave, sick pay and other issues.
 See Forbes, ‘Precipitous’ Decline in Hemp and Cannabis M&A Continuing Amid COVID-19 Pandemic, dated April 27, 2020.