Do the current financial conditions speed up or slow down cannabis normalization?
“In the business world, bad news is usually good news - for somebody else.”
- James Surowiecki, 2005
There’s a big disconnect in sentiments in the cannabis space right now. On one hand, we have the opportunity to serve sought after products to wonderful customers in environments that are close to what they would consider to be “normal” retail spaces. We do this while working with excellent partners and team members with the goal of continually looking for ways to improve. Frankly, we’re lucky to be in such a position, regardless of which category of retail - cannabis retail still feels new and exciting. But on the other hand, one would be hard pressed to find meaningful positive news on the cannabis industry right now. And we’re not saying the news cycle is purposefully perpetuating bad news. No no. The industry is giving plenty of negative news to keep that fly wheel spinning. Without getting into the licensed producer (LP) side of the business, a few of the notable retailers that have gone through restructuring in the past few months are Dutch Love, Superette, Fire & Flower, and Trees. Of course, there are plenty more, but these sit close to home for us and have certainly garnered media attention. Thoughts go to those individuals who are impacted by the changes occurring in the space.
In the past, we’ve discussed how we believed the market would take years for the cannabis products being produced to really meet the needs of the consumers. This ~15 year journey to anything that could be considered “normal” is how long it took the alcohol space to go from moonshine to beer as the top selling product category: from a supply driven product (easy production and transport) to a demand driven product. Note, we are NOT comparing cannabis to alcohol, we are drawing comparisons to regulatory controls and the relevant product development cycle required to put a new offering on the market. Given the legal cannabis industry is nearing five years old, and being cognizant of the fact that it takes months (sometimes years) to develop a new product, we are really only a couple iterations of consumer feedback into product development. For this iteration to continue, there needs to be sufficient funds available to LPs to continue investing in bringing new products to market. But as we’ve seen, even those with some of the largest market capitalizations on 10.17 have drifted from the path, with Hexo being consumed by Tilray after netting over $2b in losses (“The Billion Dollar Start-up”) and Canopy Growth needing to consolidate shares in hopes of avoiding delisting. Sadly, we know with larger players stumbling, there are smaller operations also running into trouble. This unfortunate reality has a disproportionate impact on innovation, as the niche players tend to have a higher risk tolerance on innovation. The tightened financial environment will result in less competition and could mean a heightened focus on derivative products, instead of net new development. This will leave the door open for anyone with the means to enter and innovate.
Last summer, we discussed the idea of the “Horton Bear Hug” - a strategy first used by Tim Horton (the person) to control altercations on the ice during his NHL hockey career and then later employed by Ron Joyce to control the quick serve coffee market in the decades thereafter. Even still, the place where 8/10 take-out coffees are purchased daily in Canada took 10 years to open its first 35 locations. Today, 59 years after the first café opened in Hamilton, there are over 3,500 Tim Hortons locations open in Canada and many more around the world. As a market and channel mature, consolidation occurs and other players run out of oxygen, leaving a couple major players with the lionshare of consumers’ wallets. History has shown that there is often considerable refinement that goes into any market before the leaders rise to the top. And the leaders today may not be those we would have guessed 20 years ago: when’s the last time you’ve ordered something from Sears? The first legal cannabis retail transaction in Canada happened about ~1,750 days ago. It’s fair to say we’re still in the refinement phase of this market. And consolidation is, like the “Horton Bear Hug”, inevitable.
For consolidation and product development to occur, capital is generally required. The only problem now is: If the word “cannabis” is in the deck, there’s a good chance the answer will be “no” in any request for financing or debt. Meaning, the timeline to normalization could be longer than originally expected. Tilray Brands, which is made up of multiple former large LPs (Aphria and Hexo, to name a couple), is focused on buying more alcohol beverage brands, as access to capital is so difficult right now. Not to mention, diversifying into lower taxed, higher margin, and less regulated product lines is good business and frees up more cash for future endeavours. Those that can ride this storm with cash flow positive operations should be in a position to thrive in years to come. That said, it’s been a long time since we’ve been so bullish on cannabis retail in Canada - this is the start of the next evolution of the industry.