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Darkness Looms

The pandemic could reshape the industry.

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Cannabis being deemed "essential" by many governments issuing shelter-in-place orders probably saved big swaths of the legal industry from ruin. The scene was dismal before COVID-19: stocks were down; layoffs were plentiful; businesses were closing, being acquired, or taking on capital. Illegal pot thrived. Bloomberg's index of cannabis stocks fell by more than half before the economy was shut down. In the year before that, it had fallen by two-thirds.

For the moment, though, things are looking up. Sales are generally even or rising as people stuck in their homes seek pot for therapeutic or recreational purposes. Will it last? The answer far from certain. Even less certain is what will happen after the crisis has passed.

Nobody really knows, largely because the timeline of the crisis is so uncertain. Nobody knows how long the pandemic will last, and nobody knows how deep any resulting recession or depression might be. That makes investors even more leery of a young, volatile industry.

Sales being up is hardly anything to bank on. Even if sales stay strong, the industry is beset by structural problems that will continue to worsen. Chief among them: capital markets were already becoming hard to tap. Now, it's nearly impossible to finance expansions or acquisitions, or even routine, short-term debt to cover current expenses.

The numbers are swoon-inducing. Capital raised by the industry as a whole fell by 69 percent just in March, according to Viridian Capital Advisors, which serves the cannabis industry. This week, Marijuana Business Daily published a study characterizing the situation in grim terms: an "extinction-level event" looms for some companies, Craig Behnke, an equity analyst for the trade publication, told Bloomberg News.

The study looked at 33 unnamed companies, finding that eight didn't have enough capital to last more than 10 months. With markets frozen, there are no obvious sources of capital for those companies to tap. The study examined, among other factors, operating cash flow (generally anemic) cash on hand (dwindling) existing credit lines (meager), and existing debt (mounting).

Still, some observers say the industry might end up healthier, if leaner and more consolidated. Behnke said the current situation might shake out weak players and force discipline on the survivors.

In the longer term, there is nothing but upside for the industry. Full legalization will likely continue to spread to new states, and pot might finally be legalized at the federal level, which would supercharge the business by allowing it to make use of services like banking that right now are largely unavailable to them. It would also allow interstate commerce, which would remove restraints that right now are choking potential growth.

In the background looms a larger question: how elastic is the demand for cannabis? That is, to what degree will people continue to buy it regardless of how bad the economy might get? This can't be determined with any certainty because legal, recreational pot is still a brand-new business. So far, pot is proving to be inelastic in the same way that booze and pharmaceuticals are, meaning that people keep buying it despite incomes falling through the floor. The question is whether that will last as the economy gets worse. We might be poised to find out.

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