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Cash flooding into cannabis sector a windfall for non-bank investment houses

An employee works at a Canopy Growth facility in Smiths Falls, Ont., on March 8. BMO made a splash in January when it became the first big bank to co-lead a cannabis deal by co-leading a financing for Canopy.


It has been a busy six months of dealmaking for legal cannabis companies.

The sector has captivated investors in Canada and beyond – from millennials to retirees, pro traders to first-time investors. Their cash has been flooding into marijuana equities and exchange-traded funds, helping to push the valuations of startups that have booked little to no revenue, let alone income, into the hundreds of millions and even billions.

All of this action – most of it speculative – has been a boon for the bankers, lawyers, auditors and consultants who advise public and private cannabis firms on deal-making, compliance, accounting and their operations.

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It has also caused some observers to warn of a bubble that will leave large numbers of investors holding the bag.

The frenzy is rooted in a shift in public policy that is seeing countries across several continents permit and regulate the growth, sale and use of marijuana in some form. Canada is leading the charge by becoming the first Group of Seven country to allow recreational use of the drug later in the year, building on a new medical regime that serves 235,621 patients, according to the latest Health Canada figures.

The sector ended  the last year with a bang after a quiet third quarter, as companies raised a record $900-million in equity in the last three months of 2017, according to data compiled by Canaccord Genuity Corp.

"We are seeing demand from all over the world to invest in the cannabis sector here," said Graham Saunders, the head of origination at Canaccord.​

Then, in the first handful of weeks in 2018, the industry announced more offerings worth $1.8-billion, flooding the market with new shares at or near all-time highs.

Many aren't just selling plain-old common shares. Instead, there are many deals that include warrants – which convert into shares at a certain price within a period of time – or units – which consist of a share and a half-warrant. A few are convertible debentures, which is a bond that can be converted into stock.

"Those are the structures investors are demanding for the risks they are taking," Mr. Saunders added. "It's not like we're underwriting Bell Canada or TD Bank. This sector has risk in it."

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In Canada, non-bank investment houses have dominated the young industry, taking dozens of companies public, underwriting equity sales and advising on deals. That's because the biggest banks have mostly been watching from the sidelines, as they weigh the risks of banking these early-stage companies and selling their volatile shares into their vast retail platforms.

BMO Nesbitt Burns Inc. made a splash in January when it co-led a $200-million financing for Canopy Growth Corp., marking the first time a big bank has led a cannabis deal. The transaction won't be a one-and-done for BMO: It is getting closer to Canopy, sponsoring a lunchtime speech by Canopy chief executive officer Bruce Linton in Toronto earlier this month and plotting other producers it should support.

The other co-lead in Canopy's January deal was GMP Capital Inc., which brought Canopy's – and the industry's – first equity sale to market in April, 2014.

Small firm Clarus Securities Inc. entered the fray in 2015 with Aphria Inc., now the country's third-largest cannabis grower by market cap. It has also worked with businesses linked to Aphria, including Liberty Health Sciences Inc. and Nuuvera Corp.

In 2016, Canaccord jumped into the space as part of a share sale by Mettrum Health Corp., which was sold to Canopy in early 2017, and has thrived in this market. Ever since, the investment bank has attracted clients in Canada and the United States, where it hired a banker in San Francisco who is devoted to marijuana. Operating in the U.S. cannabis market has its risks because while the drug is permitted in certain states, it is illegal under federal law.

Some cannabis companies have signed agreements that give an investment bank the right or option to lead their future transactions, meaning loyalty is written in the contract for a period of time.

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There are more than 90 pot stocks in Canada today. Many publicly traded licensed producers have raised funds since going public to pay for bigger facilities in order to fuel their growth.

Only a half-dozen companies are listed on the Toronto Stock Exchange. The majority of the country's public cannabis firms are listed on the Canadian Securities Exchange (CSE), a venue for tiny startups. As of early March, 65 of the CSE's 360 equity listings do business in the sector – and 17 are in the United States. The CSE pot stocks are worth a combined $7.2-billion, or 63 per cent of the entire market.

Interest in the space has soared. This winter, billions of shares in pot stocks have changed hands, straining the IT systems of the largest retail investing platforms at Toronto-Dominion Bank and Royal Bank of Canada.

Earlier this year, Brent Zettl, chief executive officer at CanniMed Therapeutics Inc., said his adult children and their friends had been buying and selling pot stocks even though they really didn't know how to properly value them.

"We've got a whole new generation of millennials that are buying stocks that don't understand what stocks are worth," Mr. Zettl said in January after his company was bought by Aurora Cannabis Inc. "Their metric for buying marijuana stocks is very simply: How many shares do I get for how many dollars I put in? They're newbies."

Pick any day in the past few months and at least one pot stock listed on a TMX Group Ltd. exchange will be among the most actively traded in Canada, namely Aurora, which has operations in Alberta and Quebec, and Ontario's Newstrike Resources Ltd. Shares of Aurora are high up on a recent list of the most-shorted stocks in the country, as traders – led by hedge funds – bet that their prices will soon tumble.

Companies say they are focused on reducing their costs, researching new dosage forms, building brands and getting their products in front of patients and retail consumers at the right price.

"Ultimately, what wins at the end of the day will be branding and distribution channels," said Steve Ottaway, head of the health care practice at investment bank GMP.

"We are at a unique moment in time where a whole industry that has been underground is going legitimate and going global. Canada is sitting at the forefront. How often does that happen?"

This is part of the Report on Business annual Big Deals package of stories and tables about financing and investment banking, including the winners of the 2017 Canadian Dealmakers awards.

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