Is the cannabis industry in the UK a risky business? John Binns, Partner at BCL Solicitors LLP finds out more

Few can have failed by now to spot that cannabis and cannabis derivatives, are increasingly big business, not only in countries like Canada, but also right here in the UK. But the question of how this brave new world fits with the UK’s institutional attitude towards cannabis is an important one and divides into domestic and international issues.

Taking the domestic first, those who grow, sell or do research on cannabis in the UK itself need to register with and obtain licences from a specialist Home Office unit, which is dealing at present with a very large number of applications and enquiries. Businesses that expect an easy ride from the unit, or to be able to deal with it on a commercial basis, can become frustrated with its processes and mind-set, which are – understandably, perhaps – particularly focused on the security aspects of what the law still considers a dangerous drug.

The casual observer could be forgiven for thinking that the position is more nuanced than it is, thanks to eyecatching headlines in autumn last year to the effect that medical cannabis had been legalised (1). In fact, what has happened was that an exception has been made for ‘cannabis-based medicinal products’ (CBMPs), though only where prescribed by a specialist clinician (not just a general practitioner) or granted a marketing authorisation by the Medicines and Healthcare products Regulatory Agency (MHRA) (2). Those restrictions have proved to be strict in practice and the headlines now are about why, despite the legal change, the number of patients who can actually access medicinal cannabis here remains extremely small (3) and patients who are forced to obtain their medicines abroad are still seeing them seized at the border (4).

Another common misconception is that cannabis, or cannabis products, with a THC level below 0.2% are straightforwardly legal in the UK. It arises because the threshold is relevant for various purposes in European Union (EU) legislation and other EU jurisdictions and in the UK plays a role in determining when the specialist licensing unit of the Home Office would be prepared to entertain applications for a cultivation licence (and what fees would be applicable for such licences). But where the question is whether a substance contains THC, so as to make it a controlled drug, it plays no role at all and the better legal view is that if there is any measurable THC content, the prohibition applies (subject, of course, to having a Home Office licence) (5).

That same question has also given rise to widespread confusion about CBD oils and other CBD products in the UK, which are increasingly ubiquitous on the high street. An MHRA statement in 2016 (6), to the effect that it would treat CBD products that had medical purposes (a category that, in practice, largely depends on how they are marketed) as medicines, was widely misunderstood: while those few CBD products that are described in that way will need MHRA authorisation, the statement has no effect on the broader ‘wellness’ market, including food supplements, or on (say) cosmetics, or vaping products. Many who are not well versed in this area may, in fact, be taking the risk of products being seized, premises raided, or personnel arrested.

The international issue, meanwhile, is that businesses planning to invest in cannabis overseas and then bring the proceeds here (or otherwise involve UK-incorporated entities), should also have UK money laundering laws in mind. Under the Proceeds of Crime Act 2002, it is an offence to do virtually anything with the proceeds of ‘criminal conduct’, which is defined to include conduct that is lawful overseas but that would be unlawful if it occurred here.

That does not necessarily mean that a UK investor in a Canadian cannabis company, for instance, is breaking the law by doing so. But there are judgement calls to be made about whether, when and how the investment should be reported to the National Crime Agency, with the aim of obtaining consent. Importantly, they are not made in isolation but alongside similar judgement calls by banks and others in the regulated sector, who have their own responsibilities to consider.

In the background of both sets of issues is the divide between medicinal and recreational use, as various jurisdictions consider where to draw their lines and the growing ‘wellness’ market blurs the divide still further. The UK, it seems, has some considerable way to go before even strictly medicinal cannabis is available to all who need it.

In time, perhaps, the UK may follow the example of Canada and others and adopt a more relaxed approach to cannabis. But for now at least, businesses that want to operate here must temper their enthusiasm by taking a proper look at their plans through a law enforcement lens and making sure they stay on the right side of the law as it is today.

John Binns is a partner in the business crime and corporate regulatory department of BCL Solicitors LLP in London (www.bcl.com), whose expertise includes the UK regulatory aspects of the cannabis industry.

References

1 https://www.gov.uk/government/news/government-announces-that-medicinal-cannabis-is-legal

2 https://www.gov.uk/government/organisations/medicines-and-healthcare-products-regulatory-agency

3 https://www.bbc.co.uk/news/health-47241787

4 https://www.theguardian.com/society/2019/jun/07/mother-of-epileptic-girl-teagan-appleby-has-medicinal-cannabis-seized-for-second-time

5 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/778357/Factsheet_Cannabis_CBD_ and_Cannabinoids_2019.pdf

6 https://www.gov.uk/government/news/mhra-statement-on-products-containing-cannabidiol-cbd

There's absolutely, positively no such thing as a sure thing when it comes to investing. Period. Anything you invest in comes with some level of risk. And investing in marijuana stocks comes with a lot of risk.

The closest thing to a sure thing with investing in pot stocks is a far cry from a sure thing. Having said that, there is an anomaly that I think investors can exploit to improve their chances of success with investing in the cannabis industry. It's simple. It's data-driven. And it makes a lot of sense.

What is this closest thing to a sure thing related to investing in pot stocks? I can sum it up in two words: Buy American.

Two compelling charts

Do I really think that buying the stocks of companies primarily focusing on the U.S. cannabis market gives investors an advantage? Yep. There are two charts that make a compelling case for the idea. The first chart underscores a big gap in the valuations of Canadian versus U.S. pot stocks.

DATA SOURCE: BLOOMBERG. CHART BY AUTHOR.

We can't use earnings-based valuation metrics for the simple reason that many cannabis stocks aren't generating positive earnings yet. But we can use another commonly used metric, the price-to-sales (P/S) ratio. The above chart clearly shows that Canadian pot stocks are valued much more highly than U.S. pot stocks are.

The average P/S ratio for Canadian cannabis stocks is nearly three times that of U.S. cannabis stocks. You can assign a lot of the blame for this big discrepancy to Cronos Group, The Green Organic Dutchman, and Emerald Health Therapeutics. These three Canadian stocks have much higher P/S ratios than their peers do.

Using a median P/S ratio instead of the average P/S ratio gives us a better perspective. But even watering down the effect of outliers with this approach, U.S. pot stocks are much cheaper than their Canadian counterparts with a 27% lower median P/S.

There's also another compelling reason why U.S. cannabis stocks present a significant advantage to investors: the market opportunity. The following chart highlights just how much bigger the U.S. market opportunity is than in Canada or the rest of the world.

DATA SOURCE: ARCVIEW MARKET RESEARCH AND BDS ANALYTICS. CHART BY AUTHOR.

Most of the largest Canadian cannabis stocks can't compete in the U.S. cannabis market as long as marijuana isn't legal at the federal level. This means that U.S. cannabis companies have a much larger addressable market than most Canadian companies do. 

Put aside for a moment that we're talking about cannabis stocks. If you knew that one type of technology stock had a much more attractive valuation and a much larger potential market than another type of technology stock, which would you be more likely to buy? 

The fly in the ointment

U.S. cannabis companies operate in states that have legalized either medical or recreational cannabis. But doing so doesn't change the fact that many of these companies are still violating federal marijuana laws. The ones that don't violate federal laws skirt the issue because they don't directly engage in the production or sale of cannabis. Innovative Industrial Properties (NYSE:IIPR), for example, is a cannabis-focused real estate investment trust (REIT)that leases properties to U.S. cannabis operators but doesn't run these properties itself.

This legal issue is the primary reason why U.S. pot stocks are so much cheaper than their Canadian counterparts. The issue causes several challenges for many U.S. cannabis companies. It limits their ability to access capital. It prevents them from listing their stocks on major U.S. stock exchanges. And it makes the companies susceptible to the risk that the U.S. federal government could crack down on their operations.

These challenges aren't as daunting as you might think, though. Quite a few of the pot stocks that focus primarily on the U.S. market have listed their shares on the Canadian Securities Exchange (CSE), which doesn't have restrictions on its members participating in the U.S. cannabis market. This approach, combined with listing on over-the-counter exchanges in the U.S., has allowed companies to raise the cash needed to fund operations and expansion.

Also, the risk of a federal crackdown appears to be pretty low at this point. Despite some worries early on in the Trump administration while Jeff Sessions was the U.S. attorney general, there haven't been any real measures taken by the federal government to interfere with businesses operating in states that have legalized cannabis. 

Two key assumptions

I really do think that the arguments for investing in U.S.-focused cannabis stocks are good ones. However, you should know that there are two key assumptions at the core of this approach:

1. The U.S. cannabis industry will grow at least in the ballpark of what many project that it will.
2. U.S. federal laws will be revised at some point in the not-too-distant future in a way that at minimum recognizes the rights of individual states to enforce their own laws related to cannabis.

My view is that the first assumption doesn't require too much of a leap of faith. We can look at the sales trajectory of states such as Colorado that have had established cannabis markets for several years to get a reasonable sense of how other state cannabis markets might grow in the future.

The second assumption is more iffy, though. Support for cannabis legalization at the federal level among the American public is higher than ever. The real question is exactly how intense that support is. I'm not so sure that most Americans will make voting decisions based largely on candidates' positions on cannabis legalization.

Also, because of the way the U.S. political system works, the leader of the Senate or the House of Representatives can effectively veto any bill he or she wants to by refusing to bring it to a vote. For example, the opposition of Senate Majority Leader Mitch McConnell to cannabis legalization makes the odds of anything happening much lower than you might think after looking at public opinion poll results. 

But will federal marijuana laws eventually change? I think so. In my view, it's a matter of when rather than if. 

A sure thing

If my two assumptions are correct, investing in U.S. pot stocks should pay off in a big way over the long run. My recommendation for anyone opting to take this approach is to buy multiple stocks of well-run companies that are either already profitable or have a clear pathway to profitability.

Including stocks of companies focused on the hemp market is also a good idea since hemp is already federally legal in the U.S. Keep in mind, though, that the U.S. Food and Drug Administration (FDA) hasn't finalized regulations for hemp-derived cannabidiol (CBD) products. Those regulations, when released, could change the prospects for some hemp CBD companies.

I've already mentioned one stock that I think would be a great core component of a U.S. pot stock strategy -- Innovative Industrial Properties. Not only is IIP profitable and growing, but it pays a solid dividend as well. I also like the prospects for Cresco Labs (OTC:CRLBF), a multistate cannabis operator that should close on its acquisition of California's leading cannabis distributor, Origin House, later this year.

My favorite U.S. hemp play is Charlotte's Web Holdings (OTC:CWBHF). It's another company that is consistently profitable and is growing fast. I also think new CEO Deanie Elsner's expertise in the consumer packaged goods industry will be a big plus to this CBD pioneer.

As I stated at the outset, though, buying U.S. pot stocks -- even a mix of winners like IIP, Cresco, Charlotte's Web, and others -- isn't a sure thing even though I do think it improves your chances of success over the long run. But there is one thing I'm completely sure about: If you don't invest in the cannabis industry, you won't profit from the boom in the cannabis industry. 

Following a C$250 million boost, Canadian firm Sundial Growers has splashed out one of the U.K’s largest horticultural operations to supply the booming European CBD market.

The Alberta-based company, which listed on the NASDAQ exchange earlier this month, says the purchase of the Bridge Farm Group is a key strategic move in its bid to become a ‘world-leading, global cannabis player’. In a press release Sundial says the acquisition of Bridge Farm Group will allow it to produce and sell high-quality CBD products globally.

High Quality, Sustainable CBD

Headquartered in Spalding, Lincolnshire, Bridge Farm is one of the UK’s leading producers of plants, flowers and herbs, and recently secured permission to double its growing facilities to 3.5 million sq ft. 

The business employs over 500 employees across its five locations in the county supplying many of the U.K.’s leading supermarket chains. Sundial plans to convert some of the facilities to hemp cultivation for the production of CBD, subject to regulatory approval from the U.K. Home Office.

Bridge Farm chief executive David Ball said the British consumer is increasingly aware of CBD and needs to have ‘confidence in the products they buy’. He said that its philosophy is to grow ‘high quality plants in a sustainable way, and we will now be able to bring that expertise to CBD health products’.

Sundial Establishes European Presence

Sundial Growers was established in 2014 as a licensed cannabis producer and manufacturer of high-quality CBD products and currently operates from two sites in Alberta with plans to build a third facility in British Columbia. 

The acquisition establishes its presence in Europe and represents ‘an important milestone in our international expansion’, said Torsten Kuenzlen, its Chief Executive Officer. He added: “This is a significant acquisition for Sundial, taking us one step closer to our goal of being one of the leading cannabis companies in the world.”

In early July, Sundial announced it had secured a private investment of C$92.6 million and loans totaling almost C$160m. In its first set of results since its launch on the NASDAQ it reported second-quarter net losses of C$12.4 million, on net revenue of C$19.3 million.

It has not responded to claims on the MarketWatch website that it has accepted the return of half a ton of cannabis from fellow Canadian Licensed Producer Zenabis Global.

A government appointed taskforce in the Australian state of Victoria will delve into the opportunities for industrial hemp in the state.

The Industrial Hemp Taskforce will seek to understand where the industry has potential, and if regulations need to be tweaked to support growth (and no doubt there will be a resounding “yes” to the latter).

As in other Australian states, a special licence is required in Victoria for cultivation and processing of the crop – and it can only be used for non-therapeutic purposes. While high-cannabidiol, low THC cannabis (less than 0.35 per cent of tetrahydrocannabinol in the leaves and flowering heads in Victoria) is technically hemp, once it is used for medicines it becomes medical cannabis in Australia, and subject to different and very strict regulations.

Still, there’s plenty of scope for non-medicinal hemp – for example, food, cosmetics, bioplastics, fibre and fuel. The Victorian sector currently focuses mainly on seed production for food uses.

The Victorian taskforce will also look across its borders to see what’s happening with hemp in other Australian jurisdictions – and how it’s being regulated.

“Industrial hemp is an emerging industry, and we’re excited to work out the best way to harness that potential and turn it into economic benefit for Victoria – particularly regional Victoria,” said Member for Mildura Ali Cupper, who is part of the taskforce.

Ms. Cupper is particularly excited about the possibilities for her area, stating climates like Mildura are perfect for hemp to grow.

The other members of the taskforce are Victoria’s Minister for Agriculture and Regional Development Jaclyn Symes, and Fiona Patten M.P, Member for Northern Metropolitan Region.

“Can’t wait to work with @FionaPattenMLC and @AliCupper to explore the potential of this wonder fibre and grow jobs – especially in regional Victoria,” tweeted Minister Symes.

The Victorian Government says input and feedback from the industry and public is welcomed – further information can be found here.

It’s not clear how many hemp cultivation licences have been issued in the state to date. The last recipients we noted were Murray River Organics (ASX:MRG) and Althea Group Holdings Limited (ASX:AGH), which were granted hemp cultivation licences in July.