This is the investment case for legalised cannabis markets

Neil Mahapatra
(FILES) This file picture taken on Octob
Several countries have made moves to legalise cannabis for medical or leisure purposes this year (Source: Getty)

Whether you are opposed to their presence or not, legalised cannabis markets are here to stay.

In April, Pennsylvania become the 24th state to approve cannabis for medical purposes in the US, while it is already legal to all over-21s in four states and Washington DC.

In the same month, Germany joined a host of European countries in creating medical cannabis legislation. Further afield, Australia, Uruguay and Brazil announced cannabis programmes last year and Canada is transitioning from a medical regime to a full adult-use market.

Some suggest the legal cannabis market could reach $50bn in raw cannabis sales within ten years, others suggest figures closer to $300bn.

If processed and cannabinoid-based pharmaceutical products are included, the market is potentially much larger.

Read more: Microsoft in tie-up with marijuana company Kind Financial

Whatever the forecasts, we are only at the beginning – the size of the market opportunity is immense, with a market growth rate approaching triple digits.

As a result, the next few years represent a window for investors looking for secular, supernormal-growth.

Given the dynamics of the sector, businesses can become cash flow positive within months.

The characteristics of the market are so attractive that, were this a less stigmatised sector, the investment opportunity would have passed some time ago. These characteristics include:

1. Strong existing demand

Demand for cannabis does not need to be created - it already exists. In 2005, total black market cannabis sales were estimated by the UN to be more than $140bn.

Read more: Lib Dems: Legalised pot would bring in £1bn

Even if only half of this were to move to the legal market, it would still present a massive market opportunity.

2. Outstanding unit economics

The cash-generative nature of cannabis businesses across the supply chain is breath-taking - a well-managed cannabis operation can pay for itself in a few months.

Ebitda margins are often north of 40 per cent. Whilst commoditisation is inevitable, the move into processed products (e.g. edibles, tablets), development of brands and adoption of technology will allow businesses to preserve margins.

It is difficult to find an industry anywhere with better fundamentals than those found in the cannabis market.

3. The market is currently fragmented

In this period of growth, the market remains highly fragmented, with widely varying legislation from region to region.

This has prevented businesses from expanding - the largest players in the US market command less than a one per cent share.

Read more: Cannabis firm Tweed Marijuana makes profit for first time

However, as markets mature and legislation becomes more consistent, consolidation is inevitable. Interstate US transport barriers are expected to disappear, and pan-EU legislation will evolve (though obviously this won't affect the UK in the long-term).

This provides a huge consolidation opportunity for well-capitalised businesses to pursue buy-and-build strategies, and creates strong barriers-to-entry for subsequent new entrants.

4. Regulation favours professionalism

As markets develop, regulators need professional teams who know how to build and run businesses.

While perhaps unfair on some of its historical participants, it provides a unique opportunity for new teams who are able to blend a cannabis operational skillset with professional experience across industry, investment and science.

The stricter the regulation, the more professional teams are favoured. And as governments try to divert cannabis usage away from the black market and create legal supply chains, it is well-run businesses with strong governance that will benefit most.

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