There are three big developments in the cannabis space to report.
* A buyout of one of our portfolio names, which nets us 105% gains in four months.
* A confirmation that the Biden administration is serious about some major cannabis reform, which would be a huge catalyst for the group.
* A buyable selloff. Cannabis stocks sold off sharply Tuesday probably based on false fears that rescheduling won’t happen. I think that’s wrong, and the weakness is a buy.
Here is more detail, followed by a roundup of key cannabis sector cultural momentum developments, and portfolio company news.
1. The Portfolio Stock Buyout
Back on August 9, I put Cerevel Therapeutics (CERE) into our Cannabis Plus Insider Portfolio at $21.91. Canna Plus names are companies that have exposure to cannabis trends without touching the plant. They must also have the right kind of insider buying, according to my system for analyzing insider activity. CERE has cannabis sector exposure because its lead product candidate is a therapy for schizophrenia, which is induced in certain people via cannabis use, according to several studies.
A few days ago, we learned that AbbVie (ABBV) is buying our CERE at $45 a share in an all-cash offer. That produces the 105% gain.
OK, so what now.
Since this is an all-cash offer, there will be no tax advantage (cost basis upgrade), which can happen in a stock-based offer. No point in holding on for this.
But there is a reason to wait. Notice that CERE trades at $41.05, well below the $45 buyout offer. The question is, do you want to wait for the deal to close next summer to get the full $45, or should you sell now? That depends on your own portfolio and cash needs (for other investments, for example). But I think it makes sense to wait for seven or eight months at most for another 10%. The deal is scheduled to close in the middle of 2024. A 10% gain in seven months is not bad.
There is a risk in waiting it out.
To know why, you have to understand why CERE trades at a steep discount to the buyout price. The short answer is regulatory risk.
Because of product overlap between CERE and ABBV, there is a chance the Federal Trade Commission (FTC) will challenge the merger on market concentration grounds. This particular FTC has been quite aggressive on challenging proposed mergers, including in biotech. The good news is that a lot of its aggressive attempts to block mergers have failed. This track record reduces the odds of a challenge here, in my view, and increases the odds that the FTC would lose a challenge.
AbbVie has a product called Vraylar approved for schizophrenia, bipolar disorder, and major depressive disorder. AbbVie also has a Parkinson’s Disease product. CERE’s main product candidate is emraclidine for schizophrenia and psychosis, but it also has tavapadon in development for Parkinson’s Disease.
This product overlap might not bring about an FTC challenge (or fail if it does). One reason is that these therapies have different mechanisms of action and different usage profiles. They treat different collections of ailments. This means it is harder to make the product overlap case. Another challenge for the FTC is that there are other therapies on the market for these ailments, which would also make it harder to prove market concentration.
A final consideration is that there may be another buyout offer and a bidding war. This is uncommon, but it might be worth waiting around a week or so to see if that develops. I doubt it. But it is possible.
The bottom line: It’s always tough to predict what the FTC might do, but I believe it would face pretty big challenges in questioning this merger. This lowers the odds of an FTC challenge. I could be wrong. An FTC challenge would hit CERE stock. But waiting for a move up to $45 from $41.05 is not a terrible idea. A 10% gain in around seven months is not a bad return. I’m keeping CERE in the Canna Plus portfolio in the hopes of netting an additional 10% gain.
2. A Key Rescheduling Update
Last week we learned more about ongoing Biden administration efforts to re-schedule cannabis under the Controlled Substances Act (CSA). The insights came from documents released after a Freedom of Information Act (FOIA) request. The news is quite bullish for the sector. High level, the heavily-redacted documents confirm that the administration is serious about rescheduling, and laying the groundwork for a path to get there.
This is big news.
Recall the background here. Moving cannabis to Schedule III from Schedule I under the CSA (rescheduling) would be a huge boost for the sector because it would eviscerate an Internal Revenue Service ban on the deduction of operating expenses by cannabis companies. The change would increase available cash. It would also confirm the trend towards cannabis law normalization at the federal level, and the broader cultural momentum in that direction.
Last fall, the Department of Health and Human Services (HHS) recommended to the DEA and its parent agency, the Justice Department (DOJ), that cannabis be rescheduled, according to news reports. Since then, sector experts have attempted to learn more about the recommendation using FOIA requests. Last week, HHS responded to attorneys Matthew Zorn at Yetter Coleman and Shane Pennington at Porter Wright Morris & Arthur. Here are the key takeaways, according to Pennington.
* There’s a big emphasis on the medical benefits of cannabis use in the documents. This is key, because medical benefits are necessary for rescheduling to happen. We know HHS is heavily focused on medical benefits because of a simple page count. HHS dedicated more than 150 out of 250 pages sent to Zorn and Pennington to the question of whether marijuana has an accepted medical use in the U.S. We don’t know all the details, because of the redactions, but the high page count sends a signal.
“Had HHS applied the usual standards to decide that issue, it could have resolved it in two or three pages as it did when it addressed the question in 2016,” says Pennington. “I therefore conclude that it has likely announced and applied a new standard for assessing whether marijuana has a currently accepted medical use.” He thinks it is likely that HHS found that marijuana does have a currently accepted medical use.
* There are other good hints that HHS is working hard to make the case for rescheduling. For example, HHS offers a broad definition of cannabis to include all the various strains. This is important because in the past HHS has said it’s almost impossible to analyze marijuana for scheduling purposes in part because marijuana strains and products vary in chemistry and composition. So, it was not possible to show that “marijuana” as a whole meets the “reproducible chemistry” requirement under DEA rescheduling rules. The new and all-inclusive definition of cannabis negates this obstacle.
* There are signs in the documents that the Food and Drug Administration (FDA) is reviewing evidence supporting medical use potential. The FDA is part of HHS.
* Unlike prior HHS correspondence on rescheduling, which rejected rescheduling due in part to the need for further medical-use research (and the obstacles to conducting the research), this time HHS documents appear to omit this protest, says Pennington. The documents also suggest the FDA and HHS have gathered and analyzed a lot of medical research data, he says.
* There are signs in the documents that HHS concluded marijuana’s abuse potential is relatively low, a requisite factor for rescheduling.
* HHS has been gathering a lot of intrastate sales data, which could be used to bolster the medical use argument.
One Cautionary Note
The next big step in rescheduling should be publication of a proposed rule by the DEA, in response to the HHS rescheduling request. Many cannabis experts expect a proposed rule by the end of this year. That would send cannabis stocks soaring.
But we actually might not see a proposed rule from the DEA by year end. Pennington tells me the lengthy response to his FOIA request raises doubts about this, at least in his mind. Here’s why.
A DEA proposed rule will include the release of all the documents HHS just shared with Pennington. If a DEA proposed rule were about to trigger a release of the HHS documents, why would HHS have bothered to spend resources responding to Pennington last week? One reason might be that he’s gone beyond the normal FOIA request process and taken legal action to provoke an HHS response.
It’s also possible HHS FOIA lawyers do not communicate much with the rescheduling rule makers inside the DEA. I worked in the State Department earlier in my career, and it is notable how often various parts of the government do not interact because they exist in silos. This lack of communication happens even in important matters like national security. After the 9/11 attacks we learned that various law enforcement divisions were not sharing intelligence about terrorist threats.
Even if we don’t see a proposed rule by year end, you should not give up on this catalyst. Since this attempt at rescheduling is moving at warp speed compared to the normal timeline (up to nine years), there is a reasonable chance we will see DEA news flow relatively soon (if not by year end). And we could see complete rescheduling next summer, just in time for the height of the presidential campaign.
Rescheduling is a highly politicized issue that will likely play a role in the 2024 presidential election. Biden has publicly encouraged HHS and the DOJ to reschedule cannabis. Several legal experts believe it will happen by next summer at the latest, so Biden can use the progress to swing votes his way.
We might also get an HHS update on its views of medical use soon, in another context. HHS is supposed to provide Congress with a report on the medicinal value of cannabis this month, under a deadline set by the Medical Marijuana and Cannabidiol Research Expansion Act. The bill attempts to ease access to cannabis for use in studies. If HHS really is building the case for medical uses of cannabis, we would likely see evidence of it in this report.
3. This Week’s Cannabis Sector Weakness
Cannabis stocks were down sharply Tuesday, most likely because the DEA put six synthetic cannabinoids in Schedule I under the Controlled Substances Act, citing imminent hazard to public safety. This may have raised doubts among investors that cannabis itself will be moved to Schedule III.
If this explains the sector weakness, cannabis stocks are a buy because I do not believe rescheduling has been derailed. The administration wants to book a big win on cannabis reform, to use in the upcoming presidential election.
Besides, there is a big difference in safety profiles of synthetic cannabinoids and cannabis plants. The DEA’s actions on synthetic cannabinoids does not provide a read-through on its views about rescheduling cannabis products derived from plants, in my view.
Synthetic cannabinoids are sold in gas stations and convenience stores as a legal alternative to cannabis. The DEA ban lasts until December 12, 2025.
What to Do Now
All stocks in our portfolio remain a strong buy as a trade for a big advance near term on possible rescheduling news, and are a medium-term hold as progress on cannabis reform continues – supported by the powerful cultural momentum I talk about below.
Portfolio names are: Ayr Wellness (AYRWF), Cresco Labs (CRLBF), Curaleaf (CURLF), Cronos (CRON), AdvisorShares Plus US Cannabis (MSOS), AdvisorShares MSOS 2X Daily (MSOX), ETFMG Alternative Harvest (MJ), Green Thumb (GTBIF), Organigram (OGI), Tilray Brands (TLRY), Trulieve (TCNNF) and Verano (VRNOF).
For simplicity, consider getting exposure via MSOS or the leveraged version, MSOX. Because of the weakness in the group this week, now is a good time to buy.
Cannabis News from Around the World
In each Cabot Cannabis Investor full issue and update, I provide details of news supporting my contention that there is strong cultural momentum towards cannabis law and use normalization.
It is important to understand what’s driving this trend. This helps you see why it’s a good idea to own cannabis stocks, avoid getting shaken out on weakness in this extremely volatile sector, and average down on weakness (like now).
State Legalization Trends
* Around 67% of Florida’s registered voters favor a proposed state amendment that would legalize recreational use. The results, from a new University of North Florida Public Opinion Research Lab poll, confirm similar findings by recent polls. The results suggest enough support for a proposed referendum on legalizing rec use. Support was stronger among Democrats (78%) and people between the ages of 18 and 24 (86%), and weaker among Republicans (55%) and people 65 or older (51%).
The language of the proposed amendment still needs to be approved by the Florida Supreme Court. The court has until April 1 to decide. If it does nothing, the referendum is automatically approved, and voters would get to weigh in during the 2024 election. Florida would be one of the largest cannabis markets, given the state’s population and tourist traffic.
* New York’s Cannabis Control Board (CCB) agreed to allow six cannabis companies to sell recreational use cannabis in their medical cannabis dispensaries. The stores will have to set aside half of their shelf space for independent cannabis brands to encourage the survival of smaller operators. The move marks the end of a waiting period imposed on larger cannabis companies which was meant to provide first-move advantage to social equity businesses. Cannabis companies challenged this rule in court, and the lawsuit was recently resolved.
The list includes Cabot Cannabis Investor portfolio name Curaleaf (CURLF). “As New York works to turn the tide in shutting down the illicit market, the most effective tool to do so is with a robust legal market where New Yorkers can securely purchase safe, tested, and well-regulated cannabis products, and that is what this ratified agreement ensures,” Curaleaf CEO Matt Darin said in a statement.
* The town of Lubbock, Texas has agreed to put a marijuana decriminalization initiative on the ballot in a special election next May. The Texas House of Representatives has approved a decriminalization bill, but it’s hung up in the Senate. A University of Texas and Texas Politics Project poll found 72% of people in the state support decriminalization. Several cities in Texas have already decriminalized.
Cannabis Sales Trends
Robust cannabis sales continue to confirm the cultural momentum behind legalization of recreational use sales, and greater acceptance of cannabis use.
* Connecticut cannabis sales hit a new record in November, coming in at $25.7 million. Recreational use sales were $15.4 million, the highest amount since legalization in January. Medical use sales held steady at $10.3 million, leveling off after months of declines. Connecticut sales hit a record despite the fact that limited product selection in the state could have buyers going to Massachusetts to buy cannabis.
* Third-quarter rec use sales in New Jersey grew 10% to $176.9 million compared to the prior quarter. Including medical cannabis, sales were $206.1 million for the quarter. The growth reflects ongoing store openings, but also some cannibalization of the medical market. Medical use sales were $29.2 million, down from $33 million in the prior quarter.
* Maryland cannabis sales dropped slightly in November, coming in at $89.7 million, but recreational use sales hit a new record at $56 million. Medical use sales were $33.7 million. The overall November tally was down about $2 million from the August high for the year of $91.7 million. The state legalized rec use sales in July.
* Cannabis users in Arizona purchased almost $1.1 billion worth of marijuana this year through September, though monthly sales were down slightly from peaks earlier in 2023.
Cannabis Price Declines Easing
* Wholesale cannabis prices in Canada increased in October. This could be a bullish sign that the price deflation which has hurt cannabis companies for nearly two years is coming to an end.
The average price for dried cannabis flower in October was $1.10 per gram, up 6.8% from the September average of $1.03. Available lot sizes also declined, which means fewer bulk discounts. This is another sign the cannabis glut has come to an end following the exit of many producers in the past year. The data come from the Canadian Cannabis Exchange. Firmer prices are bullish for cannabis stocks. Many cannabis companies have reported a similar trend in their U.S. markets.
Cannabis and the Workplace
* California Gov. Gavin Newsom has signed a bill prohibiting employers from discriminating against people who use cannabis outside of the workplace. The bill amends the California Fair Employment and Housing Act, which bans employment discrimination.
Starting January 1, employers are banned from firing, discriminating in hiring, or punishing people because of their use of cannabis outside of work. Employers can still test for THC, but they can’t discriminate if employees test positive for metabolized THC, meaning non-psychoactive cannabis metabolites. These metabolites do not indicate impairment. They only suggest an individual has consumed cannabis in the last few weeks.
The new California law does not allow workers to be impaired by, or use, cannabis on the job. The bill does not apply to federal employees and construction workers.
Last October, Newsom signed a bill prohibiting most employers from asking job applicants about their cannabis use. Earlier this week, California’s police training and standards commission dropped a long-standing job applicant question about prior cannabis use.
* Cleveland has rolled back pre-employment cannabis testing to target applicants for jobs that entail safety and security risks, or for positions that require a commercial driver’s license. The move comes shortly after Ohioans approved a referendum legalizing recreational use, in the most recent election. The states of Washington, Nevada and Montana have approved similar changes on cannabis testing.
* Nevada now allows people to apply for jobs as police officers even if they were convicted in the past of possessing or selling cannabis. The change does not mean that officers can use cannabis once employed.
Cannabis Reform Abroad
* Japan’s parliament has passed a bill to legalize medical cannabis use. The change would mark a big departure from the country’s stringent drug laws. However, the bill increases restrictions on recreational use. Only 1.4% of people in Japan say they have tried marijuana, compared to around half of people in the U.S.
* A recent poll found that 64% of psychiatrists in Switzerland support the legalization of recreational cannabis use. The poll also found that 49% of the psychiatrists think cannabis may treat mental disorders, and 50% said there is not yet enough scientific evidence to know. The study, published in the Journal of Cannabis Research, comes as European countries move towards legalization. The European market could be as big as the U.S. market, given Europe’s population size.
Federal-Level Reform
* The governors of six states recently sent President Joe Biden a letter urging him to reschedule marijuana to Schedule III of the Controlled Substances Act by the end of this year. The change would more closely align policy with public opinion, said the governors from Colorado, Illinois, New York, New Jersey, Maryland and Louisiana. They cited a poll which found 88% of Americans support medical or recreational use legalization.
* A bipartisan group of representatives in Congress has reintroduced legislation that would end federal criminalization of cannabis under the Controlled Substances Act in states that have legalized. The bill is called the Strengthening the Tenth Amendment Through Entrusting States (STATES).
The bill would end Internal Revenue Service rule 280E for cannabis companies in states that have legalized. This rule blocks cannabis companies from deducting operating expenses on their federal tax forms. The bill would also prevent states from blocking the transport of cannabis through their borders if it is being shipped between states that have legalized.
Ohio Republican Rep. Dave Joyce was one of the key sponsors. “This bill respects the will of the states that have legalized cannabis in some form and allows them to implement their own policies without fear of repercussion from the federal government,” said Joyce. The bill was introduced in 2019 in the House and the Senate, but it failed to even get a hearing.
* The Drug Enforcement Administration (DEA) has warned Georgia pharmacies that selling cannabis products is against the law. Georgia recently became the first state to allow pharmacies to sell medical cannabis, but now that initiative is in doubt.
Cannabis Research News
* A recent study found no evidence of cognitive impairment in patients under the influence of medical cannabis. The findings seem surprising, given that recreational users often report cognitive impairment while using marijuana. One explanation might be that medical cannabis patients are regular users. Cannabis tolerance increases with long-term use, notes the report. The study was published in the journal CNS Drugs.
* The National Institutes of Health (NIH) wants to create a Resource Center for Cannabis and Cannabinoid Research to make it easier for scientists to study the therapeutic value of marijuana. Scientists cite complex federal regulations and supply issues as research obstacles. NIH wants to “address challenges and barriers to conducting research on cannabis and its constituents” because of the growing interest in the potential therapeutic uses of cannabis.
Portfolio Company News
Ayr Wellness (AYRWF)
AYR Wellness opened a third Ohio dispensary in late November, in Dayton. The opening is part of a strategy of positioning in markets that recently legalized recreational use or look like they will in the near term. Ohioans voted in favor of legalizing recreational use in the last election.
Curaleaf (CURLF)
Curaleaf launched wholesale recreational use cannabis sales in New York December 12, just four days after getting the green light to do so from the New York State Office of Cannabis Management. It will offer five vape, edible and flower products from its Select and Grassroots brands. Curaleaf has supplied New York’s medical market since 2017. It will start off serving one dispensary, but it hopes to get state-wide distribution by the end of the year.
Elsewhere, Curaleaf has met all the Toronto Stock Exchange (TSX) listing requirements, and it will begin trading on the exchange on December 14. The listing should improve liquidity and access to institutional investors. It also means Curaleaf will be included in the TSX and MSCI indices.
The company also opened its second dispensary in Sarasota, FL, in early December, taking its Florida total to 61. Curaleaf is positioning ahead of potential legalization of recreational use in the state. Floridians may get to vote on a rec use legalization referendum in the next election. The referendum must get approved by the state’s supreme court before it can get put to voters. The court has to decide by April 1, otherwise the referendum gets automatically approved.
Green Thumb (GTBIF)
Green Thumb opened two RISE Dispensaries in Florida December 1, in Tampa and Crystal River. It is also opening a RISE Dispensary in Port Orange Florida this month. The openings take Green Thumb’s Florida dispensary count to 14, out of 90 nationwide. The openings are part of a strategy of expanding in states that may soon legalize recreational use sales. Floridians may get to vote on a rec use legalization referendum in the 2024 election.
Organigram (OGI)
Organigram broadened its loan agreement with its partner Phylos, a company that develops cannabis strains via genetic engineering. Organigram upped its lending to the company after Phylos delivered on a promise to deliver strains producing high-potency, terpene-rich, plants that reduce costs by eliminating the need for some propagation, cloning and other preparation steps.
Organigram hopes to devote more than 30% of its Moncton facility grow facility to F1 Hybrid seeds from Phylos by the end of its 2024 fiscal year. Phylos strains produce highly-uniform, predictable, and fast-growing seedlings, says Organigram.
Trulieve (TCNNF)
Trulieve just took a bite out of its huge debt load, a move that will reduce costs by lowering interest payments. The company retired $130 million in debt December 1. The retired notes paid 9.75% in interest. Prior to the debt buyback, Trulieve reported $903 million in debt against $161 million in cash.
