The Cannabis Economy | Contrarian Investing

In Peter Thiel and Blake Masters best seller “Zero to One”, Mr. Thiel shares the question he likes to ask in job interviews: “what important truth do very few people agree with you on?”. He goes on to explain that what he is looking for is contrarian thinking whereby most people believe in X, yet the truth is actually the opposite. As the research for Cannabis Capital developed, it struck me that everyone is calling cannabis an industry, when in fact it is far greater in terms of influence, and impact. So, the inception of the concept was to help bridge the gap in communication between investors and founders. When you remove the noise around the “cannabis industry” the focus shifts to discussing the core merits of a business, which is the basis any investment needs to be rooted in.

Not only did the Cannabis Economy take shape and be defined in the book, the concept has also largely informed my firm’s investment theses as venture capital investors. Our investment model is largely contrarian to most of the investors currently investing in cannabis entrepreneurship. Let me explain:

Very few people are defining cannabis as a macroeconomic trend, and rather focusing narrowly on certain elements of the cannabis economy, or following investment cycles. I believe that cannabis is not an investment cycle, but a trend that will lead to cannabis or cannabis derived products being in every home period. There will be cannabis centric companies delivering the technologies, products, services and implementation of this across all existing industries. At some point all businesses currently operating today, will in some way need to adapt or innovate to the ubiquitous cannabis economy.

The contrarian nature of how we invest is then to avoid the irrational exuberance that is no more clearly evidenced than in the public markets. We are now seeing the cannabis correction which I have previously forecast and it is my belief that we are just at the beginning of this. The following is an excerpt from a recent letter I wrote to my investors:

There is a confluence of market conditions that are all favorable to investing in private cannabis companies and in particular the BVE strategy. This current news about the public markets will not deter the entrepreneurs who are fueling the explosion in cannabis entrepreneurship. The impact is that it will be harder than ever for them to raise the capital they need. If there is also fewer funds making these types of investments, BVE will stand out as the optimal venture financing partner.  The great entrepreneurs who will be building great companies regardless of public market volatility, will continue to do so and need the right financing partner. Uber, AirBnB, WhatsApp, Groupon and Square all raised money in a recession and the investors who benefited were the firms who saw the downturn as an opportunity and invested for the long term, not as a reaction to short term volatility.

 

Comparatively the dot.com bubble in 2000 has many similarities and provides an interesting analogy to what is happening in cannabis. Valuations went through the roof due to retail investors irrational exuberance; companies were going public prematurely and without fundamental metrics like revenue and profits. And just like in 2000, investors saw the potential of the internet and the rush to invest validated that it was here to stay. This Klondike mentality however lead to quick hits and even quicker failures. And just like the dot.com bubble validated that the internet is not an investment cycle but actually a technological advancement that is here to stay. Investors are validating that cannabis is not going anywhere.

 

During the 2000 market crash, Pets.com became the benchmark for dot.com disasters after going public and raising $82.5 million in 2000 after only being launched a year earlier and raising tens of millions in venture capital. We now have the luxury of reviewing looking back at what happened and know that many of the contributing factors to this colossal failure were mismanagement and prematurely going public. If we compare pets.com to chewys.com there are two dramatically different stories. Chewy’s started in 2011 and sold to Petsmart for $3.2 billion in 2018, a year they did $3.5 billion in revenue with a strong management team. Both companies had it right, consumers were willing to buy products for their pets online, yet had two very different outcomes.

 

Society is trending rapidly towards cannabis legalization. Investors’ enthusiasm for cannabis stocks can be interpreted as validation that intuitively investors know that cannabis is here to stay. Investing in the long-term companies that will define the cannabis markets is difficult, not for the faint of heart, and not the type of investments suitable for retail investors. (October 13, 2019)          

Peter Thiel describes the dot.com bubble as the result of “delusional” popular belief. I think it is more complicated. Clearly investors are validating that it makes sense for our society to legalize, regulate, and commercialize cannabis.  We will see many investors now pull back, we are about to enter our most active period ever as investors. Many investors will be working out of legacy investments that are no longer as valuable as they were or experiencing significant compression in the public markets. We took our time to start selecting where we would be investing and with the entrepreneurs that we are most enthusiastic about. Many companies will be pulling back and I would caution that those companies may not have been the kind of businesses that were built for longevity from the outset. The management teams we are working with are moving more aggressively now than ever.

Investing in private companies is extremely difficult in any economy, let alone a nascent and highly compliance regulatory market such as cannabis. All of these growing pains in the markets and the turnover of leadership teams is nothing more than an indication of maturity. It is still early days but the markers are more positive than ever and I am beyond excited about the next generation of entrepreneurs that we are partnering with. The great companies of the future are among us today, if you know how to find them….