Cannabis in America · 8/12/2019 · residents in the country. Independent market forecasts place...

Cannabis in America: Investment Opportunities in the World’s Largest Cannabis Market

Matthew Pallotta, Analyst [email protected]

647-253-1194

Andrew Semple, Associate [email protected]

416-687-6656

August 12, 2019

mailto:[email protected]


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Matthew Pallotta, CPA, CA, MBA | 647.253.1194 | [email protected] Andrew Semple | 416.687.6656 | [email protected]

SPECIAL SITUATIONS

AUGUST 12 2019

CANNABIS IN AMERICA INVESTMENT OPPORUNITIES IN THE WORLD’S LARGEST CANNABIS MARKET

Executive Summary

Our thematic provides an analysis of the investment opportunity presented by the US cannabis industry and builds a case for its attractiveness both in absolute terms and relative to other cannabis investment opportunities in Canadian and international markets. We examine the legal cannabis industry in the US and assess the landscape from the perspective of the competitive environment, financial and valuation metrics, regulatory and legislative backdrop, merger and acquisition activity, and lay out our key investment criteria for assessing operators in the sector.

Our analysis also has a specific focus on the group of businesses referred to as Multi-State Operators (“MSOs”), which we feel present the most attractive means for investors to gain exposure to the US cannabis opportunity, due to a number of advantages over their smaller, single-state or regional peers, in terms of the scale of the business, access to capital, and exposure to key markets across the country, amongst others.

The $60B Opportunity: US Presents the Largest Addressable Cannabis Market in the World

We estimate the long-term potential of the legal US cannabis market to be ~$60B annually, using our estimates for average spending per user and usage rates, and under the assumption that recreational cannabis is eventually made legal across all 50 states. We believe the current regular user base for both legal and illicit cannabis in America is approximately 24M, with the potential to rise to nearly 30M as population and user rates increase in the coming years. Our research suggests that on a per user basis, annual spending on cannabis exceeds that of both tobacco and alcohol.

The current legal medical-only markets across the US are home to some 128M residents, while the 11 states with legal adult-use cannabis laws are home to over 92M people, in all comprising roughly two-thirds of all residents in the country. Independent market forecasts place the legal US cannabis market at $30.1B in annual spending by 2024, compared to $5.2B in Canada, and $5.4B internationally. In our view, the scale of the addressable market alone makes the US, by far, the most attractive market for cannabis investment in the world.

We believe the cannabis opportunity will emerge as a major consumer goods category over the coming years, and will have an impact on spending, product development, and strategy in related consumer categories such as alcohol, tobacco, wellness and nutraceuticals, pharmaceuticals, beverages, and packaged foods.

We note that one of the most unique and attractive aspects of the burgeoning cannabis category, relative to other high-growth consumer segments, is that significant demand for the products already exists. While education will no doubt play an important role in shaping consumer demand for the products, the majority of growth in the sector in the next several years will come as a result of migrating existing illicit users to the legal channels.

Regulatory and Legal Environment Continues to Steadily Shift in Favour of Legalization

The US has a long and storied history of cannabis prohibition throughout the 20th century at the federal level. Today, laws allowing for legal cannabis in 33 states (22 medical and 11 adult-use) stand in direct contrast to the federal prohibition, and its classification as a Schedule I substance by the US Drug Enforcement Agency (“DEA”).



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US Cannabis Industry | August 12 2019

Matthew Pallotta, CPA, CA, MBA | 647.253.1194 | [email protected]

Andrew Semple | 416.687.6656 | [email protected]

As the states continue to push forward with both medical and adult-use legislation, the cannabis industry has found new allies in the federal government in recent years, with members of Congress, and even Presidential candidates having voiced their support for reforming cannabis laws. Proposed legislation such as the SAFE Act (banking reform) and the STATES Act (assertion of state’s rights over legalization) have observers more encouraged than at any time in recent memory of pending changes to the federal government’s stance on the plant.

Large Cap MSOs are Attractive on an Absolute and Relative Valuation Basis Compared to Canadian Peers

As a group, large cap MSOs are discounted on a relative basis compared to their large cap Canadian peers on all metrics, including forward consensus sales, run rate sales, and forward consensus EBITDA. We acknowledge that several fundamental factors are the cause of this discount, including, amongst others, i) higher cost of capital and lesser liquidity in shares due to being barred from listing on major exchanges; ii) excessive tax burdens borne by US operators due to the application of Section 280E; and iii) greater risk and uncertainty from a regulatory perspective.

We also present support for our position that MSOs justify, and will continue to command, valuation premiums relative to smaller, single-state and regional operators.

The Catalysts for Revaluation of US Operators Lie Ahead

We believe the fundamental factors contributing to the discount on US MSOs relative to their Canadian peers will eventually be resolved with the passage of legislation such as the STATES Act. While we make no forecast on the precise timing of such events, we believe that the removal of these issues constitutes a prospective catalyst for a fundamental upward revaluation of US cannabis businesses. By contrast, the most significant regulatory catalysts for the Canadian cannabis market, including the expectation of international medical cannabis sales, appear to have been priced into those issuers.

We believe that once appropriate legislative reform removes these encumbrances, capital rotation will quite possibly see US MSOs trade at a valuation premium to their Canadian and international peers.

Strategic Investors and Institutional Capital have yet to Enter this Market in a Major Way

We believe that a meaningful portion of the cash currently on the balance sheets of Canadian Operators, raised from institutional investors, strategic partners and debt from Schedule I banks, is earmarked for investment into the US market. There is simply no other consumer cannabis market large enough to absorb this type of capital investment, particularly given that billions have already been invested in Canada over the past several years. As regulations allow for it, we see this capital making its way south, and quickly. The prices for US cannabis assets are only likely to become more expensive in the coming years relative to Canadian cannabis assets, which we believe was the impetus behind Canopy Growth’s (WEED-TSX, NR) move to lock in the option to purchase Acreage Holdings (ACRG.U-CA, NR) once US laws and regulations allow for it.

We also consider the possibility, which in our view is often overlooked, that the next global alcohol, tobacco or beverage company to replicate the landmark multi-billion-dollar investments by Altria (MO-US, NR) into Cronos (CRON-TSX, NR) and Constellation Brands (STZ-US, NR) into Canopy, may very well be waiting on the sidelines for federal laws to allow for their investment into a US cannabis business.

Passage of the 2018 Farm Bill Opens up Opportunity in Hemp-Derived CBD, but THC Market Remains the Better Bet

The passage of the Farm Bill in December 2018 has opened up an opportunity for the estimated $15B hemp-derived CBD market. While hemp and its derivatives have been removed from the list of Schedule I substances, regulations for both the production of hemp (governed by the USDA) and its uses in food and supplement products (governed by the US FDA) have yet to be finalized.



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While the potential for the category is no doubt significant, we are not as bullish for the prospects of upstart cannabis firms, including the largest US MSOs, competing in this category against global Consumer Packaged Goods (“CPG”) firms, and in retail channels dominated by large national pharmacy and grocery retail chains.

We continue to strongly favour companies with a core focus on the THC category, which is insulated from competition by both global CPG businesses and well-capitalized Canadian cannabis firms. Over the long term, we believe the THC category will allow for more defensible margins, and greater returns on capital.

Continued M&A Activity to Reshape the Landscape of the US Cannabis Market

M&A activity is likely to continue to play a major role in shaping the US cannabis industry, with consolidation and roll ups of smaller operators by MSOs resulting in fewer, larger credible players with advantages in access to capital, scale, and national reach.

We also note the recent proliferation of cannabis-focused Special Purpose Acquisition Corporations (“SPACs”) which have collectively raised ~$2B, the majority of which has been invested, or is earmarked for investment in, the US cannabis industry. This supports our view that a significant sum of capital is looking for investment opportunities in the US cannabis industry. The deployment of this capital may very well play a role in seeing prices of US cannabis assets being bid higher in the coming months and years, and will contribute meaningfully to an increase in M&A activity.



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Table of Contents

Preface 5

US Cannabis Market Overview: The $60B Opportunity 5

Surveying the Landscape: A Closer Look at the Dynamics in the US Cannabis Market 17

Regulatory and Legal Landscape Governing Cannabis in the US 25

The Financial Perspective: Closing the Valuation Gap with Canadian Operators 30

Capital to Flow from North to South: Be in Position to Catch the Wave 41

Vertically Integrated Operating Model of US MSOs 44

Hemp-Derived CBD Market: Competitive Pressures Likely to Make CBD Less Attractive than THC 47

Branding in the Cannabis Sector 52

M&A Outlook: Acquisition to Remain Likely Method of Expansion, Consolidation to Continue 57

Overview of Key US State Markets 61

Appendix A: Operating Models in the Cannabis Industry 89

Appendix B: Recent Developments on US Federal Cannabis Reform 93

Appendix C: Key Proposed Legislation for US Federal Cannabis Reform 94

Appendix D: Cannabis Industry Comparable Company Analysis 96

Appendix E: Key Investment Criteria 97



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Preface

Our report frequently makes reference to two groups of cannabis companies: Large Cap US MSOs and Large Cap Canadian Operators. We have constructed these two groups of companies for the purposes of tracking comparative measures of value such as EV/EBITDA, EV/Sales, and cumulative measures of both.

We compiled each group using nine of the largest cannabis firms domiciled in each country by both operational footprint and market capitalization. We believe these groups of companies are most reflective of the business fundamentals and financial performance of leading firms in the two markets (US and Canada/International). We also feel this grouping best reflects the way in which investors view the opportunities for exposure to leading businesses in each of the two markets.

Our group of MSOs specifically refers to the largest US cannabis businesses (by market capitalization) with an operating presence in at least 10 states (with one exception noted). Refer to Appendix D for our comp table that includes a list of all companies in both our tracking groups.

We also wish to point out that all references to the “cannabis market” or “cannabis industry” are specifically speaking to the sale of products containing THC from the marijuana plant, and do not include sales of hemp-derived CBD products. We separately reference hemp-derived CBD where appropriate in the report to clearly make this distinction.

All figures in the report are in US Dollars unless otherwise noted.

US Cannabis Market Overview: The $60B Opportunity

The US will Remain the Largest Cannabis Market Opportunity in the World for the Foreseeable Future

With a population of ~327M, and an economy of ~$21T in annual GDP, more than two-thirds of which is driven by consumer spending, the US continues to represent the largest and most attractive market in the world for most CPG brands and categories. It is our view that cannabis is, and will be, no exception to this.

Despite the illegality of cannabis at the federal level, the US is home to the largest legal cannabis market in the world today. There are currently ~220M residents of the US living in jurisdictions with access to legal cannabis in some form. The opportunity, and indeed likelihood, for this figure to continue to grow as more states continue to legalize cannabis is significant, with a further ~107M residents still yet to enjoy access to legal cannabis.



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Exhibit 1 – Legal Status of Cannabis and Estimated Legal Spending in the US States

Source: US Census Bureau, Arcview Market Research, Echelon Wealth Partners



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$0

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1 Canadian spending per user in 2022 based on combined adult and medical usage

$3,955

$3,164 $3,164 $3,164

$2,884$2,640

$1,723 $1,702$1,552 $1,398

$1,034

Medical Market Average, $3,362

Rec Market Average, $1,848

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NY FL PA NJ NV CO WA CA MA OR CAN(1)

2022 Estimated Annual Legal Spending Per User (US$)

This addressable consumer base for the legal cannabis industry in the US, as it stands, is a multiple of that of any other legal cannabis market in the world. However, the difference in the size of the US opportunity compared to the global markets goes beyond simply the number of residents living in a jurisdiction with legal cannabis.

The US market is also home to, on average, a more affluent consumer than most any other nation with a legal cannabis market. In addition, the usage rates for cannabis in the major US markets are near the highest of any country in the world, particularly in states with a history of a more progressive culture and legal treatment of cannabis.

Exhibit 2 – National GDP, GDP Per Capita, and Forecasted Legal Cannabis Spending

Source: World Bank, Arcview Market Research, Echelon Wealth Partners

The combination of a relatively high prevalence of usage, lesser social stigma, and higher disposable income translates to much higher potential spending on a per user basis. Even compared to Canadians – who are amongst the more affluent consumer populations and amongst the more frequent users of cannabis in the world – legal cannabis users in the US, on average, spend significantly more on cannabis each year on a per capita basis.

Exhibit 3 – Legal Cannabis Spending Per User in Various Jurisdictions (2017E vs. 2022E)

Source: Statistics Canada, Arcview Market Research, Echelon Wealth Partners

How Big? Sizing the Potential $60B Opportunity in US Cannabis

Just how big is the potential market opportunity for legal cannabis in the US? We estimate the range of the potential market size for legal cannabis in the US to be between $48B and $72B, holding either variable constant, with the mid-point implying a potential market size of $60B. The table below shows the sensitivity within these ranges based on variables of cannabis usage rates and annual spending per consumer across the US.

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GDP (US$B, 2017) Forecasted Cannabis Market Size (US$B 2024)

1 Canadian spending per user in 2017 based on medical usage only

$3,763

$3,312

$3,011 $3,011 $3,011$2,860

$2,039

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2017 Estimated Annual Legal Spending Per User (US$)



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Exhibit 4 – Long-Term Potential for Legal US Cannabis Market

Source: US Census Bureau, National Survey on Drug Use and Health, Arcview Market Research, Echelon Wealth Partners estimates

An upside scenario for each variable assumes a national cannabis usage rate of 12% amongst adults over the age of 21, and average spending of $3,000 per user per annum. Our mid-point of the range assumes a usage rate of 10% nationally, and annual spending per cannabis user of $2,500. These mid-point estimates are based on the current and forecasted per user spending across various legal cannabis markets in the US, and the broad average of usership across 10 of the largest legal cannabis markets in the US today.

We note this range of potential market sizes is calculated under a scenario with the following basic assumptions:

An average user rate and spending per user amongst the adult population throughout the US;

o Regular user is defined as someone that uses at least once per month.

Recreational and medical cannabis being legal across all 50 states;

Effectively all cannabis demand has been absorbed by the legal market;

o Inherently assumes legal cannabis markets are developed and competitive, with rational excise tax schemes to allow for prices to be competitive enough so as to not entice the vast majority of consumers to use illicit product.

All state markets have sufficiently developed to allow for the following:

o Consumers have convenient access to legal cannabis products in all jurisdictions, similar to most any other legal consumer staple product (alcohol, tobacco, etc.);

o Adequate supply of product to meet the market’s demand.

We believe it would be an unreasonable assumption to suggest anything resembling a cannabis market at its full potential, in line with the estimates we present above, will be reached within the next several years. In the era that follows the repeal of prohibition, the process of developing the legal avenues for cannabis sales and absorbing illicit demand will continue to take time, and the runway for super-normal growth rates in the cannabis industry is significant in our view.

We believe that usage rates of cannabis will only continue to rise over time, particularly as the demographics shift towards younger generations who will have grown up in an environment where legal cannabis is the norm, and in a cultural backdrop where its use carries less social stigma. A current assumption of a national average of 10% cannabis usage rate amongst adults suggests there are approximately 24M cannabis users in the US. An assumption of 12% of the adult population being regular cannabis users would suggest a user base of as many as 30M by 2021.

Table in $M Per User Spending (Annual, $)

$2,000 $2,250 $2,500 $2,750 $3,000

8.0% $38,286 $43,071 $47,857 $52,643 $57,428

9.0% $43,071 $48,455 $53,839 $59,223 $64,607

10.0% $47,857 $53,839 $59,821 $65,803 $71,786

11.0% $52,643 $59,223 $65,803 $72,384 $78,964

12.0% $57,428 $64,607 $71,786 $78,964 $86,143

Usage Rate

(Annual)



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Exhibit 5 – Forecast of Potential Cannabis Users

Source: US Census Bureau, National Survey on Drug Use and Health, Echelon Wealth Partners estimates

We also note that this market model only contemplates cannabis products that today are sold through regulated channels, meaning that they would be derived from the THC-containing form of the plant. Our potential market size does not include hemp-derived CBD infused products that have been made federally legal with the passing of the Farm Bill in 2018. We feel these markets are best viewed, at least for the time being, as distinct from one another, given the various differences in regulatory frameworks under which they operate, legal sales channels, and the consumer categories in which these products will compete in or disrupt. We discuss the potential market for hemp-derived CBD products here in the report.

In the sections that follow, we walk through the basis for our assumptions in our market sizing model, using a bottom up approach, and also compare the potential legal cannabis market opportunity against other US CPG categories to sense check our estimates.

How Does the Potential Cannabis Market Stack up Against Other CPG Categories?

The long-term potential for the cannabis market in the US is quite significant when compared to other CPG categories, which is particularly important when considering the disruptive impact it is likely to have on the markets for a number of these products.

We feel the most appropriate categories to use as comparatives to the cannabis market are alcohol and tobacco, due to their similarities with respect to increased regulatory burdens, subjection to excise taxes, age restrictions on consumption, and restrictions on location and occasions for consumption. In our view, this perspective has been validated by the oft-cited landmark investments into the cannabis space from strategic multi-national CPG firms, both of which came from the alcohol (Constellation Brands) and tobacco (Altria and Imperial Brands (IMB-LON, NR)) industries, as we discussed here.

However, we also compare the potential for the legal cannabis market to annual spending in other CPG categories which cannabis has the potential to disrupt, in order to illustrate the scale of consumer demand which the industry may tap into.

2017 2018 2019 2020 2021

239.3 241.3 243.6 245.8 248.1

8.0% 19.1 19.3 19.5 19.7 19.8

9.0% 21.5 21.7 21.9 22.1 22.3

10.0% 23.9 24.1 24.4 24.6 24.8

11.0% 26.3 26.5 26.8 27.0 27.3

12.0% 28.7 29.0 29.2 29.5 29.8

Population Forecast (Aged 21+) (M)

Number of US Cannabis Users - Sensitivity Matrix (M)

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Exhibit 6 – Comparison of Potential Cannabis Market Against Mature CPG Categories

Source: Euromonitor, Echelon Wealth Partners estimates

Our potential market size band suggests that the US cannabis market, in a mature state, has the potential to reach somewhere between roughly one-fifth and one-third the size of the alcohol market. This would also imply a market opportunity that could reach between 40-60% of annual spending on tobacco products in the US. This is a sizeable opportunity to be sure, and enough for CPG firms active in other categories to sit up and take notice.

Can Cannabis be Bigger than Alcohol? Not Likely, at Least not Any Time Soon

However, we do not share the outlook of some more aggressive cannabis bulls that the market has the potential to be “as big or bigger than alcohol”, at least not over any time horizon that is relevant for investors. This would necessitate a complete demographic shift with the replacement of Baby Boomers and Gen X with Millennials, and the cohorts that are to follow.

Alcohol consumption, even more so than tobacco consumption, is completely entrenched within our social and cultural traditions, with entire industries, such as bars and restaurants, live sporting events, night clubs, and others, built around occasions and venues for which to consume alcohol. This is not something that we see changing drastically in the foreseeable future, and no such comparable system exists to accommodate cannabis consumption to the point where it can reach a similar level of total usage and spending.

Near-Term Projections see Market at $30B by 2024

To get a better view of where the legal market opportunity is headed over the next five years, we take a look at the market forecast out to 2024, with the help of projections from cannabis market research firms Arcview Group and BDS Analytics. The forecasts for legal spending on recreational and medical cannabis in 2018 through 2024 see the US market growing from $9.9B to $30.1B, which implies a CAGR of 20.4% for the period, spurred in part by the addition of new legal markets, as well as the conversion of key markets from medical to adult-use.

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Est. US Cannabis Market Size

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Estimated Potential US Cannabis Market vs. Mature CPG Categories



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Exhibit 7 – Estimated Actual and Forecasted Legal Cannabis Spending in US (2014-2024)

Source: Arcview Market Research, Echelon Wealth Partners

US Market to Drive Majority of Legal Cannabis Spending for the Foreseeable Future

One of the primary tenets of our bullish investment thesis for the US cannabis space is the sheer scale of the opportunity. This is made that much clearer when viewed in relation to the size of the cannabis opportunity throughout the rest of the world. Taking a look at which legal markets will drive the majority of consumer spending in cannabis, there is no comparison between the size of the opportunity in the US compared to both Canada and the rest of the global legal markets.

Exhibit 8 – US Legal Cannabis Market Compared to the Global Legal Cannabis Market


Based on forecasts from Arcview Group and BDS Analytics, the US cannabis market will maintain a roughly 75% share of global legal cannabis spending as far out as 2024. A significant part of this is simply due to the fact that the population

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Medical Adult-Use

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with access to recreational cannabis in the US vastly outweighs that of the rest of the world at this time. The US currently has a population of 92M residents living in jurisdictions with legal recreational cannabis, and this number is only set to increase with the potential for legalization of adult-use in states such as NY (19.5M), NJ (8.9M), AZ (7.2M) and others before the end of 2020, possibly bringing this figure to more than 130M.

While Canada (37M residents) recently legalized recreational cannabis, the ramp up in the legal market has been significantly slower than previously anticipated, due to a host of issues with supply chain and retail roll out. While much has been made about the opportunity presented by other global legal cannabis markets, the majority of these jurisdictions (with the possible exception of Mexico in the near future) are, and will remain restricted to, medical cannabis for the foreseeable future.

Coupled with the relative affluence and proclivity for spending of the US consumer, the addressable market opportunity afforded to US cannabis businesses is easily larger than the sum of all other market opportunities available worldwide.

A Closer Look at Cannabis Usage and Spending Amongst US Consumers

Cannabis Usage Rates in America

Usage rates for cannabis can significantly differ from state to state, depending on the legal status, societal views, and market demographics. Based on survey data, ~10% of Americans consider themselves to be regular users of cannabis, which we define as at least monthly usage. This figure translates to approximately 24M users nationally, in both the illicit and legal markets, as seen previously in Exhibit 5.

Exhibit 9 – Regular Cannabis Users as Percentage of Adult Population by Market

Source: Statistics Canada, Arcview Market Research, Echelon Wealth Partners estimates

Cannabis legalization, particularly adult-use legalization, does tend to correlate to higher user rates in those markets, in our view, as a result of both providing legal channels to access product and helping to remove some of the social stigma that surrounds its use. We see that in Colorado, and Canada, cannabis usage rates have moved higher in the years that followed recreational legalization.

1 Cannabis use in the past month for those aged 18+, except Canada where usage

rates are in the past 3 months for those aged 15+2 Canada uses Q119 data to capture first full quarter of adult-use market

Adult-Use Average, 13.9%

Medical Average,

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Exhibit 10 – Cannabis Usage Rates Before and After Adult-Use Legalization

Source: Statistics Canada, SAMHSA/National Survey on Drug Use and Health, Echelon Wealth Partners estimates

From this, we can reasonably conclude that similar trends would result from adult-use legalization in other markets. We believe it is a reasonable assumption that over the longer term, as social stigma around cannabis continues to dissipate and assuming that legalization has spread to all 50 states, cannabis usage rates could conceivably climb from ~10% to ~12% nationally, and over the much longer term, possibly as high as ~15%, consistent with user rates seen in some of the more developed legal markets.

Here, we compare this to the user rates for other regulated CPG products that are often cited as the most appropriate comparatives for cannabis – alcohol and tobacco.

Exhibit 11 – Usage Rates of Cannabis and Regulated Consumer Products in the US

Source: SAMHSA/National Survey on Drug Use and Health, Echelon Wealth Partners

We see that today regular cannabis use is roughly half as common as tobacco usage, and roughly one-fifth as common as alcohol usage in the US.

However, the outlook for alcohol and tobacco use is starkly different from that of cannabis. An increasingly health conscious public, market saturation and competition from substitute products are all potential headwinds for the growth in users for these categories, which in part have driven leading alcohol and tobacco firms such as Constellation Brands and Altria to begin hedging their positions with investments in cannabis. While these moves were certainly made with an eye to gain exposure to the incredible growth opportunity offered by this new market, we also see these investments as a defensive move on their part.

Note: Canada's usage rate based on population aged 15+ in past three months, Colorado usage rate based on population aged 18+ in past month

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Over the next decade, we expect that tobacco usage rates will continue to decline, in particular due to displacement from nicotine vaporizer products. We would expect that alcohol usage rates will remain stable, though total volumes consumed and dollars spent may experience slower growth as we have seen with consumption volumes and dollar spending on beer in the US.

Exhibit 12 – Growth in Legal Cannabis Spending and Related Products (CAGR, 2018-2023)

Source: Euromonitor, Arcview Market Research, Echelon Wealth Partners

The potential for these categories’ share of consumer dollars to be cannibalized by legal cannabis sales has also been documented in several studies, which noted the substitution effect observed in certain markets amongst these goods. Though limited, these studies have shown evidence that alcohol consumption in legal states can drop by up to 15% and that the substitution effect for tobacco usage amongst cannabis was up to 12%. Extrapolating these possible substitution effects, the potential cannibalization of sales of alcohol and tobacco products by legal cannabis may be as much as $50B annually.

Exhibit 13 – Potential Lost Sales in Alcohol and Tobacco Due to Legalized Cannabis

Source: Euromonitor, International Journal of Drug Policy, University of Connecticut, Georgia State University, Echelon Wealth Partners

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Cannabis Category Drives Significant Spending per User Relative to Alcohol, Tobacco

Based on data for both illicit and legal spending on cannabis in the US, annual spending on a per user basis is surprisingly high. The average spending per user on all cannabis products (illicit and legal) in the US is estimated to be ~$2,220 per year, with average legal spending per consumer ranging between ~$1,450 and ~$2,950 across recreational and medical markets, respectively. This compares to estimated annual spending of ~$2,100 per year for each regular user of tobacco, and $1,740 per year for regular consumers of alcohol.

Exhibit 14 – Average Annual Spending per User for Cannabis, Alcohol and Tobacco

Source: US Census Bureau, MJ Biz Daily, Arcview Market Research, National Survey on Drug Use and Health, Echelon Wealth Partners

Medical-only markets see more significant spending per user, which we have included above for illustrative purposes, with data showing certain markets supporting per user spending in excess of $3,000 annually. However, we would hesitate to extrapolate these higher per user spending figures onto a broader recreational market given that they are likely not representative of adult-use spending rates in a competitive marketplace. Medical patients are typically heavier users who are less price sensitive and more likely to demand high quality products in advanced formats, depending on their specific condition. In addition, several medical-only markets are limited-license programs and are therefore likely to be less competitive than developed adult-use markets, and may suffer from supply and access shortages, which could result in higher prices.

Product Sophistication and Consumer Education are the Keys to Driving Spending Growth

Over time, we expect per user spending to remain strong, and most likely increase, as a result of a number of factors, including:

1) A greater tendency for consumer preferences to migrate towards higher margin product formats (here),

2) More sophisticated branding and development of brand loyalty,

3) A more highly stratified product offering catering to a more educated consumer base,

4) The ability to use credit cards for purchases of cannabis, and

5) Greater access to, and availability of, cannabis products, including additional storefronts and home delivery options.

Similar to the premiumization trends seen in consumers of craft beer, premium spirits and artisanal coffees, we believe consumers of cannabis will generally be willing to spend more as they become increasingly familiar about the various

1 Combined average cannabis spending includes estimate for both legal and illicit cannabis sales

Rec Average, $1,470

Combined Average, $2,216

$2,097

$1,740

Medical User Average, $2,942

-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

Cannabis Tobacco Alcohol

An

nu

al S

pen

din

g p

er U

ser

($)

US Average Annual Expenditure per User (2017)1



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products and brands. We see the buying behaviour of cannabis consumers eventually resembling that of alcohol, where consumers are willing to pay higher prices per serving for beer, wine, and whisky as their education level about the products improves.

Therefore, we would expect the average cannabis user spending on an annual basis to continue to grow over time, as the market and consumer tastes mature. The expectation of per-user spending growth is also reflected in estimates from Arcview Group and BDS Analytics, as highlighted in Exhibit 3.



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Surveying the Landscape: A Closer Look at the Dynamics in the US Cannabis Market

Legal Cannabis will Disrupt Major Consumer Packaged Goods Categories

One of the keys to understanding the commercial and societal influence of cannabis legalization is to recognize its impact on a number of other non-durable CPG categories. The effects of a legal cannabis market will disrupt, and potentially reshape, a number of adjacent consumer product categories, including alcoholic beverages, tobacco, health supplements, cosmetics and skin care, functional beverages, and pharmaceuticals.

In the legal markets across North America in particular, cannabis has already begun its transformation from an illicit plant-based drug to a refined CPG product, with unique delivery formats, sophisticated branding, and extensive retail and online distribution.

Moreover, the category is not dependent on the development of a completely new consumer base who are unfamiliar with the product. The legalization of cannabis represents the emergence of a completely new and disruptive consumer goods category, which is already supported by tens of billions of dollars of existing sales and pent up demand from consumers in the illicit market. This is a unique and important feature of the burgeoning cannabis industry relative to other new industries and product categories, because we have much greater visibility, albeit still not perfect, on the demand for the products. This makes the opportunity that much more attractive from a commercial perspective.

State Pride: The US is Really a Mosaic of Separate State Markets

While we refer to the US cannabis opportunity at the national level as the largest in the world, it is more instructive within the current regulatory environment to view each individual state as its own distinct market, separate from others. This is a function of the legal restrictions on conducting commerce across state lines due to the plant’s illicit status at the federal level (see here for more discussion on the legal status of cannabis in the US).

If we take a look at the states as distinct markets in the context of global opportunities, we still find that five of the top six largest markets globally, based on forecasts of 2024 spending, are individual US states. This only serves to highlight the depth and scale of the market opportunity across the US relative to other global markets.

Exhibit 15 – US State Cannabis Markets vs. International Markets (2024 Est.)

Source: Arcview Market Research, World Bank, US Census Bureau, Echelon Wealth Partners

Population (M)

2018 2024 2018

California $2.5 $7.2 39.6

Canada $0.6 $5.2 36.7

Colorado $1.5 $2.0 5.7

Florida $0.6 $1.9 21.3

New York $0.0 $1.7 19.5

Nevada $0.6 $1.4 3.0

Germany $0.1 $1.4 82.7

Rest of Europe $0.2 $1.4 363.7

Massachusetts $0.2 $1.2 6.9

Illinois $0.1 $1.1 12.7

Mexico $0.0 $1.0 129.2

UK $0.0 $0.5 66.0

Pennsylvania $0.1 $0.4 12.8

Australia $0.0 $0.1 24.6

Brazil $0.0 $0.0 209.3

Colombia $0.0 $0.0 49.1

Market Size Estimates 2024

(US$B)

-

50

100

150

200

250

300

350

400

-

$1.0

$2.0

$3.0

$4.0

$5.0

$6.0

$7.0

$8.0

Po

pu

lati

on

(M

)

Mar

ket

Size

(2

02

4, U

S$B

)

Market Size Forecasts and Population

Market Size Estimates 2024 (US$B) Population



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State-by-State Regulatory Landscape has Implications for Multi-State Operators

The current regulatory environment, which essentially confines each of the state markets from one another, has implications for those cannabis companies with aspirations to build a national, “multi-state” presence, and the way in which they must conduct their expansion into, and operations within, each market.

The primary hurdle for MSOs is that they must be separately licensed to operate in each new market they wish to enter. In addition, regulations with respect to medical versus recreational cannabis consumption, qualifying conditions for obtaining prescriptions, allowable product formats, testing requirements, the total number of licenses issued and excise taxation schemes, can make for vastly different competitive environments in each market.

It should be noted that the oft-referenced federal restriction on interstate commerce is applicable to products derived from the THC-containing plant, referred to most commonly as “cannabis” or “marijuana”. After the passage of the Farm Bill in December 2018, interstate restrictions on commercial activity with the hemp plant (defined as cannabis containing <0.3% THC concentration) have been lifted at the federal level, despite that final guidelines from the USDA and Food and Drug Administration (“FDA”) have yet to be issued. A more in-depth overview of the hemp-derived CBD market opportunity can be found here.

Converting Illicit Cannabis Users can Take Some Time

One of the most attractive aspects of the burgeoning legal cannabis market is the idea that companies are able to simply tap into the pre-existing demand for the products, by converting billions in illicit spending over to the legal channels. While the advancements in product development, marketing and changing social attitudes will attract first-time consumers into market in the coming years, we believe it is plainly evident that the most significant growth driver in the early years of legalization is the conversion of illicit spending to legal spending.

However, it should be noted that the process of converting illicit users to the legal market is not always an easy task. Depending on the depth and pervasiveness of the illicit channels in a particular region, the excise tax schemes (which could make legal pricing uncompetitive) and the willingness of local law enforcement to shut down illicit producers and retailers, the ability for the legal channels to penetrate the illicit market may be hampered.

Even within those markets that have been the early adopters of legal recreational cannabis, the illicit market can continue to persist, and even thrive, for years.



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Exhibit 16 – Estimates of Illicit Market Share in Various State and National Cannabis Markets (2017)


We believe branding will go a long way in assisting this transition to legal channels. We liken the period following cannabis legalization to the end of alcohol prohibition. Consumers who were previously purchasing a good from the black market, where considerations of brand loyalty were more or less non-existent, will eventually transition their purchases to the legal market, and over time, develop preferences for certain brands and products. We further discuss branding in the cannabis sector here.

The fact remains that the penetration rate of the legal channels into the illicit market has a meaningful way to go before absorbing all of the existing demand; we view this as a process that will take years.

Medical versus Recreational Channels: Distinction Remains Blurred in Many Markets

Within the illicit and legal markets, cannabis straddles two categories that, on the surface, appear completely distinct – the medical and recreational (or adult-use) markets. We know, however, that consumers use cannabis for a multitude of reasons, and this distinction between medical and recreational users is not quite so clear cut.

Cannabis users may have a wide variety of reasons for using the substance, ranging from sleep aid, pain management and anxiety relief to more lifestyle and recreational uses such as mental focus, social occasions, and relaxation. Indeed, some users straddle the two categories, using cannabis for both specific medical needs and recreational purposes. We would categorize these consumers as “dual users”.

The distribution of users between the medical and recreational categories is more accurately framed in the context of a continuum between purely recreational and purely medical use, with a large overlap between the two, which we would term “wellness and lifestyle enhancement”.

Exhibit 17 – Continuum Between Medical and Recreational Users

Source: Echelon Wealth Partners

1 Nevada, California and Canada were medical markets in 2017, and are noted as such in the chart.

96%

93%

92%

86%

78%

71%

61%

50%

33%

- 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

IL

MA

CAN

US Average

CA

NV

OR

WA

CO

Illicit Market Share of Total Cannabis Spending (2017)1

Adult-UseMedical

Medical Health and Wellness Recreational



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One of the best data points we have found to highlight this was the 2018 Deloitte Cannabis Report, which surveyed recreational cannabis users in Canada as to the reasons they used cannabis.

Exhibit 18 – Survey Responses on Reasons for Using Recreational Cannabis*

*While we have not found any similar survey of the American population, we believe it is appropriate to draw inferences from the data as to the reason is largely reflective of cannabis users in the US given the similarities between the demographics and social culture in the two countries.

Source: Deloitte 2018 Cannabis Report

The responses clearly reflect the reality of “dual users”, and the blurred line between medical and recreational use. Three of the top four responses for reasons why recreational users consumed cannabis would be fairly categorized as “wellness and lifestyle enhancement”, including sleep and relaxation (66%), reduction of stress and anxiety (62%), and improving mood (48%). In addition, 29% of respondents stated they used recreational cannabis to self medicate for the relief of specific conditions. We believe the data supports the conclusion that a significant portion of recreational cannabis users would fall into the wellness category, or dual users.

Strong Business Case for Cannabis Firms to be Active in Both Channels

Historically, legal cannabis markets have opened with legalized medical cannabis, which acts as both:

i) A politically defensible means for legalization which is more likely to receive support from opposing politicians and a potentially weary voter base, and

ii) As a ‘beta test’ for regulators on a much smaller and more manageable scale compared to full scale adult-use legalization. This has been the experience in both Canada and the US states where medical and recreational cannabis are now legal.

An early presence in the medical market allows businesses to establish production facilities, manufacturing processes, distribution networks and compliance practices, and begin to build brand awareness amongst consumers prior to the roll out of the larger recreational market. Particularly in limited-license markets, this tends to position businesses to be amongst the early leaders in the recreational markets.

In our view, however, the scale of commercial opportunity in recreational channels in most markets vastly outweighs the medical channel, particularly when accounting for the portion of registered patients in medical-only markets who are pseudo-medical users, that is, recreational or wellness and lifestyle users who are simply looking to obtain cannabis through legal channels. These users are likely to switch to recreational sales channels to obtain legal cannabis, if and when the option becomes available.

The primary reasons for this, we believe, are threefold:

Increased consumer access and convenience;

Lack of need for a prescription;

Increased consumer choice with respect to product and brand selection.



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We have seen this reflected in the data for both legal cannabis sales based on channel and patient counts, in the periods following recreational legalization in a number of US states.

Exhibit 19 – Medical Channel and Adult-Use Channels Post-Legalization

Source: Nevada Department of Taxation, State of Colorado, Arcview Market Research, BDS Analytics, Echelon Wealth Partners

We note that the transition from a medical to adult-use market, in many cases, can serve to grow the potential size of the total legal market by a multiple of 3x or 4x in a given jurisdiction.

Implications for Branding and Channel Strategies

The fact that there are two relatively distinct sales channels (medical and recreational), but not as clear of a distinction between the categories of cannabis users, we can draw some important implications for cannabis businesses with respect to branding and sales channel strategies.

First, brands designed for sale in recreational markets must keep in mind that a sizeable portion of their

consumer base is not using cannabis for what are considered purely “recreational” purposes. A meaningful

portion of recreational consumers are using cannabis for wellness and lifestyle enhancement. Companies would be

wise to have core brands in their portfolio with wide appeal that can cater to users that constitute this segment of

the user base;

Second, brands seeking to cater to medical cannabis users, particularly in markets with legal recreational sales,

would be well served by designing brands that would also place well in recreational sales channels. Those seeking

to cater to consumers who meet the definition of strict medical users, via only the medical sales channel, are likely

to see their consumer base dwindle as customers transition to recreational channels to meet both their medical

and wellness needs.

For the time being, we believe the largest players in the US (and internationally) will continue to serve both channels and will continue using the medical channel as a means for early market entry.

30%

79%70%

21%

-

10%

20%

30%

40%

50%

60%

70%

80%

90%

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18

Jan

-19

Ap

r-1

9

Mar

ket

Shar

e

Colorado Cannabis Market Share (Jan 2014 - May 2019)

Adult-Use as a % of Total Market Medical as % of Total Market

$143

$114

$29

-

$20

$40

$60

$80

$100

$120

$140

$160

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18

Jan

-19

Ap

r-1

9

Mo

nth

ly L

egal

Can

nab

is S

ales

($

M)

Colorado Monthly Cannabis Sales (Jan 2014 - May 2019)

Monthly Sales (US$M) Adult-Use Sales (US$M) Medical Sales (US$M)

May-17, 28,308

June-18, 16,934

May-19, 17,623

-

5,000

10,000

15,000

20,000

25,000

30,000

Jan

-15

Mar

-15

May

-15

Jul-

15

Sep

-15

No

v-1

5

Jan

-16

Mar

-16

May

-16

Jul-

16

Sep

-16

No

v-1

6

Jan

-17

Mar

-17

May

-17

Jul-

17

Sep

-17

No

v-1

7

Jan

-18

Mar

-18

May

-18

Jul-

18

Sep

-18

No

v-1

8

Jan

-19

Mar

-19

May

-19

Act

ive

Pat

ien

t C

ard

ho

lder

s

Nevada Active Patient Count (Jan 2015 - May 2019)

Adult Use Sales Begin

904,200

87,720

- -- -

$3.0

$0.3

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

2017 2018

Me

dic

al C

ann

abis

Sal

es

(US$

B)

Me

dic

al C

ann

abis

Pat

ien

ts

California Medical Cannabis Market

Est. California Patients Est. California Medical Sales

Adult-use cannabis implemented



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Form Factors: Trend Towards Derivative Products to Continue as Consumer Tastes Evolve

Most state markets are displaying a strong trend in changing consumer preferences, as they shift away from traditional smokable dried flower towards derivative formats, such as vapes, extracts, edibles, and beverages. All of these formats use extracted cannabinoids as an input into the various delivery formats.

Colorado saw dried flower comprise less than half of total legal sales in 2018, at 45%, while other states with mature markets such as California, Oregon, and Washington also saw non-flower categories comprise roughly 50% of total sales.

Exhibit 20 – Market Share by Category in Colorado (2018)

Source: Arcview Market Research, BDS Analytics, Echelon Wealth Partners

Such formats serve as alternatives means of consumption for cannabis consumers who have an aversion to smoking. These formats also have appeal because they are more discreet than combustion of dried flower, and serve as a far more approachable, user-friendly method to consume cannabis for first time or inexperienced users. In our view, a more health conscious public, as well as the continued improvements in creative new format development – such as advances in beverage emulsification technology, and greater predictability and control of onset and offset time for ingestible products – will only serve to push more users towards these formats as an alternative to dried flower.

Exhibit 21 – Market Share by Category (2017 vs. Forecasted 2022 US Legal Sales)


Flower, 45%

Concentrate,

34%

Edibles, 13%

Other, 8%

Colorado Market Share by Category (2018)

50%

36%

23% 36%

15% 14%

12% 14%

-

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2017 2022

Forecasted Category Share Across US Cannabis Markets

(% of Spending)

Flower Concentrates Edibles Other



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Notwithstanding certain medical markets which restrict the sale of dried flower products, it does remain the single largest product category by dollar share of total spending in the market today. However, the trend towards derivate-based categories is not expected to slow soon. Forecasts predict that by 2022, dried flower will account for just 36% of total legal cannabis spending across legal US markets. Over the long term, particularly as new cannabis users continue to enter the market, we see this number continuing to decline, potentially reaching as low as 20% of total spending.

Data collected from some of the more developed adult-use markets also highlights the significantly higher pricing and margins for derivative products in the vapes and concentrates category relative to dried flower and pre-roll categories. While not quite a perfect equivalent (as it requires a few grams of dried flower and trim to manufacture one gram of derivative product), we see derivative products selling for an average of 7-10x the price of dried flower on a per gram basis across these markets.

Exhibit 22 – Average Price per Gram for Various Product Formats in Adult-Use Markets (2019)

Source: Headset Inc., Echelon Wealth Partners

Dried flower will continue to be an important part of the market. While we do expect compression of dried flower prices on the wholesale market as supply chains continue to develop in maturing markets, we still do not expect dried flower to become completely commoditized in the retail market. In developed markets, we see this category stratifying into a value segment aimed at cost-conscious consumers, and a craft/premium product segment aimed at the connoisseur audience.

The clear implication for MSOs and other cannabis businesses focused on building a portfolio of branded, CPG products in the sector, is to continue to invest in product innovation and branding, both of which are key to winning market share in these fast growing categories.

Plenty of Blue Sky Left: Many Market Opportunities Still to Open up as States Consider Potential Medical or Recreational Legalization

The progress of cannabis-related legalization remains one of the most significant catalysts for growth in the US legal cannabis market. Despite the meaningful progress that has been made in recent years, the potential opportunities for growth that lie ahead, simply by opening access to new legal markets, are tremendous. We view this type of potential growth as the “low hanging fruit” for MSOs, as legalization in a new jurisdiction allows them to access the significant pent up demand that already exists in these markets, and depending on the regulatory environment, in some cases, without much in the way of competition.

Looking at the broader US cannabis marketplace, we see three primary drivers for new market opportunities directly related to legislation and regulation changes.

-

$20

$40

$60

$80

$100

$120

Vape Pens Concentrates Flower Pre-roll

Pri

ce p

er G

ram

($

)

Pricing by Product Format in Adult-Use Markets

Nevada California Colorado Washington



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Highly populous states that have yet to legalize medical cannabis: Despite all the progress being made both

nationally and globally on this front, governments in certain jurisdictions can be significantly more reluctant to “dip

their toes” into the legalization of cannabis, so to speak, even via a legal medical market. Some of the most

populous states in the US have yet to be opened to the legal cannabis market in any capacity, including Texas

(28.7M), Georgia (10.5M) and North Carolina (10.4M), the three of which account for nearly 15% of the US

population.

Exhibit 23 – States Without Legalized Cannabis


States that may liberalize their medical cannabis programs: Governments in some medical cannabis markets have

severely restricted access for patients, by allowing prescriptions for only a limited number of conditions that may

not afflict meaningful portions of the population. As more qualifying conditions are added to the list, these markets

can see meaningful growth in registered patient counts, as we have seen in states such as Illinois, which recently

allowed cannabis to be prescribed for opioid substitution, and saw a 50% increase in patient count over the

following six months, with y/y registered patient growth accelerating to upwards of 100%.

Likewise, states with regulations on product formats can also limit the number of registered patients willing to use legal cannabis products.

Exhibit 24 – Acceleration in Registered Medical Cannabis Patient Growth in Illinois

Source: Illinois Department of Public Health, Echelon Wealth Partners

US States Population (2018, M) Medical Cannabis Allowed?

Texas 28.7 CBD-Only

Georgia 10.5 CBD-Only

North Carolina 10.4 CBD-Only

Virginia 8.5 Cannabis Oil <5% THC

Tennessee 6.8 CBD-Only

Indiana 6.7 CBD-Only

Wisconsin 5.8 CBD-Only

South Carolina 5.0 CBD-Only

Alabama 4.9 CBD-Only

Kentucky 4.5 CBD-Only

Iowa 3.2 Cannabis Oil <3% THC

Mississippi 3.0 CBD-Only

Kansas 2.9 CBD-Only

Nebraska 1.9 No

Idaho 1.8 No

South Dakota 0.9 CBD-Only

Wyoming 0.6 CBD-Only

Total 106.0

% of US Population 32.4%

0%

20%

40%

60%

80%

100%

120%

Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19

Pat

ien

t G

row

th (

y/y)

Illinois Y/Y Patient Growth (OAPP Adj.)

OAPP Program introduced & medical cannabis access eased



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States transitioning from medical to recreational cannabis markets: The majority of the US states that initially

began to transition to recreational markets were clustered in the Western US, such as Colorado, Oregon,

Washington, California, and Nevada. However, the push for legalization of adult-use has been gaining significant

traction in the Midwest and North East, with Michigan, Illinois and Massachusetts already having passed legislation,

and strong support from governors in New York and New Jersey to do so as well. Many MSOs have made it a priority

to acquire a presence in these medical markets to position themselves as first movers in anticipation of the move

towards adult-use. We believe it is a conservative estimate that recreational legalization can increase the potential

market opportunity by 3-4x in a given state, and potentially much more.

Regulatory and Legal Landscape Governing Cannabis in the US

History and Federal Illegality

Cannabis has had a long and checkered history with respect to its legal status in the US. A patchwork of various laws and regulations at the federal level governed the use of, and commercial trade in, cannabis throughout the 19th and early 20th centuries. During these periods, while laws did restrict the use of cannabis, hemp and its derivatives due to some perceived dangers and habit-forming characteristics of the substances, it was generally accepted that the substances had some medical applications, for which they were allowed to be used and prescribed.

The outright restriction of the use of cannabis and hemp at the federal level really began in earnest in the 1930s, with the passage of the Marihuana Tax Act in 1937. The legislation imposed an excise tax on hemp, while also deeming the possession or transfer of cannabis (marijuana) illegal throughout the US.

The regulations at the federal level, as we know them today, are largely a product of the Controlled Substances Act of 1970 (effective 1971), which essentially prohibited the use of cannabis for any purpose across the US.

The difficulties faced by both operators and investors in the US cannabis industry stem from the fact that under the Controlled Substances Act, the plant remains an illicit substance at the federal level due to its classification as a Schedule I substance by the US DEA. This classification, in the eyes of the federal agency, means that cannabis has the characteristics of:

A high potential for abuse;

Lack of accepted safety profile for use;

No currently accepted medical use.

Despite a significant volume of mainstream scientific evidence, as well as public sentiment, standing in opposition to these claims, the substance remains classified as such. The restrictions on the use, possession, production, and trade in the substance have hindered both commerce as well as research on the substance in the US, at the same time exacting a significant toll on communities and individuals due to the prosecution of users of cannabis.

Slow, Yet Steady Progress Continues to be Made at the Federal Level

In recent years, we have seen some progress made at the federal level with respect to the legality of cannabis, through a combination of legislative and non-legislative actions. 2018 was a particularly important year on this front, with the acknowledgement of the medical benefit of a plant-derived cannabis pharmaceutical by the DEA, as well as the passage of the 2018 Farm Bill, which legalized industrial hemp at the federal level. The most notable developments are discussed in greater detail below.

The Rohrabacher-Blumenauer Amendment (previously the Rohrabacher-Farr Amendment) is a provision included

in the annual federal spending appropriations bill which prohibits federal funds being used in the prosecution of

individuals and businesses in the medical cannabis industry which are acting in compliance with their state’s laws.

It is important to note that the legislation does not change the legal status of cannabis at the federal level, but

simply provides the aforementioned protections. The provision has been included in the annual spending bill since



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2014, most recently being signed into law by President Trump with the passage of the 2019 spending bill, which

carries the protections through to the legislation’s expiry on September 30, 2019. The provision is not permanent

and must be continually renewed under each annual spending bill.

The 2018 Farm Bill was signed into law in December 2018 by President Trump. The legislation contained the Hemp

Farming Act of 2018, which removes hemp from the Schedule I list of controlled substances and classifies it as an

agricultural commodity. The bill legally defines hemp as the cannabis sativa L plant which contains less than 0.3%

THC content on a dry weight basis. By virtue of removing hemp from the list of Schedule I substances, it allows for

the cultivation, production, and sale of hemp and its derivatives. Most notably, this legally opens up the US market

to hemp-derived CBD products, allowing the compound to be incorporated into consumer goods across a number

of categories, though still subject to some restrictions.

Importantly, the bill also removes numerous hurdles faced by companies involved in hemp cultivation, and production of hemp-derived CBD products. Refer here for further discussion of the implications of the Farm Bill on the sale of hemp and hemp-derived products.

The rescheduling of Epidiolex by the DEA in September 2018 was a landmark change in policy, which implicitly

acknowledges the medical benefits of cannabis by rescheduling a medication derived from the cannabis plant to

Schedule V from Schedule I. Epidiolex is a CBD-based pharmaceutical drug developed by UK-based GW

Pharmaceuticals Plc. (GWPH-US, NR). It was approved by the FDA in June 2018 for use in Lennox Gastaut and Dravet

Syndrome, two rare childhood conditions.

The drug is the first botanically derived cannabis-based pharmaceutical approved for sale in the US. We note that the rescheduling is narrowly applicable only to the specific FDA approved drug itself, and does not constitute a rescheduling of cannabis, THC or CBD as compounds. On some level, this creates an implicit contradiction in the legal status of the cannabis plant itself, in our view. Recall that a Schedule I, as classified by the DEA, is one determined to have “no accepted medicinal benefits”.

While not an impetus for the rescheduling of the entire cannabis plant, it does open the door and create a pathway for any future cannabis-derived drugs to be approved and marketed to patients in the US.

Shifting Sentiment at the Federal Level Indicates Significant Changes are Closer than Ever

The current stance of politicians on Capitol Hill is more amenable to the passage of comprehensive federal cannabis legislation that would, in some capacity, end the current system of federal cannabis prohibition than any time in recent history.

The path to where we find ourselves today was not without its setbacks, particularly in 2018, which saw negative developments such as then Attorney General Jeff Sessions rescinding the Cole Memorandum – an Obama-era document that offered protection from federal prosecution for cannabis businesses complying with state regulations – and the blockage of various cannabis reform policies (including provisions to improve access to banking services) in the House Rules and Ways committee, formerly chaired by Pete Sessions (R).

However, in spite of these actions, politicians at the federal level on both sides of the aisle have been coming forward in increasing numbers to voice their support for some sort of resolution to the conflict between federal and state cannabis laws.

We further discuss a number of recent developments with regards to US federal cannabis legalization in Appendix B.

Potential Game-Changing Legislation on the Horizon

The two most critical pieces of proposed legislation that would reform the legal landscape of the US cannabis sector are the STATES Act and the SAFE Act. Both pieces of legislation would be game-changing for the cannabis industry and would have far-reaching impacts on the operations and finances of US cannabis businesses. These proposed pieces of legislation are discussed in further detail in Appendix C.



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State-Level Regulatory Environment Continues to Shift in Favour of Legalization

Dominoes of Cannabis Legalization Continue to Fall

Despite the plant’s illicit status at the federal level, we continue to see progress being made on the legalization front at the state level across the country, with new states instituting legal medical, and increasingly, recreational cannabis programs, each year.

California was the first US state to legalize cannabis since federal prohibition, with medical cannabis being legalized in 1996. A number of progressive states followed suit and legalized cannabis for medical-use throughout the following two decades. In 2014, Colorado became the first US state since prohibition to allow legal recreational sales of cannabis, sparking the latest chapter in the legalization movement.

This situation has created an inherent conflict between the state’s right to govern the use of cannabis and the illicit classification of cannabis under federal law. While this created many issues for the burgeoning legal cannabis industry, the legalization movement has continued to gain support across the country from both lawmakers at both levels, as well as the broader public.

Exhibit 25 – Americans’ Support for Cannabis Legalization Over Time

Source: Pew Research Center

33 States and Counting

Today, 33 states now allow legal medical or adult-use cannabis sales (22 exclusively medical, and 11 recreational, plus the District of Columbia).

If we include states that permit some form of CBD oil or low-THC oil for limited medical purposes, 48 states now allow some form of cannabis use. Due to the limited commercial opportunities in states allowing CBD oil only, we do not include these states in our definition of a “medical” cannabis market.

Notably, in June 2019, we saw Illinois become the eleventh US state to legalize recreational cannabis, and the first to pass adult-use cannabis laws through the state legislature. It is expected to become one of the largest legal markets in the US in the coming years. Recreational sales are expected to commence in January 2020. California, the country’s largest legal cannabis market, began legal recreational sales in January 2018 after having voted on the matter in 2016, and Michigan voters also gave the green light to recreational cannabis in the 2018 elections. Last year, we also saw three new states vote to legalize medical cannabis – Oklahoma, Utah, and Missouri.



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Exhibit 26 – Legal Status of Cannabis by State

Source: Procon.org, Arcview Market Research, Echelon Wealth Partners

Tailwinds for Legalization: Status of Cannabis Reform at the State Level

Multitude of East Coast States see Momentum Picking up for Recreational Cannabis Legislation

A number of governments and citizen groups pushing for ballot initiatives in medical-only states have expressed their support for recreational cannabis legislation that has either been proposed or is expected to be proposed in the near future. US operators have been positioning themselves in a handful of key states in anticipation of the eventual transition to adult-use programs. We view the states in Exhibit 27 as having the strongest momentum behind recreational cannabis legalization, with the potential to see votes on ballot initiatives or legislation passed as early as 2020.



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Exhibit 27 – States Pursuing Adult-Use Legalization

Source: Echelon Wealth Partners, US Census Bureau

States Population (M) Notes

New York 19.5

- Adult-use cannabis legislation in NY state would be almost certain to create one of the country’s

largest cannabis markets.

- Governor Andrew Cuomo (D) had made cannabis legalization a critical point of his campaign platform.

- Initially intended to pass adult-use legalization as part of the state spending budget in early 2019, but

the legislation was not included in the end.

- After a failed last minute push to pass legislation before the end of the 2019 legislative session, it

now appears that adult-use legalization will be revisited in 2020.

New Jersey 8.9

- NJ government was all but assured to approve adult-use cannabis legislation in March 2019, however,

the vote on the bill was canceled due to a lack of support in the state senate on the day of the vote.

- Would have been just the second state in the country to pass a bill legalizing recreational cannabis

through the state legislature instead of a ballot initiative.

- Expectations are for the adult-use legalization to be revisited in the 2020 ballot.

Arizona 7.2

- Arizona saw a failed attempt to pass adult-use laws via ballot initiative in 2016.

- A push to see the issue voted upon in the 2018 state elections also failed to garner the requisite

support.

- However, we have seen momentum pick up in support of having the issue return on the ballot in

2020, with many observers believing that voters are more likely than not to approve the legalization.

Connecticut 3.6

- Governor Ned Lamont is a vocal supporter of adult-use cannabis legalization, and his appointment

following the November 2018 gubernatorial elections has accelerated the prospect of adult-use

legalization in the state.

- Governor Lamont called cannabis legalization a top priority for the 2019 legislative session.

- Lawmakers introduced a series of draft legalization bills in early 2019 that made reasonable progress,

but were never voted on in the 2019 legislative session.

- The issue is likely to be picked up again in 2020.

Rhode Island 1.1

- Governor Gina Raimondo introduced adult-use legalization as part of the state’s FY2020 budget

proposal.

- However, the legalization measures never made it to the final bill, and instead, lawmakers expanded

the number of medical cannabis licenses allowed.

- We expect the issue may arise again in the next legislative session.

Vermont 0.6

- Vermont approved a bill to legalize cannabis possession, use and home cultivation in May 2017.

- However, it has still not established a legal commercial market for cannabis.

- Various bills to establish commercial sales in the state have stalled, but are widely expected to

eventually be passed.



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The Financial Perspective: Closing the Valuation Gap with Canadian Operators

Finding value in the cannabis space can be difficult given the lofty valuations of many of these businesses, and the inherent uncertainty and relatively higher risk profile of the nascent sector. Some investors have dismissed it altogether as “too speculative” to invest in at the moment, and have elected to stay on the sidelines for the time being due to the difficulty in obtaining visibility on revenues and profitability, limited operational histories of the business, and the ever-changing regulatory environment.

There is no doubt that winners and losers will emerge from these early stages in the development of the cannabis industry and understanding the factors that will dictate those outcomes can be challenging. However, we believe that by applying strong fundamental analysis, investors can manage risk and find exposure to well-run, high-growth companies, with opportunities to earn significant returns.

A Deep Dive into Relative Valuations for Large Cap MSOs and Canadian Operators

With the large cap US MSOs being the focus of our initiation report, we take a deeper look at the valuation parameters of this group of businesses and compare them to valuations for large cap Canadian-based operators.

US MSOs Trading at Significant Discount to Canadian Large Cap Operators on an EBITDA and Sales Basis; Better Opportunities for Multiple Expansion Lie Ahead

EV to EBITDA Basis

Our group of large cap US MSOs are currently trading at an average multiple to consensus C2020 EV/EBITDA of 10.4x (excluding outlier values) ranging from 7.1x to 16.2x amongst the group. This is a roughly 9 turn discount to the average multiple for Canadian Operators, which are currently trading at an average EV to consensus C2020 EBITDA multiple of 19.8x (excluding outlier values), ranging from 12.4x to 42.8x).

Exhibit 28 – EV to C2020 EBITDA Multiples for Large Cap US MSOs vs. Large Cap Canadian Operators

Source: FactSet, Echelon Wealth Partners | Price and consensus data as of 08/08/2019

The average multiple being paid on C2020 EBITDA for US MSOs is actually far more stable over the past four-month tracking period, ranging from about 10x to 17x during that time compared to Canadian operators, having traded in a range of 16x to 48x as a group. For the purposes of smoothing the data, for both our Canadian our US average multiples, we exclude businesses trading at multiples that are extreme outliers to the group, as we discuss in the following section.

10.4x

48.3x

19.8x

Average US, 12.8x

Average CAN, 31.5x

-

10.0x

20.0x

30.0x

40.0x

50.0x

60.0x

05-Apr-19 05-May-19 05-Jun-19 05-Jul-19 05-Aug-19

EV/C

20

20

E EB

ITD

A M

ult

iple

EV to Consensus C2020 EBITDA Multiples (Canadian vs. US Large Cap Cannabis Cos)

Adj. 2020 EV/EBITDA US Large-Cap Adj. 2020 EV/EBITDA CAN Large-Cap



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Importantly, we also point out that the recent pullback in Canadian EV/C2020 EBITDA multiples was driven by an increasing number of companies expected to be EBITDA negative in C2020, which therefore excluded their multiple from the calculation. This implies that the Canadian operators, as a group, are not necessarily less expensive on a C2020 basis than a few months ago, but rather, that the opposite is true.

To adjust for this, if we look at the cumulative enterprise values of the two groups of issuers relative to their cumulative C2020E EBITDA, the premium being paid for forward earnings of large cap Canadian Operators as a group is more accurately reflected. Canadian Operators in our group have a cumulative EV of $27.6B versus just $17.4B for the MSOs – a difference of over $10.2B, despite cumulative consensus C2020 EBITDA for the US operators being more than three times greater than the Canadian peer group. This results in a cumulative multiple on C2020 EBITDA for the peer groups of 58.6x for the Canadian Operators compared to 12.0x for the US MSOs.

In our view, this sets up the MSOs for much better odds of multiple expansion relative to their Canadian peers, particularly as regulatory hurdles are removed, and public market and institutional investor capital moves into the US cannabis sector in a much greater way in the coming years. While we hold the view that the accelerating trend of investment into the US cannabis sector will continue irrespective of any resolution of legal issues surrounding the industry at the federal level, it should accelerate meaningfully if and when these issues are resolved, as we discuss here.

Exhibit 29 – Cumulative C2020 EBITDA vs. Cumulative Enterprise Value

Source: FactSet, Echelon Wealth Partners

We are, however, not oblivious to the fact that evaluating these businesses on multiples on forward EBITDA has some inherent issues with it.

First, as mentioned, some of the large cap Canadian Operators have seen their profitability pushed out beyond 2020. This includes Canopy, Cronos and Tilray (TLRY-US, NR), three of the largest issuers by market cap in the tracking group. Because of this, in our comparison of the average multiples on EBITDA over time, we exclude such outlier values from our calculation of the average, for example, when companies such as Canopy or Tilray had shown multiples of more than 150x C2020 consensus EBITDA due to analysts pushing out their timeline for profitability. This, in our view, provides a fairer picture of the relative valuations for the two groups of businesses at any given time. Even with these adjustments, however, the Canadian Operators are still exceedingly expensive in comparison.

Second, the metric does not ascribe any value to the optionality afforded by large cash positions on the balance sheets of these firms, which inherently will make companies such as Cronos and Canopy, in particular, look more expensive than peers. Companies such as these will not have their relative value accurately reflected by this metric, given that much of the value of the business rests in the optionality afforded by their enormous cash reserves which have yet to be invested. We do acknowledge that investors in these two firms in particular, may see this as the primary driver of value, as opposed to profitability expectations in the next 12 to 18 months.

Cumulative Large-Cap EV - Canada $27,634

Cumulative Large-Cap EV - US $17,426

Cumulative Large-Cap 2020 Sales - Canada $3,612

Cumulative Large-Cap 2020 EBITDA - Canada $472

Implied Large-Cap EBITDA Margin - Canada 13%

Cumulative Large-Cap 2020 Sales - US $5,174

Cumulative Large-Cap 2020 EBITDA - US $1,447

Implied EBITDA Margin - US 28%

EV/Sales of Large-Cap Operators - Canada 7.6x

EV/EBITDA of Large-Cap Operators - Canada 58.6x

EV/Sales of Large-Cap Operators - US 3.4x

EV/EBITDA of Large-Cap Operators - US 12.0x

Valuation Gap between US and Canadian Large-Cap Operators ($M)



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A last point to note, as highlighted in Exhibit 31, is that forward estimates in the cannabis industry have been extremely volatile. This is due to the high degree of uncertainty inherent in forecasting the financial performance of these businesses, which have limited operating histories, a high rate of expected growth, and risks and catalysts arising from quickly changing regulations. Investors should keep this in mind when using any forward metrics to value businesses, as no single metric does a perfect job in telling the entire story.

EV to Sales Basis

We also find it instructive to look at EV to Sales, which inherently assumes the two groups of businesses will have roughly similar margin profiles over the longer term.

Exhibit 30 – EV to Sales Multiples for Large Cap US MSOs vs. Large Cap Canadian Operators


Based on this metric, we see that US operators are currently trading at far less than half of the average multiple on sales than the large cap Canadian Operators are trading at today. The discount for MSOs on a sales basis is even more significant when considered in the context of expected sales growth. The two groups, on a cumulative basis, are both expected to see sales more than double between C2019 and C2020 based on consensus estimates, implying that there is not much rationale for a multiple premium on Canadian operators due to higher expected sales growth.

We also feel it is worthy to note that the pro forma quarterly sales for the largest US MSOs are on par, or greater than, the quarterly cannabis product sales of the largest Canadian Operators at this moment. We only include cannabis related sales as several Canadian Operators have acquired companies with businesses in unrelated industries which have existing non-cannabis businesses, which we feel would inaccurately present the exposure these two groups of companies have to the cannabis market specifically, in their respective geographies.

Exhibit 31 – Last Reported Pro Forma Quarterly Sales for US MSOs vs. Large Cap Canadian Operators

Source: Company Filings, Echelon Wealth Partners

This data highlights the relative scale of the current US cannabis market, across the states in which MSOs have built their businesses. This is not to say we do not expect strong growth in the Canadian cannabis market. We expect Canadian Operators to grow their businesses quite rapidly as the Canadian recreational cannabis market develops, and works though some of its early issues. However, this analysis makes clear, in our view, the size of the opportunity the US MSOs have exposure to relative to the Canadian Operators. This opportunity is only expected to further accelerate in the coming years with major state markets likely transitioning to legal recreational sales.

2019 2020 2021 2020 2021

Canadian 23.6x 8.8x 5.3x 106% 61%

US 8.4x 3.1x 2.2x 160% 54%

Average EV/Sales Multiple Average Sales Growth

$0.0

$20.0

$40.0

$60.0

$80.0

Pro

Fo

rma

Re

ve

nu

es

($M

)

US MSOs Pro Forma Quarterly Revenues (Q119)

$0.0

$20.0

$40.0

$60.0

$80.0

Ca

nn

ab

is R

eve

nu

es

($M

)

Canadian Operators Quarterly Cannabis Sales (Last Reported Quarter)



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US MSOs Sales and EBITDA Forecasts Supportive of Stronger and More Stable Outlook

In assessing the relative valuations on US MSOs and Canadian operators, it is also instructive to look at the consensus expectations which these multiples are based on, and how these have evolved over time.

C2020 expectations for the large cap US MSO group have remained fairly stable over the past several months, with cumulative EBITDA estimates moving from $1.5B at the beginning of the year to over $1.4B today.

The outlook for Canadian Operators in both 2019 and 2020 has worsened considerably in the past several months, as expectations for the broader Canadian cannabis market were overly optimistic. Cumulative estimates for C2019 EBITDA for the group turned negative in May, after previously being as high as $400M in early January 2019. While expectations for both groups declined for 2019, US MSOs on a cumulative basis are expected to be EBITDA positive this year.

Exhibit 31 – Cumulative C2019 and C2020 Consensus Estimates for Sales and EBITDA Over Time


The outlook has not improved all that much based on C2020 consensus estimates either. During the tracking period, analysts have lowered cumulative EBITDA estimates for Canadian Operators estimates by more than half, while cumulative sales estimates have also declined. During this period, five of the nine names have seen downward revisions to consensus estimates for C2020 sales, and eight have seen consensus EBITDA estimates for C2020 lowered.

This is, of course, due in large part to well publicized struggles for the Canadian legal cannabis market, including supply shortages from producers, a strong black market presence, limited product selection, and a lack of dispensaries serving the key markets of Ontario and BC, all having led to a slower-than-expected ramp up of the legal recreational market.

-

$500.0

$1,000.0

$1,500.0

$2,000.0

$2,500.0

$3,000.0

Jan-2019 Feb-2019 Mar-2019 Apr-2019 May-2019 Jun-2019 Jul-2019

Cu

mu

lati

ve C

20

19

Sal

es E

stim

ates

($

M)

Cumulative C2019 Sales Estimates for Large-Cap Companies

Canada US

-

$1,000.0

$2,000.0

$3,000.0

$4,000.0

$5,000.0

$6,000.0


Cu

mu

lati

ve C

20

20

Sal

es E

stim

ates

($

M)

Cumulative C2020 Sales Estimates for Large-Cap Companies

Canada US

($300.0)

($200.0)

($100.0)

-

$100.0

$200.0

$300.0

$400.0

$500.0

$600.0

$700.0


Cu

mu

lati

ve C

20

19

EB

ITD

A E

stim

ates

($

M)

Cumulative C2019 EBITDA Estimates for Large-Cap Companies

Canada US

-

$200.0

$400.0

$600.0

$800.0

$1,000.0

$1,200.0

$1,400.0

$1,600.0

$1,800.0


Cu

mu

lati

ve C

20

20

EB

ITD

A E

stim

ates

($

M)

Cumulative C2020 EBITDA Estimates for Large-Cap Companies

Canada US



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We also acknowledge that a portion of these earnings estimate increases in C2020 for US Operators are a result of M&A activity, including some sizeable transactions which have yet to close. We have accounted for these transactions in our calculations of enterprise value which we used for our multiples quoted above, taking into account the dilutive impact of new share issuances on the multiples for these issuers.

We also highlight both sets of data for investors because we find it instructive to highlight the volatile nature of sales and earnings expectations for cannabis businesses more generally. Estimating the operating results of these businesses is incredibly difficult due to their limited operating histories and the rapidly developing nature of the legal cannabis markets themselves. This should be kept in mind when assessing businesses based on these metrics.

Sell-Off in US MSO Issuers Leads to Opportunistic Entry Point

In recent weeks, US MSOs haven seen a steep sell-off, beginning around late April/early May 2019, during which all large cap US MSOs in our tracking group have seen their shares decline between 21% and 43%.

Exhibit 32 – Large Cap US MSO Share Price Performance (April-August 2019)


We note the divergence between sentiment, and the expectations for financial results. During that time, we have not witnessed any real change in the fundamentals of the underlying businesses, or significant downward revisions to long term forecasted performance. Despite this, share prices have heavily sold off. To us, this suggests that investors with a positive view of the MSO businesses and the fundamentals and catalysts supporting the US cannabis sector as a whole, should strongly consider the current price levels as a potential entry point, or opportunity to add to long positions.

By all measures, US MSOs remain cheaper compared to their Canadian counterparts, and significantly so. In our view, cannabis investors are likely to begin taking a serious look at rotating capital out of the more relatively expensive Canadian Operators and into the relatively less expensive US MSOs, in order to take advantage of this asymmetry.

US Operators have Exposure to Greater Runway for Growth in Existing Markets

Over the next three to five years, we would expect that US operators will have far greater exposure to sales growth in their existing markets relative to Canadian operators.

Anyone taking the view that Canadian firms will enjoy sustainably higher growth rates compared to US firms beyond 2020 would likely have to assume a significant portion of total revenues coming from international markets, such as Europe, LATAM, or even the US CBD category. While we are less bullish on the CBD opportunity than many observers, as we explain here, we also feel the opportunity in international markets is somewhat overplayed relative to the growth that will be experienced in the US.

Note: Return on Acreage Holdings adjusted for cash payment to shareholders for Canopy Growth option

(21%)

(28%)(31%)

(36%)(40%) (40%) (41%)

(43%) (43%)(50%)

(45%)

(40%)

(35%)

(30%)

(25%)

(20%)

(15%)

(10%)

(5%)

-

Total Return of US MSOs (April 29th - August 7th)



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Estimates from Arcview and BDS Analytics suggest that legal cannabis spending in the US will increase by some $20.2B between 2019 and 2024, compared to $4.8B in new spending generated in international medical markets. In our view, the likelihood of attractive US markets pursuing the legalization of adult-use cannabis offers greater growth potential than new international medical markets, suggesting that US MSOs have a much greater runway for growth beyond 2020.

Exhibit 33 – Forecasted Growth in Legal Cannabis Spending, International vs. US (2019-2024)


Another point to note is that similar to MSOs looking to enter new states, Canadian Operators looking to enter new international markets will bear incremental costs associated with this and require additional capital investment and time to scale their operations in these new jurisdictions.

Though Valid Reasons for a Valuation Gap Exist, we See These Being Lifted in the Near Future

In spite of the bullish stance on the US cannabis sector, we acknowledge that there are some fundamental reasons for the valuation gap that exists between Canadian Operators and US MSOs, which are primarily a function of the regulatory and legal environment in which these businesses operate.

While the justification for the magnitude of the relative discount can certainly be debated, there is a sound rationale behind the fact that we see these two groups currently trading at different multiples today. In our view, the four primary causes of the valuation discount are:

i) Tax burden: Due to the scheduling of cannabis at the federal level, cannabis operators face the issue of the non-deductibility of certain expenses for tax purposes under U.S. Code § 280E (referred to as “280E”). This rule causes US cannabis operators to face a significantly higher effective corporate income tax rate, which can, in many cases, range from 40-50% on taxable income – more than double the statutory federal corporate tax rate of 21%;

ii) Access to banking, senior securities exchanges, and implications for cost of capital: Cannabis companies do not have access to traditional banking services from federally regulated banks and financial institutions (see discussion of the SAFE Act in Appendix C). This extends beyond deposit taking and payment services, to lending and debt financing, thus shutting out cannabis businesses from accessing lower cost financing options such as secured bank debt, credit facilities, and term loans.

$20.2

$4.8

Estimated Growth in Legal Cannabis Spending (US$B, 2019 - 2024)

US International (ex-Canada)



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These businesses also are also barred from listing on major public exchanges, including the NASDAQ and NYSE in the US. This results in lower liquidity, and further, hinders access to some of the larger institutional investors in both North America and other overseas markets, all of which have the effect of raising the cost of capital.

Here, we can see the meaningful uptick in daily trading volumes for five of the large cap dual-listed Canadian Operators with a US (NYSE or NASDAQ) listing;

Exhibit 34 – Cumulative Trading Volumes by Exchange for Cross Listed Cannabis Issuers


iii) Prohibition on interstate commerce of cannabis products: Due to the federal prohibition on interstate trade in cannabis products, MSOs are forced to apply for or acquire licenses in each separate state, and construct a manufacturing facility to serve each distinct market they choose to enter. This contrasts with Canadian Operators, which are able to produce product from a single facility and ship it to any jurisdiction in the country.

In this environment, MSOs face relatively high costs of entering new markets, whether through organic means, or via acquisition. Additionally, MSOs are prevented from taking advantage of economies of scale, as they are unable to centralize cultivation and production at one large-scale site. This results in operating and capital inefficiencies, due to the required duplication of cultivation and manufacturing facilities and personnel;

iv) Overall regulatory uncertainty: While difficult to quantify, the MSOs, and other US operators, almost certainly are discounted by the market as a result of the general overhang of regulatory uncertainty at the federal level in the US, which prevents a number of investors, strategic partners, and institutions from engaging with these businesses. Issues are further complicated for Canadians seeking to work with or for MSOs, given the potential for denial of entry into the US. A legislative solution and a clear position from the US federal government that seeks some resolution of the conflict between state and federal laws regarding cannabis’ legal status would assist with lifting this general air of regulatory uncertainty weighing over the US cannabis sector.

Despite these factors currently resulting in a discount on US MSO valuations relative to their Canadian peers, we see this as an opportunity for investors to position themselves ahead of the resolution of these issues. The removal of any of these hurdles serves as a catalyst for a fundamental revaluation of US cannabis operators to the upside.

The competitive dynamics in the US cannabis sector, particularly within many of the highly attractive limited-license markets, are, in our view, likely to generate meaningfully higher returns on capital once placed on an even playing field with Canadian cannabis assets from taxation and cost of capital perspectives. We have the same view of US cannabis assets relative to investments in the slower-moving international medical cannabis markets.

We believe that once the aforementioned issues related to tax, access to capital, and regulatory uncertainty are resolved, it will result in US operators, on average, trading at a valuation premium to their Canadian counterparts. Though we cannot make a prediction as to the timing, we see the eventual resolution of the conflict between state and federal laws governing the use of cannabis as a near certainty given the momentum and support for such a resolution from both politicians and the public, alike. In our view, it is not as much a matter of IF, but WHEN these burdens are removed. A single piece of well-formulated legislation, such as the STATES Act for example (see discussion here), could resolve several of these issues on its own.

By comparison, similar fundamental catalysts – that is, the “low hanging fruit” such as removal of regulatory risks and access to capital – for Canadian-based Operators are behind us, with the benefits of the passage of national recreational

Company TickerAverage 90-Day Volume

(All Exchanges)CAN US GER UK

90-Day Average Volume

Prior to US Listing

90-Day Average Volume

After US ListingIncrease in Volume

Canopy WEED-CA 6,605,312 39.2% 62.1% 0.2% 0.0% 7,489,735 12,452,580 66%

Aurora ACB-CA 21,365,312 39.0% 58.0% 1.0% 0.0% 42,410,756 72,684,900 71%

Cronos CRON-CA 6,160,765 24.5% 75.4% 0.2% 0.0% 3,514,335 4,635,926 32%

Aphria APHA-CA 8,382,425 45.8% 47.7% 0.4% 0.1% 19,150,057 23,523,569 23%

CannTrust TRST-CA 7,984,066 51.6% 50.7% 0.2% 0.0% 2,637,928 6,185,787 134%

Average 10,099,576 40% 59% 0% 0% 65%



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legislation, a lower cost of capital, and the ability to produce centrally and ship not only across Canada, but even globally, are largely accounted for in forecasts and valuations.

Assessing Premium on Valuations for MSOs versus Other US Cannabis Issuers

One of the strategic advantages in pursuing growth through M&A in favour of publicly traded US MSOs is their ability to capitalize on the value arbitrage available to them, by rolling up single-state and non-vertically integrated operators and private assets at a relative discount.

When we look at the relative valuations of large-cap MSOs compared to their non-MSO peers in the US cannabis space, we see that the MSO group trades at a considerable premium. Today, we generally do not see non-MSOs trading much higher than 5x 2020 consensus EBITDA, compared to ~11x for the MSO peer group. We also note that with very few analysts covering these businesses (generally only 1 or 2 per issuer), any estimates are likely far less reliable than for their MSO peers.

In any case, we feel it is quite apparent, and fairly self-evident that leading MSOs do command a valuation premium to their smaller peers, on any basis of measurement. We also believe the market is assigning MSOs a premium to their smaller peers based on important fundamental differences in the businesses.

There are two primary drivers of this valuation premium, in our view. The market is assigning premium valuations to US operators who are both vertically integrated and have extensive multi-state footprints.

Vertically Integrated Operations

At this early juncture in the development of the cannabis industry, investors have gravitated to companies with vertically integrated operations, primarily for three reasons:

Optionality: While most agree that cultivation assets, for example, are not likely to be an attractive investment in

more developed markets as wholesale supply of raw flower becomes commoditized, the ideal timing for divesting

of such assets is uncertain, and largely dependent on the dynamics in each individual market. The vertically

integrated model provides optionality and a hedge against uncertainty as to which assets are best to own in each

market;

Strategic advantages: Owning the entire supply chain offers some strategic advantages to firms, particularly in less

competitive markets where wholesale supply, services, and market data are not yet dependable and cost-effective.

Retail, for example, offers benefits including data collection for consumer buying patterns, and ownership of shelf

space to push in-house brands, while extraction and cultivation assets allow for a secure supply of product in supply

constrained markets;

Margin capture: Particularly in limited-license markets, where undersupply and lack of retail locations are more

likely to be an issue, owning all verticals in the value chain allows businesses to capture the greatest potential

margins, if operated effectively. Investors, at least for the time being, find the margin upside more attractive than

the potential difficulties in operating a vertically integrated business, and the capital investment requirements that

come along with it.

See Exhibit 39 for further discussion on the advantages of a vertically integrated model.

Multi-State Footprint and Large Addressable Markets Driving Premiums for MSOs

We believe the data supports that MSOs are receiving a premium for the breadth of their operations, with investors willing to pay a premium for businesses with access to multiple states and larger addressable markets.

While regulations do prevent MSOs from fully taking advantage of scale due to the inability to conduct interstate commerce, there are benefits to the size and scale afforded by a multi-state presence, particularly for back office functions, product R&D, lower cost of capital, and building brand equity across a larger audience, which inherently increases the value of a company’s brand portfolio over the longer term.



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As noted above, we believe the facts support the observation that due to their relative size, the large cap MSOs also enjoy a lower cost of capital than their smaller peers, which we have seen play out though a number of recent secured debt financings in the sector. This offers significant advantages in pursuing acquisitions and expansion into new states.

We note that every large cap MSO in our tracking group has licenses to operate in at least 11 markets (pending acquisitions), with the exception of Trulieve (TRUL-CA, NR), which is included due to its market cap.

Exhibit 35 – MSOs by Number of States with License or Operations

Source: Company Filings, US Census Bureau, Echelon Wealth Partners

The scale of their presence alone would be too simplistic of a view as to the value of these business’ national footprints. After all, a company could easily and inexpensively obtain a license to operate in California, and boost its addressable market by nearly 40M, though the odds of any business successfully capturing a significant portion of such a highly competitive and fragmented market without significant capital investment are slim to none.

The key in this regard is that majority of the large cap MSOs in our tracking group have used their relative size and advantages in access to capital to obtain licenses in some of the most sought after, limited-license markets, including New York, Florida, Illinois, and Nevada, which we believe command a premium over most states.

Exhibit 36 – MSOs with Common Market Presence in Key States


By securing footprints in attractive states with access to the largest addressable markets, MSOs have built a significant runway for growth in the coming years, which we believe justifies the premium valuations relative to their non-MSO

MSO Number of States Population (M)

Acreage 20 179.4

Curaleaf 19 177.1

Harvest 16 152.0

Columbia Care 14 160.4

MedMen 12 159.3

Green Thumb Industries 12 151.8

Cresco Labs 11 150.5

iAnthus 11 120.6

Trulieve 4 71.3

Ticker Company Florida New York Penn. Illinois New Jersey Maryland Nevada

CURA-CNQ Curaleaf Holdings, Inc.

CL-CNQ Cresco Labs, Inc.

HARV-CNQHarvest Health & Recreation,

Inc.San Felasco

Nurseries

GTII-CNQ Green Thumb Industries Inc.

MMEN-CNQMedMen Enterprises, Inc.

Class B

Through

PharmaCann

licensing

ACRG.USD-CA Acreage Holdings Inc.

TRUL-CNQ Trulieve Cannabis Corp.

CCHW-CA Columbia Care, Inc.

IAN-CNQ iAnthus Capital Holdings, Inc.

Legend: Current

Operations

Acquisition in

Progress



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peers in the US cannabis space. We also view the scale of the MSO platform as more attractive to potential strategic investors and partners.

MSOs also have the added complications of dealing with different regulations across a number of various markets, which significantly adds to the costs and difficulties of expanding into new states, and building a truly national footprint. These added costs, however, create a moat around the MSOs that manage to successfully navigate the complex regulatory environment, serving as a barrier to other would-be competitors looking to achieve similar scale and reach. Despite the added challenges, successful MSOs will be rewarded by being one of the few companies in the country to achieve national scale and presence.

How are US MSOs Priced Compared to Related Sectors?

Here we take a look at where the US MSOs are trading on a forward sales and EBITDA basis relative to leading businesses in the CPG categories which serve as the most appropriate comparatives, in particular, tobacco, beer and spirits.

Exhibit 37 – Relative Valuations for Tobacco, Spirits, and Beer Sectors

Source: Company Filings, Echelon Wealth Partners, FactSet | Note: closing prices as of 08/07/19

We note the obvious here – these major alcohol and tobacco firms are mature, global businesses with strong histories of earnings and cash flows, and relatively stable earnings profiles relative to cannabis firms, which have a vastly different growth rates, capital investment requirements, and risk profiles. However, in a mature state, the businesses are reasonable comparatives given that their primary activities are the manufacture and sale of branded CPGs, and in the case of alcohol and tobacco, in categories subject to additional regulations and excise taxes.

Therefore, we believe it is instructive to take a look at the valuations of cannabis firms relative to these mature businesses to understand how we might expect the valuations would evolve as the businesses mature.

We view the spirits segment, specifically, as the most appropriate comparative, due to greater shared similarities in gross margin profile, and due to facing higher excise taxes, in most jurisdictions, than beer. In addition, the sale and dispensing of spirits are generally more tightly regulated than beer in most jurisdictions, which is also the case with cannabis. For example, in numerous jurisdictions in the US, it is not uncommon for corner stores and convenience stores to sell beer, but only licensed liquor stores may sell spirits.

While tobacco companies also serve an appropriate comparative, we note these are two sectors moving in opposite directions in terms of regulation and acceptance in America, with tobacco regulations tightening, while cannabis regulations continue to open up.

We see many leading firms in the spirits sector trading at between roughly 15-20x NTM EBITDA, and 25-30x NTM operating cash flows. Looking several years out, we think it is not unreasonable to use these figures as a basis for where

Ticker Company NameMrkt Cap.

($M)

Net Debt

($M)FD EV (SM) EV / Sales

EV /

EBITDAP/E P/CFPS EV / Sales

EV /

EBITDAP/E P/CFPS EV / Sales

EV /

EBITDAP/E P/CFPS

PM-US Philip Morris International Inc. $128,015 $25,858 $153,873 5.2x 12.5x 16.1x 14.0x 5.1x 12.2x 15.8x 13.8x 4.9x 11.3x 14.7x 13.1x

BATS-GB British American Tobacco p.l.c. $85,328 $56,897 $142,225 4.8x 10.6x 10.4x 7.9x 4.5x 9.8x 9.5x 8.3x 4.3x 9.2x 8.8x 7.9x

MO-US Altria Group Inc $86,484 $27,438 $113,922 5.8x 11.5x 11.6x 10.7x 5.8x 10.4x 11.1x 11.3x 5.7x 10.3x 10.3x 10.8x

2914-JP Japan Tobacco Inc. $38,781 $6,998 $45,778 2.2x 6.7x 10.7x 8.0x 2.2x 6.8x 11.1x 7.8x 2.2x 6.6x 10.9x 7.7x

IMB-GB Imperial Brands PLC $24,550 $15,564 $40,115 3.8x 8.4x 7.7x 7.1x 3.6x 8.1x 7.4x 6.7x 3.5x 7.7x 7.1x 6.4x

SWMA-SE Swedish Match AB $6,530 $1,176 $7,706 5.7x 14.2x 18.6x 17.5x 5.2x 12.6x 16.2x 14.1x 4.8x 11.5x 14.5x 13.4x

Tobacco Average 4.6x 10.6x 12.5x 10.9x 4.4x 10.0x 11.9x 10.3x 4.2x 9.4x 11.1x 9.9x

ABI-BE Anheuser-Busch InBev SA/NV $192,179 $100,811 $292,991 5.4x 13.5x 29.0x 14.2x 5.3x 12.6x 20.2x 12.5x 5.1x 12.1x 19.9x 11.0x

HEIA-NL Heineken NV $61,186 $0 $61,186 2.4x 10.2x 22.5x 13.0x 2.3x 9.5x 21.5x 14.3x 2.2x 9.0x 19.9x 12.5x

STZ-US Constellation Brands, Inc. Class A $36,417 $13,299 $49,716 6.3x 16.9x 22.3x 18.6x 6.2x 16.2x 20.5x 16.7x 5.8x 14.8x 17.7x 14.7x

2502-JP Asahi Group Holdings,Ltd. $21,191 $9,234 $30,425 1.5x 9.9x 14.8x 8.3x 1.5x 9.9x 14.7x 7.9x 1.5x 9.2x 13.3x 7.3x

TAP-US Molson Coors Brewing Company Class B $11,368 $9,062 $20,431 1.9x 8.3x 10.4x 6.4x 1.9x 8.8x 11.7x 6.2x 1.9x 8.9x 11.8x 6.3x

CARL.B-DK Carlsberg A/S Class B $22,346 $2,765 $25,111 2.7x 12.6x 27.6x 13.8x 2.5x 11.8x 24.9x 15.6x 2.5x 11.2x 22.6x 13.1x

2501-JP Sapporo Holdings Limited $1,824 $2,343 $4,167 0.8x 10.9x 22.6x 5.0x 0.8x 10.9x 26.0x 4.7x 0.8x 10.4x 19.3x 4.8x

SAM-US Boston Beer Company, Inc. Class A $4,870 $37 $4,907 4.9x 29.2x 51.5x 31.4x 4.0x 23.5x 43.7x 29.1x 3.5x 19.1x 36.8x 23.3x

Beer Average 3.2x 13.9x 25.1x 13.8x 3.1x 12.9x 22.9x 13.4x 2.9x 11.8x 20.2x 11.6x

600519-CN Kweichow Moutai Co., Ltd. Class A $173,350 -$13,064 $160,285 14.8x 22.0x 34.7x 29.0x 12.6x 18.1x 28.3x 24.1x 10.7x 15.2x 23.7x 20.5x

DGE-GB Diageo plc $96,750 $13,971 $110,721 7.3x 20.7x 27.1x 25.0x 6.8x 19.3x 24.7x 22.3x 6.4x 18.0x 22.8x 22.6x

RI-FR Pernod Ricard SA $46,408 $8,062 $54,470 5.4x 18.0x 26.2x 26.1x 5.1x 16.6x 23.5x 25.5x 4.8x 15.3x 21.2x 21.8x

BF.B-US Brown-Forman Corporation Class B $26,515 $2,133 $28,648 8.3x 23.4x 31.3x 31.5x 7.9x 22.1x 29.2x 28.8x 7.4x 20.6x 26.9x 26.3x

CUERVO-MX Becle Sab De Cv $5,408 $138 $5,547 3.8x 17.6x 27.0x nmf 3.5x 15.9x 25.4x 150.0x 3.3x 14.0x 22.9x nmf

Spirits Average 7.9x 20.4x 29.2x 27.9x 7.2x 18.4x 26.2x 50.1x 6.5x 16.6x 23.5x 22.8x

Tobacco

Beer

Spirits

All figures in USD equivalent Consensus C2018 Consensus C2019 Consensus C2020



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to expect leading cannabis CPG firms in the US to eventually trade, assuming the aforementioned regulatory catalysts are achieved.

Taking into account the added risk and uncertainty, and other factors acting for and against US MSOs, we would suggest that if one has a positive view on the US cannabis market, that current valuations of MSOs are not unreasonable, particularly in light of the recent sell-off in the sector, and leave significant room for upside, especially upon revaluation catalysts which we discussed here.

The one obvious difference between the businesses of all three groups of mature companies and vertically integrated MSOs is the ownership of retail operations, which we expect they will maintain for the foreseeable future. While it remains to be seen how significant of a percentage of their business retail operations remains as the market further develops, for now, selective investments in retail, in our view, continue to be a high returning allocation of capital for cannabis businesses in most US markets.



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Capital to Flow from North to South: Be in Position to Catch the Wave

The multi-billion-dollar strategic investments made into Canadian Operators from major global CPG businesses have been the subject of much attention from the cannabis investment community, as well as the source of great speculation as to who will be the next cannabis company to strike such a deal.

The two landmark investments most often referenced are the C$5B investment from global alcohol giant Constellation Brands into Canopy Growth in August 2018, and the more recent C$2.4B investment by Altria, one of the world’s largest tobacco companies, into Cronos Group in December 2018.

More recently, Imperial Brands also entered into the cannabis market, albeit not on the scale of the aforementioned deals, with a C$123M convertible debenture purchase from Auxly Cannabis Group (XLY-TSXV, NR), and concurrently entering into an R&D partnership, and licensing Auxly its IP related to vaping technology. The deal will see Auxly become Imperial Brand’s exclusive global partner for cannabis initiatives.

Massive Cash Reserves on Canadian Licensed Producers’ Balance Sheets Earmarked for a Move South of the Border

These two landmark investments, in particular, will have significant implications for the broader cannabis industry, well beyond the businesses who received the investment. The several billion dollars of cash invested into these firms by strategic partners will no doubt have a cascade effect, as the capital is used to seed further investments and fund growth projects across various verticals and geographies in the cannabis industry and adjacent segments.

But one must ask, where is all this money going to be put to work? In our view, the lion’s share of this money is earmarked for investment in the US cannabis market, and is headed south at the first opportunity, once it is able to be invested without brushing up against regulations that would force these entities to de-list from major exchanges, due to a lack of compliance with US federal law.

US Market is the Prized Opportunity, Canadian Capacity is Fully Funded, and will be Overbuilt

As we noted, the US market is by far the largest and most critical market for businesses looking to build a CPG brand in the cannabis industry, and no doubt represents the most significant financial opportunity of any cannabis market in the world. It would seem apparent, in our view, that these strategic partners are backstopping their investees with billions in capital specifically to attack this market when they are able to.

The Canadian and international markets are simply not big enough to absorb this kind of investment. In Canada in particular, excess capital has already been invested in cultivation and production, to the point where it is widely accepted that the market will face a situation of severe oversupply in the near future, current supply issues notwithstanding. Most major Canadian Operators have already fully financed their investments in Canadian cannabis infrastructure.

It is our view that the bulk of remaining new capital investment to come into the Canadian market will be directed to building out the underserved brick and mortar retail vertical, rather than production – and the majority of large cap Canadian Operators are simply not looking to be, or are unable to be (due to regulations), overly active in this segment.

That most of this capital is destined for the US market is the most obvious conclusion based on the relative supply and demand dynamics of each market, as well as the potential opportunities that each market offers at this time. We also note that both of these strategic investors are American businesses, and would almost certainly have an eye towards eventually capturing a dominant share in their home market, once it is permissible to operate there.



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Canadian Operators Already Buying their Tickets and Lining up to Get in

Canopy Growth and Acreage Holdings Tie up Signals Canadian Operators Interest in US MSO Platform

In April 2019, the first major deal between a Canadian-based Operator and a US MSO was agreed to when Smith Falls, Ontario-based Canopy Growth announced its proposed arrangement to acquire a call option to acquire New York-based Acreage Holdings for consideration of $3.4B in stock.

The deal is an important one in that Canopy, a TSX and NYSE listed issuer, is barred from owning an interest in any US cannabis business due to the plant’s illicit status at the federal level. Most observers had believed that the market would not see any deals of this nature until legislation in the US was passed that allowed for it.

Canopy, however, found a creative structure by which it could acquire the right to purchase 100% of Acreage at an agreed upon ratio of 0.5818 Canopy share per Acreage share, and paid Acreage shareholders $300M ($2.63/shr) to obtain the right to do so. The “call option” to purchase Acreage shares could be triggered by Canopy upon the changes in US federal laws that would enable it to acquire ownership of the company while not being in violation of both US law, and TSX and NYSE regulations. The option would be able to be exercised for a period of 7.5 years.

Deal Reflects Canopy Growth and Constellation Brands’ Views on Importance of the US Market

In our view, Canopy’s forward thinking and aggressive strategy that led to this deal supports our outlook on the need for the Canadian Operators to find a way into the US market as early as possible. Canopy’s urgency to sign this deal, using the creative structure that it did – effectively securing the rights, and pricing, potentially years in advance of federal legalization – implicitly reflects its view that the price for US assets is likely to become more expensive relative to that of Canadian assets in the period between now and federal legalization.

Canopy’s management understands that waiting for both a) revaluation catalysts such as a STATES Act passing, and b) allowing MSOs more time to continue to build out and increase the scale and value of their operations, would necessitate them paying a significantly higher price to enter the US market in the future. This realization, which we concur with, is the clear impetus that spurred their action to lock up the call option for these assets at a fixed share exchange ratio that could be agreed upon today.

Some observers with a more bullish view of the US cannabis sector have commented that this deal was a favourable one for Canopy shareholders, at the expense of Acreage Holdings shareholders. This is certainly the view held by activist shareholders Marcato Capital Management (owners, at the time of the announcement, of ~2.7% of Acreage Holdings equity), who publicly stated its displeasure with the deal, and felt that the timing of a deal of this nature is premature, and undervalues Acreage’s US assets.

Other Canadian Operators Have Been Looking South as Well

We note however, that Canopy’s uniquely structured deal to acquire a call option on the Acreage assets was not the first time this has been used by a large cap Canadian Operator listed on major US and Canadian exchanges – it is only the first time it had been used for an acquisition of such noteworthy size.

Investors may also be aware that Aphria (APHA-CA, NR) had similar call options on multiple US cannabis assets, including its previously held interest in Liberty Health Science (LHS-CA, NR), as well as GA Opportunities Corp., a vehicle holding US cannabis assets, including an equity interest in Green Growth Brands (GGB-CA, NR). These options have since been settled by Aphria with the counterparties.

Canopy itself also had already held warrants to purchase ownership interests in two issuers with US cannabis assets –SLANG Worldwide (SLNG-CA, NR) and TerrAscend Corp. (TER-CA, NR).

Aurora Cannabis (ACB-CA, NR), through its holding of warrants in Australis Capital (AUSA-CA, NR), also possesses optionality to participate in the US cannabis industry. Aurora spun-off Australis Capital to its shareholders in 2018, with Aurora maintaining a 10-year back-in right to acquire up to 20% of Australis at $0.20/shr, and up to an additional 20%



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at the then 5-day VWAP. In this sense, Australis Capital effectively acts as Aurora’s US-focused venture capital arm, with Aurora able to participate in any potential upside should the US’s federal regulations permit it to do so lawfully.

M&A Fast Becoming the Only Pathway to Enter the US Market at Scale

US MSOs continue to build out their national footprint, currently free of the threat of competition from even the most well capitalized Canadian Operators. This current environment actually, in many ways, provides these businesses an advantage, allowing them to be the first movers into lucrative markets, while TSX-, NYSE- and NASDAQ-listed cannabis businesses, despite their advantage in access to capital, are shut out from the US cannabis market.

The longer this situation persists, the stronger and more entrenched the competitive positions of US operators in these markets becomes. At some point, the head start afforded to US MSOs will have allowed them to build a market leadership position too costly for new entrants to attempt to recreate organically, in terms of both capital and time. The passage of time simply increases the likelihood that Canadian Operators, once they are allowed to enter the US market, will be left with few options to obtain an early leadership position in the market, but to acquire a US competitor who has already built one, assuming that is even a viable option at all.

Acquiring Large Cap MSOs not an Option for Everyone

Despite the impetus, we are not convinced the Canopy-Acreage deal will set off an acquisition spree for MSOs at this time. In our view, most significant shareholders of US MSOs, which in many cases include management, are positioned as such in anticipation of the revaluation catalysts that lie ahead, and see the advantage in continuing to be able to build their national footprint in the absence of competition from some of the well-capitalized large cap Canadian Operators.

In addition, as the US MSOs continue to build out their operations, and lower their cost of capital, we believe their valuations could exceed the thresholds of affordability for most Canadian Operators. With the notable exceptions of Canopy and Cronos, we do not see any other obvious candidates amongst the Canadian Operators with the requisite balance sheet or strategic relationships that would allow them to make an offer that is attractive enough for shareholders of a top-tier US MSO to accept.

We believe that shareholders of US cannabis firms stand to gain more by waiting for these catalysts and continuing to build strong businesses, which opens the opportunity for more attractive investments and M&A from partners outside of the cannabis sector as well.

Future Strategic Partners may be Holding Out for Chance to Invest in US Operators

While many investors are waiting with anticipation for the next major Fortune 500 CPG business to hand pick their cannabis partner, US MSOs are not often discussed as legitimate candidates for these partnerships, similar to the Canopy/Constellation or Cronos/Altria investments, primarily due to the regulatory hurdles presented by the federal illegality and inability to list on major exchanges – both issues that are not concerns for businesses partnering with Canadian Operators.

However, given our view that these CPG businesses ultimately prize the US market above the Canadian market and international medical markets, we contend that many of these Fortune 500 businesses may be waiting on the sidelines until it is permissible to invest in a partner with an existing US footprint.

While we believe that waiting to enter the US cannabis market will increase the costs of doing so, we also feel that mature CPG companies view the costs from a risk-adjusted perspective. In our view, they are likely willing to pay more in absolute terms for assets with a more appropriate risk profile, perhaps even two or three years out, but with a much clearer picture of the market opportunity, potential returns, and regulatory environment.



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Vertically Integrated Operating Model of US MSOs

Vertical Integration is the Standard Operating Models for MSOs

The vertically integrated model is employed by MSOs in the majority of markets in which they operate, and as such, is the model that is of central interest for our companies under research coverage.

The large cap MSO businesses are widely viewed as the dominant market players in the US cannabis space, occupying the greatest breadth of market presence across the country, and in most markets, own fully vertically integrated operations throughout the industry value chain from cultivation through retail.

Exhibit 38 – Cannabis Industry Value Chain


We compare the advantages and challenges associated with pursuing a vertically integrated operating model to the other alternatives – a traditional branded CPG model, and the retail model (refer to Appendix A for discussion of the operating model). We also discuss why we believe the large cap MSOs are the most suited for successfully executing a vertically integrated model across multiple jurisdictions, and how we see these businesses’ operations evolving as the industry matures.

Exhibit 39 – Analysis of Cannabis Business Operating Models


How we see Vertically Integrated MSOs Operating Models Evolving in the Future

Challenges with Vertical Integration Act as Barriers Favouring MSOs

The challenges associated with a vertically integrated model – capital intensity and operational execution – would suggest that larger MSOs would be the clear candidates to implement and successfully execute this strategy in markets across the country. Their advantages in scale, human capital, operational knowledge, and access to financial capital favour their ability to operate a vertically integrated business relative to smaller players.

At the moment, most MSOs find it financially beneficial to pursue vertical integration, especially in limited-license markets, given the relative undersupply of both product and retail locations. In some markets, the lack of a developed supply chain not only encourages but requires these companies to build and operate assets throughout the value chain in order to ensure adequate and dependable supply. In others, full vertical integration may also be a requirement of the licensing regime, which, in theory, would favour larger MSOs in those markets.

Cultivation RetailManufacturing and

Product DevelopmentBranding, Marketing and

Distribution1 2 3 4

Attributes Branded CPG Retail-Only Vertically Integrated

Capital Intensity Moderate-High Moderate High

Level of Operational Difficulty Moderate-High Moderate High

Barriers to Entry Moderate Low-Moderate High

Share of Value Captured Moderate Moderate High

Optionality Moderate-High Low High

Margin Defensibility Moderate-High Low-Moderate High

Challenges

Benefits



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Strong returns on capital can be earned in all activities throughout the value chain in relatively uncompetitive environments such as these, and the market is not forcing these companies towards specialization quite yet. However, we do expect the development of the supply chain in most markets, as well as increasing competitive forces, to eventually reshape the way these businesses choose to operate in particular markets.

MSO’s Retail Presence: Apple and Nike’s Retail Strategy Likely to be the Blueprint for MSOs as the

Industry Evolves

It is our view that the vertically integrated MSOs are likely to find the most long-term value in owning the development, manufacturing, distribution and marketing of branded products, in the mould of the traditional models employed by leading businesses in categories such as beverage alcohol, tobacco, and packaged foods. Controlling a widely distributed and recognized brand holds significant value, as it creates a stickiness amongst consumers and preserves pricing power for the sellers. Given our frequent comparisons of cannabis businesses to beverage alcohol, tobacco and CPG companies, we would point out the obvious – these businesses, for the most part, do not own retail operations, and instead, have a virtually exclusive focus on the middle two verticals, branded product manufacturing and distribution.

However, we believe that MSOs will continue to maintain a retail presence in some capacity, even as the cannabis market develops in the coming years to more closely resemble beverage alcohol and tobacco categories. In our view, Apple (AAPL-US, NR) and Nike (NKE-US, NR) serve as appropriate examples for MSOs target mix of the use of wholesale and retail channels to distribute and market their products.

These companies maintain an active touchpoint with the end-consumer (retail), while also achieving significant scale through distribution to third-party vendors (wholesale), which remains their primary channel of distribution. Both of these iconic consumer goods businesses derive roughly 30% of their total sales from their own platforms: owned brick and mortar retail and online direct-to-consumer sales.

Exhibit 40 – Retail and Direct Channel Sales Contribution for Apple and Nike

Source: Apple Inc. Corporate Filings, Apple.com, Nike Inc. Corporate Filings, Echelon Wealth Partners

The retail vertical remains particularly important for MSOs with respect to brand building in the current environment, where advertising is limited in many markets. In-store experience is one of the primary ways in which a company is able to influence the perception of its brands with consumers. Managing this key touchpoint with end-consumers can be critical in this regard.

Another business we point to that has effectively used retail as a means to control brand perception and consumer experience is Lindt & Sprüngli AG (LISN-SWX, NR), the makers of Lindt chocolates. A strategy that has been fairly unique amongst major confectionery manufacturers, Lindt & Sprüngli has invested in expanding its network of premium chocolate retail locations in the past decade. It now operates more than 460 high-end retail stores globally, accounting for about 13% of the company’s total sales. The ability to control the perception of the brand through its retail stores has been instrumental in expanding into new markets.

Owned Retail Stores 507 1,182US 271 392

International 236 790

Last FY Revenues (US$ B) $265.6 $37.2

% of Sales from Owned-

Retail and DTC29% 31.5%



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Cultivation May Go, but we Think Retail is Here to Stay

We expect cultivation to eventually decline to a relatively low margin business, similar to most any agricultural business, particularly in markets with competitive and well-developed supply chains. It is quite possible that MSOs may choose to divest of cultivation that they own in the years to come or enter new markets without needing to internally build these assets. We note this will largely be a function of the maturity and competition in the supply chain in those markets.

However, in our view, in most cannabis markets across the US, owning at least some retail presence makes sense from both a financial and strategic perspective. We do not see the vertically integrated MSOs divesting of their retail assets any time in the near future and expect them to maintain a presence in this vertical over the long term.

Due to the relative lack of retail coverage, particularly in limited-license markets, most MSOs still derive well over half of their sales from their owned retail stores. We would expect that as the rules surrounding retail of cannabis products becomes more liberalized, and as the size of the network of retail locations in legal markets further develops, wholesale will eventually overtake retail as the more significant portion of total sales for the majority of vertically integrated cannabis businesses.

It is this reason that we place a particular importance on the development of wholesale distribution presence as a determinant of long-term success for the issuers we analyze. However, we acknowledge that this process could take several years, and is largely dependent on the regulations and competitive dynamics in each specific market. However, in any case, unlike beverage alcohol companies, we would expect MSOs to continue to drive anywhere from 30-40%+ of total sales from retail and home delivery channels over the over the next several years.

Factors that might determine which markets and locations where MSOs will invest more heavily in their retail assets will be a function of the regulatory environment, and factors such as the total number of cannabis retail licenses in a specific area, population density, significance of the market from a cultural and media perspective (e.g., Los Angeles and New York City), foot traffic, and access to transportation.



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Hemp-Derived CBD Market: Competitive Pressures Likely to Make CBD Less Attractive than THC

Passing of the Farm Bill Opens up New Opportunity for Small and Large Players Alike

The passing of the 2018 Farm Bill in late 2018, which includes the Hemp Farming Act of 2018, opened up the opportunity for companies to play in the hemp-derived CBD market, which has been estimated to potentially reach ~$15B in sales by 2024. Cannabidiol, or “CBD”, is a non-psychoactive cannabinoid compound found in both marijuana and hemp, with purported benefits such as anti-inflammatory, anti-anxiety, pain relief, and assistance with sleep issues, amongst others.

Exhibit 41 – US CBD Market Forecast


The landmark legislation has far reaching implications for the cannabis sector, as well as the broader CPG industry, with the potential applications for CBD extending beyond traditional cannabis products, and into consumer goods such as nutraceuticals, wellness supplements, sport supplements, skin care, beauty products, and food and beverages.

The primary changes enacted as a result of the passing of the legislation include:

De-scheduling of hemp: The bill defined hemp as the cannabis plant containing less than 0.3% THC content on a

dry-weight basis. With the new definition being distinct from that of marijuana (or cannabis), the bill has the effect

of removing it from the list of Schedule I substances, and therefore legalizing hemp and its derivatives at the federal

level;

Permits interstate commerce of hemp and hemp products, removing barriers on shipment of hemp and hemp

products across state lines;

Allows companies dealing with hemp and hemp-derived products access to banking services from federally

regulated financial institutions, as well as access to capital markets:

o In May, Charlotte’s Web (CWEB-TSX, NR), a hemp-derived CBD product business, up-listed to the TSX from the CSE, due to the new regulations allowing this;

o Companies listed on senior exchanges in the US, such as Cronos, Canopy Growth and Tilray, have already made investments into hemp operations in the US.

1 2024 excludes $5.4B "Low-THC/CBD" sales through licensed dispensaries so as to

not double licensed dispensary channel sales

$0.6

$14.8

-

$2

$4

$6

$8

$10

$12

$14

$16

2018 2024

CB

D M

arke

t Si

ze (

US$

B)

US CBD Market Size Forecasts1



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Removes the burden of the non-deductibility of expenses for federal tax purposes for companies dealing with

hemp and hemp-derived products – commonly referred to as Section 280E, which still applies to companies that

have contact with the marijuana plant.

With this, farmers have already begun switching their crops to hemp cultivation to service the high demand which has been spurred by this legislation. As a result, we see CBD derived from hemp becoming increasingly available and cheaper to source for CPG businesses looking to infuse various products.

Exhibit 42 – US Spending on CBD Products, Category Share


Investors and Operators Alike Quick to Pursue the Hemp Opportunity, but we Believe the THC Market Remains the More Attractive Market

The hemp-derived CBD opportunity has received significant attention from investors, media and businesses, due to both the potential for disruption across a number of consumer categories, as well as the ability to enter and scale quickly now that the restrictions on hemp have been lifted.

The short runway to market has seen a number of MSOs quickly acquire, or launch their own lines of hemp-derived CBD infused products, which allows them to, for the first time, have products that can be sold across states lines and outside of licensed dispensaries.

THC Businesses Should Maintain Greater Margins, Premium Valuations Compared to CBD-Focused Firms

When evaluating the US cannabis opportunity, it is our view that the “THC” market – that is, the market for products derived from the marijuana plant, not industrial hemp – remains the more attractive market for MSOs. We would strongly favour cannabis businesses that maintain a focus on THC products, distributed through tightly regulated channels, as their core business.

We favour a focus on the THC category over the hemp-derived CBD category for the following reasons:

Greater barriers to entry: The significant barriers to entry in the THC market provide long runway to build market

leadership position for MSOs. The federal restrictions on marijuana prevent the entrance of both well-funded

Canadian Operators, and larger global CPG businesses, into this market in the US, effectively insulating the largest

MSOs from serious competitors of comparable or greater resources. The lifting of the ban on hemp-derived CBD

Wellness, 23% Wellness, 21%

Beauty/Skin, 21%Beauty/Skin, 18%

Food, 7% Food, 14%

Beverages, 7%Beverages, 12%Confection, 6%

Confection, 9%Supplements, 10%

Supplements, 9%Sublingual, 10%

Sublingual, 7%Pet Care, 8%Pet Care, 6%

Inhalables, 8% Inhalables, 4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2018 2024

US CBD Spending by Category Share



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infused products allows both of these groups of competitors to enter the market, which several have already done,

making for a much more crowded competitive landscape.

In fact, we have already seen companies such as Unilever (UNA-AMS, NR) announce its plans to roll out products infused with CBD in the coming months. And we believe this is only the first of many. Competing with businesses that have the scale of a Unilever will be difficult for upstart cannabis firms, as this is not an arena where they hold a competitive advantage. We also would expect to eventually see Unilever’s competitors enter the category, including companies such as Johnson and Johnson (JNJ-US, NR) and Procter and Gamble (PG-US, NR).

We also note Cronos Group’s recent $300M acquisition of CBD brand Lord Jones as an example that supports our view of capital from well-funded Canadian Operators entering the CBD category, as this is the only space in the US market where these companies can compete at this time.

Fewer competitors in THC will make a brand-focused differentiation strategy more feasible: With the enthusiasm

surrounding the benefits of CBD, we can expect both start-up firms and major CPG conglomerates to begin to add

the compound to an endless variety of different products across various consumer categories, potentially even as

a line extension on existing well-known brands in segments like cosmetics, skin care, and eventually, when

regulations allows for it, food, beverage, and supplements. The plethora of new products and brands will make

differentiation significantly more difficult compared to the relatively protected THC market.

Cannabis retail channels should allow for more defensible margins: With major box retailers such as CVS (CVS-US,

NR) and Walgreens (WBA-US, NR) quickly becoming substantial retailers of several brands of CBD products, the

ability for companies producing these products to defend their margins will be significantly challenged over the

medium to longer term, in our view. Large box retailers of this scale hold significant bargaining power in the CPG

space and are unlikely to allow suppliers to earn outsized profit margins.

The entrance of major CPG firms with competing products who have an advantage in both scale and existing relationships dealing with these retailers, are likely to outcompete MSOs for share of shelf space in these retail channels. Large retailers like a CVS or Walgreens may even look to roll out their own private label brands of everyday products containing CBD in the future, which could make access to shelf space even more difficult to maintain for competitor products.

Long term, MSOs navigating the regulatory challenges and other hurdles faced in the THC category will be rewarded with a dominant position in a category with a deeper moat around it due to greater barriers to entry. The federal restrictions on THC actually act to insulate these firms from greater competitive pressures, while their would-be competitors are shut out from the marketplace.

Once the burdens related to taxation and cost of capital (as discussed here) are removed from companies competing in the THC segment, we believe their profit margins and returns on capital will be higher and more defensible than businesses in the hemp-derived CBD segment.

Build versus Buy: THC Businesses are More Likely to Attract Greater Premiums as Acquisition Targets for Global CPG, Alcohol and Tobacco Firms in the Future

When major CPG firms, particularly those in tobacco and alcohol, do look to enter the US cannabis sector upon federal legalization, the MSOs will most likely be strong candidates for acquisition. Given the relative difficulty and cost involved in building a national footprint in the THC category, compared to the hemp-derived CBD market, we suggest that MSOs occupying leadership positions would command significant premiums compared to CBD-focused firms upon acquisition in the future, when permissible.

Conversely, in the hemp-derived CBD category, we believe that major CPG businesses are more likely to attempt to build their presence in the category internally, given the relative lack of hurdles in licensing, ease of access to supply of hemp, and given that they already own the distribution footprint and relationships with retailers that will be the primary channels through which these products are sold.



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That said, we do not suggest that we will not see any hemp-derived CBD businesses to be acquired by larger players, however, in assessing the two categories, we believe a multi-state THC business is far more difficult to build versus buy, which will have implications for the likelihood of acquisition and premiums paid for the businesses.

CBD Should Remain Non-Core to THC-Focused Companies: May Serve as Strategic Category for Brand

Building

While we strongly favour MSOs that do not commit significant organizational and financial resources into the hemp-derived CBD category, we do acknowledge that an intelligent CBD strategy could be employed by these firms to utilize the mainstream retail channels as a means to familiarize consumers with their brands. While this strategy is not one that we see as a necessary investment for success in the THC category, we view the potential for a hemp-derived CBD product line to serve as a non-core offering for MSOs that complement their core THC business.

An effective strategy aimed at gaining distribution in strategic retail and online channels can serve to build brand awareness with customers who are not yet consumers of THC products. For many consumers who are inexperienced with cannabis or new to the category entirely, CBD may serve as a more approachable segue into THC products.

For example, obtaining shelf presence in a national retailer with presence in states without legal cannabis programs may serve as an introduction to consumers in those markets to the brand and product formats that a company may eventually introduce in the future after legislation has been passed. Once consumers have become familiar with the brands through more mainstream retail channels, they can potentially be migrated into the THC category, if and where those products are legal.

We have seen a number of MSOs begin to employ this strategy already, rolling out hemp-derived CBD product lines, with some having obtained distribution in major retailers across numerous states.

A Fully Developed Regulatory Framework Will Take Some Time

Despite the passage of the law that removes hemp and its derivatives from the list of DEA Schedule I substances, a complete regulatory framework around the production of hemp and use of hemp derivatives in consumer products has yet to be developed for both the production of hemp, and sale of products containing its derivatives.

The regulation of its production has now been removed from the Department of Justice (“DOJ”) and placed under the Department of Agriculture, though they expect to have finalized regulations on hemp production by the end of 2019 and should be issued prior to the 2020 planting season.

Further complicating matters, the legislation provides states with the ability to establish their own agriculture and commerce programs. Through our discussion with business managers in the industry, some have expressed their views that this could possibly lead to state protectionism, which could enforce rules requiring hemp products sold to have been grown or processed in the state, or added regulations surrounding the product standards for packaging and testing.

Furthermore, the new legislation does not openly and plainly allow the use of hemp derivatives (CBD in particular) in any food or beverage product. Importantly, the FDA will continue to retain oversight over the use of hemp and hemp derivatives in consumer products, and the administration is currently in the process of reviewing and constructing a comprehensive set of rules around the use of these compounds. The absence of clearly defined guidelines from the FDA leaves the market in a state of some uncertainty with respect to what types of products may be marketed, and what sorts of claims can be made with respect to the benefits of their use.

Curaleaf (CURA-US, NR), one of the largest MSOs and a leading player in the emerging CBD products market, recently received a warning letter from the FDA on the manner in which it marketed certain CBD products, highlighting that even leading companies may be at risk of overstepping unclear regulations. As a result of the uncertain regulations, manufacturers and retailers, while beginning to roll out hemp-derived CBD-infused products, are treading carefully.

FDA Remains Cautious on CBD in Food and Supplements; Timeline for Rules Unclear



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The FDA has issued some guidance with respect to their views on the use of hemp-derived CBD, and they appear to be placing much greater scrutiny on its use in ingestible products (food, beverages and supplements), and the claims being made surrounding the purported medical benefits from CBD use. Former FDA Commissioner Gottlieb issued a warning letter in April 2019 admonishing several companies for the use of CBD in supplement products, due to “unsubstantiated claims” regarding the compound’s ability to stop cancer cell growth and treat Alzheimer’s disease, amongst other things.

He has also been quoted as stating that without congressional action to legalize food and supplement products containing CBD derived from hemp, the FDA could take years to do so. Newly instated Commissioner Dr. Norman Sharpless has been similarly cautious regarding the allowance of CBD in food and supplements in public comments he has made on the matter since taking office in April 2019.

As such, due to the still somewhat uncertain regulatory environment, the roll out of hemp-derived CBD products in mainstream retail channels has been limited to cosmetic, beauty, skin care and hygiene products, such as topicals, ointments, and sprays. Traditional retailers and CPG firms are still not venturing into ingestible CBD products quite yet, until guidance from the FDA becomes clearer. It is our interpretation that regulations around the production and sale of ingestible products containing CBD would still, for the time being, fall under the purview of the cannabis laws in each state.



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Branding in the Cannabis Sector

Brands are Central to the Future of Cannabis, but Iconic Brands may be Years Away

Much emphasis is placed on the importance of building consumer brands in the cannabis space by both operators and investors. The story of brand is touted as central to the strategies and investment thesis behind these businesses and their product portfolios, as they seek to model the most successful and recognized brands in the CPG industry. However, the establishment of iconic brands that are ubiquitously identifiable, even by demographics who do not consume the products, such as Coca-Cola (KO-US, NR), Pepsi (PEP-US, NR), Jack Daniel’s (BF.B-US, NR) or Budweiser (BUD-US, NR), are not on the immediate horizon for the cannabis industry.

With respect to mainstream recognition, cannabis brands are still nascent in terms of consumer awareness. Based on anecdotal evidence from our observations and discussions with those in the industry, even amongst cannabis consumers, brand awareness remains fairly low, with the demographic we would label as “connoisseurs” being the primary group that is most plugged in to the various brands available in the legal cannabis markets across North America.

As a general observation, the majority of cannabis consumers, including those migrating from the black market, are still in the process of familiarizing themselves with various strains and product formats, and have not yet taken to stickiness with specific brands.

Why Building a Brand is so Critical: Brand Loyalty and Differentiation Preserves Pricing Power

There has been much discussion around fears of price compression in oversaturated markets, such as Oregon and Washington, which has led most MSOs to avoid these states in favour of limited-licenses markets where returns on capital are likely to be much higher. However, over the long term, we believe that fears of price compression on the wholesale level are confounded with the issue of price compression for branded products.

A strong, differentiated brand is a company’s defense against commoditization, and thus, margin compression. Brand loyalty is one of the keys to building defensible margins for CPG businesses, and we expect cannabis will be no exception. We agree that an undifferentiated dried flower product will be far more susceptible to commoditization and pricing pressure. However, a branded, user-friendly and differentiated product will be able to take the cheaper, commoditized input, and generate strong, defensible margins. Even high-quality flower can be positioned effectively as a “craft” product, though obviously, these categories will appeal to a smaller segment of the consumer base who is more educated about cannabis products.

We would point to two of the most obvious examples of this, alcohol and tobacco companies – businesses that take inputs of agricultural commodities and manufacture branded consumer products which generate gross margins of between 45-65% on a wholesale basis.



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Exhibit 43 – Gross Margins for Tobacco, Beer, and Spirits (2018)

Source: FactSet, Corporate Filings, Echelon Wealth Partners

This basic concept, while simple to preach, is obviously much more difficult to practice. Building a moat around the business through a recognizable and differentiated brand that commands customer loyalty is the goal of every CPG business outside of those looking to compete as the low-cost provider in a given market. Long term, as brands establish leadership and consolidate market share, we would expect concerns surrounding pressure on pricing to moderate across categories.

Brands Still Mostly Regional…For Now

As we noted earlier in our discussion, no cannabis brand has yet staked their claim as the dominant consumer brand at this nascent stage of the industry, at least not on a national level.

While we still believe a US presence is key for young cannabis companies looking to build an industry leading brand, we should make it clear that this process is still in its early stages. Due to the restrictions on interstate commerce, and MSOs still being somewhat selective about which markets they choose to enter, certain brands are able to command a dominant state or regional presence, though may be entirely absent from other key markets. Given this dynamic, we believe that the market will still maintain somewhat of a regional bent for the foreseeable future, with certain brands being able to claim leadership in specific markets.

This makes it somewhat difficult to prognosticate which brands will be the national and potentially global leaders in the future. To this end, we look to cannabis firms that have a brand-oriented strategy, a strong presence in the key US markets (NY, CA, NV, FL, etc.), and depth in organizational talent on the marketing team.

Why we Believe the Most Recognizable Cannabis Brands will Likely Emerge from the US Market

The notion that the most dominant and recognizable brands in the cannabis industry will come from outside the US marketplace is unlikely, in our view. Looking at the landscape today, while again acknowledging that brand recognition remains tepid within the industry, the legal markets in the US have had a considerable head start on Canadian companies insofar as building those brands that are recognizable amongst the most knowledgeable consumers.

The US consumer market remains the world’s largest by total spending, and across other consumer categories, and also remains home to the majority of the world’s most recognizable consumer brands, as well as the fastest growing brands.

Industry Company Ticker

2018 Reported

Gross Margin

Philip Morris International Inc. PM-US 63%

Altria Group Inc. MO-US 63%

British American Tobacco p.l.c. BATS-GB 66%

Imperial Brands PLC IMB-GB 35%

Average: 57%

Heineken NV HEIA-NL 40%

Anheuser-Busch InBev SA/NV ABI-BE 60%

Carlsberg A/S Class B CARL.B-DK 48%

Molson Coors Brewing Company Class B TAP-US 38%

Average: 47%

Brown-Forman Corporation Class B BF.B-US 65%

Diageo plc DGE-GB 61%

Pernod Ricard SA RI-FR 62%

Average: 63%

Spirits

Beer

Tobacco



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To further illustrate this point, we note that we are already aware of a number of Canadian cannabis companies having entered licensing agreements to utilize some of the more established US cannabis brands in the Canadian recreational market. Conversely, prior to the Canopy-Acreage deal – which will see Canopy licence the use of its brand portfolio to Acreage prior to the exercise of its option – we are not aware of any major US cannabis businesses that have actively sought out the use of Canadian cannabis brands for use in the US market.

Exhibit 44 – Canadian Cannabis Companies’ Licensing Arrangements with US Cannabis Brands

Source: Corporate Filings, Echelon Wealth Partners

We see the US cannabis market as the most likely breeding ground for the most recognizable brands of the future, primarily based on the following advantages.

Fewer restrictions on advertising and marketing: Generally, it is accurate to say that most US cannabis markets,

particularly recreationally legal ones, have more relaxed regulations on advertising, including the use of influencers

and celebrity spokespeople. Influencer marketing has been key in the building of iconic brands, with sports apparel

perhaps being the most prominent example of this with companies such as Nike and Adidas (ADS-ETR, NR),

although sports beverages like Gatorade (owned by PepsiCo Inc.) and major alcohol brands have also historically

been tied to key influencers to build awareness and brand recognition.

Additionally, some recreational markets, such as Nevada and California, allow for out-of-home marketing of cannabis, including billboards and digital ads, with certain restrictions on targeting youth under legal age.



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Exhibit 45 – US Cannabis Public Advertisements

Source: Google Images

This is in stark contrast to the extremely strict advertising laws in Canada, where cannabis businesses are prevented from advertising in any place where youth may be able to view the ad.

Greater freedom to create unique products, delivery formats, and packaging design: With Canada yet to have

legalized derivative and edible formats, despite having legalized recreational cannabis in 2018, the US operators

are well ahead of their northern counterparts with respect to developing and perfecting non-flower delivery

formats. Operators from mature legal markets such as California, Colorado, , and Washington are able to leverage

years of experience in manufacturing these various form factors, which make up more than half of sales in mature

markets where they are permissible. MSOs can leverage IP developed in these mature markets to deploy across

their national footprint as they become allowable.

Even the newly proposed Health Canada regulations for the derivatives and edibles market set to take effect later this year are considered by most industry observers to be severely restrictive compared to US adult-use markets. We see this hampering consumer choice, creativity in product development, and the ability for companies to differentiate their offering.



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Exhibit 46 – Canadian (left) vs. US (right) Cannabis Packaging

Source: BNN Bloomberg, Company Filings

A larger audience caters to building mainstream brand awareness: Simply having the ability to market to the

largest addressable audience for cannabis products in the world allows companies to gain a significant head start

on building brand awareness that can approach something resembling “mainstream” status. While in our view,

having any cannabis brand achieve mainstream awareness is still likely to be a few years out, we believe the clear

favourites to achieve this status are those that are catering to the largest audiences. With 92M residents in adult-

use markets, and another 128M in medical markets, there is little comparison with respect to the addressable

audience for US brands.

US is home to the influential cultural centres for entertainment, sports, and media: The US is home to cities that

are trend-setting markets for Western culture in terms of entertainment, fashion, and media such as New York, Los

Angeles, Las Vegas, and Miami. The consumer brands who can leverage presence in, and associations with, these

markets, we believe will most likely be positioned to succeed in generating brand awareness amongst mainstream

consumers of cannabis. We view California in particular as a key centre for cultural influence and trend-setting

within the cannabis sector, as a result of its (relatively) long history of legalization (1996), and its deeply rooted

cannabis sub-culture.



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M&A Outlook: Acquisition to Remain Likely Method of Expansion, Consolidation to Continue

M&A activity amongst US MSOs has continued to gather momentum throughout the first half of 2019 and is showing no signs of slowing. During the past several quarters, we have witnessed a number of landmark deals by publicly traded US cannabis businesses, including some of the largest in the brief history of the industry.

Exhibit 47 – Reasons to Pursue M&A in the US Cannabis Industry


Build versus Buy Depends on the Market

In the fervent race to establish scale in both state presence and distribution in key states, acquisition has been one of the preferred methods for US MSOs to enter new markets. While winning licenses organically through the application processes is a much more cost-effective option at market entrance or expansion, this is not always necessarily a viable option for operators, and as such, acquiring licenses is the most expedient, or in some cases, the only route to market.

As we noted earlier in our report (here), two of the major advantages of the publicly listed MSO vehicle is the relatively lower cost of capital, and premium valuation relative to single-state and private operators. This presents these companies an attractive value arbitrage opportunity, whereby they should be able to acquire these assets at valuation-accretive prices. MSOs can also apply the same strategy to the acquisition of businesses and assets that are not vertically integrated, such as specific brands, retail operations, or distribution assets.

Some of the scenarios under which we have seen MSOs pursue M&A activity, and the rationale behind those strategic decisions, are discussed here, with examples of transactions provided.

Entering Limited-License States

Acquisition has been a popular method of market entry for MSOs into limited-license states, including highly coveted markets such as Florida and New York, with 22 (recently increased from 14) and 10 vertically integrated licenses issued, respectively, as of writing.

Enter into Limited License StatesExpand• Acquire necessary state cannabis licenses to enter an attractive limited license market

• Examples: various MSOs acquiring Florida and New York state licenses, MedMen acquiring Illinois dispensaries

Acquire Attractive Brands, Distribution or RetailFocus• Bring leading brands in-house, securing shelf space in dispensaries through distribution,

acquiring unique/prized retail assets

• Examples: Curaleaf + Cura Partners (Select), GTII + Beboe, GTII + Integral Associates (Essence), Cresco Labs + Origin House

Merge Complementary MSOsScale• Gain scale quickly by merging complementary assets

• Interstate: Larger platforms may have more partnership/acquisition potential

• Intrastate: Deepen capabilities and acquire market share in attractive regions

• Examples: iAnthus + MPX, MedMen + PharmaCann, GTI + Integral Associates (Essence), Curaleaf + Grassroots



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During 2018 and 2019, we have seen a number of high-priced acquisitions for operators with a presence in these markets, some with consideration paid worth over $100M for a single-state presence. We have even seen licenses in these states, with no operations, valued at significant sums in acquisitions.

Exhibit 48 – Recent M&A Transactions to Enter Limited-License Markets


Roll Up of Operations with a Specific Focus – Retail, Brands, and Distribution

Acquiring operators that have established operations within one or two verticals in the value chain, such as wide scale distribution or a strong brand in a particular market, make for a more attractive way for an MSO to strengthen its vertically integrated footprint, even in markets where licenses may be readily and cheaply acquired. This may provide the acquirer with speed to market, attractive brands, or appealing retail locations that they likely would otherwise not be able to build organically.

For example, an acquirer can leverage the acquiree’s distribution presence and share of shelf space in dispensaries by placing their own brands into the distribution network. An acquirer may also look to add an attractive retail presence in a market where prime locations are limited by state or municipal regulations.

Acquirer Target AnnouncementConsideration

($M)

Description of

Consideration

Green Growth

Brands

Spring Oaks

Greenhouses04-Jun-19 $55

$26.2M in cash, $17.1M in

stock and a $11.4M

promissory note

Cresco Labs VidaCann 18-Mar-19 $120 Mix of cash and stock

Harvest San Felasco 21-Nov-18 $70$34.1M in cash and $29.7M

in stock, + $4M to lender

Acreage Nature's Way Nov-18 $67$63M in cash and ~$4M in

stock

MedMen Treadwell Nursery 06-Jun-18 $5350% ($26.5M) in cash and

50% ($26.5M) in stock

GTI KSGNF Pre-public $65$46M in cash and ~32.7K

multiple voting shares

iAnthus GrowHealthy 17-Jan-18 $48$17.5M in cash and $30.5M

in stock

New York


($M)

Description of

Consideration

GTI Not disclosed 12-Jul-18 $61

$46M in cash and 1.7M

shares, priced at

C$12.00/shr

Acreage NYCanna Pre-public $37$10.3M in cash and $26.3M

in stock

iAnthus Citiva Medical 14-Aug-17 $18

3.6M in cash and 14.4M in

stock at $2.40/shr

(C$3.03/shr)



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Exhibit 49 – Acquisitions of Branded Product Producers with Solid Distribution Capabilities


Merger or Acquisition of MSOs

Another trend we have seen on the M&A front in recent months is the acquisition or merger of MSOs. Multi-state operators with complementary license portfolios across various state markets have combined to create pro forma businesses with a greater depth of presence in larger addressable markets, and greater scale for their brands and products.

A number of landmark transactions of this nature have been announced or completed in the past several quarters. To date, most of the “merger of MSOs” transactions have been between a public acquirer and a private acquiree, though there have been some notable exceptions to this.

We also note the landmark arrangement between Canopy Growth and Acreage Holdings, which, although not yet executed, would constitute the largest ever deal for a US cannabis business.

Exhibit 50 – US MSO Acquisitions of MSOs


Takeaways on M&A

Consolidation, Roll Ups and SPACs to Continue Driving M&A Activity

We see no signs of M&A activity in the US cannabis sector slowing down. As the US cannabis sector continues to develop, we also expect consolidation to continue to be a dominant theme. MSOs are likely to continue to take advantage of the value arbitrage, by rolling up smaller operators, and larger MSOs with potentially complementary asset portfolios explore mergers to create size and scale.

The MSOs are likely to continue to be acquisitive as a means of growth, particularly for entering new markets. While the majority of states with major population centres have at least legalized medical cannabis in some capacity, a number of key states have yet to do so. The eventuality of legalization in states such as Texas and Georgia, and the recent legalization of adult-use cannabis in Michigan, will no doubt attract a number of MSOs to these markets, where


($M)

Description of

ConsiderationDescription of Target Assets - As of Announcement Strategic Rationale Provided

Curaleaf Cura Partners (Select) 01-May-19 $949 All-stock

Makers of the Select Oil and Select CBD brands. The Company

has a large presence in OR, CA, NV and AZ. TTM sales of

$117M.

-Accelerates growth

-Diversifies product range

-Expands customer reach and accessibility

Cresco Labs Origin House 01-Apr-19 $810 All-stock

Primarily based in California, OH delivered over 130 branded

cannabis products from 50+ brands to the majority of licensed

dispensaries in that state.

-Become a premier distribution company serving California

-Accelerates CL’s entrance into the California market

-Multi-state footprint that includes leading distribution market

share in some of the largest states in the country including CA, PN,

and IL

-Combines the expertise of two industry leaders

-Positions CL as a preferred partner for premier cannabis brands

seeking distribution on its expansive platform

-Enhances CL’s capital markets presence

GTI Integral Associates 13-Nov-18 $290$52M in cash and

20.8M shares

Essence retail dispensaries (3 locations in Las Vegas), a 54,000

SFT cultivation and processing facility, and another 41,000 SFT

cultivation and processing facility

-Immediately accretive

-Scale in one of the only limited license (retail) adult-use markets


($M)

Description of

ConsiderationDescription of Target Assets - As of Announcement Strategic Rationale Provided

Curaleaf Grassroots 17-Jul-19 $875$800M in stock and

$75M in cash

Vertically integrated MSO, with presence in key markets

such as IL, PA, MI and OH. Licensed for 61 stores nationally,

with 8 cultivation and 7 processing licenses.

-Creates "world's largest" cannabis company by revenue

-Scale: combines largest private MSO with largest public MSO

-Immediate access to attractive state markets

-Strong brands in medicinal and adult-use markets across the US

Harvest Verano 11-Mar-19 $850 All-stock

Verano was reported to be cash-flow positive, had

operations/licenses in 11 states, owns a proprietary portfolio

of over 150 product SKUs, and possesses ethanol extraction

technology at pharma-level standards.

- Capabilities: Executive team, extraction IP

- Brand portfolio

- Large licensed footprint

iAnthus MPX Bioceutical 18-Oct-18 C$835M All-stock

A vertically integrated MSO with holdings in five states (NV,

AZ, MA, MD, CA). Owns the successful Melting Point

Extracts (high-margin concentrates wholesale) product

brand and Health for Life retail dispensary brand.

-Solidify US East Coast assets with additions in MA and expansion to MD,

while also securing a presence in key West Coast states (AZ, NV, CA)

-Provide 3 key factors to success: scale, access for capital and great people

MedMen PharmaCann 11-Oct-18 $682 All-stock

10 dispensary locations and 3 cultivation/processing

locations were operational in IL, MD, MA, and NY. Licensing

was in place to support 18 retail locations and 8

cultivation/processing facilities.

- Creates largest cannabis company (at the time)

- Strengthens capabilities

- Enhanced infrastructure for M&A and license applications

- Revenue synergies

- Medical assets accretive to MMEN's primarily adult-use assets



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few have any presence. Depending on the restrictiveness of the licensing schemes in these states, acquisition may remain the only viable option for these businesses to gain a presence. Because of this, we continue to view a strong balance sheet as a key requirement for MSOs pursuing entrance into new markets.

In the past year, we have also seen the proliferation of a number of cannabis-focused Special Purpose Acquisition Companies (“SPAC”), many of whom have raised several hundred million dollars each. The majority of the SPACs we have seen appear to be pursuing opportunities primarily related to the US cannabis sector in particular. The capital raised by these SPACs will no doubt be a major driver of continued activity in the cannabis space.

Exhibit 51 – Cannabis-Focused SPACs

Source: Corporate Filings, Echelon Wealth Partners

We see this capital being used to accelerate the roll ups of smaller operators and brands into larger publicly traded vehicles, or potentially being used as a means to list an existing business and inject additional capital into the company for growth projects.

Antitrust Scrutiny a Hurdle, but Unlikely to Slow M&A Activity Amongst MSOs

We note that the one potential hurdle to more consolidation amongst the largest MSOs is the potential for antitrust issues.

Certain states apply restrictions barring a single entity from owning multiple cannabis licenses, which could make certain assets redundant, and thus, a transaction with overlapping assets can occasionally be quite difficult to execute from a legal and regulatory perspective. In addition, we have seen a number of these M&A transactions between larger US operators recently scrutinized by the DOJ, under the Hart-Scott-Rodino Antitrust Improvements Act. Although, to our knowledge, none have been blocked by the DOJ, but the added scrutiny does add potential risk, time and financial costs to businesses pursuing these types of transactions.

Unless and until we begin to see transactions of this nature blocked by the DOJ, we expect consolidation amongst these companies to continue to be a theme moving forward.

Status Name Ticker/Exchange

Funds Raised

(US$M) Target

Cannabis Strategies Acquisition Corp AYR.A-NEO C$135Washoe Wellness, LLC, The Canopy NV, LLC, Sira Naturals,

Inc., LivFree Wellness, LLC and CannaPunch of Nevada LLC

MTech Acquisition Corp. KERN-NDQ $58 MJ Freeway LLC

Canaccord Genuity Growth Corp. CCHW-NEO C$46 Columbia Care LLC

Subversive Capital Acquisition Corp. SVC.UN.U-NEO $575

Mercer Park Brand Acquisition Corp. BRND.U-NEO $403

Tuscan Holdings Corp. THCB-NDQ $240

Tuscan Holdings Corp. II THCA-NDQ $150

Canaccord Genuity Growth II Corp. CGGZ.A-NEO C$100

Raising Capital Bespoke Capital Acquisition Corp. TSX $350

Total: $1,986

Closed

Qualifying

Transaction

Closed Capital

Raise



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Overview of Key US State Markets

Table of Contents

Illinois 62

Florida 67

California 71

Nevada 75

Massachusetts 79

New York 82

Pennsylvania 85



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Illinois – Adult-Use Market Could be 6x the Cannabis Opportunity

Why it matters: Illinois recently enacted legislation to allow adult-use sales to begin on January 1, 2020. With impending adult-use legalization, Arcview and BDS Analytics forecast the IL legal cannabis market to reach $1.1B by 2024. Illinois will be the second largest state by population to legalize adult-use cannabis sales, and the first to establish a commercial adult-use cannabis market through a legislative process. A number of characteristics make Illinois an attractive market, including its scale, the density of its population, as well as an established and growing medical market, which currently serves ~79,000 registered patients. Regulations on allowable conditions for medical cannabis prescriptions have been easing over time, helping to boost patient count and sales.

Current licensing regulations have created a balance between upstream and downstream assets, allowing for various operating models to be successful in Illinois’s cannabis market. We believe the market is particularly well suited for MSOs that pursue a vertically integrated model in this state, and we view these businesses as having a significant advantage in the transition to adult-use sales.

Source: Illinois Department of Public Health, Bureau of Economic Analysis, Illinois Department of Financial and Professional Regulation, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

ILLINOIS $1.1B Market Opportunity (2024) Adult-Use/Medical

Population / Rank 12.7M / 6th Median Household Income $61,229

Proportion over 21 74% (9.4M) Trailing 10-Year GDP CAGR 0.40%

Population CAGR (to 2024) -0.2% Years Legalized

Adult-Use Market

Market Size (2024E) $928M

TTM Sales $0M

Forecasted CAGR to 2024 N/A

Adult Usage Rate (2018): 7.1%

Number of Monthly Users 0.7M

Initial Adults (21+) Per Dispensary 85,000

Adult-Use Regulatory Landscape

Adult-Use Dispensaries 110 + 75 to be issued

Cult./Processing Licenses 20

Forced Vertical Integration? No

Adult-Use Cannabis Taxation

Medical Market


TTM Sales $178M

Forecasted CAGR to 2024 3.4%

Unique Monthly Patients 47,011

Registered Patients1 78,871

Dry Flower as % of Sales 46% (Q219)

Medical Regulatory Landscape

Current Medical Dispensaries 55 (up to 60 permitted)



Medical Cannabis Taxation 7% Excise, 1% Sales

1 Includes Opioid Alternative Pilot Program registered patients.

Rec - 2019 (Sales commence

2020), Medical - 2013

7% Excise, 10%+ Sales,

up to 3.5% Local

Other Considerations: Adult-use sales begin Jan-2020. Medical

cannabis companies will have a head start in the adult-use market.

$0.3

$0.4

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2,6637,707

23,300

42,203

78,871

0

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Medical Market Picks up Steam Following New Rules Increasing Patient Access

Medical program showing rapid growth, patient access has been increasing: Illinois enacted the Compassionate Use of Medical Cannabis Pilot Program Act in August 2013, which came into effect on January 1, 2014, with first sales from the program beginning in November 2015, due to a lengthy approval timeline for cannabis businesses. The program allows persons diagnosed with a qualifying debilitating medical condition – a lengthy list of 40 conditions, including cancer, Crohn’s disease and PTSD – to register with the Illinois Department of Public Health (IDPH) and obtain access to cannabis for medical use. In January 2019, the IDPH implemented new rules to ease the patient enrollment process by rescinding requirements for background checks and by instructing local health departments and medical cannabis dispensaries to provide medical cannabis application support without charge. The IDPH also established a new Opioid Alternative Pilot Program (OAPP), allowing patients to access medical cannabis as a replacement for a prescription for opioids, as certified by a licensed physician. These combined efforts significantly accelerated the growth of the medical market, as we reiterate in the exhibit below.

Exhibit 52 – Increase in Registered Medical Cannabis Patient Count in Illinois

Source: Illinois Department of Public Health, Echelon Wealth Partners

Key medical licensing rules: Illinois’ current medical cannabis program rules allows for the issuance of up to 60 dispensary licenses and 22 cultivation/processing facilities. The state has so far approved 55 operational dispensary licenses and 20 cultivation/processing facilities. An entity is allowed to own up to three cultivation licenses and five medical dispensary licenses. 38 dispensary licenses (63% of total licenses) have been reserved for the Greater Chicago Metropolitan Area, while 22 licenses (37%) are available outside of Chicago. All medical cannabis product sold in Illinois must first be tested by a licensed testing agency.

Adult-Use Market Ready for Take Off in Illinois

Adult-use market would be 6x the cannabis opportunity, medical operators to receive priority treatment: On June 25, 2019, Illinois Governor J.B. Pritzker signed a bill to allow adult-use cannabis consumption, possession, and commercialization beginning in 2020. Recent estimates from Arcview predict that the adult-use market will reach $928M in annual sales by 2024. Combined with forecasted medical sales of $213M, legal sales are expected to exceed $1.1B in 2024, or more than 6x larger than TTM medical market sales of $178M.

Importantly, current medical cannabis operators would be given preferential treatment in the adult-use market and will be allowed to commence adult-use sales as early as January 1, 2020. New entrants would have to apply for adult-use licenses, which are scheduled to be handed out in mid-2020, giving existing medical operators at least a half-year head start in the new adult-use market. Currently, licensed medical dispensaries will also be allowed to sell recreational cannabis in existing dispensaries (of which there are 55 locations), and grow/process recreational cannabis in their existing facilities, allowing medical operators to take advantage of their already established retail footprint and cultivation/processing infrastructure. Medical operators may also opt for an additional store location per dispensary license held (allowing for 110 adult-use stores in total).

0%

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40%

60%

80%

100%

120%

Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19

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y/y)

Illinois Y/Y Patient Growth (OAPP Adj.)

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In addition, current medical cannabis licensees will control the 20 currently operational commercial-sized cultivation licenses, with only small-scale (<5,000 SFT) “craft grow” cultivation licenses to be issued post adult-use legalization, which we believe will be largely uncompetitive against the more experienced and larger-scale/lower-cost established operators. While we generally view cultivation as the least favourable part of the value chain to own, the current regulations effectively hand current medical cultivators control over the state’s supply of cannabis, which may grant these companies greater pricing power and leverage in building a cannabis CPG business. Given these factors, we view Illinois’ current licensed cultivators under the medical regime as exceptionally well positioned for the transition to an adult-use market.

More details on the adult-use regulations – Tax rates will be high, new licenses will be issued: The bill legalizes adult-use cannabis for those over 21 years of age and allows possession of up to 30 grams. Excise taxes on cannabis are relatively high, with an excise tax of 7% on cultivators, a sales tax of 10% (including 25% for products with greater than 35% THC), and would also allow municipalities and counties to apply up to an additional 3.5% in sales taxes.

Adult-use licenses will be issued for up to 75 new stores, 40 processors and 40 craft growers in the initial round of licensing by May 2020, with no entity allowed to control more than 3 cultivation facilities and 10 dispensaries. Another round of licenses is scheduled for December 2021, where up to 60 additional craft growers (100 total) and processors (100 total) may become licensed, as well as up to 110 more adult-use dispensaries (295 total). The distribution of licensing between the various verticals seems fairly balanced, with exception for the amount of cultivation assets, which seems low relative to other state markets.

Exhibit 53 – Illinois Adult-Use Licenses Permitted

Source: State of Illinois, Echelon Wealth Partners

Home to some of the biggest and best: Illinois has been a key hub from which some of the largest US cannabis businesses have emerged. Two of the five largest publicly listed US MSOs – Green Thumb Industries (GTII-CSE, Buy, PT C$24) and Cresco Labs (CL-CSE, Speculative Buy, PT C$15.00) – call Illinois home, while many prominent private MSO have also emerged from the state, including Grassroots (in the process of being acquired by Curaleaf), Verano (in the process of being acquired by Harvest Health & Recreation), and PharmaCann (in the process of being acquired by MedMen). Over time, we believe Illinois will emerge as one of the preeminent cannabis markets in the US.

20

110

2 Unallocated Licenses 40 40

75

60 60

110

0

50

100

150

200

250

300

Cultivation/Processing Craft Grow Processors Adult-Use Dispensaries

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Number of Cannabis Licenses Allowed to be Issued

Reserved for medical

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Issuable in mid-2020

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Chicago and its suburbs are key to Illinois market: The state’s economic activity and population is densely concentrated around the Chicago greater metropolitan area, which accounts for approximately 83% of the state’s economic output and is home to 75% of its population.

In such a densely populated area, securing prime real estate locations will be a key determinant of success for medical and adult-use dispensaries in the state, though relatively few dispensaries being open at the commencement of recreational sales should translate into early success for those that are operational. Companies that currently operate dispensaries serving the medical market will be best positioned to transition existing medical-use locations into adult-use locations.

Control, moat, optionality; Why vertically integrated MSOs are well positioned in Illinois: We reiterate that established medical cannabis companies have pole positioning for the transition to adult-use, given their head start in the market, ability to leverage existing infrastructure, and control over the state’s commercial-scale cannabis supply. Of the established medical companies, we view vertically integrated operators as best situated in the Illinois market for three overarching reasons: 1) stronger economic moats, 2) greater control over the supply chain, and 3) the optionality of vertical integration as a ‘hedge’ to still-developing cannabis regulations.

Limited licensing regime favours larger, better capitalized operators: As it stands, IL is best characterized as a

limited-license market. Though Illinois has authorized the issuance of up to 185 adult-use dispensary licenses by

the end of 2020, the ratio of stores to population is well below the level seen in other adult-use markets (see Exhibit

54 below). In terms of the medical market, Illinois has issued only 55 medical dispensary licenses to serve 79,000

registered patients.

At the same time, MSOs also control many of the only 20 issued commercial-sized cultivation/manufacturing licenses in the state, allowing them to service the wholesale market with branded products, while also ensuring consistent supply for their own dispensaries. We also view the number of medical and adult-use dispensaries as being supportive of a robust and sizeable wholesale market for these upstream assets A number of MSOs which we follow that are active in the state are committing significant capital to expanding their cultivation capacity, in anticipation of significantly increased demand which we believe may result in supply shortages in the early days of the legal rec market (see following section).

This model is capital intensive to implement and is best suited for larger MSOs with the capability to manage a vertically integrated operation. As mentioned, enacted adult-use regulations give preference to cannabis businesses already licensed and serving the medical market, which provide yet another advantage of establishing operations in IL ahead of this.



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Exhibit 54 – Number of Age 21+ Adults per Adult-Use Dispensary in Legal Recreational Markets


Switch from medical to adult-use may leave market undersupplied at a critical juncture: Control over cultivation

and manufacturing will be crucial in the early days of the transition from a medical to adult-use market. As we have

seen in other state markets, and in Canada, this transition to adult-use is often accompanied by severe cannabis

shortages. Controlling cannabis cultivation ensures supply for manufacturing in-house brands, and preferential

supply for their owned and operated dispensaries.

Because the existing medical operators will control the only commercial-scale cultivation facilities in the state, we view them as extremely well positioned to navigate and potentially benefit from such a supply shortage situation. Though the state plans to issue “craft” grow licenses for the adult-use market, we believe these to be too small in scale to be of interest to most MSOs and will likely be uncompetitive against larger-scale facilities managed by more experienced MSOs. At most, only 200,000 SFT of combined total canopy is available to the 40 potentially issuable craft grow licenses in 2020, which would supply only a fraction of Illinois’ likely cannabis demand. Under these conditions, we view Illinois as one of the states where there continues to be significant value in maintaining cultivation operations for the foreseeable future.

Note: Illinois' number of adult-use dispensaries is assumed to be 185 (110 reserved for medical operators + 75 more to

be issued in 2019). We use 127 adult-use stores for Nevada, which includes the 61 retail licenses recently issued.

51,000

47,000

17,000

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Illinois California Nevada Washington Colorado Oregon

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Florida – Opportunities Look Bright in the Sunshine State

Why it matters: Florida is the fastest growing medical-only legal cannabis market in the US and is almost certain to overtake Michigan as the largest medical-only cannabis market in the world. The active patient count recently surpassed 248,000, growing ~132% y/y. With a population of over 21M, Florida also boasts highly favourable demographics for a medical market, with more than 20% of its residents over the age of 65 – the highest such ratio of any US state.

Florida is an attractive market for cannabis companies fortunate enough to have secured, or acquired, one of the state’s few initial cannabis licenses and established themselves as a first mover in the market. As an example, Trulieve, the market leader in the state, currently reports some of the highest quarterly revenues (Q119: ~$44.5M) and EBITDA margins (Q119: 43%) of any publicly listed cannabis company operating in the US, all a result of its early-mover advantage and leading position in Florida.

Due to the initial limited-license regime, well capitalized MSOs quickly flooded into the state to acquire licenses, mostly from privately held companies, taking control of 9 out of the 14 cannabis licenses available as of YE 2018. Barriers to entry have been slowly eroding, with 22 (8 new in 2019) licenses now outstanding and authorization to issue up to 7 more.

Source: Florida Department of Health, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

Medical market: Qualifying conditions are relatively broad, allowing for a robust medical market. Important allowable qualifying conditions include: cancer, chronic non-malignant pain, terminal illness, MS, PTSD, and Crohn’s disease, among others. Patients are required to register with the Florida Department of Health (“DOH”) with a prescription from a qualified physician, after which they receive a registry ID card. To date, ~332,000 unique patients have registered and ~248,000 still hold an active ID card.

FLORIDA $1.9B Market Opportunity (2024) Medical

Population / Rank 21.3M / 3rd Median Household Income $50,883


Population CAGR (to 2024) 1.0% Year(s) Legalized Medical - 2016

Medical Market

Market Size (2024E) $1.9B

2018 Sales $0.6B


Active Patients 248,380

Registered Physicians 2,397

Active Patient Growth Y/Y 131.9%


Medical Dispensaries Open 143

Total Licenses Issued 22

Forced Vertical Integration? Yes

Medical Cannabis Taxation None

Other Considerations: Various lawsuits may change the regulatory

landscape in Florida. Dried flower only recently permitted.

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Exhibit 55 – Registered Medical Cannabis Patients in Florida

Source: Florida Department of Health, Echelon Wealth Partners

How 7 grew to 22 – Moat surrounding license holders gradually easing: Florida’s medical cannabis program is one of the more restrictive in terms of the total number of licenses issued (22 licenses), relative to such a large population and active patient base. However, Florida’s barriers to entry have been slowly easing, primarily due to legislation and a number of successful lawsuits filed against state regulators.

Florida’s licenses (referred to as Medical Marijuana Treatment Centers, or “MMTCs” by the state program) mandate vertical integration, allowing for an operator to own cultivation, processing, a number of dispensary locations (currently capped at 35 locations), and the ability to provide statewide delivery of medical cannabis products. License holders are not permitted to hold more than one license in the state.

Below, we present how the number of licensees and maximum number of dispensaries have grown over time.

Exhibit 56 – Florida License Issuances Since 2015 (LHS), Maximum Dispensaries Allowed (RHS)


By law, per each 100,000 active patients in the state’s medical cannabis registry, another four licenses are available for issuance and the dispensary cap per licenses also rises by five locations. While the number of licenses – and therefore the number of companies – remains restrictive compared to the size of the population/patient base, it is apparent that competition, particularly at the retail level, will continue to intensify as more dispensaries come online.

26-Jul-19, 332,465

26-Jul-19, 248,380

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Patients in the Registry Active ID Cards

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Nov-15 Nov-15 toDec-16

Aug-17 Nov-17 Jul-18 May-19 Today

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We note that only a fraction of the permitted dispensaries are currently operational (143 out of 770, or ~19%). We feel that with the possible exception of the first movers in the state (including Surterra Wellness, Trulieve and Curaleaf, each with over 20 locations), most new MSOs ramping up operations in Florida will not elect to open their full allocation of retail stores. In our view, with Florida still a medical-only opportunity, the market would likely become oversaturated if all license holders were to fulfill their entire allocations. Home delivery also allows companies to serve nearby customers without needing to open additional brick and mortar locations.

Handful of companies control the market: Despite the recent increase in issued licenses, the market remains dominated by the first movers, as only a handful of newcomers have managed to open a significant number of dispensaries. Just five companies collectively own 109 (or 76%) of the 143 operational dispensaries in Florida.

Exhibit 57 – Number of Operating Medical Dispensaries in Florida (July 31, 2019)


To this point, the positions of the businesses with leading share have been largely unchallenged. Over the past year, well capitalized MSO license holders have been investing heavily in building out their operations in the state, and the increase in operational dispensaries from these newer entrants – such as iAnthus (GrowHealthy), MedMen and GTI (Rise) – are very likely to begin eroding the market share held by the incumbents in the near future.

Vertically integrated model required in Florida, but be prepared to pivot: We view Florida as one of the few truly vertically integrated regulatory models in the US cannabis industry, since the wholesaling of cannabis products is not permitted between LPs. In essence, this means that operators can only sell what they are able to grow, and forces operators to own cultivation, retail, and everything in between. This structure places a number of added costs on licensees, including higher capital requirements and a wide range of operational competencies, and creates added operational risk.

As it stands, the system greatly favours larger, more experienced cannabis operators with better access to talent and capital resources. We believe that the well-capitalized MSOs hold a significant advantage in the current environment, which we feel will hold up against the new entrants allowed through additional licensing. The most intense rivalry would appear to be amongst the MSOs themselves, as they look to steal market share from one another.

We note, however, that the possible removal of the vertical integration mandate (see discussion in the following section) would likely reduce the barriers to entry and may incentivize vertically integrated firms to pivot their business models, and exit lower value activities that could be outsourced. More important though, it would likely see the creation of a robust wholesale market, allowing firms to sell their products in the (potentially) several hundred dispensaries in the state, which will have significant implications for brand-focused CPG business models employed by most MSOs.

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Path forward is through the courts: Regulators in Florida have been subject to a number of lawsuits since the program launched, some of which have forced significant revisions to the medical cannabis program. More so than any other US state, it seems court challenges will remain an important driver of cannabis regulatory changes in Florida going forward. We profile a number of the most impactful pending and completed legal challenges below. We also note that the last nine cannabis licenses issued by the DOH have been prompted by legal challenges.

Smokable products now available: Earlier this year, Florida’s lawmakers repealed a ban of smokable medical

cannabis products after a court ruled the prohibition was unconstitutional. A legislative solution to repeal the ban

passed in March 2019, and smokable products were available for sale by the end of that month in certain locations.

We view this as a significant expansion to the medical cannabis program in Florida, since smokable products

typically account for about half of sales in other major medical markets where it is allowed.

Dispensary caps ruled unconstitutional, Trulieve benefits from subsequent settlement: A February 2019 ruling

found that the cap on the number of dispensary locations for each license was unconstitutional. The cap was

determined to increase costs and delay access to medical cannabis products. Trulieve, which filed the initial

complaint, settled with state regulators by accepting an agreement which stipulated that dispensaries opened

before the cap was established are not included in the calculation. As such, Trulieve’s license currently allows for

49 locations, while its peers are capped at 35 locations. Of note, no Florida cannabis company has yet to reach their

dispensary cap within that state.

“One-Pointers” score nine cannabis licenses through court challenges: Nature’s Way and a group of eight former

cannabis license applicants filed a series of separate legal cases against Florida’s DOH after they failed to win

licenses in the initial 2015 issuance, with scores just one point lower than the winning applicant. Nature’s Way was

successful in its court challenge, which concluded with the issuance of a license to Nature’s Way in 2018. The

success of this lawsuit prompted a series of additional court battles against the DOH from other “one-pointers”,

and the DOH settled with eight of the plaintiffs in mid-April 2019, with licenses issued by early May, according to

regulatory filings. This resulted in the increase in total issued licenses to 22 from 14.

Limited licenses and forced vertical integration being challenged: In our view, this may be the most important

legal challenge still outstanding in the state, which if successful, could potentially force an overhaul of the licensing

system in Florida.

Florigrown LLC filed a lawsuit alleging the limited licensing and forced vertical integration (with no wholesale market permitted) is unconstitutional. A judge initially sided with the plaintiff, though an appeal was filed by the DOH and the case is currently on hold.

A successful challenge could see the abolishment of the restrictive cap on licenses in Florida, and repeal the requirement for vertical integration, opening up the market to new entrants, including those focused on specific activities such as cultivation, manufacturing and retail. Over time this would result in increased rivalry in the market and lower barriers to entry, but also enable a more competitive and developed supply chain, and a robust wholesale market. Governor DeSantis has remarked that he supports eliminating the forced vertical integration of Florida’s cannabis licenses.

Adult-use prospects dim in the medium term: Adult-use legalization looks to be an unlikely prospect over the intermediate term. Florida’s Republican Governor, Ron DeSantis, has previously voiced opposition of recreational use cannabis, and we understand there also remains significant opposition in Florida’s House of Representatives. A bill to legalize cannabis in March 2019 died in the House weeks later after it failed to secure a hearing. We are aware of a movement by activists in the state to attempt to place a vote on recreational cannabis placed on the state ballot in 2020, though it is unclear if this is at all likely to succeed at the moment.

Despite the lack of concrete near-term catalysts, we believe adult-use cannabis should remain on the radar as a possibility over the next several years, as this has the potential to add billions in annual sales. Companies that establish a strong retail footprint in ideal locations, and a recognizable brand widely distributed throughout the state’s dispensaries, would be very well positioned for an eventual transition to adult-use cannabis.



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California – The Elephant in the Room

Why it matters: California is currently the world’s largest legal cannabis market and is set to remain so for the foreseeable future. Even with a challenging 2018, due to the implementation of new recreational regulations that resulted in licensing issues throughout the industry, California generated $2.5B in legal sales, 61% more than the next largest US state market, Colorado.

The state offers unmatched potential for any cannabis company able to navigate the complexities of the regulatory and competitive environment in the Golden State. However, a patchwork of regulations at the state and municipal levels, and a strong illicit market presence, have hampered the legal market from achieving its full potential.

In addition to the sheer size of the market, we also view California as a key centre of influence for cannabis sub-culture, owing to it being the de facto home of the countercultural movement supporting cannabis legalization in America. It becomes hard to conceive of a truly national consumer brand in cannabis, without having at least some modest success in California. We believe most US MSOs are still contemplating the best approach to successfully attack the California market, where various strategies appear to be viable, though it is not obvious which will be ideal.

Source: Bureau of Cannabis Control, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

The elephant in the room: Enormous potential that no company has managed to wrangle: Despite the enormous size of the adult-use market in California, no single cannabis company, in our view, has managed to establish a meaningful position as the dominant player in the world’s largest adult-use market. The market has been plagued by frequent regulatory changes, strong municipal pushback, license expiries, and fierce competition across most of the supply chain. We highlight some of the more pressing issues that cannabis companies face in operating in the California market.

Municipalities have power, creating a regional patchwork of regulations: Municipalities have the authority to implement their own cannabis regulations on top of the state’s rules, including the ability to opt out of allowing legal cannabis business activity altogether. An MJBiz report in February 2019 highlighted that less than one-third of municipalities allow cannabis activity of any kind within their boundaries. Almost 80% do not allow dispensaries (neither medical nor adult-use), leaving residents no legal brick and mortar outlets from which to purchase cannabis.

CALIFORNIA $7.2B Market Opportunity (2024) Adult-Use/Medical

Population / Rank 39.6M / 1st Median Household Income $67,169


Population CAGR (to 2024) 1.1% Years Legalized Rec - 2016, Medical - 1996

Adult-Use Market


2018 Sales $2.5B




Adults (21+) per Dispensary 47,000


Adult-Use Dispensaries 634

~20% of 482


Adult-Use Cannabis Taxation15% Excise, $9.25/ounce,

8-10% Sales

Municipalities Allowing

Dispensaries

Other Considerations: Much of the state's cannabis businesses are

operating under temporary licenses. Many muncipalities have

banned commercial cannabis activity.

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Even for those that allow cannabis businesses, often additional regulation is imposed. In April 2019, a group of 24 municipalities filed a lawsuit against the state for allowing home delivery of cannabis to municipalities that had banned cannabis dispensaries. The lawsuit is ongoing but serves as a reminder that local municipal cannabis policy may continue to contest the roll out of the legal cannabis market.

Shifting regulations prove challenging in 2018, with ongoing impacts in 2019: California’s legal cannabis market has been stunted by a series of regulatory changes that confuse businesses and, in our view, have prevented many of the larger MSOs from committing significant capital to investing in the state. Below, we highlight some of the major changes that repressed the legal adult-use market in 2018, and which continue to cause some issues for operators in 2019.

Botched adult-use transition: California’s adult-use market commenced on January 1, 2018, under emergency regulations to accelerate the launch of the legal cannabis industry under less strict rules, including temporary licenses. However, even the accelerated licensing failed to support the transition to adult-use sales. Of the 1,150 retail storefronts and 2,000 delivery services operating as of December 31, 2017, only 150 medical retailers, 99 adult-use retailers, and 17 medical delivery licenses possessed temporary licenses to legally continue operating the next day. Legal sales plummeted 55% m/m, according to Arcview Market Research estimates. Even as temporary licenses became more widely available, MSOs were rightfully hesitant to invest in licenses that expire in less than 12 months.

Transitional rules expire, supply dries up as testing and compliance prove too burdensome for many: Transitional rules that allowed businesses to issue non-compliant packaging, allow medical and adult-use licenses to transact with each other, and to ignore the state’s track and trace system, expired on July 1, 2018. California concurrently implemented stricter testing and packaging requirements, as well as limits on THC levels in products. We understand these changes caused meaningful supply shortages. A report by The Associated Press in September 2018 claimed that 18% of almost 11,000 cannabis products tested failed the new testing requirements during July/August. In addition, a shortage of licensed testing labs further constrained cannabis supply. Cannabis sales fell 13% m/m in July 2018 and did not recover to prior levels by the end of the year, according to Arcview Market Research estimates.

Final rules more reasonable, dominoes begin to fall: Final regulations came into effect January 1, 2019, which reinforced a policy of state-wide delivery (even into municipalities that have banned cannabis dispensaries), provided a legal route for white-label manufacturing for non-cannabis licensed entities/brands, implemented new testing requirements, and enacted additional changes to the packaging regulations, among other items. It was only after these final regulations were implemented that MSOs begin to make meaningful investments into California. Earlier this year, we saw that, for example, Cresco acquired Origin House for $810M and Curaleaf acquired Cura Partners for $875M.



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Exhibit 58 – Most Temporary Licenses Expired by July (LHS), New Rules Gets the Ball Rolling (RHS)

Source: Marijuana Business Daily (left), Los Angeles Times (right), Echelon Wealth Partners (right)

Politicians approve a ‘Band-Aid Bill’ to stem tide of expiring temporary licenses: The primary obstacle faced by licensees and regulators in early 2019 was a tsunami of temporary license expirations. Temporary licenses were only valid for one year, after which the licensee was to secure a full annual license. A chart produced by Marijuana Business Daily in March 2019 shows that cultivators and manufacturers have endured most of the license expirations, including 5,600 cultivation licenses during the first four months of 2019, according to a spokeswoman for the California Department of Agriculture. California Governor Gavin Newsom signed bills (AB 97 and SB 97) on July 1, 2019, to allow for further extensions of temporary cannabis licenses, allowing regulators to issue “provisional licenses” to companies that previously held temporary licenses, as well as for new entrants to the legal cannabis industry.

Well established illicit market continues to thrive: Anchored by cultivation out of Humboldt, Mendocino and Trinity counties, often referred to as the “Emerald Triangle,” the illicit cannabis market continues to thrive in California. The New York Times quoted public and private sector studies that showed approximately 14M pounds of cannabis is illegally produced in California annually; only 20% is consumed in the state while the rest is exported illegally through trafficking routes. Using recent spot pricing provided by Cannabis Benchmarks for the US industry, we calculate that California’s illegal harvest is worth ~$16B/year at legal market price levels. Meanwhile, there continues to be a greater number of illicit dispensaries in the state than legal dispensaries. For example, the Los Angeles Police Department recently estimated there were 300-500 illegal dispensaries in the city, compared to only 76 legal dispensaries with an active license as of early-August.

Legal cannabis businesses in California face stiff competition from this deeply entrenched illicit market, which already has an established supply route, lower production costs, and lower pricing than legal product. Meanwhile, legal cannabis operators face tax burdens that can reach 45% or even higher, and a high fixed cost base driven by compliance policies.

Highly competitive landscape potentially more impactful than regulatory/political issues: While the regulatory and political landscape caused its fair share of challenges to cannabis operators, a more entrenched issue is the intense competitiveness in the Californian cannabis industry, in our view. Competition in the state has stemmed from a number of factors, including the high total number of operators, no cap on licensing, and strong competition from the illicit market. Nonetheless, the scale of California may be an incredibly profitable opportunity for those able to gain a significant market share, who lead in targeted segments of the value chain or in a product category, and those companies who can build brand equity.

Branding machine – California the preeminent cultural and cannabis hub in America: California is a centre of strong influence in American culture, media, and entertainment, owing to being a major population centre (the largest state by population), its importance in the film and music industries, its leading exposure to increasingly influential technology companies, and as a hub for R&D through many of the world’s leading universities. We must also acknowledge California’s immense impact on cannabis culture, specifically. For these reasons, the consensus view is

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that California is one of, if not the, most important markets in the world for building widely recognizable cannabis brands. We view it difficult to conceive of any truly national cannabis brand that does not have a strong presence in California.

Fragmented market and disintegrated licenses a challenge for the vertically integrated MSO model: In contrast to many other major markets, the licensing system in California does not require vertical integration, nor is the number of licenses limited, two of the hallmarks of many of the states in which the large cap MSOs have a strong presence. This environment supports the creation of a competitive market with the opportunity for operators to specialize and outsource, potentially allowing multiple operating strategies and business models to succeed.

Compared to other state markets, we believe a non-vertically integrated strategy, particularly for brand-focused businesses, is potentially most viable in California. Specialization is a more efficient use of capital, focusing on leveraging a company’s core competencies and avoiding having to invest capital in cultivation, and potentially only making highly selective investments in retail assets.

A traditional roll-up strategy may be difficult to execute, given the sheer number of licensed operators and the lack of obvious winners over the long term. In addition, it is an expensive proposition to invest in building out a statewide operation from the ground up, particularly when the path to financial reward is not so clear given the intense competition and highly fragmented marketplace.

It is our view that the fractured regulatory structure, low barriers to entry, and a highly fragmented competitive environment have kept most MSOs from investing heavily in this market, first preferring to establish operations in the limited license markets where the competitive dynamics are simply more favourable. Over time, we see capital beginning to flow into California in a more meaningful way, with consolidation beginning at the midstream and retail verticals, where we currently see the best opportunities as discussed below.

A focus on midstream verticals, selective retail assets, offer the best prospects: The relatively strong and competitive legal supply chain of cultivators and processors in the state has allowed companies to focus on the midstream verticals, without the requirement to invest in and operate upstream assets, as branded CPG businesses look to secure shelf space for their products in the state’s 634 (according to Arcview Market Research as of July 2019) operating legal dispensaries.

Another model we have seen deployed in California with some success is a distribution strategy. Distributors can offer value to retailers by aggregating the upstream product offering into a single logistics solution, while also offering companies a chance to rapidly accelerate penetration into retail shelf space. Though a lower margin business, this model can succeed in the California market by taking advantage of scale, where in contrast to limited-license state markets, distributors have a market of several hundred – and likely to reach well over 1,000 as licensing continues to progress – dispensaries to place products into.

Retail can also be a defensible model in certain Californian regional markets, taking advantage of municipal caps on licensed dispensaries, land use restrictions and attractive real estate, which can make dispensary licenses quite valuable, despite the lack of caps on total dispensaries in the state.

For example, the city of San Diego (pop. 1.4M) allows just 36 retail licenses within its city limits (only 23 permits actually issued), while San Francisco (pop. 0.9M) has issued just 34 retail licenses (32 of which are approved for adult-use). Owning one of these coveted licenses where the addressable market is measured in millions, and the number of cannabis retailers in dozens, can certainly make for an incredibly valuable retail operation.



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Nevada – Tourist Participation to Increase, Driving Outsized Spending

Why it matters: Nevada has become a sought-after market for investment by cannabis operators due to the early success of its adult-use program, as well as it being a major tourist centre in the US. More than 46M tourists visit Nevada’s largest city, Las Vegas, each year. Attracted to Sin City for the hotels, clubs and casinos lining the iconic Las Vegas Strip, the vast majority of tourists are over 21 years of age and are generally price insensitive, an ideal target market for any cannabis business. With the substantial number of out-of-state and out-of-country tourists that visit Las Vegas, we view Nevada as another key market for cannabis operators looking to establish a truly recognizable consumer brand.

Cannabis licenses are limited in Nevada, but not severely so, allowing for a modest level of competition and a robust product offering. We view retail as ultimately the most defensible and lucrative vertical in the state, primarily based on location, though a CPG model focusing on distributing branded value-add products such vape, edible and pre-roll products throughout the state’s high-traffic dispensaries should also find success in the market.

Source: Nevada Department of Taxation, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

NEVADA $1.5B Market Opportunity (2024) Adult-Use/Medical

Population / Rank 3.0M / 32nd Median Household Income $55,434

Proportion over 21 73% (2.2M) Trailing 10-Year GDP CAGR -0.1%

Population CAGR (to 2024) 2.1% Year(s) Legalized Rec - 2016, Medical - 2001

Adult-Use Market


2018 Sales $0.5B


Cannabis Usage Rate (2018): 7.7%


Number of Tourists to Las Vegas 46M


Adult-Use Dispensaries 66 + 61 recently i ssued

Cult./Processing Licenses 134 Cult. / 96 Proc.


Adult-Use Cannabis Taxation15% Excise (C), 10%

Excise (R), 2.6% Sales

Medical Market


TTM Sales $0.1B

Forecasted CAGR to 2024 (11.9%)


Registered Physicians 762

Most Reported Condition (%): Severe Pain (87%)



Medical Cannabis Taxation15% Excise (C), 2.6%

Sales

Other Considerations: Adult-use sales of $425M in the first full year

(July 17 - June 18) was well above the state's estimates of $265M.

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Viva Las Vegas: The most recent data published by the Nevada Department of Taxation showed that nearly 80% of taxable retail cannabis sales were derived from Clark County, which includes the City of Las Vegas and the surrounding metro area. Clark County also accounts for about 73% of the state’s population. We believe Clark County’s share of total statewide sales will continue to grow as it becomes easier for tourists to purchase – and consume – cannabis products in the city. This will be driven by increased store count, a wider offering of brands and products, and the approval of consumption lounges.

Exhibit 59 – Location of Licensed Cannabis Establishments (LHS), Sample of Dispensaries Surrounding the Las Vegas Strip (RHS)

Source: Nevada Department of Taxation, Google Maps

Tourism will drive outsized spending: Tourists to Las Vegas are on average 45 years old, though 38% are millennials. They tend to stay three nights and four days on average, 80% originate from another US state, and 82% are repeat visitors. We view the tourist population as generally being price insensitive, given that the majority are visiting the city on vacation (many mentally prepared to gamble money at one of the Strip’s many casinos) or expense-paid business travel.

We view the following as key success factors to attracting the tourist to cannabis dispensaries.

Proximity of real estate to Las Vegas Strip is key: Dispensaries in proximity to The Strip, which serves as the

epicentre for tourism in the state, are more likely to win customer traffic in the city that competes heavily for share

of a tourist’s time and wallet. However, cannabis dispensaries are not permitted directly on the Las Vegas Strip (per

its strict definition of Las Vegas Blvd South, stretching from Russell Road to Sahara Avenue), though many are

located just outside its official boundaries, so getting the word out about where the nearest dispensaries are to the

tourist population is also of vital importance.

80 of the 127 (or ~63%) of the state’s dispensary licenses are located in the City of Las Vegas or the surrounding Clark County area. Though this may at first appear highly saturated, we point out that this is actually lower in proportion to the percentage of the state’s population living in Clark County. Given that the vast majority of the state’s tourism is also centred in that area, this distribution implies the area is, if anything, somewhat underserviced relative to the rest of the state.

Service providers are a choke point for access to retail stores: Though we view proximity as important, even the

closest cannabis retail stores are still beyond walking distance for most prospective customers. We understand that

taxi cabs and rideshare providers are therefore an important method of transportation tourists use to travel to and

from a dispensary. Given that tourists are often unfamiliar with the names and locations of the local retail outlets,

cab and limo drivers, ride share drivers and hotel concierges may be very influential in directing customer traffic to



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certain the dispensaries. Incentives to attract cab drivers (whether through cash payments, gift cards or ancillary

services) may be a key factor in driving increased customer traffic.

Online presence a must for the unfamiliar tourist: Those unfamiliar with the local stores are also likely to turn to

online reviews and forums to find the best-rated cannabis dispensaries in their area. A strong online presence

coupled with positive customer reviews may be decisive in winning customer traffic in Las Vegas more so than most

markets, where simple convenience or familiarity may be the primary determinant.

Cannabis consumption regulations push users towards vape pens, edibles, and distillates: The average product mix at a Las Vegas dispensary is likely different than in most other dispensaries across the country. Tourists are not allowed to consume cannabis in their hotel rooms, in public, or anywhere on The Strip. Smoking cannabis is currently only legally permitted in private residences, of which the vast majority of tourists would not have access to. As such, products that offer a discreet and user-friendly means to consume cannabis would be heavily favoured by tourists purchasing from Las Vegas dispensaries. These products command premium pricing, as seen in Exhibit 60, with the sales mix therefore being favourable to retailers and CPG brands marketing products in these categories.

Exhibit 60 – Average Price per Gram for Various Product Formats in Adult-Use Markets

Source: Headset Inc., Echelon Wealth Partners

Las Vegas approves consumption lounges, more tourists likely to participate: In early May 2019, the Las Vegas City Council approved a new class of cannabis license that will allow social consumption lounges within the city, which may assist somewhat with providing a solution for the lack of settings for legal consumption. Legal consumption lounges could see a boost in tourist participation in Las Vegas’ legal cannabis market as a result. Licensed marijuana operators are permitted to apply for special-use permits to open consumption lounges, with the application being more broadly available after one year.

Tourism, entertainment industries make Nevada a key market for brand-focused companies: Few cities are a magnet to people from all over the US, and globally, in the way Las Vegas is. We view Nevada, Las Vegas specifically, as an important market for cannabis businesses looking to build national visibility for their brands with consumers across the demographic spectrum. Las Vegas offers an opportunity for cannabis brands to gain exposure to millions of cannabis users across the US, who can be won over, and eventually seek out these products in legal dispensaries in their home state, if and when it is legal to do so. For many travelling from non-legal states, this may be their first exposure to any brands within the cannabis space altogether. Marketing and advertising restrictions for cannabis products are far more liberal in Nevada than most other states, adding yet another key attraction for brand-focused operators in the state.

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Competitive dynamics – Retail dispensaries and branded CPG manufacturing are the best way to play Nevada: In our view, adult-use dispensaries and manufacturing and marketing of branded cannabis products offer the best opportunities for success in Nevada’s cannabis market. We present our reasoning below.

Adult-use dispensaries: This model is likely to generate the most significant financial returns in the Nevada market,

particularly if prime locations near the Las Vegas Strip can be secured. The sales figures being generated by

recreational dispensaries located near The Strip are near unheard of compared to retail locations in most any other

market in the country.

The defensibility of the retail model in this market is predicated on the quality of the real estate locations, where it is perhaps more of a differentiator than in any other local market in the country. As mentioned, the relative price insensitivity of the tourist base also makes pricing less of a differentiator than in other markets.

While the issuance of new licenses may signal forthcoming increased competition, many of the first round of license winners have already established operations in prime real estate around the Las Vegas Strip (49 of the 66 currently operating dispensaries are in Clark County). It may be difficult for these new licensees to be as successful if they are forced to locate further away from The Strip, though other locations may still be viable.

Licensing structure benefits midstream and downstream operations: As shown below, the number of dispensary

licenses is outnumbered by the number of cultivation licenses. We have seen conflicting data on wholesale pricing

in the state in our research. However, we feel the sheer number of upstream operators relative to retailers suggests

the market may move towards an oversupply situation at some point. While cultivation may continue to be

attractive in Nevada over the medium term, over the longer term, we see less defensibility of margins for wholesale

of dry flower as supply is likely to become less of an issue as the market develops.

This should eventually benefit product manufacturers of branded products through lower input costs. Meanwhile, the demand side of the equation should remain healthy, supporting midstream/downstream pricing and margins.

Exhibit 61 – Number of Adult-Use Cannabis Licenses Issued (Feb. 2019)

Source: Nevada Department of Taxation, Echelon Wealth Partners

For reasons already explored, the Las Vegas market is also an important one for brands from an exposure perspective, adding value beyond simply the dollar sales.

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Massachusetts – Slow Start to Adult-Use, Though Potential is Significant

Why it matters: Massachusetts is the most populated of the East Coast states to have legalized adult-use cannabis. Progress towards expanding access to recreational cannabis in the state has been slow, bogged down by state regulators as well as municipalities that hold significant power in the licensing process. Only 23 adult-use dispensaries have secured final licensing in Massachusetts, serving a market of nearly 7M residents. Nonetheless, for operators able to navigate the lengthy regulatory approval process, the state will be an attractive cannabis market opportunity for early movers.

Source: Cannabis Control Commission, Commonwealth of Massachusetts, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

Regulatory overview: The medical and adult-use cannabis industry is regulated by the Cannabis Control Commission (“CCC”). The CCC has overseen the adult-use market since its inception, and inherited control of the medical program in December 2018. Cannabis regulators have not limited the total number of licenses that can be issued in Massachusetts. However, each license holder is capped at three cultivation or processing facilities and three of each type of retail location (adult-use and medical dispensaries), with the ability to co-locate on the same premises.

MASSACHUSETTS $1.2B Market Opportunity (2024) Adult-Use/Medical



Population CAGR (to 2024) 0.5% Years Legalized

Adult-Use Market


2018 Sales $16M




Adult-use Revenue Jan-Apr 2019 $96M


Adult-Use Dispensaries 23 Licenses Issued

Cult./Processing Licenses 16 Cult. + 16 Proc.


Adult-Use Cannabis Taxation

Medical Market


2018 Sales $201M

Forecasted CAGR to 2024 -9.7%

Monthly Patients Purchasing 37,513


Certified Providers 293


Current Medical Dispensaries 49


Medical Cannabis Taxation No tax

Rec - 2016, Medical - 2012

10.8% Excise, 6.3%

Sales, up to 3% local

Other Considerations: Adult-use sales began in late 2018, but the

rollout has so far been slow.

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Medical and Rec can both be sold in the same dispensary, but adult-use products subject to additional rules: Adult-use products face different regulations than their medical counterparts which increase the cost base of these products. For example, adult-use cannabis is subject to taxation of up to 20% (17% state sales and excises taxes, plus up to 3% municipal tax) while medical products are not taxed. Recreational products also face additional labelling/stamp requirements, and the purchase limits are more restrictive on recreational sales. Product must be set aside for medical patients in dispensaries that service both markets, which may initially limit the supply of cannabis available for adult-use sales.

Local governments wield significant authority, increasing licensing costs and timelines: Operators require municipal approval to operate a cannabis business within the jurisdiction. These approvals, called Host Community Agreements (HCAs), can be costly for cannabis companies to negotiate for each of the municipalities in which its operations are located. Moreover, we understand that municipalities have taken advantage of the regulations that make HCAs mandatory, by charging high “community impact fees”, applying additional local taxes, and stipulating one-time or annual HCA payments or donations upon entering into an agreement. This has caused the CCC to issue guidance on HCA fees in August 2018 though the fee structure may still be burdensome, especially for smaller cannabis companies without sufficient access to capital.

In addition, a number of municipalities initially elected not to allow cannabis operations within their boundaries. The majority of these bans were temporary, and many have since been lifted, though many of the recently opened municipalities have yet to issue any cannabis licenses. We thus view municipalities as continuing to be a significant hurdle to navigate for cannabis operators in the state, however, those companies that have been successfully able to navigate this process are effectively protected by higher barriers to entry.

Roll out of recreational market continues to face delays: The roll out of the recreational market continues to be a relatively slow process in Massachusetts. After missing the initial start for adult-use sales by about 11 months, the CCC has yet to issue final approval for enough licenses to support the adult-use market. Only 23 final adult-use retail licenses, 16 cultivation, 16 processing licenses, and 2 testing laboratories have been issued for the adult-use market so far. A number of additional licenses are provisionally reserved for issuance; below we provide a map showing the number of applications outstanding by county.

Exhibit 62 – Map of Conditionally Approved Cannabis Licenses in MA

Source: Cannabis Control Commission (Note: the map shows provisionally approved licenses, though not all approvals have been granted final licensing)

Cannabis supply currently constrained due to cultivation and testing license hold ups: Testing of cannabis products is mandatory in Massachusetts, but only two independent testing laboratories have been approved by the CCC to date.



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Both of these testing labs are located on the eastern portion of the state (near Boston), potentially creating logistical challenges and/or additional costs for retail operations on the western side of the state.

May the best operator win – Cap on Retail locations favours quality: In the short term, with only a limited number of recreational stores operating, we expect success for any location that is operational. However, longer term, with only three adult-use dispensaries allowed per operator, we view quality locations as a key driver of successful retail operations. We expect it will take time, possibly years, for serious rivalry to emerge in the adult-use market, given the relatively sluggish pace at which new locations are being approved as a result of the regulatory environment. In a market with unlimited licenses available, competition may eventually pose challenges to cannabis retailers in this state.

We view vertical integration as the best play for this market: The Massachusetts market appears to support a vertically integrated strategy, combining a branded CPG product line(s) and the ownership of the maximum permissible number of retail stores, given the relative undersupply of operational companies in all verticals at the moment. Medical cannabis licenses are vertically integrated in Massachusetts, but vertical integration is optional for the adult-use market.

There is the potential for an early mover advantage in securing the most sought-after retail locations, though as we have noted, the dispensary cap will limit growth of downstream operations. A retail presence may be synergistic with a branded CPG portfolio, whereby the storefront drives increased customer awareness of the branded product portfolio in key, high-traffic locations. Longer term, however, with an unlimited amount of total potential cannabis dispensaries in the state, a successful wholesale presence in Massachusetts is necessary to exploit the full market potential, given the limits on dispensary locations owned by a single operator.

Ownership of cultivation assets, at this juncture, also appears to be an investment with strong returns for the foreseeable future, as supply appears to be short, resulting in strong pricing for wholesale dried bud based on conversations we have had with operators in the state. This also, until the supply chain becomes more developed, serves to ensure sufficient supply for a company’s own branded products.



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New York – Empire State Decriminalizes Cannabis; Still Waiting on Adult-Use Legislation

Why it matters: A New York cannabis license has been one of the most sought after in the country, despite its relatively small and restrictive medical market, as operators position for the likely passage of adult-use legislation in the near future. It is home to the largest and most densely populated city in the country, New York City (NYC). New York State also borders other important East Coast cannabis markets, including Massachusetts, Pennsylvania, and New Jersey amongst others, and serves as a hub for commercial and cultural influence for these nearby markets.

As mentioned, the current legal medical cannabis market in New York is quite small relative to other markets of similar population. Its obvious potential is being constrained by restricted patient access, limited product formats, and stiff competition from a well-established illicit market.

Governor Andrew Cuomo is in favour of a legislative solution for recreational cannabis, as it was a central part of his election platform in late 2018. A recent attempt to pass adult-use legalization along with the state’s annual budget in March 2019 and a subsequent attempt to push through a bill prior to the end of the legislative session in June 2019 were both unsuccessful. We expect the issued will be taken up again in the 2020 legislative session.

Despite the setback with respect to adult-use legislation in June, the Governor continued to push forward with reform, signing a bill in July to decriminalize cannabis possession in the state, and expunge past records for possession of up to 25 grams of cannabis. The law changes the possession of up to 2 ounces (56 grams) to a violation punishable by fine, rather than a criminal offence. The law bans the smoking of cannabis anywhere that tobacco is also prohibited.

Source: New York State Department of Health, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

Medical Market Overview

Medical market program gradually expanding as regulations ease: The trajectory of the medical market program drastically changed after a series of reforms were introduced in 2017. Chronic pain was added as a qualifying condition in March of that year, five additional licenses were issued in August doubling the number of licensed entities, and new product formats were allowed as of December 2017. Opioid replacement was also added as a qualifying condition in

NEW YORK $1.6B Market Opportunity (2024)1 Medical1



Population CAGR (to 2024) 0.5% Year(s) Legalized Medical - 2014

Medical and Adult-Use Market

Market Size (2024E)1 $1.6B

2018 Sales $38M



Registered Physicians 2,402

Arcview: First Adult-Use Sales 2022


Medical Dispensaries Open 35 (40 licensed)

Total Licenses Issued 10


Medical Cannabis Taxation 7% Excise

1 Market opportunity includes adult-use sales beginning in 2022 as forecasted by Arcview, though New York has yet to legalize adult-use sales.

Other Considerations: The state actively considered adult-use

legalization in 2019. The issue is expected to arise again in 2020.

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July 2018 under emergency regulations issued by the state’s Department of Health. Patient growth has accelerated since these changes were made, as demonstrated in the chart below.

Exhibit 63 – Registered Medical Patients in New York

Source: New York State Department of Health, Echelon Wealth Partners

Limited licensing: Regulators have opted for a highly limited licensing regime within the state. Only 10 vertically integrated medical cannabis licenses have been issued. Despite the small size of the state’s medical program, the licenses are amongst the most valuable in the country, with 9 of 10 either currently owned or in the process of being acquired by a large cap MSO.

Each license allows for the operation of one cultivation/processing facility and four medical dispensaries. License holders are referred to as Registered Organizations (“ROs”). There are currently 35 dispensaries operational in the state. As part of the license rules, the NY State DOH allocated dispensary licenses to certain regions, in order to ensure the dispensary network is spread out across the state.

Forced vertical integration: License holders are forced by the nature of the licenses to be vertically integrated. This requires greater capital investment and organizational competencies as companies must successfully operate in various segments of the value chain. Securing leases for highly sought-after real estate for dispensary locations, particularly in the New York City metro area, can also be an expensive endeavour, and may not be justified by the sales generated in certain locations prior to the introduction of recreational cannabis. We view this licensing structure as advantaging the larger MSOs, with greater access to capital and experience in operating all segments of the supply chain.

Limited product offering and price caps hamper medical market potential: Dried flower and edible products are not permitted for sale in New York’s medical market. This has almost certainly limited the success of the program, given that dried flower remains one of the most widely used consumption formats in medical cannabis markets across the US. Allowed product formats include: liquid or oil preparations (oils and vape pens), solid and semisolid preparations (e.g., capsules, chewable and effervescent tablets, lozenges), ground plant preparations, topical forms, and transdermal patches. ROs must also submit the costs to manufacture and market a product to the DOH, as well as proposed pricing for the product. The DOH must then approve the proposed price, which is then established as the maximum price at which the product can be sold for in the dispensaries.

Looking Ahead to Adult-Use in the Empire State

Adult-use timeline accelerated as Cuomo shifts stance: The support at the state government level for adult-use legalization has dramatically strengthened following efforts by state Governor Cuomo to legalize the recreational market. The rapid shift in Governor Cuomo’s stance on adult-use marijuana caught many observers by surprise. In 2017, he called cannabis a gateway drug. Just months after, he commissioned a study into the viability of adult-use legalization by the state’s DOH, which was completed in the summer of 2018 and concluded that the benefits of legalization

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outweighed the potential costs. Following his re-election, Cuomo has since called the legalization of cannabis one of his top priorities in 2019.

A measure to legalize cannabis in the state as part of the 2019 budget was dropped after lawmakers remained divided on the issue. Governor Cuomo predicted that an agreement could be made by June 2019, before the legislative adjourned for the summer. However, Governor Cuomo eventually acknowledged he lacked support in the senate for the bill, and further discussions are on hold for the summer recess. The Governor and supportive lawmakers will continue their push to pass legislation in 2020.

Black market poses serious challenges to adult-use cannabis potential: The New York DOH estimated that the illegal market size of the cannabis industry was worth $1.7-3.5B in the state, making it one of the largest underground cannabis markets in the US. This will likely pose a challenge to an eventual adult-use market, as these distribution networks are entrenched, and will likely be able to outcompete a tax-burdened legal market on convenience and price, as we have seen in California.

Medical licensees uncertain regarding status in eventual transition to rec market: Clearly, one of the primary motivations for MSOs to establish a presence in the state is the anticipation of adult-use legalization in the very near future. However, the competitive and regulatory landscape of an adult-use market in New York remains uncertain. The legalization measure proposed in Governor Cuomo’s initial budget bill called for an auction of an unspecified number of licenses, without preferential treatment of the existing medical cannabis ROs. Though the final method for awarding recreational cannabis licenses will likely change by the time of legalization, we note that there is no guarantee that medical operators will be the ‘first in line’ for adult-use licenses.

Nonetheless, we believe that medical marijuana operators already established in New York are highly likely to be best positioned to navigate the regulatory approval process there and will have a first mover advantage in brand building, operational roll out, and access to premier retail locations. With some reports also noting that proposed legislation would not have allowed for vertical integration, MSOs with established operations will have optionality in selecting which assets and activities they want to continue to own, and which to divest.

New York City (pop 8.6M) will be key: New York City is the most populous city in the US, and a global centre for media, culture, business, and entertainment. It is estimated that over 65M tourists visited NYC last year, in addition to New York being the most popular business travel destination in the world. New York City is a key market for any emerging consumer brand looking to generate brand visibility and awareness. In the eventual transition to an adult-use market, NYC will be a sizeable and important target market that cannabis companies can look to capitalize on.

Domino effect: Count on New York State legalizing adult-use to influence policy changes in neighbouring states: Further progress on the legalization of adult-use cannabis in New York would put immense pressure on nearby states to consider their own recreational legalization bills. NYC directly borders Jersey City and Newark, New Jersey’s most populous municipalities. This could create problems of ‘cannabis tourism’ where New Jersey residents travel across the border to purchase cannabis where it is legal, without New Jersey being able to capture the benefits of this spending, including added jobs and excise tax revenues. Neighbouring states of Connecticut, as well as Pennsylvania, another highly populous East Coast state with a robust medical market, are also beginning to explore adult-use legalization, as we discuss in more detail herein.



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Pennsylvania – Sizeable Medical Market Outpacing Nearby States

Why it matters: Though early days, Pennsylvania has the potential to become one of the country’s largest cannabis markets upon an eventual transition to adult-use sales. The medical program is rapidly growing after first sales began in February 2018. The state allows for a fairly comprehensive list of qualifying conditions for medical cannabis use and has allowed for a reasonable number of licensed entities to support the sizeable and growing market.

Already, lawmakers are contemplating adult-use legalization. Listening tours have been held across the state – similar to the approach that New York has taken – and an adult-use legislation bill has been tabled in the state’s Senate, though observers are not yet confident about the prospects for such legislation passing in the near term.

Source: Pennsylvania Department of Health, Bureau of Economic Analysis, US Census Bureau, Arcview Market Research, Echelon Wealth Partners

PA medical market off to fast start – Sales of over $132M in first year and a patient count that has since surpassed 120,000: The state’s medical laws were signed into effect on April 17, 2016, though the first medical cannabis dispensary did not open until nearly two years later in February 2018. Since then, the program has registered over 121,000 patients with more than 87,500 patients having active ID cards. By comparison, the medical cannabis programs of nearby medical markets New York and Illinois each attracted ~13,000 patients after one year, despite New York having a greater population than Pennsylvania, and Illinois’ population being similar.

We view the early success of Pennsylvania’s medical cannabis program as a result of its relatively broad set of qualifying conditions – which includes chronic pain, cancer, opioid use disorder and terminal illness – as well as the allowance of a reasonable number of dispensaries to serve the patient base, with 58 currently in operation with product available.

Licensing remains limited, but not restrictive: Pennsylvania lawmakers authorized the issuance of only a limited number of medical cannabis licenses, though the amount has been sufficient to support the success of the medical program to date. The regulations support up to 25 grower/processors and up to 50 dispensary permits – each dispensary permit allowing for up to 3 dispensaries – with only 20% of growers/processors allowed to be vertically integrated. The state’s DOH has since authorized the maximum number of cultivation/processing (25) and dispensary permits (50 permits allowing 150 total dispensaries, with 79 locations approved to open).

PENNSYLVANIA $446M Market Opportunity (2024) Medical



Population CAGR (to 2024) 0.3% Year Legalized Medical - 2016

Medical Market


2018 Sales $120M


First Full 12 Months of Sales $132M

Registered Patients 121,000


Licensed Medical Dispensaries 79 (up to 150)



Medical Cannabis Taxation 5% Excise Other Considerations: The state held listening tours for adult use

legalization in early 2019.

58 medical dispensaries currently operating

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Regulations are supportive of competition amongst operators, with no license holder allowed to own more than 5 dispensary permits, or 15 total dispensaries, which caps a single holder at 10% of total dispensaries in the state. Rules also allow for an operator to own only one cultivation/processing license of the 25 issued.

Licenses awarded by region: Pennsylvania has awarded retail cannabis licenses with a regional focus, and we view some regions as more favourable locations for a dispensary than others due to the population density of those regions. Pennsylvania’s population is generally denser in the southern half of the state, where its two largest cities are located – Philadelphia in the Southeast region and Pittsburgh in the Southwest region. Allentown and Erie are the two largest cities in the northern half of the state. The Southeast and Southwest regions also have the most favourable ratio of residents to permitted dispensary licenses.

Exhibit 64 – Population by Region Relative to the Number of Dispensaries Permitted

Source: US Census Bureau, Pennsylvania Department of Health, Echelon Wealth Partners

Balanced licensing regime and early stage market supports vertically integrated strategy: We view the balanced number of licenses between upstream and downstream assets as indicative of opportunities across the value chain. Vertical integration appears to be the best way to play Pennsylvania’s cannabis market, though only five companies are permitted to do so. The current market structure in Pennsylvania enables synergies between cultivation/processing operations and retail operations, including greater margin capture, control over the supply chain, and flexibility as regulations develop – with this last point being especially important as adult-use regulations are potentially implemented. However, vertical integration requires more upfront capital and knowhow, and is therefore best suited to the MSO model.

For those not fortunate to be one of the five vertically integrated companies permitted, we view a retail presence as likely the most lucrative vertical. We base this view on the potential for expansion and market share of the particular verticals. Under the assumption that each licensee would own a proportionate share of potential sales in either vertical, retail would seem to offer more potential upside, given a company’s ability to expand to up to 15 locations – 10% of the retail market – while owning one of the 25 cultivation and processing licenses would cap a wholesaler at 4% of the market.

Clearly not all operators will earn pro-rata shares of total sales in their vertical, given that the better capitalized and superior operators with scale can easily capture a disproportionate share of the wholesale market. Despite our view that retail may prove to be more lucrative in the state under the current regulations, we do not mean to suggest a wholesale-focused model could not be incredibly successful in the state either, with 150 potential dispensaries providing a sizeable market opportunity.

Attractive retail opportunity: Based on anecdotal information through discussions with several operators in the

state, we understand that retail operations have been thriving, which remain underserved at the moment with only

52 dispensaries in operation.

There is significant potential for dispensary locations in attractive regions, including situations where many dispensaries could be the only legal cannabis location operating in a city, given the limited licensing specific to each region. For example, Green Thumb Industries’ Rise Erie dispensary (see the map below, top left corner) is the only

RegionPopulation

(M)

Number of Approved

Dispensaries

Population /

Approved Dispensary

Permitted

Dispensaries

Population /

Permitted Dispensary

Southeast 5.22 31 168,471 57 91,624

Southwest 2.66 15 177,510 27 98,616

Southcentral 1.72 12 143,102 21 81,773

Northeast 1.61 11 145,919 21 76,434

Northwest 0.90 6 149,384 12 74,692

Northcentral 0.70 4 175,416 12 58,472

Totals: 12.81 79 150



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dispensary in a >100km radius, and is only a few kilometres away from the busy I-90 highway, the longest interstate highway in the US, and a major traffic route.

Regional based license awards may also prevent the urban centres from becoming overly saturated, meaning licensing in these regions can be particularly attractive. For example, there are only three retail dispensaries operating in downtown Pittsburgh, with a population of over 300K. We also note that retail stores require a lower upfront capital investment and allow cannabis companies to begin building consumer brand awareness.

Exhibit 65 – Operating Dispensaries (Green, 58) and Dispensaries Without Product (Red, 1)

Source: Pennsylvania Department of Health, Google Maps

The VIPs – Better together: Vertically Integrated Permittees (or “VIPs”) will be better able to capture margin in a

state where antitrust rules will mandate at least some level of market fragmentation for the foreseeable future.

Vertical integration allows operators to retain optionality as the young medical market continues to develop and

as regulations unfold, which may make some aspects of the value chain more attractive than others. To our

knowledge, the current list of VIPs includes Green Thumb Industries, Cresco Labs, PharmaCann (in the process of

being acquired by MedMen), Grassroots (to be acquired by Curaleaf), and Ilera Healthcare (to be acquired by

TerrAscend).

Adult-use gaining traction: Adult-use cannabis legalization was not viewed as an issue that would gain serious traction in Pennsylvania until only very recently, after lawmakers and regulators took a number of steps to advance discussions earlier this year. Governor Tom Wolf, who had previously said that the state “isn’t ready” for recreational-use cannabis, changed his tone in late December 2018 by stating that it is time for a “serious and honest look” at cannabis legalization.

In January 2019, Governor Wolf announced that Lieutenant Governor John Fetterman will tour the state’s 67 counties to hear arguments both for and against legalization of recreational-use cannabis. The hearings began in mid-February and concluded in May. Two Philadelphia-based senators have since filed a legalization bill in the state’s Senate, though the bill is expected to face significant hurdles in the House, and Governor Wolf has urged patience as he would prefer to hear feedback from the listening tours. It is still early days in the process, and observers are not overly optimistic about Pennsylvania passing adult-use legislation in the near term.



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Nonetheless, it is apparent that the discussion around adult-use legalization is beginning to gain traction in America’s fifth most populous state, which could have significant implications for the cannabis industry and the medical operators located there.



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Appendix A: Operating Models in the Cannabis Industry

In the body of our report (here) we examine the merits and challenges of the vertically integrated operating model employed by most US MSOs today. Here we examine the advantages and drawbacks of the models in greater detail.

Exhibit 66 – Analysis of Cannabis Business Operating Models


Vertically Integrated Model

A cannabis business implementing a vertically integrated operations model owns all assets and operations throughout the value chain, from cultivation and processing, to manufacturing and branding, sales and distribution, as well as retail. Vertical integration is mandated by the licensing rules in several markets, including New York and Florida, while other state regulations allow for it, but do not require it. This operating model is nearly always implemented by large cap MSOs in the majority of the markets in which they operate.

Advantages of the Vertically Integrated MSO Model

Optionality

With many cannabis markets still in their infancy, operators may be required, either by virtue of the licensing regime in a particular market, or by necessity due to a lack of qualified vendors, to take on all activities within the industry value chain. However, it is highly likely that at some point in the future this will not be the case, and businesses will likely become more competitive by specializing in a particular vertical (or verticals). The vertically integrated model provides the business with optionality for the future in terms of which lines of business activities they want to retain as part of their core operations, and which they might choose to divest and outsource.

For example, in a state with a significant supply of dried flower at relatively cheap prices, the balance of power favours buyers of the input, and an operator may determine that continuing to own the cultivation operations will not provide as high a return on investment. Capital from the divestiture is freed up to be reinvested into higher ROI growth projects.

Margin Capture

Another advantage to the model is that, at this stage in the life cycle of the broader market, most activities, at least in supply constrained or oligopolistic markets, yield fairly healthy margins. By owning all the activities in the value chain, the vertically integrated MSOs are able to capture this margin at every step from cultivation, to production, to distribution and retail. However, over the longer term, as certain verticals become more competitive and market entrance less constrained, as in most industries, we would expect that certain activities will appear less attractive than others. Part of this equation will also be dictated by the regulations and supply/demand constraints specific to a certain market.

Controlling Shelf Space in Retail License-Constrained Markets

In cannabis markets with limited retail licenses, a vertically integrated model offers MSOs another key advantage – control over shelf space. In this way, MSOs can carve out and protect significant shelf space in their owned retail locations for their in-house products, offering key exposure for their brand portfolio and generating top of mind awareness amongst consumers. This is particularly important in the legal markets in the earliest stages of development, where consumers tend to be less informed about brands, as well as those markets with restrictions on advertising for the cannabis sector.

Attributes Branded CPG Retail-Only Vertically Integrated

Capital Intensity Moderate-High Moderate High

Level of Operational Difficulty Moderate-High Moderate High

Barriers to Entry Moderate Low-Moderate High

Share of Value Captured Moderate Moderate High

Optionality Moderate-High Low High

Margin Defensibility Moderate-High Low-Moderate High

Challenges

Benefits



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Most operators we have spoken to typically target anywhere between 30-50% of shelf space occupied by their in-house brands within their owned retail locations. Most continue to offer a diverse mix of product offerings from competitors, however, favourable placement and pricing is often afforded to their in-house portfolio of products.

Challenges with Vertical Integration

While capturing the full margin available throughout the value chain sounds like a clear win for vertically integrated players, there are some obvious drawbacks and challenges associated with the model. The two primary challenges are that it is both capital intensive and more difficult to execute from an operation perspective, due to the requirement to be competent and efficient in all different activities.

Capital Intensity

The most obvious disadvantage, or barrier, of the vertically integrated model is the high capital costs, particularly in the current regulatory landscape of the US market, where companies do not have access to federal banking services or the ability to list on senior exchanges. Particularly due to the inability to centralize operations in the US market due to lack of interstate commerce, vertically integrated businesses must acquire licenses and build cultivation and production facilities in each separate market they enter. In addition, they bear the costs of managing distribution and building out a retail footprint. Therefore, pursuing this model across many markets requires significant access to capital and a strong balance sheet. It is our view that only a handful of businesses have the appropriate resources to effectively deploy this model across the country.

Operational Execution

Second, the difficulty in executing the vertically integrated model is an obvious challenge, given the need for the organization to be competent in such a breadth of different activities. This is a particular challenge given the early phase of development that a cannabis business finds itself in at this stage of the industry. These young companies are still in the process of scaling and optimizing their business processes, such as supply chain, manufacturing, and quality control. Quite simply, the more activities that are required to be performed internally, the more difficult execution becomes.

Traditional Branded CPG Model

The “pure play” traditional branded CPG model sees companies strictly focus on the development, production and marketing of branded products, focusing on midstream activities within the value chain. These companies seek to gain distribution across various outlets and markets, without the ownership of either upstream (cultivation and processing) or downstream (retail) assets.

A branded CPG firm employing this model is likely to use a central R&D and production facility to develop and test product formulations, and design packaging for various SKUs, which are codified into standardized operating procedures (SOPs) and brand trademarks, and own and leverage the IP around their products and brands.

Advantages

Outsourcing activities and taking advantage of favourable market dynamics: The company’s IP can be leveraged by lending or licensing these processes to service providers for cultivation, processing and even manufacturing activities in each of the various markets where they look to launch the product. Such businesses typically look to take advantage of abundant supply and favourable pricing for these inputs and services in certain markets.

Capital-light business model: This business model also has the advantage of relatively low capital requirements, without the need for the construction of cultivation and production facilities, or retail stores. While these businesses will not capture the same margins as their vertically integrated competitors, they can typically deploy this model at a fraction of the cost, which could, in the end, still generate attractive returns if executed well.

Offloads operating risks and costs: A branded GPG model will see companies outsource those activities which it sees little advantage in doing itself in a given market, and thereby reduces the operational risk of the requirement to competently and cost-effectively execute all activities in the value chain. In this way, the business need not be



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concerned with managing a large headcount and integrating these activities internally, freeing up its resources to focus on the activities at which it excels, and which will generate the best returns.

Licensing becomes less of a hurdle: By controlling the IP related to product formulations and brands, the “pure play” model can leverage these valuable assets to enter new markets via licensing agreements, circumventing the need for obtaining licenses to cultivate, process, and sell cannabis in the state. They can then leverage third-party companies with the requisite state licenses, or even license this IP in exchange for a royalty to other operators in the market. This is a potential option that allows them to enter new markets quickly and at a low cost.

Disadvantages

Captures lower margins: This strategy will capture less of the total margin available to producers across the value chain than a vertically integrated business which maintains ownership of its production, distribution, and retail activities. Though as discussed, if employed effectively, overall ROI would not necessarily suffer.

Dependent on quality and consistency of third-party vendors: The dependency on third-party vendors is a particular risk in fledgling cannabis markets, where third-party suppliers and service providers have yet to establish their own best practices, and may not be dependable partners. It may be difficult to find third-party partners who are able to provide a consistent supply of quality product or may have trouble delivering products and services on time, and of the requisite standards. This can disrupt the supply chain for the pure play CPG business, and delivery of low quality or inconsistent product could also damage their brand in the local market.

Retailer Model

Retailers in the cannabis space will ultimately succeed or fail based on their ability to leverage their ownership of access to the cannabis consumer. This can be achieved in a number of ways. Some will strategically choose to enter those markets with limited retail licensing where dynamics favour retailers.

But over the longer term, sales of cannabis, in all legal markets, is likely to trend towards liberalization and greater customer access. Therefore, over time, we believe the defensible determinants of success for retailers will ultimately be controlling real estate in prime locations and building customer loyalty through better experiential shopping.

Advantages

Owning Customer Access

The ability to own the direct access to consumers is one of the significant points of advantage for cannabis retailers – particularly in a market where its tastes and consumption habits with respect to brands, formats and occasion are still developing, and rapidly changing, the position of the retailer as the touch point with these consumers is highly valuable. Being able to leverage the access to shelf space and consumer point of sale data places retailers who have successfully carved out a dominant presence in a position of advantage with brand manufacturers in a given marketplace.

Operational Focus

The narrow operational focus on the downstream portion of the value chain allows retailers to invest resources to specialize in building relatively fewer relevant core competencies that they can leverage for success. Like a “pure play” traditional branded CPG model, these companies benefit from this focus. Particularly for young companies in a rapidly changing regulatory environment and marketplace, building out and managing operations across so many different activities and processes can be exceedingly difficult to execute well.

Fast Turnover of Capital and Scalability in New Markets

Entering new markets without the need to obtain multiple classes of licenses, build out of expensive production facilities, and obtain distribution for one’s brands, makes scaling relatively simpler from an operational perspective. Opening a new retail location is often a quick and capital-efficient means to rapidly scaling one’s sales. Compared to the relative expense and operational difficulties in ramping up a vertically integrated operation, a retailer can relatively



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easily replicate their store design and branding, as well as back end processes like inventory management systems into new markets and new locations.

Disadvantages

Capital Intensive

Finding and securing prime real estate, as well as the design and build out of physical stores can require significant upfront capital investment, particularly when looking to build a large retail footprint. Certain markets will be more expensive than others depending on the prices for rent and the size of the dispensaries being constructed. However, comparatively, capital requirements are still lower than a vertically integrated model.

Defensibility Against New Competition and Generating Consumer Loyalty

At the moment, cannabis retailers are, in our view, earnings outsized returns relative to most traditional retail businesses selling high-volume CPG products, due, at least in part, to the restrictive nature of licensing for cannabis retail in most markets. In our view, the restrictions on the sale of cannabis are likely to be more relaxed in the coming years, and competition and availability will increase.

Therefore, similar to alcohol or packaged food products, we foresee consumers placing a greater emphasis on convenience, selection and price (for the same products and SKUs) when deciding on which dispensaries to shop at, particularly as more options become available to them, possibly driving down returns for retailers. By contrast, we feel that strong brand recognition (for traditional branded CPG businesses) creates a stickier relationship with the consumer, with lower price sensitivity.



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Appendix B: Recent Developments on US Federal Cannabis Reform

Federal legislators and Democratic presidential candidates support cannabis reform – To our knowledge, for the first time in history, a majority of the US presidential candidates are supportive of cannabis reform in some capacity. Though we note these presidential candidates are running for leadership of the Democratic Party (given that Trump is the incumbent), this is still a remarkable shift in sentiment at the highest level of politics in the country. In addition to being vocal supporters of cannabis reform, leading Democratic candidates Bernie Sanders (I), Kamala Harris (D), and Elizabeth Warren (D) were all co-sponsors on the re-introduced Marijuana Justice Act in February 2019, tabled by Cory Booker (D), another presidential candidate.

A number of elected officials have been very active in pushing for cannabis legalization, with Representatives Earl Blumenauer (D) and David Joyce (R), as well as Senators Cory Booker (D) and Cory Gardner (R) being amongst the most vocal of supporters. In addition, a number of senior appointed officials including the Chair of the US Federal Reserve, the US Treasury Secretary, and the US Attorney General have also called for legislative reform, if only to clarify regulatory priorities.

US Treasury Secretary and Attorney General call for federal legislative reform – In April 2019, two prominent federal officials in the President’s administration called for reform and clarity on federal cannabis rules. US Treasury Secretary Steve Mnuchin called on Congress to resolve cannabis banking regulations, without further commenting on whether he believes rules should be eased or tightened. He did note that banking regulators are facing challenges in conflicting state and federal laws, and that Congress should move to provide clear guidelines for bank regulators. His comments echoed those made by Federal Reserve Chair Jay Powell in late February. Mnuchin took it a step further in specifically calling on legislators to pass a bill, saying that the current situation is beyond the reach of the executive branch or regulators.

Also in April, US Attorney General William Barr reiterated comments from his confirmation hearings that conflicting federal and state regulation is untenable and called for federal reform. AG Barr has stated his preference for cannabis to remain illicit under federal law, but he has also said he is open to legalizing and regulating cannabis federally if consensus supported that. He noted the Justice Department is reviewing legislation that would allow states to legalize cannabis (i.e., the STATES Act), though he noted at the time that he himself had not yet reviewed the bill. This stance is much more amenable than that taken by former Attorney General Jeff Sessions. AG Sessions was responsible for rescinding the Cole Memo. The Cole Memo stated that the Justice Department would not enforce federal cannabis policy in states that have legalized and regulated cannabis sales, due to limited resources at the department and other more pressing priorities. Though we are unaware of any federal enforcement actions that took place after the Cole Memo was rescinded, the action itself was perceived as a setback for US cannabis businesses.

US House Committee held first-ever hearings on cannabis legalization – In early July 2019, the House Judiciary Crime, Terrorism and Homeland Security Subcommittee held a hearing to learn more about practical options for advancing cannabis reform. The primary takeaway from the hearings is that lawmakers largely concurred that at least some level of federal reform is needed. Representative Tom McClintock (R-CA), the acting ranking member of the subcommittee according to Marijuana Moment, stated he believes that cannabis reform may be one of the few issues that may find bi-partisan support in the legislative session. We also note that since the mid-term election resulted in a Democrat-controlled House, Congress is seen as being largely supportive of policy reform.

We note two important caveats, however. First, there does not appear to be a consensus, even amongst supporters, on how to best pursue reform of federal cannabis policy, with a range of options including the passing of the STATES Act, decriminalization, or full legalization, with some supporters making social impact and equality the primary goals of any legislative solution. Second, it appears unlikely that there is sufficient support within the Republican controlled Senate to advance any significant proposed reform put forth by the House.



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Appendix C: Key Proposed Legislation for US Federal Cannabis Reform

SAFE Act

The Secure and Fair Enforcement (SAFE) Banking Act of 2019 (H.R.1595), introduced by House Representatives Danny Heck (D-WA) and Earl Perlmutter (D-OR), is a proposed legislation that would provide federal protection to banks and financial institutions who work with cannabis companies that are in compliance with their states’ cannabis laws, as well as those businesses providing ancillary services to cannabis companies (such as legal, marketing, accounting, real estate, etc.).

Implications: This would open up services such as deposit taking and treasury services, lending, and payment processing. The implications would be far reaching, including the ability for customers to use traditional credit cards for payment at cannabis dispensaries, as well as the ability for cannabis companies to access debt provided by federal banks, thereby lowering their cost of capital.

Current status: With the Democrats controlling the House, observers seem to be most optimistic about the SAFE Act being passed when compared to other proposed federal cannabis legislation of substance. The bill was approved by the House Financial Services Committee in March 2019 by a vote of 45 to 15, and has 165 Congressional co-sponsors (148 Democrat and 17 Republican), suggesting strong support at the Congressional level if the bill is brought to a full House vote. However, it would seem the most significant hurdle would be having a version of the bill pass the Republican-controlled Senate. A similar version of the bill received 20 co-sponsors during the last session of Congress but was never voted on.

STATES Act

The Strengthening the Tenth Amendment Through Entrusting States (STATES) Act (S.1029) is a proposed bill introduced in the most recent session of Congress (116th) that would, in effect, by amending the Controlled Substances Act (1970), remove the threat of all interference for state-compliant cannabis businesses from the federal government.

Implications: The STATES Act would be the most sweeping legislation related to cannabis legalization ever passed at the federal level. Though it would not legalize cannabis federally, it would have the effect of removing the threat of any federal interference with companies and persons who are involved in cannabis-related activities that are compliant with their state laws. It is unclear to us, however, based on the language in the latest version of the bill, if this would enable interstate commerce with the cannabis plant, as it does not have any discussion specifically related to this issue. A conservative take would suggest, at best, the issue left to the states to decide to either allow or prohibit trade in cannabis. This would have obvious implications for the entire composition of the supply chain for the US cannabis industry.

The majority of industry observers and participants we have spoken to feel that the wording of the bill provides strong enough protections that it would allow businesses to effectively overcome all of the most significant hurdles facing US cannabis operators resulting from the substance’s federally illicit status, including i) access to banking and financial services; ii) access to capital markets through listing on major US exchanges including the NASDAQ and NYSE; and iii) remove the burdens of non-deductibility of taxes resulting from Section 280E. Under this interpretation, the bill would also enable those Canadian-based Operators listed on the major US and Canadian exchanges to enter the US market and build or acquire cannabis operations.

The passage of such a law would signal a monumental shift in policy that would be likely, in our view, to set off a frenzy of M&A activity, up-listing and capital raises, and potential strategic partnerships. The lifting of the threat of federal prosecution for US-based cannabis companies would see foreign-domiciled cannabis companies (Canadian-based Operators) and CPG businesses scramble to establish a presence in the US market, while US-based Operators look to enter strategic partnerships and take advantage of fresh access to a vastly expanded pool of investor capital to finance their expansion plans.

Current status: In April 2019, during the most recent session of Congress, the bill was re-introduced in both the House – by Reps. Earl Blumenauer (D-OR), Maxine Waters (D-CA) and David Joyce (R-OH) with 26 bi-partisan co-sponsors (13



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Republican and 13 Democrats) – and the Senate – by Sen. Elizabeth Warren (D-MA) and Sen. Cory Gardner (R-CO), with 8 bi-partisan co-sponsors (4 Democrats and 4 Republicans), and was referred to the Senate Judiciary Committee.

A version of the bill was introduced to both the House and Senate in the last session of Congress (115th) in 2018, however, it failed to receive a vote after being blocked by House Majority Leader Mitch McConnell. In the past, President Trump has even been quoted as saying he will “probably end up supporting (the bill)” if passed, when it was introduced back in the previous session of Congress in 2018.

Despite these comments, and bi-partisan support, popular opinion is that with a Republican-controlled senate, the bill is unlikely to receive enough support to pass during the current session.



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Appendix D: Cannabis Industry Comparable Company Analysis

Our group of MSOs were selected to reflect the largest US cannabis businesses (by market capitalization) with an operating presence in at least 10 states. The one exception to this is Trulieve which is included in our tracking despite only having a presence in four states.

Our group of Canadian Operators were selected to reflect the largest businesses in the Canadian-domiciled cannabis industry by market capitalization. We also note that the majority of these business also have operations internationally, though none have business operations that contact the THC-containing marijuana plant within the US at this time.

Source: FactSet, Company Filings, Echelon Wealth Partners | Pricing and consensus as of 08/08/2019

Ticker Company Last Price52-Week

High

52-Week

Low

PD Mkt.

Cap. ($M)

PD Net

Cash ($M)PD EV ($M) C2019 C2020 C2021 C2019 C2020 C2021

# Of

Analysts

US - Large Capitalization Companies

CURA-CSE Curaleaf Holdings, Inc. C$9.49 C$15.75 C$5.12 C$6,675 ($94) $5,135 13.9x 5.2x 2.8x 68.1x 16.2x 7.4x 9

CL-CSE Cresco Labs, Inc. C$10.49 C$18.37 C$5.29 C$3,892 ($33) $2,972 14.2x 4.1x 2.6x 141.3x 14.1x 7.8x 7

HARV-CSE Harvest Health & Recreation, Inc. C$6.99 C$14.50 C$4.56 C$2,921 $64 $2,142 11.7x 2.5x 1.6x 69.8x 8.1x 4.6x 7

GTII-CSE Green Thumb Industries Inc. C$11.86 C$32.50 C$8.42 C$2,418 ($11) $1,837 8.8x 3.9x 2.5x 74.8x 13.2x 8.9x 10

MMEN-CSE MedMen Enterprises, Inc. Class B C$2.55 C$9.88 C$2.51 C$1,719 ($178) $1,476 5.3x 2.8x 2.1x nmf 50.9x 8.8x 7

ACRG.U-CSE Acreage Holdings, Inc. $11.20 $28.30 $10.76 $1,360 $98 $1,262 5.3x 2.5x nmf nmf 10.6x nmf 7

TRUL-CSE Trulieve Cannabis Corp. C$12.82 C$23.85 C$9.10 C$1,415 ($32) $1,100 4.7x 2.8x 2.3x 10.9x 7.2x 5.8x 5

CCHW-NEO Columbia Care, Inc. C$6.64 C$11.95 C$4.52 C$1,497 $103 $1,027 9.8x 2.9x 1.7x nmf 11.9x 5.5x 2

IAN-CSE iAnthus Capital Holdings, Inc. C$4.12 C$9.49 C$3.18 C$842 $20 $616 4.2x 1.9x 1.6x 97.8x 7.1x 5.9x 8

Average 8.7x 3.2x 2.2x 77.1x 15.5x 6.8x

Median 8.8x 2.8x 2.2x 72.3x 11.9x 6.7x

CAN - Large Capitalization Companies

WEED-TSX Canopy Growth Corporation C$43.45 C$76.68 C$32.01 C$16,933 C$4,762 C$12,172 20.6x 10.3x 6.0x nmf nmf 39.4x 23

ACB-TSX Aurora Cannabis Inc. C$8.83 C$16.24 C$5.23 C$9,815 C$665 C$9,151 18.9x 9.6x 5.3x nmf 42.8x 21.2x 16

TLRY-NDQ Tilray, Inc. $43.89 $300.00 $24.00 $4,611 ($18) $4,630 26.2x 12.4x 8.2x nmf nmf 47.6x 17

CRON-TSX Cronos Group Inc C$18.40 C$32.95 C$7.33 C$6,770 C$2,460 C$4,309 72.7x 20.7x 11.6x nmf nmf 50.1x 14

APHA-TSX Aphria Inc C$8.88 C$22.00 C$4.76 C$2,260 C$108 C$2,152 4.5x 2.7x 2.1x 88.7x 18.0x 10.0x 11

HEXO-TSX HEXO Corp. C$6.02 C$11.29 C$3.98 C$1,678 C$395 C$1,283 7.4x 3.2x 2.4x nmf 15.8x 8.7x 14

OGI-TSXV OrganiGram Holdings Inc C$7.50 C$11.30 C$4.11 C$1,211 C$98 C$1,112 8.3x 4.7x 3.4x 21.9x 12.4x 8.8x 12

TGOD-TSX Green Organic Dutchman Holdings Ltd. C$3.36 C$10.24 C$2.19 C$1,066 C$339 C$727 16.5x 2.7x 1.3x nmf 25.2x 6.5x 5

TRST-TSX CannTrust Holdings, Inc. C$2.99 C$15.50 C$2.45 C$422 C$241 C$181 1.6x 0.8x 0.5x nmf 4.5x 1.9x 11

Average 19.6x 7.4x 4.5x 55.3x 19.8x 21.6x

Median 16.5x 4.7x 3.4x 55.3x 16.9x 10.0x

EV/Sales EV/EBITDA



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Appendix E: Key Investment Criteria

Beyond the financial and operational analysis we conduct specific to each firm, there are a number of key criteria we look for when evaluating US MSOs in our coverage universe. Some of these factors in our checklist have specific relevance to US cannabis businesses resulting from both the nature of the business activities in which these companies engage, as well as the nascent stage of the industry.

Below, we highlight what we believe are the most important factors for investors to keep in mind when assessing cannabis businesses, specifically in the context of US MSOs.

Growth and scalability: Companies must exhibit their ability to continually grow sales quarter-over-quarter

and expand their operations across the various markets in which they have a presence. We have already

shown that the market is rewarding companies for expanding their operating footprint and addressable

market. Having the ability to scale the business effectively into new, distinct state markets can be a challenge

financially, operationally, and particularly from a regulatory perspective. Companies exhibiting the ability to

effectively scale the fastest should be rewarded.

Focus on the right verticals: Businesses focusing on the midstream and downstream verticals, particularly

brand development, advanced product manufacturing, and achieving widescale product distribution, will

best be able to defend margins over the long term, particularly as activities such as cultivation become

increasingly commoditized in the more highly developed markets over the long term. Investment in building

wholesale distribution of the company’s brands, marketing and product development, and retail experience

are all factors we believe are important in generating long-term defensible market leadership positions in

the category.

Competent management with incentives aligned to shareholders: With the inherent operational and

regulatory risk inherent in the sector, having a strong management team that is able to navigate these

challenges is extremely critical. We look for management teams with thoughtful and focused strategies, as

well as those who are focused on developing organizational talent across functions such as marketing,

finance and operations. In addition, being aligned with shareholders is also of importance, particularly given

the complex voting and share ownership structures of many cannabis firms.

Beyond simply being solid operators, pay particular attention to management’s abilities and decision making with respect to capital allocation, which we discuss further in our next point below.

Cost of capital, capital management, and M&A strategy: The rapid pace of growth in the sector has spurred,

and to a degree, necessitated, frequent M&A and capital raising activity, which is challenging from both a

capital management and integration perspective for young firms. Management’s philosophy and thinking

process surrounding these types of decisions is critical to a firm’s success, as poor management of these

corporate activities can very easily destroy shareholder value. This is something we pay particular attention

to.

While the market obviously favours businesses that are rapidly growing, we must be aware of how much of this growth comes at the cost of dilution. The cost of growth must not be overlooked, and we have seen a number of companies pursuing growth initiatives at prices, and in ways, that we believe are dilutive to shareholders. We strongly favour businesses that have a proven track record of winning licenses and creating value for shareholders through opportunistic and accretive M&A transactions with strong strategic rationale.

We also look for businesses that have shown an ability to effectively lower their cost of capital through the use of secured debt, and have managed the issuance of new capital in a manner that is opportunistic and as non-dilutive as possible.

Strong balance sheet: While some investors compare the prospects for cannabis firms to high growth, early

stage firms in the tech sector, one must understand that the businesses are fundamentally different.



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Cannabis is ultimately a CPG business, and as such, has a relatively high degree of capital intensity relative

to tech firms required to scale the business, particularly for vertically integrated firms. Having a strong

balance sheet with ample cash to fund growth plans is of particular importance for MSOs given their

relatively high cost of capital at this time.

We view a large cash balance as a significant advantage, as it provides optionality for firms to opportunistically capitalize on the ample growth opportunities available in the industry as they present themselves. The cash balance acts as a margin of safety for these firms who may otherwise need to issue new shares or raise additional capital at inopportune times to pursue these opportunities.



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ECHELON WEALTH PARTNERS INC. DISCLOSURES

Important Information and Legal Disclaimers

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recommendations; it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investing strategy. Any

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Any resulting transactions should be effected through a U.S. broker-dealer.

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RATING DEFINITIONS

Buy The security represents attractive relative value and is expected to appreciate significantly from the current price over the next 12 month

time horizon.

Speculative Buy The security is considered a BUY but in the analyst’s opinion possesses certain operational and/or financial risks that are higher than average.

Hold The security represents fair value and no material appreciation is expected over the next 12-18 month time horizon.

Sell The security represents poor value and is expected to depreciate over the next 12 month time horizon.

Under Review While not a rating, this designates the existing rating and/or forecasts are subject to specific review usually due to a material event or share

price move.

Tender Echelon Wealth Partners recommends that investors tender to an existing public offer for the securities in the absence of a superior

competing offer.

Dropped Coverage Applies to former coverage names where a current analyst has dropped coverage. Echelon Wealth Partners will provide notice to investors

whenever coverage of an issuer is dropped.

RATINGS DISTRIBUTION

Recommendation Hierarchy

Buy Speculative Buy Hold Sell Under Review Restricted Tender

Number of recommendations 52 37 16 0 7 2 1

% of Total (excluding Restricted) 46% 33% 14% 0% 6%

Number of investment banking relationships 12 14 4 0 2 2 0

% of Total (excluding Restricted) 38% 44% 13% 0% 6%



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ECHELON WEALTH PARTNERS INC. DISCLOSURES

ANALYST CERTIFICATION(S)

INDUSTRY REPORT I, Matthew Pallotta, hereby certify that the views expressed in this report accurately reflect my personal views about the subject securities or issuers. I also certify that I have not, am not, and will not receive, directly or indirectly compensation in exchange for expressing the specific recommendations or views in this report.

IMPORTANT DISCLOSURES

Is this an issuer related or industry related publication? INDUSTRY Company Name Ticker Disclosures

1) Does the Analyst or any member of the Analyst’s household have a financial interest in the securities of the subject issuer? If Yes: a) Is it a long or short position? b) What type of security is it?

iAnthus Capital Holdings IAN-CSE 5, 6, 7 (Nov 2018 acquired Las Vegas cultivation/processing facility, Apr 2019 Maryland & New York dispensaries)

2) The name of any partner, director, officer, employee or agent of the Dealer Member who is an officer, director or employee of the issuer, or who serves in any advisory capacity to the issuer.

Green Thumb Industries Inc.

GTII-CSE 5, 6, 7 (Apr 2019 Maryland cultivation and dispensary operations)

3) Does Echelon Wealth Partners Inc. or the Analyst have any actual material conflicts of interest with the issuer?

Cresco Labs Inc. CL-CSE 7 (May 2019 Illinois production facility)

4) Does Echelon Wealth Partners Inc. and/or one or more entities affiliated with Echelon Wealth Partners Inc. beneficially own common shares (or any other class of common equity securities) of this issuer which constitutes more than 1% of the presently issued and outstanding shares of the issuer?

Columbia Care Inc. CCHW-NEO 7 (May 2019 Illinois dispensary and New York dispensaries)

5) During the last 12 months, has Echelon Wealth Partners Inc. provided financial advice to and/or, either on its own or as a syndicate member, participated in a public offering, or private placement of securities of this issuer?

MedMen Enterprises Inc. MMEN-CSE 5, 6, 7 (Nov 2018 Las Vegas dispensaries and office)

6) During the last 12 months, has Echelon Wealth Partners Inc. received compensation for having provided investment banking or related services to this Issuer?

Trulieve Cannabis Corp. TRUL-CSE

7) The analyst had an on-site visit with the Issuer within the last 12 months.

Curaleaf Holdings Inc. CURA-CSE

8) Has the Analyst or any Partner, Director or Officer been compensated for travel expenses incurred as a result of an onsite visit with the Issuer within the last 12 months?

Acreage Holdings Inc. ACRG.USD-CSE

9) Has the Analyst received any compensation from the subject company in the past 12 months?

Harvest Health & Recreation, Inc.

HARV-CSE

10) Is Echelon Wealth Partners Inc. a market maker in the issuer’s securities at the date of this report?



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