Cannabidiol (CBD) has taken off lately, and the recent passage of the Farm Act in December has accelerated interest in the cannabinoid found in cannabis plants that was also the active ingredient in the first FDA approved drug derived from botanical cannabis, GW Pharmaceuticals’s Epidiolex, which is indicated for the treatment of seizures in treatment-resistant forms of two types of epilepsy, Dravet syndrome and Lennox-Gastaut syndrome. Products containing CBD are becoming increasingly available in a variety of formats and through an increasing number of venues, with consumers able to access products derived from industrial hemp through mail order, convenience stores, health food stores, some restaurants and coffee shops and now even malls. CBD is also sold through state-regulated medical cannabis programs or in states where cannabis is legal for adult-use and can be derived from plants that fall outside the definition of industrial hemp, with THC levels above 0.3% of the weight.
The mainstreaming of CBD began years ago, with the 2013 CNN Special ‘Weed’, hosted by Dr. Sanjay Gupta, bringing attention to the potential health benefits of CBD to a global audience. Despite a murky regulatory environment, several companies were extracting the compound from industrial hemp grown outside the United States and importing the paste into the United States and then converting it into products like tinctures. At the time, very little lab-testing was being done. In 2014, the federal government passed the Farm Act that permitted pilot programs for hemp production in states that permitted it. Some CBD companies began to manufacture products from hemp grown in states like Kentucky and Colorado, while others, maintaining a more conservative stance, continued to import the base material, suggesting that the Farm Act didn’t permit commercial activities but only research.
The industry prospered despite the lack of regulatory clarity, with only slight push-back from the federal government, with the FDA taking actions against companies on three occasions. Warning letters were sent in 2015 to several companies for making health claims that weren’t supported as well as for not having purported levels of CBD. In 2016 and 2017, it again issued letters to online retailers who were making unsubstantiated health claims. At the state level, many of the sellers advertised their products as “legal in all 50 states”, but this was not the case, as several states, in fact, did not allow it. Over the last few years, there have been only isolated instances of regulatory action, typically at the local level.
The recent Farm Act that legalized industrial hemp was supposed to clear the path for the sale of CBD from industrial hemp, but this is only at the federal level. It turns out that states must create legislation to govern hemp production and the commercialization of hemp. At the federal level, within moments of President Trump signing the Farm Act, FDA Commissioner Scott Gottlieb, MD, issued a statement asserting the FDA’s right to oversee CBD.
We’ll take enforcement action needed to protect public health against companies illegally selling cannabis and cannabis-derived products that can put consumers at risk and are being marketed in violation of the FDA’s authorities. The FDA has sent warning letters in the past to companies illegally selling CBD products that claimed to prevent, diagnose, treat, or cure serious diseases, such as cancer. Some of these products were in further violation of the FD&C Act because they were marketed as dietary supplements or because they involved the addition of CBD to food.
While products containing cannabis and cannabis-derived compounds remain subject to the FDA’s authorities and requirements, there are pathways available for those who seek to lawfully introduce these products into interstate commerce. The FDA will continue to take steps to make the pathways for the lawful marketing of these products more efficient.
Gottlieb had recently announced that the agency would hold public hearings on the issue in April. His pending departure throws into question how this will all play out, so uncertainty will persist for a while.
Investing in CBD
With the tremendous growth in the market, investors have expressed keen interest in CBD, and the number of publicly-traded stocks has skyrocketed. Before discussing the sector and some of the stocks, I want to be real clear about the risks, as it is easy to get caught up in the hype without being aware. First, as I have discussed above, investors need to understand that the regulatory landscape is in flux, though it appears to be headed in the right direction. There are scenarios where the federal government’s policies could potentially impede the ability of companies to operate as freely as they do today.
Another risk is that the opportunity of CBD has attracted many opportunists. Many of the publicly-traded companies don’t appear to be real, with several trading on the OTC that don’t even file with the SEC, including one of the first public companies in the space, Medical Marijuana, Inc. This is a red flag, and I highly recommend that investors avoid any stock that doesn’t file with the SEC. The market has also seen a number of companies suddenly decide to enter the space. While some of these appear to be more substantive than others, a sudden change in business models is certainly a yellow flag, and investors should be slow to credit companies for just simply stating their intentions.
A Look at the players
I follow three companies most closely, including Charlotte’s Web (a client at New Cannabis Ventures), CV Sciences and Elixinol Global. Each of them has a good reputation in the marketplace, a long record of being in the business, strong financials and a high level of revenue and growth. Charlotte’s Web, founded by the Stanley Brothers of Colorado, who were featured in that Sanjay Gupta 2013 documentary and profiled just this week in the New York Times, is the clear leader at present. In Q3, it generated sales of $17.7 million and was profitable. CV Sciences reported sales of $13.6 millon in Q3 with positive EBITDA and is scheduled to report Q4 this week. Investors will be looking for continued sales momentum as well as possibly news about a potential uplisting to the NASDAQ, a move that could be a catalyst for its two peers as well. Elixinol, a highly successful IPO in Australia last year, has three lines of business, the largest of which is related to CBD. In Q4, it generated overall sales of A$11.8 million (US$8.4 million). It didn’t break out the quarter by segment, but CBD represented 88% of sales for all of 2018, with the balance in hemp food.
Others who have recently entered the space as publicly-traded companies include Level Brands, which trades on the NYSE American and recently acquired cbdMD, a company that had sales of $7.5 million in 2018. Direct marketer Youngevity, which trades on the Nasdaq, recently extended into the CBD market, offering three proprietary formulas that sure sound like the company making health claims (Soothe, Uplift and Relax). Another new entrant to the public markets is Abacus Health Products, a recent new issue on the CSE in Canada that sells CBD topical products over the counter under the brand CBDMEDIC as well as to practitioners directly under the brand CBD CLINIC. Canadian licensed producer TerrAscend recently acquired CBD marketer Grander Distribution for $13 million in cash and stock equally, with the potential for earn-out payments of up to $10 million based on 2019 and 2020 sales targets of $35 million and $50 million, respectively. Finally, I mentioned above the recent introduction of mall-based CBD stores, and leading the charge is Green Growth Brands (a client of New Cannabis Ventures), which is also involved in state-legal cannabis operations. It sells online and has already opened several Seventh Sense kiosks and has inked a deal with Simon Properties to open 108 locations to sell cosmetics, which are likely to be less vulnerable to regulatory oversight than the oral supplements market. The company has close ties to the famous retailing family, the Schottensteins (DSW, American Eagle Outfitters). Other operators of state-legal cannabis businesses with recently announced separate hemp-derived CBD businesses include Cresco Labs, Curaleaf Holdings and Liberty Health Sciences.
Some of the interesting new potential entrants include two of the leading global cannabis companies, Canadian licensed producers Canopy Growth (a client of New Cannabis Ventures) and Tilray. Canopy Growth has received a license in New York and has secured intellectual property through the recent purchase of ebbu. It also inked a deal last month with Martha Stewart. Tilray recently acquired Canada’s largest hemp company, Manitoba Harvest, and is developing CBD products that will be branded by Authentic Brands Group. Similarly, Village Farms, which owns half of Canadian LP Pure Sunfarms, is developing plans to grow hemp in Texas, where it currently isn’t yet legal. These cannabis-focused companies aren’t pure-play bets on CBD, but the diversification that they offer may shield investors from any setbacks on the regulatory front.
Again, if the company doesn’t file with the SEC, then I suggest to readers that they not even consider investing in the company. In addition to Medical Marijuana, Inc., I would add Endexx (which is changing its name to CBD Unlimited), Potnetwork Holdings and Ubiquitech Software. I routinely advise subscribers of 420 Investor of the pitfalls with several other companies in the sector as well, one of which is Isodiol, listed in Canada and the U.S. and in disarray with the Chairman of the Board leaving abruptly, several pending deals not closing, many related-party transactions and fading fundamentals, with growth lagging peers. Another apparent exploiter of the theme is Marijuana Company of America, which has seen a tremendous amount of press releases and insider stock sales but no material revenue.
Wrapping it up
While the regulatory landscape at both the federal and state levels lacks clarity, it appears to be moving in the right direction. Investors have a lot of choices when it comes to participating in the CBD space. Several companies have already created strong and growing businesses, and many new entrants are staking their positions. As is often the case when a trend takes off, the hype is likely ahead of the reality. Additionally, many of the companies purporting to be in the space don’t appear to be substantive, suggesting that investors be cautious when evaluating potential investments. I believe a key to success in the CBD business will be the ability to operate in a regulated environment, and many of the fly-by-night operators, both publicly-traded and privately held, will likely not succeed. Look for companies with good access to capital, strong management teams, proprietary and innovative products, posted lab results and a quality control team up to the task of assuring confidence in the products sold.
Disclaimer: I mentioned Canopy Growth, Charlotte’s Web, Green Growth Brands and TerrAscend, which are clients of mine at New Cannabis Ventures, where we provide investor dashboards on their behalf. We disclose all public company clients here. I do not own any stocks mentioned in this article, though I may include them in one or more model portfolios at 420 Investor.