Cannabis Industry Outlook Research and Education

February 17, 2021

From Niche to Mainstream? The cannabis industry has grown in popularity over the last 3 months Author(s): on the back of the Biden administration endorsing plans for federal Matthew Leung & Chiranjeev Beniwal legalisation. Over the years, inefficiencies exist for producers in the Research Analysts sale and distribution of cannabis because transportation of the Editor(s): product requires crossing state boundaries where cannabis is illegal or only legal for medicinal uses. However, with increasing calls to Ethan McTavish & Michael Jung legalize cannabis and the presence of political support, the Co-VPs of Research and Education opportunity has arrived for cannabis to go from a niche industry to a well-established one.

Total Estimated Sale of Cannabis in the United States 25 23.0 21.6 20.1 20 14.5% CAGR 18.5 (16' to '25) 16.5 14.5 15 12.4

9.8 10 8.3

6.8 Sales in Billions Sales Billions in (USD) 5

0 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Product Types This section describes common ways cannabis is being consumed in the U.S.:

Buds Buds currently dominate the market with heavy usage in both the medicinal and recreational spaces. Dried buds are used in a medicinal manner by aiding against ailments such as cancer, Alzheimer’s and chronic pain. The main method of ingesting buds is by smoking as it is more economical, quicker than oils and tinctures, and is mainly associated with recreational use.

Oils Oils are experiencing the fastest growth out of any product type in the cannabis industry because of the stigmatization against buds and smoking. More specifically, many doctors and consumers alike are not fond of using smoking as the main ingestion of cannabis due to harmful chemicals. In contrast, oils are being recognized as a growing and established way to safely ingest cannabis and as a result are mainly used for medicinal purposes.

1 Hemp Hemp has lower amounts of cannabis (<0.3% THC content) compared to buds and oils. As a result, users do not experience the same psychoactive effects from ingesting hemp due to low THC levels. Hemp is mainly known for its industrial usage; however, it is also now being experimented for medicinal use due to its lack of side effects.

CBD Sales, by Channel, in the United States 1400

1200 Hemp-Derived

Marijuana-Derived 1000 Pharmaceuticals 800

600

400 Sales in Millions Sales Millions in (USD)

200

0 2014 2015 2016 2017 2018 2019 2020 2021 2022

Promising Legislation The main reason as to why the cannabis industry has recently been experiencing great success is due to promising legislation and support from the recently elected Biden administration. The following approved acts will help destigmatize marijuana, as well as provide cannabis companies with much needed financial backing from banks.

Marijuana Opportunity Reinvestment and Expungement (MORE) Passed by the U.S. House of Representatives on December 4, 2020, The MORE Act “removes marijuana from the list of scheduled substances in the U.S., as well as eliminate criminal penalties for any individual who manufactures, distributes, or possesses marijuana.” (Nadler, 2020) This would significantly aid the producers of cannabis as they would no longer have to take specific routes to avoid boundaries of states who designate marijuana as an illegal substance to distribute. It also removes the fear of illegality from the mind of any potential consumers as cannabis would be legal across the U.S.

Secure and Fair Enforcement (SAFE) Banking Act of 2019 The SAFE Banking Act would increase the availability of banking services for cannabis companies. (Blumenauer, 2020) This means that from an operational and financial standpoint, cannabis companies would see a far more normalized environment in the U.S., which would help streamline their business processes. This normalization process would let cannabis companies enter the corporate mainstream.

2 Major Players & Opportunities for Growth Major Players The major players in the industry include Tilray (NASDAQ: TLRY), Aphria (TSE: APHA), Aurora Cannabis (TSE: ACB), and Canopy Growth Corporation (TSE: WEED). Aphria and Tilray have announced their intention to merge under the Tilray name, which will create the largest cannabis company in terms of pro-forma revenue. (George-Cosh, 2021) Tilray plans on issuing nearly 270 million new shares, which would be given to Aphria shareholders in return for their stock. In essence, every 1000 Aphria shares would be replaced with 838 Tilray shares, but the relative size of Aphria compared to Tilray means that the former Aphria shareholders would be dominant in this new consolidated company, holding 62% of the total shares.

Summary of Financial Statements

Tilray Aphria Canopy Growth Aurora Revenue $183M $682M $506M $285.5M Cost of Goods Sold $230.5M $381M $338M $332M Gross Margin (%) (25.96%) 36.71% 23.32% (16.29%) Operating Expenses $186M $211M $863M $328M Operating Income ($233M) $10M ($745M) ($374M)

Current Ratio 2.3 2.4 6.2 5 Debt/Equity 278% 28.1% 17.9% 22.5% Return on Equity (161.8%) (11.8%) (48.5%) (16.29%)

Cash from Operations ($195M) ($135M) ($579M) ($281M) Cash from Investing ($30M) ($396M) ($395M) ($111M) Cash from Financing $280M $223M $283M $624M

Opportunities for Growth The cannabis industry and its major players have a series of characteristics that are like one another. The industry giants have a positive financing cash flow, with most of the funding coming from equity issuances, as companies are unable to secure debt due to their negative free cash flows. As a result, apart from Tilray, none of the companies suffer from indebtedness, which means these companies do not have large costs related to interest expenses. However, all these companies still had negative returns on equity over the past year because revenue is hard to come by with recreational use being illegal in 20 states. Additionally, all these companies have significant investing cash outflows, primarily due to the high capital expenditure of the industry. Overall, none of the companies apart from Aphria have shown positive operating income – Tilray and Aurora have a cost of selling goods which is higher than revenue, and Canopy Growth’s strong gross margin is countered by large selling, general and administrative (SG&A) expenses. However, the poor fundamentals of the cannabis industry can be improved upon if companies fully capitalize on the improving political and economic environment over the next few years.

How Legalization is Beneficial for the Cannabis Industry Legalization benefits the cannabis industry in a major way not only through a holistic manner but also a financial one. Legalizing cannabis will ultimately destigmatize the practice of consuming cannabis in both a medicinal and recreational manner. With 2/3 of Americans supporting the legalization of marijuana, it will ultimately lead the way for potential customers to use cannabis products without any legal repercussions as suggested by the projected growth for total cannabis sales in the United States reaching $23 billion dollars by 2025. As more consumers use cannabis products, it will ultimately increase the revenue of major players in the industry. Furthermore, with legalization it will optimize the distribution and sale of cannabis products since producers would be able to cross all state boundaries without fear of marijuana being illegal in a state.

3 Who Will be the Winner? With the Tilray-Aphria merger on track to be completed, there seems to be another strong merger opportunity between Canopy Growth and the revitalized Tilray-Aphria entity. Canopy Growth presents a solid company to merge with, considering its massive balance sheet which has the largest equity out of any of the four companies. Canopy also has the lowest debt/equity ratio, ensuring solvency, while also maintaining the highest current ratio, indicating solid liquidity.

Furthermore, Canopy Growth is the only company apart from Aphria which has a positive gross margin, indicating strong fundamentals relative to the industry. However, the firm’s negative income is primarily derived from its large operating expenses - namely its SG&A costs. In addition, research and development (R&D) costs have been increasing at a fast rate, as well as depreciation and amortization, which, as a non-cash expense, may be viewed as a positive, since it acts like a tax shield.

A merger between Tilray-Aphria and Canopy would create synergies between the two companies. This would come because of Aphria’s ability to keep operating expenses at 35% of revenue, compared to over 170% of revenue for Canopy Growth. This would result in the creation of an industry-dominating company with a massive balance sheet and improved profitability margins. Through consolidation, cost savings could be put towards R&D and other productive expenses, resulting in progress towards a more financially sustainable cannabis sector.

Takeaways Although the cannabis sector is still an emerging industry, the legalization of cannabis under the Biden administration will ultimately ensure it becomes a mainstream industry that is here to stay. As an industry that has an estimated CAGR of 18.1% from 2020-2027 (Grand View Research, 2020), there are great opportunities for existing cannabis companies to not only improve upon themselves through new legislation like the SAFE Act, but also to merge and synergize to propel their growth even further. By taking the right steps moving forward, the cannabis sector and companies within it have a bright and sustainable future ahead, supported by increasing consumer interest year over year.

4 References

Blumenauer, E. (2019, May 15). All info - H.R.2093 - 116th Congress (2019-2020): States act. Retrieved February 20, 2021, from https://www.congress.gov/bill/116th-congress/house-bill/2093/all-info

Daniller, A. (2020, May 30). Two-thirds of Americans support marijuana legalization. Retrieved February 20, 2021, from https://www.pewresearch.org/fact-tank/2019/11/14/americans-support-marijuana-legalization/

George-Cosh, D. (2021, February 17). Tilray reports profitable Q4, SAYS Aphria merger is on track - article. Retrieved February 20, 2021, from https://www.bnnbloomberg.ca/tilray-reports-profitable-q4-says-aphria- merger-is-on-track-1.1564987

Grand View Research. (2020, February). Legal marijuana market size Worth $73.6 billion by 2027. Retrieved February 20, 2021, from https://www.grandviewresearch.com/press-release/global-legal-marijuana-market

Grand View Research. (2020, February). Legal marijuana market Size, GROWTH: Industry Report, 2027. Retrieved February 20, 2021, from https://www.grandviewresearch.com/industry-analysis/legal-marijuana-market

Nadler, J. (2020, December 07). H.R.3884 - 116th Congress (2019-2020): MORE act of 2020. Retrieved February 20, 2021, from https://www.congress.gov/bill/116th-congress/house-bill/3884