Big Opportunities and Big Risks in the Cannabis Market
Featuring Todd Harrison
Published on: July 8th, 2019 • Duration: 54 minutesAs founding partner and CIO of CB1 Capital Management, Todd Harrison is uniquely positioned to talk about the frontier market of cannabis investing. In this wide-ranging interview with Tony Greer, the editor of the Morning Navigator Newsletter, Harrison does a deep dive into the cannabis space. He talks about the efficacy of cannabis for medicinal purposes, as well as for health and wellness. Harrison also discusses the parallels to the “Dotcom” free-for-all and warns that while some companies will become the “FANG” stocks of the space, as with early internet investing, many companies will cease to exist. Filmed on June 13, 2019 in New York.
TODD HARRISON: We look at this and we see a two to $3 trillion industry in a decade. If you look at this news and you use dot-com parallel that there's going to be a lot of companies that don't make it but the ones that do are going to be generational opportunities, and that was the bell went off when Kim Kardashian had that CBD theme baby shower, I turned to my trader, I said, this can't be good for this space and sure enough, that was pretty much the top ticket the end of April.
TONY GREER: Hi, this is Tony Greer. I'm Editor of the Morning Navigator Newsletter. I'm excited to have a conversation with Todd Harrison today, founder of CB1 Capital. Todd spent seven years at Morgan Stanley as a derivatives trader. He worked at Galleon Group, he ran trading for Kramer Berkowitz. He started an internet media company in 2003 called Minyanville and he won an Emmy Award. I'm excited to talk about global markets and cannabis markets with Todd today. So, let's get started.
Todd, thank you for joining me today and taking time away from your hedge fund, CB1 Capital. Why don't we start right in the cannabis patch today. Tell me about what's going on in the market. And tell me about CB1 Capital?
TODD HARRISON: Sure. CB1 Capital. We're a hedge fund. We're investing in the cannabis space or cannabinoid wellness space across the US. We have some Canadian exposure, but really US biotech, Australia, some Europe. And we're looking at three to five years, we think the market is misunderstood here. Certainly, the total addressable market and the use cases are misunderstood. So, we're positioning to take advantage of that.
TONY GREER: Got it. Full global cannabis hedge fund with a three to five-year time horizon.
TODD HARRISON: Yep.
TONY GREER: Perfect. Let's segue right into what's going on outside the window today in cannabis. So, the stocks are under pressure. And it seems like a pretty good time to talk about the cannabis market. Would you agree?
TODD HARRISON: I would agree. I much prefer to come in and talk about these things when a lot of these stocks are down 40%, 50% in the last month, a lot of that froth is off. So, they're for sale. So, it's a good time to be having this conversation.
TONY GREER: Yeah, I agree with you a hundred percent. And I've been treating this like the frontier market that it is and buying carefully, but with confidence on dips.
TODD HARRISON: Sure. So, unpack that a little bit in terms of the strategy. I do agree. If you look at this news, and you use dot-com parallel, that there's going to be a lot of companies that don't make it but the ones that do are going to be generational opportunities. And that's how we're looking at this. And we're trying to look through all this near term volatility. It's a lot of retail holders right now, notoriously emotional retail holders that are moving with a herd mentality, which is why we're seeing these monolithic moves across this space.
But I think if you can look out call it two to four years now, whereas last year, when we did this, it was three to five years- but two to four years now, where we look at the catalyst and the horizon, whether that's banking reform, or whether that's brought a decrim. But really, at the state level, at the federal level, and at the international level through the UN, we think that we have a lot of regulatory arbitrages heading our way. So, I do agree if you can find the right companies with the right management and stick it out, you want to be buying into this with a two to four-year horizon.
TONY GREER: I would love to know if you think that's the strategy. But most importantly, I am obsessed with your process of following the science. And it's been very good to me in following the sector. I would love to know what is on your mind lately in the science narrative.
TODD HARRISON: In terms of the science, which I agree, informs our decisions, and we look at the cannabis landscape really and say okay, well, there's the CPG story, and everybody seems to be starting to understand that more. That's beverages, nutraceutical, cosmetics and vanity, pet supplements, there's a lot of they're there on the consumer side with a more traditional CPG model. And I think more people are starting to understand that this isn't about smoking cannabis, but about eating it and drinking it and rubbing it on and taking bubble baths in it. There's a lot of form factors that aren't going to provide that cardiovascular, those cardiovascular concerns that come along with smoking.
That is starting to get unpacked right now on Wall Street. We're looking really through that. And what's going to take a bit longer from a tail standpoint is really that clinical evidence. As this moves from drugs from state dispensaries to medicine prescribed by doctors covered by insurance, that takes time because of clinical trials. There's over 100 clinical trials right now. So, we saw GW last summer get the first FDA approved plant based medicine for childhood onset epilepsy. We think that that's the tip of the iceberg in terms of indications, and whether that is brain cancer or autism, or traumatic brain injury or Alzheimer's, we think all of that is on the horizon, obviously, as you can tell by the narrative. Doctors want proof, obviously, before they get involved. So, this has to go through that Western medicine protocol.
TONY GREER: Is GW Pharmaceuticals, last earnings report, pretty good evidence that Epidiolex is working, doctors are approving it, they're spreading the science? That was a pretty barn burner report.
TODD HARRISON: We think so. But also, remember that there was a lot of pent up demand going into that. So, I think that some of that is going to play out. But we will get Epidiolex and we say this is terrific and only 4% of treatment for childhood onset epilepsy is front door for cannabis. So, the way they found this was really because nothing else was working for these parents for their children. 300 seizures a day in some cases, now disappearing or being occasional. And as we talked to these parents, and they explain how this isn't just for the child, but for the whole family when you have a child who's that ill, the whole family's just absorbed with that and consumed by that.
So, it's really people talk about this as a discretionary advice. We had these conversations like this is impact investing. We think that chasm between perception of reality has to close. The endocannabinoid system, it helps to regulate neuro transmissions a big deal, was first discovered in the early '90s, call it '91-'92. I was graduating college. So, this is not something that is well-understood. And certainly, the uptake in medical schools hasn't been there. So, I think the medical community is starting to really understand the ECS, what the gap right now is the parallels between the plant, people and pets.
We all have an ECS that helps to regulate our neuro transmissions. We produce what's called endocannabinoids to help do that. The cannabinoids found in cannabis in the cases that we've been able to study are identical in action to the cannabinoids, your endocannabinoids, your body produces. Everybody thought the runner's high for years was endorphins, we now understand it's an endocannabinoid. Identical in action to THC. So, when you consume THC, same chemical process, same chemical reaction is when you get that runner's high internally. So, that part still needs to be understood by the medical community. That's the exciting part going forward is the health and the wellness benefits is this comes off the blacklist that's been off for the last 90 years.
TONY GREER: Yeah, totally. And I think that that's what the market is missing. The good part about this frontier market is that there's no shortage of bears. And there's no shortage of naysayers. And it's amazing to me that people will rush in and buy something like beyond meat. And they still want to be a naysayer in cannabis and say that the uptake for that won't be what the market is expecting.
So, I believe differently, because I believe that when it gets legalized and people have that as a legal choice, then the growth will be even bigger than I think sell side estimates are at this point. So, that's where I think that we have a lot of opportunity now. Talk to me a little bit about another theme that you have in cannabis investing, and it's the opportunity to front run mutual funds and hedge funds.
TODD HARRISON: Yeah. Well, we think that we were going to see the bastardization of cannabis through the financial products plans, we're going to see a lot of ETFs, we're going to see a lot of hedge funds, we're going to see a lot of products, financial products are going to have to buy the underlying stocks in these things. And so, when we talk about our strategy, and people say, well, why are you primarily in publicly traded securities, when there's all this opportunity in private? We say, yes, the opportunities, they're in private right now, the private to public market, that's a pretty good vig from a valuation standpoint if you're right on your vehicle.
But we look at this and say, okay, where's the puck going? We think institutions are going to articulate their cannabis strategy as they better understand it. They're going to articulate that strategy through publicly traded securities, because that's how they do. They want their monthly nav, they want those metrics. But what I think that they don't understand is really the ubiquity of the use cases. And we talked about CPG, we talked about the efficacy- driven solutions, think about sustainable industrial use cases- concrete, plastic composites, biofuel.
Millennials are going to want to use that as their source, as their ingredient, we think, instead of some of these fossil fuels and instead of the pharmaceutical poison. So, we think that's all in front of us. And it's trying to keep loose grips on the handlebars right now with this volatility, with these bears. And understanding a lot of these companies aren't going to make it. But if you can find the companies that are, I think it's going to be generational, and it's a cause and effect.
TONY GREER: So, what do we need to look out for in terms of the banking acts that are coming on the horizon? I think those may be some of the biggest events that I can find on the cannabis calendar. What are your thoughts on that?
TODD HARRISON: Well, two things. First, about the CBD. Because obviously, since the FDA meeting, a lot of these names gotten crushed. CWEB, which is a name that we've started to build a position and it's down 50%, 55%. Charlotte's Web. Elixinol, all of these names. We looked at 1933 Industries and other name we own, all of these companies that we started to buy into this because paradoxically is these rules and regulations are fleshed out. And we do think there needs to be a pretty robust regulatory environment. There's a lot of labels and claims out there that are doing nobody any good. And a lot of times, you're not even getting what you think that you're getting when you buy the product. So, there needs to go through this regulatory process.
But paradoxically, we think the existing players with topical solutions that are building brands, that are building distributions are going to stand to benefit. And those are the names that are getting hit the most right now. So, we think there's a bit of an offsides there. But it's hard to gauge that sentiment when it's all one way as we saw late last year. But in terms of the forward catalyst and we see this now, it's June 13th, was you sit here, and these names are all for sale and pretty harshly. Everybody's getting out.
We've heard stories about generalist funds that are exiting the cannabis space too volatile. They don't see the catalysts on the horizon. We do see catalysts on the horizon. But obviously, this is what we do for a living. We're looking for those catalysts. We think things like New York, which we'll hear about probably next week, or for sure, by next week, by the 19th. Nobody's expecting this, Cuomo has said it's DOA. It's probably DOA. But he's done a pretty nifty job of rope-a-doping the issue and lowering expectations. So, I don't think anybody's expecting New York to pass.
But certainly, Illinois, having passed a few weeks ago, we think provides that roadmap for other states to adopt. And certainly, from a tax revenue and job growth, most states need this right now. But we think that New York, we think Texas, just passed, the governor just signed the hemp bill, which is big. This was yesterday and we have medical cannabis potentially by this weekend. And then the SAFE Act should start to move its way through the house within a matter of weeks. This is big. Because if you can lower the cost of banking, allowing banking for cannabis will lower the cost of capital, allow for debt financing, as opposed to equity offerings that are dilutive, and certainly, is going to allow for the business to legitimize itself within the stage set they're operating in.
We also think that is big from a supply demand standpoint, and that if these institutions are allowed to custody these assets, we think institutions will start to move into this space and start to accumulate equities. Whereas right now, it's pretty much 99.99% retail holders.
TONY GREER: So, do you think that they're all going to have to wait until it's one hundred percent legal at a federal level? And do you think that there is any chance of that during the Trump administration or not?
TODD HARRISON: So, I don't think legal is the way we want to look at it. I think decriminalization is probably a more apt forward path. Leave it in the hands of the states, the infrastructure is there plus you have the whole states right issue. If we go down that path, and we follow the precedent of online gambling, it's very similar, we think, a parallel from a court standpoint that they would back the states' rights. We think it's the state's right issue anyway. So, we think banking reform is probably most likely in this year.
And certainly, as we look out next year, we do see a bit of serendipity with the WHO last year in November already saying that they recommend de-scheduling cannabis to the UN. The UN's never veered from a WHO recommendation. Interestingly, they sealed that recommendation until February and then said they didn't have enough time to review it by March. So, they pushed it out to 2020, which seems to align with the US presidential election. I don't know. Every Democratic candidate is running on this.
So, it's the most populist issue of generations. Most populous president in generations, I have a hard time seeing him with this be used as a catalyst to get people to the polls for the other team. So, if the status quo remains status quo between here and there, I do think he tries to maybe sweep the leg and claim this. I think that would probably be a very intelligent political move given the 96% support among the constituency for medical.
TONY GREER: You just spoke a little bit about the branding. And that being one of them, major, major, major ways to win over a client base. And so, I have my ideas of what are the coolest brands out there and name that we can trade. What are the names, in your opinion, that are building the strongest brands? And they're going to be have the chance to survive in the cannabis markets in the years to come?
TODD HARRISON: Yeah, now, it's a loaded question. Because there's so much paper out there right now. There's so many brands out there right now. I think Paul Pierce just launched a brand and I think every day I turned on the TV, the bell went off when Kim Kardashian had that CBD theme baby shower, I turned to my trader, I said, this can't be good for this space. And sure enough, that was pretty much the top ticket the end of April. But certainly, there's going to be winners. We think Charlotte's Web is a terrific brand. We think Elixinol. We think Canna Hemp, which is a 1933 property, we own all these companies.
So, talking my book, putting our money where our mouth is. So, we think that there's Canna Hemp 1933, it's like a very under the radar situation, they have distribution through 46 states. So, what you're looking at, at this point, is you're looking for the integrity of management, yes. But you're also looking for the formulation, the product, bio availability, you're looking for a good product with solid distribution. And until we see that Banking Act allow for that marginal buyer, which we think is going to be a big gorilla, or many big gorillas for that case. But until they're here, you're at the mercy of emotion in the retail space. And that's what we're going through now.
TONY GREER: I think one of the eureka moments for me in terms of the full wholehearted buy into the cannabis sector was sitting in CB1's office with you and Loran DeFalco, your partner and co-founder, and listening to his CBD story and what he's been through, how he discovered it. Could you please tell us a little bit about that? And tell us where your story fits in with that? Because I know there's a bit of a connection there.
TODD HARRISON: Yeah, sure. And I hope I do it justice. Loren is my partner, Loren DeFalco, and he heads our research effort then. And we found each other online, I guess, about four years ago, and it was researching GW Pharmaceuticals as the case may be because we were both keen to explore the brain cancer trials. And this was a while back. We started to talk about the space. And he told me his story about how a decade earlier, he was in an airport, coming back from a business trip and collapsed and started seizing and had never had those types of issues before, long story short, I had an EEG and found seizure activity in his brain.
They started a protocol of many different medicines. And they told him at the time he said, why this one verse that one, they said, we want to see which one has the least amount of side effects. And in his words, it was a really onerous process and a really debilitating process. And he started to research a company, GW, and learning about the anti-seizure properties in the trials they were doing and adopted a high regimen cannabinoid diet, copious amounts of hemp diet and exercise, which certainly, if you understand that ECS and the triggering, it has to be a package deal. There's no shortcuts there.
But long story short, he went back a year later, and there was no more seizure activity in his brain. And he right then, this was about 10 years ago, 11 years ago now- he started to research this and really, just all of it's behind him now. And he started to research the science. So, he's been studying the science for a good decade. And there's been a lot of anecdotal stuff out there, obviously, because of the regulatory environment and the inability to really research cannabis. Like I said, that parallel between the plant, the people and pets remains largely unknown, unless you've actually experienced it, unless you've viewed that part of that 1% will call it that's had this magical reaction with this plant.
But he told me this story. For me, it resonated because I came from a slightly different place with this, and I worked right down the street from the towers. So, when the planes hit back in 911, it was I saw a lot of things that I wish I didn't see, and experienced a lot of things that obviously, we all wish we didn't experience. And I think for a long time, I felt really guilty about that, because so many people lost so much more. And here I am trying to process all of these things. And without really getting into the long and arduous details, it was a very difficult decade.
I had not even understanding what PTSD was during this process. But just it was a very dark time in my life, I pushed away pretty much everybody, dove into work and really just lost me in myself. And I was very fortunate, I gone to a doctor by the name of Dr. Julie Holland, who is one of the world's, in my opinion, foremost leading authorities on cannabis, has written a number