Venture capital funding lags in Canadian pot space
Weeks after being part of one of the biggest cannabis acquisitions ever, Marc Lustig is ready to catch the next wave – literally.
The chief executive officer of Origin House, the trade name of CannaRoyalty Corp., isn't sitting idle after U.S. cannabis operator Cresco Labs Inc. acquired his company last month in a friendly, all-stock deal worth $1.1 billion. While the deal has yet to close, Lustig is setting his eyes on another one of his pastimes – surfing along the British Columbia coastline.
“My timing was perfect,” said Lustig in a wide-ranging lunch interview with BNN Bloomberg at Momofuku Kōjin, one of his regular restaurant haunts while doing business in Toronto. “I was investing in the U.S. when I couldn’t even have a conversation with a financier because everyone was looking at Canada.”
The deal to combine Cresco's U.S. cannabis cultivation and retail operations with Origin House's extensive marijuana brand portfolio effectively created a North American pot conglomerate at a time of warming legalization efforts on both sides of the border. The combined company will have a footprint across 11 U.S. states and distribute more than 50 brands that are available on hundreds of dispensary shelves, most of which reside in California, the largest legal market in the United States.
But as Lustig put it, it was a deal that was rooted in urgency. Cannabis companies likely face an uphill battle raising money as capital markets encounter fatigue with the hundreds of Canadian firms operating in a fairly regulated environment, while the U.S. remains restrictive unless you’re a major player, Lustig notes.
Indeed, financing transactions in the global cannabis industry totaled roughly $500 million in the first quarter of 2019, compared to about $2.75 billion in the prior quarter, according to figures from Canaccord Genuity. That dearth of available capital likely means 70 per cent of all pot firms will go bankrupt or insolvent within the next several years, Lustig estimates.
“The valuations for some companies right now are insane,” he said, in between bites of the restaurant’s famed beef stew. “They can’t be sustained. Ultimately, they’re going to run out of money and the rubber is going to hit the road when they go to ask somebody for more money.”
Lustig's foray into the cannabis space started when he joined pharmaceutical giant Merck & Co. after graduating from McGill University with a master’s degree in molecular biology in 1997. He soon joined GMP Securities LP as an analyst in 2001 and worked up the ladder to senior executive positions there, later jumping to Dundee Capital Markets, where he ran the investment bank's capital markets arm and was first exposed to the then-nascent cannabis sector.
In 2013, Lustig left Dundee to join KES 7 Capital, a merchant bank focused on investing in the cannabis space and other growth sectors. A year later, he founded the company that eventually would become Origin House after recognizing the once-in-a-generational opportunity in cannabis.
“By then, [I’d] made enough money in capital markets and I told myself that I didn’t need those relationships in my world anymore,” he said. “So, this was my jumping-off point to dive out and either to risk it all and lose it, or do something bigger than I’ve ever done.”
With Origin House, Lustig immediately focused on the burgeoning legal U.S. market, where he saw more opportunity than in Canada, which had just legalized medical cannabis. In the U.S. he saw a contrasting industry from Canada’s, where the cost of operating was too high and any values tied to owning a rare production facility would eventually fade with the government granting new licences.
“Companies got rewarded for having more than a million square-feet of capacity, but today that is known as a death bed,” he said. “You need scale but you also have to be smart about what the cost of this entire operation is.”
Instead, Lustig said he wanted to run a cannabis company like how Heineken sells beer. The brewer doesn’t own the land that farmers grow hops on, but it owns the brand, manufacturing, and distribution and keeps the product consistent in every market that they sell their beer in.
“That's where the value is,” he said. “It wasn't owning the liquor store or the farm. Knowing that cannabis is a consumer packaged goods product, how well you package and sell it is 90 per cent of the value.”
Meanwhile, those companies that focused on the two ends of the cannabis space – growing and selling – are likely to face significant writedowns at an alarming rate, Lustig said, pointing to some of Canada’s biggest cannabis producers who not only grow massive amounts of cannabis and also have substantial investments in retail stores across Canada.
The timing may vary, but Lustig expects the Canadian industry to advance slowly while combating its biggest competition – the black market which still accounts for between one-third to half of all pot sales in Canada, according to various reports.
“We have a legal market in Canada that's slow and may take upwards of five years to get something right in terms of eradicating the black market,” he said. “We’re still waiting for that killer brand to dominate the market.”
With the Origin House-Cresco Labs deal set to close in the coming weeks, Lustig says he is looking forward to fulfilling some of his responsibilities as a director for several cannabis companies including Cresco Labs, Planet 13 Holdings Inc. and National Access Cannabis Corp. He has no plans to return to a CEO role but wants to spend much of his free time raising money for his charitable venture researching medical cannabis.
And, of course, in the meantime, he’ll be hanging 10 out in the Pacific Ocean.