Financial impact of rescheduling cannabis

Since August 2023, when the Department of Health and Human Services (HHS) recommended moving marijuana to a less restrictive schedule under the federal Controlled Substances Act (CSA), the industry had expected approval from the Drug Enforcement Administration, which houses the scheduler . In mid-May, confirmation came in the form of a message from the Department of Justice, of which the DEA is a division. While the timeline remains unclear, the move represents the most important controlled substances reform since President Richard Nixon signed the CSA in 1970.

Shares of most major multistate carriers jumped as much as 15 percent on the day of the announcement. Since then, lawyers, business leaders and analysts have speculated almost endlessly about what the reclassification will mean for state-level legal markets, banking and federal legalization.

Probably the most dramatic impact cannabis rescheduling could be to remove the prohibition in Section 280E of the Internal Revenue Code from deducting normal business expenses from federal income tax obligations. Viridian Capital Advisors highlighted several potential consequences:

• Cash flow increases as the tax burden decreases. The ten largest companies alone would save more than $700 million a year; the entire industry could save more than twice that amount.
• Mergers and acquisitions are gaining momentum. The valuation gap between large and small companies may widen as markets recover, creating greater opportunities for major companies to make incremental acquisitions.
• Stocks are rising. Viridian analysts expect the market to rise above the 15.73x multiples that occurred after the reintroduction of the Cannabis Administration and Opportunity Act in May, likely reaching the 18.35x achieved three years earlier after the House of Representatives passed the SAFE Banking Act for the first time fifth.

According to Viridian founder and CEO Scott Greiper, removing the 280E yoke from the industry would dramatically impact company valuations going forward, with implications for both investors and lenders.

“It would significantly increase the value of companies because the most important metric for valuing a company – whether public or private – is free cash flow,” he said. “If you allocate a billion and a half dollars of free cash flow to cannabis companies, they will be much easier to fund. Lenders are always looking for two things: they look for a company that can pay off the interest and the note, or a company that has sustainable cash flow. This increases the company’s attractiveness to lenders and equity investors because it means the company is in a growth phase.”

However, increased cash flow can put small and medium-sized businesses in a difficult position. On the one hand, they could invest in new technology, larger grow rooms and extraction machines, or any other equipment and services needed to scale their operations. On the other hand, larger competitors could scale up and lower wholesale and retail prices, pushing for larger market shares and displacing smaller operators.

“I think we’ll see continued consolidation of second- and third-tier companies because they simply won’t be able to raise the finances to maintain scale, which means they won’t be competitive in the market on price,” Greiper said.

Another likely consequence of the rescheduling of cannabis sales, according to Greiper: multi-state operators (MSOs) continue to expand and consolidate their power through acquisitions.

“About nine out of 10 acquisitions were made by a public cannabis company, mostly an MSO because that’s what their business is,” Greiper said. “They move from state to state, usually by taking over existing operators. So for public MSOs, the top 10, if they have an additional $700 million in cash, that simply puts them in the position of being a more powerful acquirer – not only because they have more cash on their balance sheet to use for acquisitions, but also their stock prices they could have doubled.”

Of course, all of these predictions are theoretical because, like everything else in Washington, the cannabis rescheduling process will take many months. Any change that ultimately comes out of the DEA may have to work its way through other congressional agencies and committees, in addition to a public comment period that could last as long as ninety days. DEA may then need to make adjustments to the policy or promulgate compliance and enforcement regulations before the final rule is published in the Federal Register.

While the Biden administration appears to be pushing for this process to be completed before the November presidential election, some experts predict the cannabis timeline change won’t happen until late this year or early 2025 – assuming the election doesn’t usher in a new administration with a different program.