The SAFE Act Could Lead To Big Changes In The North American Cannabis Industry

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Includes: ACB, ACRZF, APHA, CGC, CRLBF, CTST, CURLF, CVSI, CWBHF, GTBIF, HEXO, HRVSF, IIPR, MJ, SAFE, TGODF
by: The Stock Stooge
Summary

The SAFE Banking Act is headed to the House Financial Services Committee on Tuesday.

The SAFE Banking Act, if passed, would allow big US banks to provide banking services to cannabis companies.

It's possible that the SAFE Banking Act could be expanded to affect exchange listings, allowing US cannabis companies to list on the major exchanges.

These changes are good for some players and bad for others.

Important legislation for the U.S. cannabis industry is coming. On Tuesday the House Financial Services Committee is scheduled to review and mark up a draft of what is being called The Secure and Fair Enforcement (SAFE) Banking Act. The SAFE Banking Act has several significant implications for the cannabis industry.

Banking Services

The main purpose of the SAFE Banking Act is to protect banks from being prosecuted by the federal government for servicing the cannabis industry. See here for the draft text of the bill. This would have far-reaching implications in the US for the cannabis industry. For one, it would allow major banks to provide bank account services, which will lower operational costs as companies could then easily get bank accounts and make transfers. More importantly, the SAFE Banking Act would allow large US banks to provide debt financing to cannabis companies, which would lower the overall cost of capital for an industry that has had to rely to a large extent on equity or equity-linked financing.

These changes will benefit the industry generally, but there are some companies it may hurt. For example, cannabis REITs like Innovative Industrial Properties (IIPR) currently offer the industry a form of debt financing through sale-and-leaseback transactions of the land and facilities where the marijuana is grown. As more traditional bank financing becomes available, REITs like IIPR won't be the only game in town anymore and will likely have to adjust their pricing to be competitive.

Stock Listings

The current listing situation is a mess. US companies are not allowed to list on the major US exchanges, so they list on Canadian exchanges or over the counter in the US. Meanwhile, Canadian companies are able to list on the US exchanges. Obviously, there is a big premium in being able to access US investors and the publicity and legitimacy that a US listing brings. The result has been that Canadian companies have used their access to the US exchanges to become the best known and largest cannabis companies in the world. These companies have no US operations and pay no US taxes, yet have benefited enormously from their access to the US capital markets. Meanwhile, actual US companies are shut out of the US capital markets and have been forced to list in Canada.

It's unclear whether the SAFE Banking Act will change this. The SAFE Banking Act as currently written only applies to "depository institutions" and it's not clear whether the NYSE or the Nasdaq could qualify as a depository institution. But the SAFE Banking Act is at the early stages of the drafting and review process and it's entirely possible that this language is expanded. After all, if Congress is going to allow banks to provide financial services to US cannabis companies, why not also allow the companies to list on the major US exchanges?

If the SAFE Banking Act is expanded in such a manner it would have two major consequences. First, it would allow (obviously) US cannabis companies to list on the major US exchanges, which would bring tens of billions of market cap onto the US exchanges, expand the potential investor base and increase the mindshare of these companies. This could have a major impact on stock valuations as well, with investors starting to take notice that perhaps the US companies can be quite competitive with the Canadian ones.

This could cause a major rebalancing with money flows out of Canadian cannabis companies and into US cannabis companies. The play here would be to short the Canadian companies such as those listed in the MJ ETF (MJ) and go long US cannabis companies like Curaleaf (OTCPK:CURLF), Acreage (OTC:ACRZF), Charlotte's Web Holdings (OTCQX:CWBHF), CV Sciences (OTCQB:CVSI), Cresco Labs (OTCQX:CRLBF), Green Thumb (OTCQX:GTBIF), Harvest Health (OTCQX:HRVSF) and others.

The second major impact would be that the Canadian companies would be able to expand into the US without fear of losing their listings on the NYSE and Nasdaq. They would first have to obtain clearance from the exchanges (their original listings were contingent upon not engaging in operations in the US). This would open the floodgates for the Canadian companies to set up growing facilities and retail units, acquire US companies and enter into joint ventures in the US.

I would expect a flurry of activity and deal-making, which could create a lot of excitement among investors over the short term who bid up prices across the board. But in the long term, this development would only serve to increase competition, provide even more capital to the industry and bring new players into the fold. While I think this would create long-term pressure on the entire industry from intense competition, the clear losers here would be the smaller Canadian companies that do not have the wherewithal to expand outside of Canada such as CannTrust (CTST), The Green Organic Dutchman (OTCQX:TGODF) and Hexo (HEXO), particularly as the Canadian market becomes oversupplied over the next year.

Conclusion

The SAFE Banking Act will be a big development for the industry if it gets through Congress. Although it doesn't change the fact that cannabis remains illegal under federal law, it will clear the way for banking services and, perhaps, stock exchange listings. These changes will be good for some players and bad for others, and could be a big story in 2019.

Disclosure: I am/we are short TLRY, APHA, ACB, CTST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.