Are We Experiencing A Cannabis Bubble? Lessons From The Dotcom Days

By Evan Eneman, Chief Executive Officer of the MGO | ELLO Alliance, an accounting and consulting services firm for the cannabis industry.

In 1999 companies such as Pets.com, eToys, UrbanFetch and Priceline shared what are now considered hallmark traits of the dotcom bubble: products sold at a loss to gain market share; big branding and bigger advertising budgets to raise awareness; and sky-high stock market valuations that didn’t mirror the companies’ actual performance. 

Now, 20 years later, entrepreneurship appears to be peaking again; spurred by VC-backed tech unicorns such as Uber, Lyft and Slack. Following suit, we’ve seen a “green rush” in cannabis, with new companies being formed seemingly every day and existing companies ‘profiting’ at a level we have not seen since those wild dotcom days. Perhaps because of that association, a lot of investors are worried that we’re living through a cannabis bubble that might burst at any moment. But should we be so apprehensive?

There are certainly reasons to be cautious, but the similarities between the early aughts and today break down when you look up close. To examine the differences-- and what lessons can be learned--, let’s dive into what led the dotcom bubble to burst and how the case might be different for the cannabis industry and cannabis stocks.

How Does The Growth Of These Two Industries Differ?

Scaling Challenges

If the problem with choosing growth over the bottom line was a telltale problem with the dotcom burst, the challenge with scaling profitable cannabis businesses feels much more logistics-driven. After some cannabis stocks saw valuations soar to unrealistic heights, due to a wave of legalization in Canada, the U.S. and around the world, massive drops in valuation, upwards of 80 percent, followed. 

The reasons for these fluctuations lay in the logistical challenges facing cannabis operators across verticals and borders. Canada, for example, has experienced growing pains with supply-side and retail challenges, as well as licensing backlogs, and are reflected in valuations. In the US, any operator who wants to be in a new legal market needs to get licensed and operate within that state’s borders and can’t transport any products across state lines, that leads to very inefficient infrastructure and high costs of operations.  Additionally, US banks and creditors have, for the most part, avoided working in the cannabis space due to the legal limbo presented between federal and state laws. Any financial entity that finances or works with money for a cannabis company could face serious federal repercussions, even in states where it’s legalized. Though the House of Representatives recently passed, with strong bipartisan support, the Secure and Fair Enforcement (SAFE) Banking Act, it’s not likely that the bill will pass the Senate. There is more work to do, but different from the Pets.com era, these issues are temporary and solvable, and with solutions will come even more customers to legal channels.

Carte Blanche Marketing Spends

At the center of runaway spending during the dotcom years was branding, that period’s rocket fuel. Pets.com, for example, spent $11.8 million on advertising in its first year, essentially committing financial suicide from the get-go. The company was in the stock market for only 268 days before collapsing.

In cannabis, marketing, advertising and public relations budgets are considerably more targeted, and can be healthy for those trying to build a brand ahead of infrastructure and operations. Some public relations (PR) companies have now created cannabis practices, groups within their firms dedicated to expanding knowledge in every facet of the industry. They’re in contact with the growers (lifestyle PR), influencers (cultivating key opinions), and even shops that sell paraphernalia (shepherding retail initiatives). 

Strong branding creates an emotional connection with customers and uses distinct processes to determine a company’s place in the market. Of course, this is not applicable to every company in the industry, but to a select few (e.g. MedMen) who can afford it. And that’s a good thing, an improvement on the lavish, often nonsensical spending days of the dotcom era. 

 

Source: https://www.researchgate.net/figure/Etoyscom-Stock-Prices-during-the-alleged-Dotcom-Bubble_fig7_220137783 

Reviewing the data correctly

Myriad factors pricked the dotcom bubble: the rise of interest rates, an open attempt to rein in equity prices, Wall Street’s advice to lighten up on internet stocks, and the weak constitution of companies without a realistic chance to make money over the long term. By October 1999, the market cap of all 199 internet stocks was $450 billion, even though the total annual sales of these companies came to only about $21 billion (just under five percent). Over the next year and a half, hundreds of these companies would see the value of their stock drop by 80 percent. In the end, the dotcom bubble wiped out $5 trillion in investments. 

This Is Not A Cannabis Bubble

Consistency at the Top

Probably the most important thing to note now is that the top cannabis stocks are still trading at a value considerably higher than their first traded price. The following chart depicts the rise and fall of cannabis stock prices in 2019:

As observed, companies including Cronos CRON, GW Pharmaceuticals GWPH, and Canopy Growth CHC are still up, despite declines in recent months. Wall Street’s projections for growth are still significant, with the low-end suggesting worldwide sales will hit $50 billion by the end of the next decade, while some investment firms like Stifel predict $200 billion in global spending during that same time period. To give some context, global sales for 2018 were only $10.9 billion, meaning the compound annual growth rate for legal cannabis could be as high as 27% per year. 

What’s Next

The U.S. will be at the center of these sales figures, with estimates predicting U.S. sales will account for one third to one half of worldwide cannabis sales by 2030. This is, naturally, a much happier scenario than that faced by the dotcom industry, as evidenced by, for instance, the evolution of the Etoys.com stock prices in the late ‘90s. 

The truth is that there’s been a pattern over the last 25 years when it comes to ‘next big thing’ investments – such as the internet, blockchain, B2B commerce, or 3D printing – in which overly ambitious moves lead to significant declines in valuation. As the cannabis industry transitions from the illicit market into the stock market, governments and investors are creating new systems that aim to create more stability, trust and transparency, but we have to remember that developing industries need time to mature. In that sense, hiccups are to be expected, from supply challenges in Canada to high tax rates in select U.S. states such as California.

Final Takeaway

The three biggest lessons to be learned from the dotcom bubble are: (1) stay “on brand”, (2) don’t be unreasonable in your assumptions and projections, and (3) don’t be overzealous with your marketing spend. The balance to strike is managing storytelling angles that cater to a new generation and a new culture. One that is not of excess, like the dotcom bubble, but one that focuses on clean-living, is passionate about social issues, and busts stereotypes. Marketing for cannabis should also have an eye toward differentiation. Many dotcom brands were in similar market spaces, and it was often difficult to tell which online pet or office supply site was better or worse than another. 

It’s clear that the cannabis industry is still experiencing growing pains, but it’s equally evident how different the future seems in relation to the dotcom days. If investors are thinking long-term and would be comfortable with that time horizon, then current market fluctuations should not have too much impact on their business decisions. There is a clear indication that the long term value of the cannabis industry is positive and yet to fully be recognized.

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The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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