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Wood pecking for value

July 17, 2018

Greetings,
 
A friend of Presidio View Capital often uses the analogy of “the woodpecker felling a tree” to describe triumphs of perseverance over long-odds. He believes that small, but consistent, pressure applied over long periods can accomplish great feats. After reflecting on the cannabis industry this quarter, we think the “woodpecker” is a great way to describe the industry’s progress. While we have an unshakeable belief in the ultimate, global legalization of cannabis, we’d be lying if we said we could predict when this will happen. What we do see, however, is a constant wave of events chipping away at the resistance.
 
First up, President Trump struck a deal in April with Colorado senator Cory Gardner to support Congress’s efforts to protect states’ rights for cannabis regulation. Sen. Gardner had been blocking all DOJ nominees in response to the DOJ’s elimination of the Cole Memo (see previous newsletter on this topic). Later, Trump announced his likely support for a bipartisan bill to end the Federal ban on cannabis and defer to states’ laws. Though not ironclad by any means, this represented a solid reversal of the political tide.
 
Secondly, as mentioned in the last newsletter, Canada was on the precipice of a legislative-driven, national legalization. Well, the creators of poutine (look it up…it’s delicious) came through, with congress approving the final laws in June to make cannabis fully legal by October. While the success of the rollout will depend on the particulars of the regulatory schema, the largest national legalization to date is a watershed moment. 
 
Finally, the FDA decided to get in on the act, approving the first ever drug derived from cannabis. We found this fascinating, as Schedule I of the Controlled Substances Act, on which cannabis is listed, is defined as “drugs with no currently accepted medical use and high potential for abuse.” Amazingly to us, this means that those suffering from severe epilepsy (which the drug treats) cannot legally buy their medication. Will this contradiction in policy force the DEA to reschedule cannabis (or at least CBD)?
 
Taken together, we see the “woodpecker” process hard at work, and this gives us great comfort in our long-term thesis about cannabis legalization and that our strategy of investing in the bedrock of the industry (the “plant-touching” segment, including growers, processors, distributors, and retailers) is solid. But…(there’s always a “but”)…the caveat here is that a highly-regulated industry like cannabis requires deep, specialist knowledge to succeed. There are regulations upon regulations in the cannabis industry and they are being developed and implemented by government workers without sufficient resources and experience. Take California, for example, which has levied 40% taxes on consumption and created a product shortage due to complex testing regulations. This had led to a dramatic shortfall in expected tax revenue and frustrations amongst market participants. We use this example, not to say successful investments are impossible, but that success is not the easy pickins’ described by many industry observers and investment advisors. This is why we favor a concentrated investment portfolio, based on regulatory expertise, manager selection, and competitive positioning, rather than a scatter-shot approach.
 
Thanks for tuning in, and we look forward to providing you with more industry and business updates in the coming months. Until next time!
 
Cheers,
Mike and Kip
Co-Managers, Presidio View Capital

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