Without Analogs, Data and Experience Are Invaluable Currency
As the market for cannabis-related companies digests an uncertain regulatory environment, and the broader investment ecosystem struggles to find the right valuation metrics for private and public companies in the cannabis industry, Merida Capital Partners has found one fundamental truth to rely on in our investment approach: Information is power.
It should come as no surprise that in the case of cannabis, information is the single hardest commodity to collect, vet and then contextualize because there is no historical analog that fits what we are all witnessing in real time. This is a dangerous thing for cannabis investors since association learning (i.e. the reliance on patterns) is fundamental to all animals, from the simple worm C. Elegans to our very own H. Sapiens.
Time and time again we have seen this desire to compare cannabis to something so that it can be contextualized. Everyone compares cannabis to something else. Having participated in medical cannabis licensing processes in several states, diligence on hundreds of companies, and countless meetings with entrepreneurs, regulators and fellow investors, we often hear comparisons to the end of alcohol prohibition, casino licensing, online wagering, the advent of the internet, commodities trading and so on. The need to associate this emergent industry to others that came before it is so pervasive that it ranks somewhere between the potential for cold fusion and the Einsteinian search for the Theory of Everything in mankind's Quixotic pursuits.
The truth is that we are likely seeing a unique industry evolve without a measurable precedent. In broad strokes, agriculture, pharmaceuticals, information technology, energy and real estate, as well as other industries all play a part in this industry. Segments of many industries have some relationship to cannabis but there is no perfect analog.
It is this recognition of a unique confluence that drives Merida Capital Partners to value information first and to collect a voluminous amount of it before making an investment. We score our investments for a wide range of attributes from the their ability to cross the fragmentation gap (what we call a C-score) to the likelihood of growth as new states change their laws (what we call an L-score).
How has the broader investment ecosystem, always hungry for high growth, reacted to this lack of recognizable analog? Many investors have turned to what they perceive as the most straightforward areas of cannabis. Nearly $480 million in investment poured into cultivation last year. Another $80 million poured into real estate. The only sector that came close within cannabis in 2016 was Biotech/Pharma, with $344 million of capital invested.
Biotech and cultivation are both incredibly capital intensive, which can partly explain the investment amounts. Other explanations also seem rational. Biotech is an area where institutions may feel more comfortable investing, hence there is some small analog on which they can rely. Cultivation is something many people feel is easy to understand, which attracts an incredible amount of investment because it looks like agriculture, a very mature, well understood industry. So there are some analogs to be found in pockets throughout cannabis.
However, it feels like the industry is at the first crossroad of many that are sure to come. Sophisticated investors who have recently turned their attention to the space, have tempered the gold rush mentality of early investors and operators and are recognizing some of the idiosyncrasies in this space which can hurt returns. They're asking smarter questions and diligencing investments with more caution. In many cases, we see that the lack of experience means these smart investors lack the context to properly analyze the companies they are reviewing. Hence the need for specific, context rich information.
Specialization has led to greater industry specific knowledge that brings with it optimized tools for operating in almost every vertical in the space. Which brings with it more information that can be distilled to better educate newer entrants.
Experience matters but superior information is the great equalizer. The information available is finally starting to catch up with the amount of speculation required to push ahead in a new industry. Our investment in New Frontier Data, a premier provider of information and business intelligence to the industry, has certainly accelerated this process. New Frontier's most recent is an incredibly informative survey of the cannabis marketplace and is of a quality you might see in almost any mature industry. We are proud of the annual report as the definitive source of survey data for the cannabis industry.
However, even with New Frontier's efforts, information is still scarce in many quadrants. Due to the imperfect information available and without analogs to draw on, at Merida we focus our investments on fundamental infrastructure with strong revenue pipelines. Equipment, data and information technology, lab testing, and now specialized equipment (smart lighting) are components of our portfolio. But our core investment is actually in superior information…and experience, both of which we pursue with a passion specifically because we cannot rely on historical analogs to guide us.
We dig in every day on every investment prospect as if it’s a new paradigm, because it quite possibly could be. It’s why our largest investment is in New Frontier Data. We, along with many others, crave the kind of intelligence New Frontier produces because very little has existed up to now. In pursuing information and experience in our investments, we take the same approach to building our team.