As the market has entered into a rough stretch over the past few months, we have heard from many industry participants and investors about their fears about the possible roadblocks to industry growth. We share many of their concerns but through a fortunate coincidence we had a chance to take a step back recently and look into an intriguing analog for the cannabis industry that put the youth of the cannabis industry in context. Biotechnology as an industry was barely able to create profit for nearly 10 years and there were serious doubts for the first 5 years whether it would ever enjoy commercial success. One thing we learned by looking at the early days of biotechnology is that cannabis will be a long term industry that is going through a shakeout phase but it is here to stay and there are opportunities to make incredible returns in the right companies if you can tune out some of the fear and panic of the current zeitgeist.
With the amount of information coming at cannabis industry participants every day, and the continuing unstructured and unpredictable nature of the cannabis industry’s evolution, we at Merida think it is essential to constantly look to historical or current analogs as frames of reference for our investment efforts. Context is crucial every time we sit with a company since we are looking for companies that have their own embedded advantages and that do not simply rely on the ability to outperform the competition. No one can guarantee a 100% success rate in their investing, but we believe the rampant consumption of information, mixed with intellectual curiosity and rigorous debate, assists us in identifying certain inevitabilities of the changing cannabis landscape that can reduce risk and enhance returns.
Some of this comes down to pure crunching of information and data. It is in this information gathering, and the relentless consumption of information during that process, where we often come across intriguing analogs that are far from obvious. What truly excites the Merida team is when the insights that can be gleaned from these non-obvious efforts point us in a direction that has escaped the glare of the cannabis investment masses. The analogs, both obvious and non- obvious, often show us areas in which we can invest confidently rather than limiting our scope to companies alone. We then identify the universe of potential companies in these areas, diligence them all and further identify the best potential fits for our return profile. Rinse and repeat and voila, the Merida ecosystem comes into view.
With the way investors/operators pile on a concept to death, Merida is able to use this understanding and synthesis so that our pursuit of value is more Ninuki-Renju than the FOMO driven Bo-taoshi, particularly where a company’s ability to capture mindshare and investment leads to almost instantaneous “us too” efforts. This is not opinion. It is fact. “Funded capacity,” for example, went from a laughable concept of explaining projected revenue to must-have buzzword amongst the investment set quickly. Was there a Canadian company not using those words in their pitches in 2017/18? Then the industry matured a bit and investors realized “Funded Capacity” has almost no relation to “profit.” FC is not such a hot concept anymore.
The same thing goes for “Phased Build-Out,” “EU-GMP certification” or others you likely know well. The U.S. has some unique examples as well. U.S. companies have stretched the original definition of multi-state operator to call themselves an MSO as one great example. The list could go on but this commentary was actually born out of a random set of coincidences that happen to align to help contextualize an emerging area of cannabis while also offering some of the framing of the cannabis industry that Merida pursues with our customary voraciousness. Which leads me to biosynthesis.
Let me start by saying out of the gate: Biotechnology, and biosynthesis, are going to play an important role in cannabis on the consumer side and they could play a huge role in how cannabis-based medicine grows as a category. Which is to say that the science of creating cannabinoids is going to play a large role in research, development, and the medicalization of cannabis. If you have read our previous commentaries (particularly “Size Matters”), you know how big we think the medical vertical will be. But…(did you doubt there would be a counterpoint?), without seeming like the Flash playing ping pong with himself, let us argue with our leading point. On the way to all this value, a significant amount of companies have figured that throwing biosynth into the mix is a way of signaling how advanced or cutting edge they are for having introduced a complex level of science that most investors will simply take on face value.
We get two biosynth or biotechnology-related pitches a week right now. We often need our CSO, Dr. Deb Kimless, as well as other experts, to chime in on the actual science since we are not exactly chemists at Merida. Many seem like compelling opportunities. Sure, some of the pitches are simply buzzwords and borrowed talking points with very little substance or context. I become Leo Anthony Gallagher with a watermelon every time I hear a biosynthesis pitch like that. Nevertheless, there will be some huge winners in biosynthesis. If history is any guide, however, there will be far fewer winners than people think and even some winners will be of a modest nature because winning in this vertical might be a bit like navigating Scylla and Charybdis.
It is hard to disagree with the premise of biologically manufacturing cannabinoids on its face. Produce cannabinoids cheaply at scale and then isolate compounds even further as they become desired by pharma, ingredients in drinks, etc. Sounds amazing. Biosynthesis is neither new nor cutting edge at this point so we do not have a defined sense as to whether individual cannabinoids work nearly as well as the entourage effect of a variety of cannabinoids, so biosynth could end up being an answer in search of questions. Think of an ingredient that requires a second set of scientific skills to make it into a viable commercial product and you can see why we have some doubts that Willie Nelson will be doing shots of lab made cannabinoids with Snoop Dogg any time soon. We also don’t see Mel Brooks remaking the Comicus scene in History of the World to feature a giant hose spraying cannabinoids at the pursuing Romans to back them off. So the commercialization of the end product of biosynthesis is an area we have some questions about. But it definitely will be an area of cannabis that creates a ton of value.
Speaking of History of the World, I might not have known much about the history of biotechnology or biosynthesis other than reviewing deals made in the space had I not been in Columbia, Missouri at a presentation by a well-known author. She was discussing why companies with brilliant founders/executives sometimes go the way of Theranos, or Enron, rather than say Microsoft or Amazon. I have some ideas on this but let’s save that for a later commentary in early 2020. For purposes of this commentary, suffice it to say that much of the discussion and later Q&A centered around governance. The author highlighted the example of Genentech as how companies can be bleeding edge without devolving into a governance mess, or, as in the case of Theranos, becoming an outright fraud. We are always on the lookout for governance related insights as that is an incredibly important area of our investment focus, so I ordered two books on Genentech’s founding roots while sitting there.
What I learned from these two books made me feel like the famous ConSec guy whom Revok sorts out in Scanners. Genentech is not only one of the few companies that helped usher in the biotechnology revolution; it just so happens that they built their business on science (recombinant DNA manipulation or rDNA) that was in a nebulous legal area in the 1970s which prevented virtually everyone with distinct expertise in this scientific area from engaging in any commercialization attempts. Biotechnology was largely a white space to be dominated by entrepreneurial pioneers or academic researchers affiliated with institutions conducting unstructured research, all of whom needed to manage the scientific elements while navigating around the prohibitions around rDNA work. Sound familiar?
Reading about the roots of biotechnology, and how the industry developed in the late 1970s, provided some ideas not just about biosynthesis but about the cannabis industry at large and how some of the regulatory uncertainty, government oversight, and large established pharmaceutical companies shaped the industry once it became clear that it was here to stay. Genentech’s origins and the early biotechnology industry offer analogs that can be instructive to cannabis operators and investors alike as we move forward as an industry.
Closing the loop on biosynthesis, it is an area of tremendous promise, but before investing in companies pitching it as the NEXT BIG THING, it is essential to understand the capital intensity of biosynthesis, how individual cannabinoids could be regulated and restricted, challenges around commercial scale and the simple facts around the 40 year history of the science and its commercial cousins which have had more failures than successes. If a company in the space wins, it is likely to win big. However, if the 40 years of this technology are a guide, many companies will lose (or invest) so much money on the way that they will either be acquired for pennies later, or just outright fail.
If you do not want to read about Genentech and how its humble beginnings mirror many a cannabis company, and just want the conclusions, then skip the next three pages or so. That said, be advised that the Genentech story covers government interference, the lack of traditional institutional involvement at the early stages, and fear mongering so you may want to tune in because those are three hallmarks of the cannabis space as well.
Genentech's Origins in Brief
As detailed above, the whole concept of engineering yeast or other bacterium to produce cannabinoids is neither new nor novel. Genentech and others have been engineering bacterium to produce medicines for 40 years.
Genentech is really an interesting study in scientific excellence, visionary pursuit, tireless work towards a goal, luck, grit, and a dash of arrogance. The company succeeded mostly because it understood the landscape in which it was competing. Founders Robert Swanson and Herb Boyer worked together seamlessly to identify and take advantage of a huge information asymmetry they had in 1976 about the advantages of rDNA and applied it in a thoughtful, aggressive way. When Roche paid nearly $46B for 50% of the company in 2009, the approach borne out of those early years was validated in incredible fashion.
The Genentech story also touches on an area more personal to several of Merida’s partners, that of the intransigent executive. We have written about this at length, but it bears repeating that Merida places a great deal of its diligence efforts on finding executives who are not only good operators, but clear thinkers who value respectful disagreement as a way to see other perspectives. We look for open-minded thinkers capable of frank dialogue about identified weaknesses or challenges who can adjust their thinking based on feedback they receive from aligned stakeholders. This often results in company leaders who believe governance is a valuable component of the informational feedback loop that drives their decision-making process. We have refined our process to find such executives, but more importantly, to identify and avoid executives who want investors to rubber stamp every decision, tune out feedback and often will simply say what they must to raise capital. Those executives do not get very far with us.
Robert Swanson not only was an open-minded thinker, he constantly revised his plans based on the feedback of his partners, his stakeholders and the market itself. That is how Genentech changed the world and led us to the biotechnology industry we have today. Before Genentech existed, Swanson, and his employers at venerable venture capital firm Kleiner Perkins (KP), were invested in a biotechnology company called Cetus. Swanson and KP brought concerns about the the company’s unfocused vision and lack of execution to the founders, who agreed to brainstorm avenues of pursuit for their business. While Cetus partner, Nobel Laureate Donald Glaser, was supportive of recombinant DNA as a commercial venture and pursuit, the other founders were not, and were unreceptive to other ideas relating to rDNA commercial efforts. Swanson immediately saw the potential of Glaser’s suggestion and became obsessed with it even if Cetus’s founders disregarded it. When KP asked Swanson to join Cetus and lead a rDNA effort, Cetus’s founders were highly skeptical of rDNA, and had no intention of following Swanson, who had become convinced that rDNA was a revolutionary technology that was going to change the world far faster than Cetus’s founders, who thought rDNA would take ten years to develop into a commercial opportunity.
Part of the problem was that Cetus’ founders also did not like Swanson’s personality and believed that they knew better than Swanson, whom they viewed as just a regular businessperson. They thought rDNA would not produce much for the next decade and rejected the notion that scientists should be led by a lay person like Swanson.
Swanson’s vision escaped the Cetus team, whose aversion to Swanson swelled because of his insistence to pursue rDNA. This dislike led to their flat-out refusal to engage in a meaningful discussion of how they could pursue the expansive vision. KP sold its entire position shortly thereafter and Genentech was well on its way to becoming a reality when Swanson was dismissed from KP soon after since, without a position in Cetus, KP had no need for Swanson’s rDNA efforts.
Swanson then went on a pursuit of a scientist who would see the potential in rDNA and as he burned his way through hundreds of interactions, he eventually met Herb Boyer from UCSF, who similarly believed in rDNA. Their initial meeting was memorialized in a statue on Genentech’s campus due to its importance in biotechnology and the fact that 20 minutes became several hours. Cetus, on the other hand, was on its way to inspiring an article called “A Collision Course with Failure” and was generally considered what we in cannabis refer to as a governance-challenged.
Lest you should minimize the importance of executive vision and the ability to consider the ideas of others, in this case it was worth something like $45B. Cetus, which piggybacked on the general biotech boom and Genentech’s bold vision in the early 1980s to raise capital and achieve some modest goals, sold in 1991 for roughly the same amount as Genentech’s market cap at market close on October 14 th , 1980, the day of its IPO. While $600M and several successful drugs is nothing to scoff at when looking at Cetus, consider that Roche paid $2.1B in 1990 for 60% of Genentech and in late 1990s paid $3.7B for the other 40% before spinning off 33% of the company back to the public for $5B. Roche eventually bought the remaining shares of Genentech back for more than $46.8B, in 2009. There will be stories like this in the cannabis industry one day as well.
Operational Lessons from Genentech
Operators can learn some lessons from Genentech before we even get to the investment lessons. In 1999, Genentech gave new employees a booklet called the Genenlab Notebook that had the following inscribed inside the front cover:
This notebook is for disclosure outside of Genentech, and it can be removed from the premises without authorization. Other organizations and companies can read it and eat our dust.
That is a confident company. Not cannabis company beer muscles because of some “strategic partnership” or other puffed up press release, but a company that by 1996 had essentially stewarded the biotech revolution and could detail its history with an eye towards what it had accomplished in the 20 years since its founding and what it would still achieve in the years ahead. Genentech had by then created dozens of drugs and revolutionized the way scientists could use rDNA to splice the genetic material of bacterium to express new genes of proteins, hormones, and enzymes that were desired, so that the bacterium could then pump out the new material.
A short, simple primer on biotechnology is useful here. Biotechnology is the exploitation of biological processes to create industrial or medical materials, particularly the genetic manipulation of microorganisms for the production of commercial material like insulin, which was one of the first substances to be produced by biotechnology. Rather than extracting insulin from the pancreas of animals, which limits the amount that can be produced, Genentech could produce insulin at scale by inserting a human gene into a bacterium and then replicating that gene in a lab once it proved it could produce the genetic material for insulin. This also reduced any type of potential side effects from animal insulin since the bacterium would produce human insulin. Genentech showed incredible insight in focusing on insulin first for a few reasons, all of which will resonate with cannabis operators, who can heed the following set of guidelines to hone their strategies:
Insulin only has 51 amino acids, making it a relatively simple peptide hormone.
Lesson: Identify simple ways to apply your excellence. Prove your model, then expand the vision.
Insulin was not a new drug, meaning the regulatory oversight and approval would be relatively straightforward. Genentech focused on this aspect so that they could proceed with confidence before moving on to more complicated materials.
Lesson: Identify where you can skip friction (regulatory or otherwise) within your opportunity set. Friction is expensive and drains energy from core performance.
Insulin has an embedded constituency of diabetes patients, who require daily insulin. It also was a substance which had significant limitations because of the way it was harvested from animals, which was a problem regulators were naturally open to solving.
Lesson: Beginning with large addressable markets provides a margin of error for early products.
Genentech’s scientific team spent a significant amount of time deciding whether to pursue somatostatin or insulin but ultimately decided on insulin because of the simplicity of the insulin’s amino acids and the need to establish that recombinant DNA as a concept worked before they could start solving more complex medicinal challenges. Which brings us to an essential lesson for cannabis operators that helped Genentech separate themselves.
Lesson: FINISH! As in, consolidate early successes by finishing the actions/work around your core initiatives before moving on to other strategic initiatives.
Genentech relentlessly pursued insulin as their first product and saw completing the rDNA work as essential before they could move on to other products. They made sure that every person on the team who could contribute to it understood the urgency of finishing insulin first because of how many companies were chasing the opportunity and the value of being first.
Navigating a Murky Legal Landscape
Cannabis companies have built up incredible muscle memory navigating the current landscape of federal illegality in the U.S. This illegality has brought with it a lack of banking resources, an uncooperative regulatory bureaucracy, legacy stigmas around cannabis, and a lack of formal medical buy-in because of the lack of research, which is largely due to the bureaucracy surrounding cannabis prohibition. The best companies in the space have learned how to rise to these challenges while continuing to push their businesses forward.
This is another distinct parallel in the early days of biotechnology. While rDNA research was not illegal in 1976, many researchers and pharmaceutical companies avoided it because there was a consensus that it was a potential hazard that the government would regulate in a draconian way. The 1976 Congress considered several bills regulating rDNA research and a number of cities, including research hot spots like Berkeley and Cambridge, were in the process of considering restrictive local ordinances. The Cambridge City Council went so far as to put a moratorium on rDNA research because of their fear over biohazards. Had that not happened, the team of Wally Gilbert at Harvard may have beaten Genentech to the insulin or somatostatin successes.
It is remarkable to consider that the response to both rDNA research and cannabis resulted in municipal ordinances around a subject fraught with headline fear and uncertainty. The echoes of the early cannabis industry do not stop there. Political uncertainty also surrounded rDNA in 1976. In particular, rDNA was very much on the minds of the NIH. Donald Frederickson, then Director, hosted 30 companies and two manufacturing associations to discuss rDNA guidelines the NIH was considering in order to avoid any guidelines that would become future regulations which could affect R&D. The political situation around rDNA was so unsettled that big pharmaceutical companies largely sat on the sidelines and hesitated to create internal rDNA programs.
Genentech was incredible at navigating the patchwork of rules, potential rules, and the need for flexibility around public/private research because they built relationships necessary to carry out their core mission. Just look at a list of the original Genentech team to get a sense of how unstructured the industry was at the time:
Robert Swanson: CEO
Herb Boyer: UC San Francisco
Herb Heyneker: UC San Francisco
Art Riggs: City of Hope National Medical Center
Dave Goeddel: City of Hope
Keichi Itakura: City of Hope
Tadaaki Hirose: City of Hope
Roberto Crea: City of Hope
City of Hope is in Duarte, California which means the Genentech collaborations involved two institutions hundreds of miles away from each other. When the diverse, and far-flung Genentech collaborators accomplished their first success, it began as a race that is still going on today.
The catalysts that drove biotechnology forward are much like those which have pushed cannabis from an illicit substance to a legal substance in a federally grey area but clearly moving towards legality…and legitimacy. You would have to refer back to our “Size Matters” commentary to dig deeper on how legality has a profound and measurable de-stigmatizing effect on society. It moves verticals by normalizing the concept of cannabis-based medicines while traveling horizontally to remove judgments about consumption. You can see the effect of state-based legalization on behavior and opinions whether it is a medical law or an adult-use law. New Frontier and MJ Freeway (now Akerna) partnered on an incredible consumer survey which was overlaid with other survey data that supports this.
It is not hard to see the truth of this. As soon as medical laws get passed in a state, support for adult-use spikes and rests at much higher levels in that state. It is also the reason no state has ever skipped straight to adult-use without starting as a medical law. Ohio had what most consider the most robust “direct to rec” effort, which spent almost $10MM on a ballot measure that lost 56-44. A medical ballot measure passed overwhelmingly six months later. In controversial areas, regulators tend to care about what people “need” and are less concerned with what the consensus “wants.” It seems like most regular folks feel the same way, even if they are not fans of adult use laws.
As people see others get a medical card for reasons known only to them, it begins a discussion and that discussion alone propels approval levels for adult-use legalization. ‘Why’ is obvious. Or is it? Merida tends to think there are many ‘whys’ depending on time, place and our favorite investment-related word, context. The one reason we think is obvious, is that a medical law typically calls for strict controls. As they see patients jumping through hoops, they realize that regulating it actually works. With regulation comes certainty as to what you can expect if you choose to consume, or use medically, and the lack of any criminal repercussion if rules are followed. When people lose fear of criminal prosecution, or any negative effect if they follow a clear set of rules, behavior will change quickly as will stigmas.
The Phases of Biotech and their Cannabis Analog
1. Discovery Phase
The first phase of biotechnology can be thought of as the Discovery Phase. From 1975-1979 most successes and advancement in biotechnology were achieved in labs attached to universities because rDNA research was in a legal grey area that deterred large companies from deploying capital into its development. This led to a wildly fragmented industry (if it could even be called that) that consisted more of lone research teams than anything since very few competing researchers were collaborating at this point. Many of those pioneers would meet at conferences and knew each other from afar. The landscape looked a bit like pins on a map with almost no connection. Like the cannabis space from 1995-2015, this phase was defined primarily by the pioneering nature of participants, who deserve enormous amounts of credit and respect for pushing ahead in a nebulous legal environment while also achieving significant successes in developing the early foundations for the respective industries.
Most of the participants in this phase are early adopters and visionaries, and investment capital is scarce. In the cannabis industry, we left this phase around 2015, as the legal landscape began to shift and capital flowed in as uncertainty around the advancement of the industry dissipated. As a visual, think of the ape in 2001: A Space Odyssey grabbing the bone and crushing the fossil skull. Within a few weeks, he and his cohort are bashing in their rivals’ skulls and taking over the watering hole. That is basically what cannabis looked like when well-funded companies began flowing into the space and met head on with the ultimate equalizer - the difficulty of growing cannabis at scale under incredibly tight regulation without the proper expertise. In echoes of the cannabis industry and journalistic fascination in covering the early stages of the space, a 1979 article in Science magazine, “Recombinant DNA: Warming Up for the Big Payoff” reported on money flows into the various companies in the space and an E.F. Hutton seminar featuring Genentech, Cetus, Genex and Biogen attracted 500 people instead of the expected 35. “Biomania” had arrived. In the cannabis world, the equivalent would be some of the early articles around cannabis in 2013 when even Time magazine was covering the early gold rush of cannabis evolution.
2. Acceleration Phase
While the Discovery Phase has incredible advancements of both science, technology, and the level of communication between participants, resulting in the beginning of “Biomania”, the Acceleration Phase can be defined by early growth and catalysts that push an industry into hyperspeed while creating the foundation for an eventual normalization. When Diamond v. Chakrabarty was decided by the Supreme Court in 1980, it threw the doors of the biotechnology industry wide open. The Diamond case was an intriguing look at early biotechnology challenges relating to intellectual property and what innovators could do to protect their discoveries. The facts of the case echo early cannabis industry disputes as a General Electric engineer had genetically engineered, through non recombinant means, a microbe that could breakdown crude oil. When the engineer sought patent protection for the living organism, it began an uncertain phase in scientific development that ended when the case made its way to the Supreme Court.
In a 5-to-4 decision, the Court explained that while physical phenomena, abstract ideas, or minerals are not patentable, a live artificially engineered microorganism is. The creation of a bacterium that is not found anywhere in nature, constitutes a patentable "manufacture" or "composition of matter."
This validated not only the science behind engineered organic matter, but also gave certainty to the companies who might otherwise hesitate to spend millions developing technology and science that could be copied with impunity without patent protection. When that legal certainty arrived, similar to the coming legalization in the U.S. (as well as many other countries) for cannabis, an investment arms race began. Institutional stakeholders began investing in the infrastructure around biotechnology, looking for partnerships with those who already established some level of proficiency in the science and had a team that could execute on innovating rDNA research. Eli Lilly, Roche, and Johnson & Johnson were among the heavyweights who looked into early rDNA investments. J&J actually rejected an $80M offer for Genentech in the early 1980s (oopsie!), because they could not figure out how to fit rDNA into their product focus. In some ways, the large investments made by Constellation, Altria or any host of large companies who have already made significant investments in the cannabis space may be looked on in the opposite way than rDNA in the late 70s. At that time, big pharmaceutical companies barely engaged in rDNA until it had established some core successes, whereas in cannabis large companies may have fallen prey to the FOMO of rapid legalization and invested in opportunities that may never prove to be worth what an inefficient market dictates.
This is about where we are in cannabis today. There is sufficient legality to have multinational companies engaged but enough uncertainty that legal progress is one of the features of the landscape. If you stopped the continuum here, cannabis would still be well on its way as an industry and within 5 years, songs of דיינו (Dayenu for my non-tribe readers) with new stanzas for the cannabis industry would ring out every 4/20.
Alas, while “it would have been sufficient” for economic opportunity if the evolution of cannabis stopped here, the full potential of the plant, and its impact on reducing opioid abuse, creating plant based medicines and a host of other applications we have written about over the past two years, would suffer greatly. Luckily, the legal framework of the SAFE Banking Act, Canada’s adult-use law, approaching legality in most of Europe, the Carers Act, and an eventual U.S. framework, as well as other stabilizing forces are inevitably going to do for cannabis what Diamond v. Chakrabarty helped do for rDNA. In 1980, it removed a cloud over the industry and helped usher in the biggest financial validation biotechnology had seen until then: The Genentech IPO.
3. Legal Recognition Phase
While cannabis has already had its share of IPOs, due partly to the Canadian legality which allowed banks and financial institutions to participate in the cannabis industry writ large, it is not hard to see how the U.S. illegality is one of the remaining legal clouds over the industry advancement. In rDNA, the Genentech IPO was big news, and cocktail party chatter (for those younger, think internet stocks circa 2000) was all about biotechnology in the early 1980s. In fact, it is not hard to imagine Gordon Gecko on his 20kg phone doing a biotechnology deal, except that Oliver Stone probably did not want to confuse viewers so Blue Horseshoe loved Annacott Steel and Blue Star Airlines. In real life, “Biomania” went into hyperdrive when the fruits of biotechnology companies could be protected and the public could actually buy into one of these companies through an IPO.
While Genetech prepared for its IPO, the process of educating the masses helped in two ways. It deconstructed some of the mythology around the dangers of rDNA, which were at almost hysterical levels in the mid to late 1970s. Some regulators thought of it like Three Mile Island or the current dark matter work being done at CERN, which in truth could be the end of us all..seriously. Dark matter is pretty scary. rDNA...not so much. Secondarily, the hype around Genentech’s IPO allowed biotechnologists and lay scientists to map out the future of how biotechnology could help the average person through pharmaceutical advances. This is a crucial step in normalizing any industry but matters more so when the industry being normalized is being created out of thin air.
The process of “selling to the masses” is an absolutely essential milestone in that it also creates changes around the industry itself, due mainly to the scrutiny now placed on it and the interaction with the masses as interest grows in learning more. It also shines a light on existing industries that will be displaced and dislocated by the newer industry as it normalizes. A prominent example of this is the early days of television, which started in only a few homes, before emerging content, public education and technology created cheaper versions and demand from the masses. The radio industry was never the same. Likewise, the early days of computers, which used TV advertising as a way to sell to the masses, including the famous 1984-themed advertisement for Apple, educated skeptics as to why this machine would change lives. As early adopters acquired computers, the nature of software and things a computer could do rapidly changed. The dislocation of existing industries is too large to list there.
In Genentech’s case, the run up to the IPO identified sticky issues around the public-private partnership that Genentech had built its research on. Boyer and much of the Genentech team had dual roles early on at universities where they had created aspects of research that may or may not have ended up in the final products Genentech was producing. While the issues surrounding intellectual property were eventually worked out legally many years later, the IPO certainly made many of the various parties, including the universities themselves, aware that what had seemed like intriguing research that could lead to advances was now on the verge of having a value ascribed that at the time seemed enormous. With the IPO, the capital Genentech would receive was sure to lead to additional advances and that brought both scrutiny, and a belief that contributing parties and organizations would have to be compensated.
As for the hype around the IPO and how it relates to cannabis, the Los Angeles Times reported that it was “a frenzy the likes of which hasn’t been seen on Wall Street since the go-go days of the 1960s.” The Wall Street Journal called it “one of the most spectacular market debuts in recent history.” The articles promoting the trading of Genentech’s shares and the rise to $88 from the $35 opening dominated financial trades for a week which is something cannabis industry participants can relate to.
4. Normalization Phase
After the Genentech IPO, the public began to better understand what could be possible because of biotechnology. Doctors now had research and white papers to educate themselves on new medicines and therapies. Patients would come in contact with these medicines on a routine basis. Investors could study not just Genentech, but other companies engaging in biotechnology and get a greater sense of the economic opportunity. This creates a critical mass that can make something seem normal very quickly. Anyone remember the hype around monoclonal antibodies in 1999 or so? Many people heard about them in the context of the stock market as the companies who were driving the scientific elements were publicly traded, like Immunex.
Therapies from monoclonal antibodies are now ubiquitous and are widely considered the top cancer fighting method. Their roots harken back to biotechnology methods developed years before during the early 1980s biotechnology frontier expansion.
The accessibility of information drives normalization, particularly when traditional channels provide that information. In Genentech’s case, newspapers, magazines and television news all covered biotechnology and the financial trades were dominated by the IPO. As people became more familiar with something, they discuss it, and the Overton window for discussion shifts.
In some ways, here is where cannabis divides from the biotechnology history since in many ways the discussion of cannabis becoming a normal, everyday substance has only started recently, as legality moved to the forefront after the 2016 election, where ballot measures passed in seven of the eight states which had either medical or adult-use measures. Unlike the biotech revolution, which was helped along by the hype around Genentech’s IPO, the financial element in cannabis had done very little to move the needle prior to 2016 since trading of cannabis stocks had been widely discussed well before that and a fair amount of folks were trading cannabis stocks before the 2016 election. Merida itself had already helped take GrowGeneration public before that election, and well-known companies like Kushco, Surna and Terra Tech had already been traded for more than a year by then as well. In the case of cannabis, it is the illegality that has held it back from being normalized. The financial side had done little to move that needle until legality went into hyperdrive in November 2016.
With those ballot measure successes came a broader discussion, and then when several Canadian companies went onto the Big Board and Nasdaq, the average retail investor started paying much closer attention. With cannabis, normalization cannot occur until people feel comfortable using, either medically or for recreational purposes, without fear of legal consequences. When the legality is resolved in the U.S., the opening of a more egalitarian financial opportunity, as well as the effect legality will have on stocks, can be expected to accelerate the normalization of cannabis, which will lead to a massive rush of research, development and consumer product refinement.
5. Industrial Phase
As normalization tracks forward, engagement from all levels of society begin to move cannabis to its ultimate phase, the Industrial Phase. In biotechnology, this meant a broad effort by thousands of scientists to drive their research forward, buoyed by money from strategic partnerships with companies like Eli Lilly. It also meant a gold rush as other companies flooded the stock market and raised significant investment capital There are no 300 biotechnology companies and a fair amount of companies that could be designated as biotech related. As the industry matured into the 1990s, technological advancements took biotechnology in a variety of different directions, one being monoclonal antibodies. Biotechnology spurred scientific methods that eventually led to a decoding of the human genome and the industry became so broad that at this point, biotechnology can describe everything from the development of pharmaceuticals, to the testing of an individual’s genotype to determine whether their iron is low or what medicines could work best for a variety of ailments.
I am not going to predict when this phase of industrialization occurs in cannabis, but we do believe that normalization will start to settle in by the middle of 2022, as a potential U.S. descheduling or legality begins to filter through every facet of society. It could take another year for the Industrial Phase to begin, although in some ways, one could argue that it already has. That is what is so incredible about the cannabis industry and the opportunity it presents. There is no perfect analog. The global illegality that is crumbling in different ways in each country make far flung predictions difficult. What is clear is that very few recent emergent industries have seen such an influx of investment before the largest markets in the world are even legal. That is simply astonishing. Add in the restrictions of the U.S. banking system and the absolute disconnect between federal and state law and you have something that could reasonably be called a “Second Peculiar Institution.”
Even with the recent volatility and price action in the industry, we do not think we are going out on a limb to say the investment opportunity in cannabis has a long way to go as we migrate from illegal, to legal, and all of the incredible stops along that continuum. Genentech went public in 1980 and closed at a $500M market cap. It took 20 years but it was eventually valued at $5B. 12 years later, it was valued near $90B. As we have often said at Merida, there is no perfect analog for cannabis, but we think there is enough overlap that we can gain a greater understanding of the potential of the cannabis industry’s medical side from the early biotechnology industry. As we look to how that medical side coexists with the consumer, adult-use side, let’s all learn a little from the biotechnology evolution and take a longer view of how cannabis will affect health care and pharmaceutical development.
If you are investing in the growth of an entire industry and not trying to time a trade, you are looking through the right end of the cannabis microscope. We think those that can do so and see the long-term opportunity in their cannabis investments will be rewarded greatly.