Valuation insights

This cannabis ramp-up isn’t without some precedents worth examining.

When the Internet stocks that are stalwarts today were in their infancy, the valuation multiples being paid then may have appeared absurdly high on first blush.

Analyst outsiders back then struggled to find creative ways to look at those early Internet stock valuations — using site metrics, even though there was much noise in the data in those early years.

Valuations in an industry poised for explosive growth and disruption of other competitive alternatives may look absurd on the surface in comparison to other industries.

However, the expected future cash flow (the growth story) is the key to rational analysis.

There may be cannabis operating statistics that can help explain the valuations.

A prudent analysis will look at factors such as: how many licenses the business has and the type oflicense; how many retail locations and the quality of those locations; and how many key employees and their level of equity in the business.

Operating metrics will not translate easily into valuation multiples until the industry matures, but it may be useful to start analyzing deals in terms of such metrics.

Valuations multiples throughout the value chain will likely differ. The legalization of cannabis in Canada creates a new, more robust licencing framework that segments the value chain by various activities: cultivation, processing, sale, import/export, analytical testing, and research.

Ancillary businesses — companies that provide inputs, technologies, and services to cannabis companies — will also experience tremendous growth. It will be important to analyze each value chain segment for its particular risks and opportunities relative to the overall cannabis opportunities.

Appropriate valuation multiples may be different at every value chain segment or level.

Valuation techniques from the Life Sciences sector can be useful.

In a Life Sciencesbusiness, key milestones may include: scientific acceptance, regulatory approvals,commercialization, early customer acceptance, and market maturity.

At key stages there maybe ‘haircuts’ to the valuation for the probability of failure.

The eventual mature opportunity may be huge (e.g., if a global market), but the probability discounts along the way may also be huge.

Growth opportunities in the Agriculture (Ag) sectors are highly relevant. Ignoring the supply-managed industries, it’s worthwhile to look at Ag sectors with niche agricultural products (e.g., non-GMO, cage-free, organic, hand-mixed, farm identifiable, certified humane).

Cannabis producers will be learning about factors that drive consumer buying decisions, and what attributes consumers will be willing to pay for, versus ‘nice to have’ but not sought after (or not changing the price point).

Typically, higher valuations will go to businesses that develop the brands (e.g., buying experience) and products that result in customer loyalty and premium pricing.

The Ag sector can also teach us about possible risk factors.

Consider Ag risks such as: pests, weather, freshness protection, contamination, and quality inconsistencies.

Adding in risks of social license, and the developing nature of the legal and regulatory environment means we are looking at a significant risk profile in the cannabis industry for the early years.

Capital providers will typically expect the risk premium for the Cannabis sector to be high inearly years which have a range of significant development and management risks.