Wall Street's Invasion of the Legal Cannabis Market

DeAngelo co-founded the first cannabis angel investment network, ArcView Group Troy Dayton, in 2010 to match investors — dentists and doctors at first, now family offices and the Silicon Valley rich — with weed entrepreneurs. One of the most respected cannabis testing labs, the Steep Hill Labs, also belongs to his burgeoning empire. Part pot evangelist, part capitalist, DeAngelo asks outsiders to partner with people who have worked illegally in the trade for decades. They have deep agricultural and processing knowledge and understand how the drug works in food, alcohol, and the body. He thinks weed’s charms will eventually win over even the most mercenary capitalists. “After a year or two, they come to me, kind of a confession, and say, ‘Steve, I’ll be honest with you, it was just about the money. But then I started hearing these amazing stories.’ And then they tell me a few of these amazing stories. ‘I understand now why you’re so moved by this. I’m with you.’”

It is about the money, though. Even though California has been a quasi-recreational state for years, as almost anybody can get a doctor’s prescription for cannabis, the state is making it legal for people to partake just for the fun of it beginning January 1. California, which is closely watched because it now represents about 40 percent of the U.S. market for cannabis products, first legalized the medicinal use of marijuana in 1996 after years of lobbying by AIDS activists. Next year, shocking even some longtime advocates, marijuana will be fully legal in 17 states, with 12 more allowing people to use it as medicine.

Matt Karnes, a former equity analyst who started cannabis research firm GreenWave Advisors four years ago, expects U.S. legal retail weed sales to reach $30 billion by 2021, up from $6.5 billion in 2016. In just three years an astonishing 29 states are expected to have fully legal markets, and all 50, as well as Washington, D.C., will allow at least medicinal use, he says. In comparison, wine sales in the U.S. are $29 billion. “The smoke is out of the bong,” says Karnes, who says he loves the excitement of being off Wall Street and part of the Green Rush. He estimates that 30 million people in the U.S. use cannabis recreationally and by 2021 will spend $1,500 a year on average. Over the same period a further 26 million possible medical users will spend a projected $3,200 a year.

Given the momentum behind the legalization of marijuana in the U.S., the most powerful investors in the world are seriously evaluating how they can profit from an industry that governments around the world once spent billions trying to eradicate. Cannabis-focused private equity firms include Northern Swan Holdings, started by former KKR and Och-Ziff Capital Management executives; Tuatara Capital; and Privateer Holdings, which raised money from Peter Thiel’s Founders Fund in 2015. They’re primarily targeting ultrahigh-net-worth investors, family offices, and other sophisticated investors flexible and brave enough to put money into gray markets. Meanwhile, traditional mutual funds, private equity firms, institutional asset managers, pension funds, and endowments that have had nothing to do with cannabis are sizing up the opportunities from a safe distance. Most don’t care much about the history of the plant. They’re doing due diligence, attending conferences, and getting to know their way around an industry whose foundation was — and still is, in most cases — illegal. Fidelity Management & Research Co., among others, has ventured into hot companies like PAX Labs, which makes perfectly legal vaporizers for tobacco and cannabis.

Institutional investors can also put money into companies listed on the Australian Securities Wall Street's Invasion of the Legal Cannabis Market

Exchange and perhaps soon on Börse Berlin, and into all kinds of ancillary businesses, including agricultural technology, software, and cultivation equipment. The stock of Scott’s Miracle-Gro, a suburban garden shed staple, has been on a tear since the company expanded into hydroponics and other products attractive to weed growers.

“We’ve had more conversations with larger institutional investors in the last six months than ever before,” says Brendan Kennedy, CEO of Privateer, which focuses on consumer brands in cannabis. Kennedy first heard of the industry in 2010 while chief operations officer of tech start-up SVB Analytics, when a client from a medical cannabis company came into the firm’s offices. “When they left, I went to the computer, which had every business database at the time, and I typed in every word I could think of for cannabis. Nothing came up!” he says. “If you can’t find information, that’s an opportunity.” Kennedy left SVB, put together a team, and spent a year visiting dispensaries, cultivators, retailers, lawyers, politicians, and others around the world, including in the hills of Oregon and northern California, British Columbia, and Israel. Like many early investors in the markets, he and his co-founders started Privateer to help usher in an end to prohibition and its resulting social problems — and make killer investments along the way.

Legal recreational use in California and Canada is slated to begin next year, which Kennedy thinks contributed to the recent spike in institutional interest. “Sometimes I point out two of the world’s top ten economies are legalizing cannabis for adult use. Canada will be a model for other countries,” he notes. From California — the global superpower in cultural exports — Kennedy expects movies and television programs that show adults smoking pot.

Finance people see vast opportunity in former black markets: They are messy, opaque, cash-based, often without any records to speak of, and have plenty of holes to fill. It’s the stuff Wall Street careers are made of. When an investor successfully cleans up a mess, it is called alpha or excess returns. After the pot is smoked, the financial industry will take a business, document its process, build better systems, bring in professional managers, squeeze out efficiencies, and do a few mergers and acquisitions. Already in 2017 public companies have raised $1.4 billion in 177 equity and debt deals, compared with $543 million raised in 2016, according to Viridian Capital Advisors. Private companies have done an additional 110 deals, raising $494 million, compared with $193 million last year. This year there have been 118 M&A transactions, compared with 58 in 2016, says Viridian.