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High Hopes: Cannabis Stocks, Big Tobacco and M&A

Federal legalization is critical, and Big Tobacco is poised to step in.

Market expectations that the Biden Administration and Congress would support federal legislation to legalize cannabis led pot stocks to peak levels in early 2021. But when legalization took a backseat to other initiatives, cannabis stocks trended downward as the year wore on and continued to do so through the first seven months of 2022. But lawmakers’ lack of haste could present an opportunity to others in the market, including tobacco companies.

Federal legalization remains critical to the industry’s growth. At the moment, just 37 states have legalized marijuana for medicinal purposes, and only 19 have approved its recreational use. The resulting gaps among federal and state laws create roadblocks, preventing traditional bank financing and consumer credit services. Dispensaries in states that have legalized cannabis can only collect cash or charge debit cards, as federal regulations keep credit cards out of bounds. And — because the U.S. government classifies marijuana as a Schedule I drug (with a high potential for abuse and little medical benefit), transporting cannabis across some state lines as it moves from producers to consumers can carry severe trafficking penalties.

So cannabis stocks have gone up in smoke since their early 2021 highs as investors have become frustrated with the lack of federal movement. Curaleaf (CURLF), the cannabis company with the top market cap, fell from $18.38 in Feb. 2021 to $6.054 per share on Aug.12, or 67%. Tilray (TLRY) dropped from $67.00 in February 2021 to $4.03 per share on Aug. 12. The 94% drop was dramatic, but the stock reached a $300 per share high in September of 2018. The diversified AdvisorShares Pure Cannabis ETF product (YOLO) that holds shares in a portfolio of cannabis companies fell from $31.87 in February 2021 to $5.78 per share or 81.9% at the end of last week.

To be sure, demand is not the problem, including by a U.S. government hungry for tax receipts and on the prowl for new tax verticals. But Washington lobbyists may have ulterior motives, including especially the tobacco industry, which in 2021 had 236 federally registered lobbyists (78.4% of whom were former government employees). Tobacco companies are likely planning to enter the burgeoning marijuana business once federal legislation makes it legal. In the meantime, they are advantaged by the progressive weakening existing players: Federal delays play to Big Tobacco’s strengths.

Two of the three leading publicly traded tobacco companies, Philip Morris ( PM ) and Altria Group ( MO ), have combined market caps that equal about 50% the market cap of the top 16 cannabis industry leaders. Philip Morris’s and Altria’s combined market cap is over $235 billion. At $99.24 per share, the former pays shareholders a $5.00 or 5% dividend. At $45.15, the latter’s dividend of $3.60 translates to an 8% yield. At the same time, both are cash-rich, with plenty of resources for growth acquisitions.

Low market caps create attractive take-over candidates. Curaleaf has a market cap of $4.29 billion, and is a leader in the sector. Tilray’s market cap was around $2.33 billion. Both, and others, are compelling take-over candidates that could create accretive returns for PM, MO or other cash-rich companies. Such acquisitions would supply know-how, cultivation and distribution facilities and a customer base. The well-capitalized companies would create economies of scale. Once legalized, cannabis is a natural and synergistic fit.

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