"Weeding Out The Competition" – An Update On M&A Activity In The Cannabis Sector

As discussed in previously, the legalization of cannabis in October 2018 sparked a flurry of activity in the Canadian market, as both foreign and domestic investors were eager to enter the space. Notably, in 2018, M&A transactions peaked with over 700 deals completed in the cannabis sector, the total value of which exceeded US$12 billion.

While high entry costs and capital expenditures may continue to be drivers of consolidation in the cannabis sector, there are other emerging factors that may significantly impact the trajectory of M&A activity. With the 2019 year-end rapidly approaching, a reflection on some of these significant changes may shed some light on what's to come for the Canadian cannabis sector.

Legalization of Alternative Cannabis Products

The Government of Canada announced that the production and sale of edible cannabis, cannabis extracts and cannabis topicals will be legal in Canada, as of October 17^th, 2019. We expect that this diversification of cannabis products will both spur market growth and drive M&A activity. However, there are other important implications of this change:

1. As legal cannabis products diversify, so too will the parties of major M&A transactions. A recent report by Deloitte suggests that cosmetic, alcohol, food and beverage, and consumer packaged goods companies are all likely to enter the space to avoid outside encroachments on their respective market shares. This development may not only bring new companies into the market, but change the hierarchy of big players.
2. Alternative cannabis products may also blur the lines between the current market segments. The divide between recreational and strictly medicinal use products will likely become less clear once cannabis food and drink products become available.

While M&A activity in the space is likely to decrease as the industry matures, we expect this maturation to be delayed by the legalization of alternative cannabis products this fall.

Supply Issues

Cannabis producers have had difficulty keeping up with the current market demand, and this issue may be exacerbated by the emergence of new cannabis products. Cannabis shortages may also continue to impact the way cannabis companies scale their businesses. Vertical integration between retailers and producers will likely continue to be a common strategy driving future M&A deals.

For the past two years, the cannabis industry has been a significant driver of the Canadian economy, but the industry is already on the precipice of drastic change. We will be watching with interest to see how these new countervailing forces impact M&A activity, and the cannabis sector more generally.

The author would like to thank Tegan Raco, articling student, for her assistance in preparing this blog post.

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