Analyzing and Understanding the Implications of the Trump Administration's Recent Comments
As many of you may be aware, Trump Administrations spokesman Sean Spicer made certain comments regarding medical and recreational cannabis which have roiled the markets and could have a profound effect on the cannabis industry. We wanted to give Merida’s perspective on Mr. Spicer’s comments because we believe such comments were much more from a lack of preparation on the issue rather than any type of significant policy shift that could change the nature of federal/state interaction on the issue.
Mr. Spicer answered what we perceive is a gotcha question meant to bring an issue to the forefront which the Trump Administration has barely commented on in almost 40 days. To the extent his comments had substance, they seemed to try and mirror a “law and order” perspective that is a key element of Trump’s supposed plank.
Clearly, Mr. Spicer had little idea about what he was saying regarding cannabis and we believe a clarification from the Administration is likely to be shared in the coming days, particularly with the blowback that has already erupted.
We feel it's necessary to treat the comments with the seriousness as if they are new federal policy and want to quickly go through our current portfolio. We'll then provide a broader perspective on why it is highly unlikely Mr. Spicer’s comments reflect anything other than empty, vapid spin from an unprepared interlocutor. By the time our commentary goes out, this dynamic situation could already be oriented much differently, as Washington State’s AG has already expressed the investigation into actions to prevent any such enforcement against operators there.
The Merida Portfolio
With regards to our portfolio, Merida Capital Partners is positioned specifically to minimize volatility from changing regulations and always factor the potential for a stall or rollback in the expansion of cannabis laws when making our investment decisions. One of the reasons we specifically avoid brands at this early stage is because it is very difficult to predict where we are on the regulatory continuum and how that could affect products which rely on recreational consumption.
With this in mind, one direct consequence of Mr. Spicer’s comments was a downdraft in the public equities within the cannabis space. With respect to our investment in GrowGen, which is public and has dropped on the news, we feel strongly that any negative effect on the stock is unlikely to last very long because of the mix of their business and the fact that many large cultivators who they serve are diversified across both medical and recreational cultivation. More than 50% of GrowGen sales occur in stores that either existed before recreational cannabis was legal or were in a medical market. Factoring in its expansion to Nevada and California, both of which do not yet have their recreational laws launched and while there are sure to be ups and downs related to being public, we feel that at worst, any crackdown (which we think unlikely) on recreational cannabis would be negative for GRWG but not significantly so over the long term.
As an example of this, GRWG was one of the few stocks in the sector to be up yesterday, rebounding from a late Thursday/early Friday drop in the cannabis sector that took some stocks down more than 35%. GRWG dropped 20% and settled Friday around 15% down since Mr. Spicer’s comments.
As for our investment in New Frontier, it has never looked more prescient than over the last two days. Over the past 72 hours, New Frontier's econometric data has been in incredible demand as industry participants and observers look for data and information to justify their pushback against Mr. Spicer’s comments. They have garnered an 82.7% “voice share” of all data-related media activity since the comments. New Frontier has been cited in numerous publications reaching over 300 million people and did interviews on prominent television stations.
If the way forward in cannabis will in fact have real risks related to a crackdown on recreational states, people will demand accurate information sources so they can closely manage that risk, and New Frontier is one of the only companies positioned to deliver such information. Even if the Administration walks these comments back, realizing enforcement would be a crushing economic blow, it will have been New Frontier who helped bring such information to light, further establishing credibility as a trusted source of information and business intelligence.
At the same time, our investment in Steep Hill Labs is primarily driven by the need for testing in stricter legal markets, which skews heavily towards the medical side. A lion’s share of Steep Hill's 2016 revenues came from cultivators in medical markets and so regardless of what the Administration does, Steep Hill is well positioned to continue moving forward. We do think that if the Administration wants to further create a “law and order” environment in cannabis, be it recreational or a medical ecosystem, then more lab testing and quality control seem like a likely place to start.
Why a Recreational Crackdown is Highly Unlikely
Generally, we believe that a significant crackdown on recreational states is highly unlikely for four specific reasons which we believe deserve to be highlighted in concert with all of the varied commentary coming out on this matter.
1. Rohrbacher-Farr Amendment: The Rohrbacher/Farr amendment to each annual budget bill has passed with wide support since 2013. This budget amendment prevents any funding for DOJ (which oversees the DEA and ATF) enforcement actions against state legal operators, whether recreational or medical. For the Trump Administration to act in concert with Mr. Spicer’s comments, it would need to find funding for any actions at a time when immigration, Obamacare and jobs are its three main areas of focus. It is hard to imagine a scenario where new funding emerges for the DOJ since such funding would have to come from one of the three areas above, all of which are central to Trump’s ruling plank.
In addition, most drug enforcement is carried out by local law enforcement in collaboration with federal officers. That means local Washington and Colorado agencies would have to cooperate with such enforcement and provide manpower to any actions. We just do not see that happening.
2. Jobs/Tax Revenue: Unless the Trump Administration is going to write a $150 million check to Colorado for the lost tax revenue, the concept of Mr. Spicer’s suggested enforcement is dead on arrival. New Frontier’s projection that any enforcement against recreational states could cost billions of dollars of revenue and thousands of jobs has been widely cited over the past two days. This independent research is not fantasy; it is based on excruciatingly detailed analysis and fact collection. We predict that President Trump will not kill these crucial jobs at a time when manufacturing jobs are permanently gone from the U.S. This does not even factor in the effect on real estate, incomes and other ancillary effects such a crackdown could have on local economies.
3. The Mutability of Medical Laws: If the government were to crack down on recreational cannabis, we believe much of that activity would shift into legal medical markets now that consumers have grown accustomed to purchasing their cannabis legally. It is not hard to envision recreational states moving immediately to broaden medical access which allows almost instantaneous medical cards (such as California’s current medical law) which would make any consumer a potential “patient.” The Trump Administration, in researching ways to enforce a crackdown, would realize that medical laws like California’s current law would subvert the intention of a crackdown to a degree where the Administration's unflinching support for medical cannabis, as evidenced many times in statements by President Trump himself, would act as a stamp of approval of such state activities.
4. Current Status of State Laws: In looking at what a federal crackdown would mean, it’s important to recognize that Congress could pass laws that would essentially force the Administration to deschedule cannabis to Schedule 2 (or lower), which would render the federal threat of a potential enforcement crackdown moot. Scanning the current state ecosystem there is a short list of states that have passed medical laws allowing research (essentially a descheduling), or recreational laws. Looking at the list, it seems like a congressional move to loosen federal laws to blunt any recreational crackdown would have a fair amount of bipartisan support.
5. States where congressional support could be presumed for a descheduling of cannabis if such a law were put forward: California, Colorado, Oregon, Massachusetts, Nevada, Vermont, New Hampshire, Alaska, Illinois, Maryland, Pennsylvania, Connecticut and New York.
Merida Capital Partners will continue to structure its portfolio in a manner that seeks to minimize the risks of any such changes in federal or state policy and hope our commentary adds clarity to a confusing situation. We also want to provide comfort to investors that a significant federal change in its enforcement practice is unlikely to occur.