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opinion

Part of cannabis and investing

One short year ago, Canada could proudly claim to be a world leader in cannabis. The federal Liberal government’s decision to legalize recreational marijuana sparked a new industry and a string of public market debuts. The 10 largest cannabis companies in the world called this country home.

Today, Canada’s first-mover advantage in a multibillion-dollar sector is going up in smoke. Five of the 10 largest publicly-traded cannabis companies are now American. Canopy Growth Corp., the country’s largest and most successful player, is effectively controlled by Victor, N.Y.-based wine maker Constellation Brands Inc.

Financiers who helped give birth to the boom fear that ill-conceived federal and provincial government policies will doom Canada to second-tier status in cannabis. “The ultimate global winners will be the cannabis companies with the best products, brands and distribution,” said Neil Selfe, long-time adviser to Canopy and other cannabis companies and a founding partner at investment bank Infor Financial Group. He said: “On all fronts, the lack of regulatory planning has handicapped Canadian producers.”

Anyone who shops for a buzz on the other side of the border can get a first-hand look at the government’s most obvious policy misstep. In California, retail chain Dosist welcomes shoppers with pastel colour schemes and shelves stocked with vape pens, offering a clearly curated experience: bliss, passion, calm or arouse. U.S. cannabis outlets take inspiration from Apple stores or Victoria’s Secret boutiques.

In Ontario, a prohibition-era urge to make the product look as boring as possible means the government-owned online retailer runs a website featuring indistinguishable photos of marijuana buds, labelled with nothing more than their THC content and price. Communist-era Russian bakeries had more charm. And Canadian cannabis producers are largely prevented from expanding south by U.S. federal regulations.

“Currently in Canada, developing recognizable brands is challenging," said a recent report from CIBC World Markets Inc. analysts John Zamparo and Krishna Ruthnum. They said: “Health Canada advertising and labelling restrictions are onerous relative to most legalized states south of the border, and product limitations mean producers are stuck trying to brand more items (i.e. flower) that are considered more commoditized compared to other products.”

As the cannabis industry matures, there will be a growing gap between the valuation of companies that simply grow the product and those that innovate, by spinning THC and CBD into medicine, tinctures and wax. Under Canadian laws, many of these products are still illegal, forcing domestic players to focus on lower margin products. We’re still hewers of wood and drawers of water, not home builders and Evian bottlers.

Yet the way Bay Street talks about cannabis is changing, to reflect an evolving view on the value-added approach that will distinguish the sector’s big winner. When the first public cannabis companies emerged, investment banks valued their shares based on the cost of every gram of “flower” they produced, and the price they could get for the dried plants. By January, CIBC World Markets’ analysts shifted their metrics to calculate the price and cost per serving of THC, to reflect the fact that consumers were moving from smoking a joint to tapping products such as oils and edibles.

As a rough guide, a cannabis producer can make in five cents for every milligram of THC they produce from selling flower. Revenue jumps to nine cents a milligram for THC in cannabis oils and 12 cents a milligram of THC in gummies. Margins are expected to be even higher when the industry comes up with cannabis-infused beverages. CIBC analysts said: “The reason that producers and retailers wish to sell products beyond flower is not only much greater ability to develop brands, but to also make better use of cannabis production and extraction.”

The initial euphoria around cannabis legalization in Canada dissipated around massive shortages of the product and an uneven retail launch – only nine of 25 licensed stores in Ontario managed to open their doors when legislation permitted on April 1. Cannabis shares are also coming off a high, with valuations on many companies dropping significantly in recent months. Industry consolidation is now a major theme among mid-tier Canadian companies.

Looking ahead, Infor’s Mr. Selfe said: “The future global leaders are much more likely to hail from the U.S. and the great Canadian cannabis experiment will be another footnote in a long list of Canadian business firsts that failed to produce sustainable global leaders.”