IN-DEPTH: Light it up

Although companies in the cannabis sector continue to grow, their corporate governance remains poor, providing opportunities for activist investors. Advisers that Activist Insight Online spoke to for this report said the cannabis industry will soon attract many activists, especially in Canada where the sector is booming due to the October 2018 legalization of cannabis products in the country.

Since 2017, nine companies in the cannabis space globally have been subjected to public activist demands as of September 30, according to Activist Insight Online.

“We’re expecting more of that to come,” said Ian Robertson, Kingsdale Advisors’ executive vice president of communication strategy. Last month, Robertson moderated a panel at the Skytop Strategies Conference in Toronto, focusing on governance issues in the cannabis industry. “The series of operational and regulatory issues that have affected shareholder value provide a lot of unique opportunities for activism,” he said at the time.

Changing landscape

The cannabis sector is an ever-evolving space where companies have seen dramatic shifts in their shareholder bases. Most firms initially attracted retail investors that were excited about the prospects of the business and less concerned about the governance issues that might befall young companies.

“What that creates is an environment where there is no checks and balances for management,” Sunny Puri, a portfolio manager at Anson Funds, said at the conference. Anson financed most of Canada’s public cannabis companies, including Tilray and Isodiol International.

However, the larger cannabis companies have started to see a turnover from retail to institutional shareholders driven by impending legalization, increased market caps and indexing, and the need for capital for things like greenhouses and acquisitions.

The emergence of these institutional investors, like Anson, has created more oversight. So have proxy advisory firms like Institutional Shareholder Services (ISS) and Glass Lewis, which are tasked with providing shareholder voting recommendations, often based on governance factors.
Governance qualms

Nonetheless, with the rising share prices and hopeful outlooks, the temptation for directors to be complacent is strong, Kingsdale wrote in a February 2018 report. Companies often have non-independent boards comprised of the firm’s founders, family members, and friends; diversity has not yet become a priority; and company bylaws do not always keep up with best practices.

“We see a litany of governance issues,” Robertson said. “Governance has taken a back seat.”

“You have CEOs that are very good at growing cannabis and know very little about running public companies,” added Teresa Tomchak, a partner at Farris, Vaughan, Wills & Murphy who also sat on the panel.

These governance issues can attract activist attention, as was the case at Ascent Industries where Drew Malcolm acquired a 44.7% stake from concerned shareholders that wanted to exercise their rights for better company disclosure. Malcolm eventually replaced the firm’s entire board following negotiations to avoid a shareholder meeting he requisitioned in February of this year.

Mix and match

Cannabis corporations also need to start thinking about their cash flows and profitability, various advisers told Activist Insight Online. In an industry growing at such a fast pace, not many firms are profitable. The underperformance of some might create opportunities for M&A in the space, sources said.

In March of this year, activist investor Nelson Peltz of Trian Partners announced that he will work with Aurora Cannabis as a strategic adviser to explore potential partnerships that could help Aurora successfully enter into contemplated market segments.

“The space remains interesting as there will be some material winners in cannabis,” Puri told Activist Insight Online. “In that regard, M&A may continue whether the market stays hot or not as companies look to diversify and differentiate.”

And with the announcement of new deals comes the opportunity for M&A activism. Earlier this year, Marcato Capital Management unsuccessfully pushed for an enhanced takeover offer of Acreage Holdings by Canopy Growth, claiming the bid “substantially” undervalued Acreage. However, shareholders approved the $3.4 billion deal in June.

Tomchak told Activist Insight Online that the acquirers in the space will likely be the firms that improved their governance due to shareholder demand. “They are likely to acquire smaller cannabis companies that have not evolved at the same pace, particularly in corporate governance, but who have potential beneficial assets for an acquirer,” she said. “This is likely to lead to a few key players dominating the industry.”