How pot producers are able to play in Ontario's highly-regulated retail market
What do the Edmonton Oilers have in common with Canada's latest multimillion-dollar pot deal? More than you think.

Sundial Growers Inc. made waves earlier this week when it announced a deal to buy Inner Spirit Holdings Inc., Canada's biggest pot retail chain with 86 Spiritleaf stores across the country, for about $131 million. The deal puts the Alberta-based company in a rare group that includes Canopy Growth Corp. and Decibel Cannabis Company - a cannabis producer that will also own a major retailer.

It also will help to cement Sundial's presence in Ontario, the country's largest cannabis market, while ensuring its products get prime billing within Spiritleaf's store network. There are 28 Spiritleaf stores that operate in the province but have been structured to allow a producer like Sundial to own them despite ownership restrictions set by the province's cannabis retail regulations.

Ontario's pot shop regulations essentially limit the number of stores one entity can own to 30 (which will increase to 75 in September) while also capping the ownership stake a cannabis producer can own in a retailer to no more than 25 per cent of voting control in the company.

However, the Ontario regulations do allow for a franchise model to be implemented in the cannabis retail space, providing a window of opportunity for pot producers to capture a greater piece of the pie in the province. Inner Spirit does have a handful of corporate-owned stores in Ontario which would need to be divested to appease regulators before the deal closes. 

"If you're a licensed producer, and you want to own a retail brand that has a presence in Ontario, you really need to be looking at a franchise," said one cannabis retail expert who declined to speak on the record because they were involved in the Sundial deal.

That model is largely borrowed from a similar strategy employed by Canopy Growth with the Katz Group, one of Canada's largest privately-owned enterprises and the owner of the NHL's Edmonton Oilers.

The two have an exclusive licensing agreement where the Katz Group is a master franchisee for the Tokyo Smoke brand in Ontario and owns and operates the stores under its license. That agreement also franchises out the Tokyo Smoke brand to franchisees, who own their stores to remain in full compliance with the Ontario retail regulations.

"Our goal is to be the number one retail cannabis brand in Canada. Our strategy, much like we did with our pharmacy business, is to expand into several other provinces," said Katz Group spokesperson Tim Shipton in an interview.

As a result of the agreement between the two, Canopy Growth does not own any of the franchised Tokyo Smoke stores in Ontario either directly or indirectly.

"The Katz Group has an incredible track-record of operating responsibly in a highly regulated industry. We are proud to partner with them to grow the Tokyo Smoke retail banner across Ontario," said Grant Caton, general manager of Canada for Canopy growth. 

For now, the regulations will continue to allow a franchise model to flourish in Ontario and await the next cannabis producer willing to invest in a retailer, but the government is keeping a close eye on how the market will play out.

A spokesperson from the Ontario Attorney General's office said the provincial government will "continue to monitor the cannabis retail landscape and explore changes under Ontario’s open cannabis market if they become necessary". 

THIS WEEK'S TOP STORIES

Tilray closes deal for Aphria, eyes fresh lobbying to improve legal pot distribution: CEO 
Tilray formally closed its $8.2 billion blockbuster deal to merge with Aphria, creating the biggest cannabis company in Canada and a formidable competitor on the global stage. Tilray's new CEO Irwin Simon told BNN Bloomberg on Monday that he plans to lobby U.S. and Canadian governments to expand access to legal pot products, while also expecting sales in the Canadian market bounce back following a volatile year brought on by COVID-19 lockdowns and remaining bullish on the burgeoning European market. "One of the things I have to try and do in Canada is how do we get the government to allow us to change the way we can market to consumers," Simon said during a broadcast interview. Tilray also shook up its management team with Michael Kruteck and Jon Levin departing the firm while it appointed Aphria's former CFO Carl Merton as the new CFO and Jamie Meyer's running its Canadian operations. Former Coca-Cola Co. lawyer Dara Redler will be Tilray's interim chief legal officer. Tilray’s former head, Brendan Kennedy, will take a board seat in the newly-merged company.   

Organigram CEO resigns amid steady decline in quarterly sales 
Organigram Holdings announced the abrupt resignation of its CEO Greg Engel on Monday, marking the end of the executive's four-year tenure with the New Brunswick-based pot producer. The company didn't provide a reason on Engel's departure and appointed Chairman Peter Amirault to run the company until a permanent successor is found. Engel secured a $221-million investment from British American Tobacco for a 19.9 per cent stake in Organigram, but also couldn't stem a steady decline in sales which one analyst now sees falling by about 10 per cent to $77 million this year.   

Ontario to handle fewer incoming shipments in May due to COVID

May is going to be another rough month for some of Canada's pot producers. BNN Bloomberg reported Monday that the Ontario Cannabis Store (OCS) will accept fewer incoming deliveries from the country's pot producers this month to help curtail the spread of COVID-19. That development is likely to weigh on industry sales in the second quarter of 2021 and will push a sector-wide recovery toward the latter part of the year, according to Raymond James Analyst Rahul ​Sarugaser. Licensed cannabis producers typically get paid once they deliver their products to provincial wholesalers, which then distribute products to retail stores. 

Mars Wrigley files lawsuit after Zkittlez trademark infringment claim

Mars Wrigley, one of the biggest candy makers in the world, is suing California-based Terphogz for infringing on the company's Skittles trademark. Terphogz, which sells the Zkittlez strain and brand, is being sued in an Illinois court with Mars demanding the company destroy all Zkittlez merchandise, surrender their website and pay attorneys fees, Leafly reports. A similar lawsuit was filed in Canadian federal court, with the company suing four unnamed individuals who allegedly operate online cannabis marketplaces in Canada. 

Quarterly Results Wrap: Cronos, ScottsMiracle-Gro, Lowell Farms

Here's a summary of some of the cannabis industry companies that reported quarterly results this week: 

• Cronos Group: First quarter revenue up 50 per cent to US$12.6 million, US$37.1 million in an adjusted EBITDA loss, compared to a similar sized loss a year earlier. Cronos continues to control more than US$1 billion in cash on its balance sheet, although that figure fell by nine per cent from a year ago. (Release​)  
• ScottsMiracle-Gro: Second quarter revenue up 32 per cent to US$1.83 billion, US$322.3 million in profit, compared to a US$253.8 million gain a year earlier. Sales at Scotts' Hawthorne business, which focuses on cannabis growers, rose 66 per cent to US$363.8 million.  (Release)
• Lowell Farms: First quarter revenue up 17 per cent to US$11 million, US$4.6 million in an adjusted EBITDA loss, little changed from the same loss a year earlier. The company also posted a net loss of US$6.7 million. (Release)

Analyst Call of the Week - Jefferies on Tilray

Tilray's stock jumped more than 14 per cent Friday after Jefferies Analyst Owen Bennett re-initiated coverage on the company with a double-upgrade to "buy" and a $23 price target on the company's stock. Tilray is now Jefferies' top pick in the cannabis sector as it has a much stronger sales and profit profile than its peers such as Canopy Growth and Cronos, making it a better opportunity to capture sales in Europe's burgeoning cannabis market and "compelling optionality" for the U.S. pot space. Bennett sees Tilray's revenue tripling to US$601.5 million this fiscal year and could expand to as much as US$2.67 billion by 2029. "When full federal legalization comes, infrastructure/brand equity/awareness from its wider consumer businesses (hemp-food/CBD/alcohol) will then also be advantageous," Bennett said.

CANNABIS SPOT PRICE: $5.72 per gram -- This week's price is down 0.8 per cent from the prior week, according to the Cannabis Benchmark’s Canada Cannabis Spot Index. This equates to US$2,120 per pound at current exchange rates.

WEEKLY BUZZ

 “If something makes sense, we're going to look at and evaluate all the options and partnerships with a lot of consumer-packaged goods companies."
- Tilray CEO Irwin Simon on the company exploring potential partnerships​ once cannabis is legalized in the U.S.