Cannabusiness Advisory

A Look into the 2024 Cannabis Crystal Ball

February 13, 2024

   

Introduction

As books for 2023 have officially been closed, we are looking forward to greener pastures in 2024. 2023 proved to be a difficult year for many operators, and some even fell victim to a tough financial market and were forced to shut their doors for the final time. With new legislative reforms and the emergence of new market opportunities, we have a lot of optimism for the year ahead. Discussed herein are a few areas where we expect to see some movement in 2024 and what we expect to see develop as the year progresses.

Rescheduling

Perhaps the most dynamic shift that the cannabis industry could see in 2024 would be the rescheduling of cannabis from a Schedule I substance to a Schedule III substance under the Controlled Substances Act. In September 2023, the Department of Health and Human Services recommended to the Drug Enforcement Agency that cannabis should be reclassified to a Schedule III substance. Since that point, cannabis operators and investors alike have been eagerly waiting for the other shoe to drop and for the DEA to formally make the reclassification. Many believe the DEA is waiting until the April 20th holiday to make such an announcement.

If cannabis is rescheduled to a Schedule III substance, operators would no longer be subject to the burdensome tax implications of Section 280E of the Internal Revenue Code. Section 280E forbids cannabis businesses from ducting otherwise ordinary “expenses from gross income associated with the ‘trafficking’ of Schedule I or II substances.” Based on this change, many operators could see their effective federal tax rate drop by almost fifty percent. As a result of the decrease in annual tax expenses, many operators would be able to maintain an overall healthier company by keeping more cash in their pockets.

Rescheduling could also result in an operator’s ability to uplist their stock from the OTC markets to the U.S. Exchanges. This would open the capital floodgates for some of the larger multi-state operators. With easier access to capital and decreased tax liability, a rescheduling of cannabis under the Controlled Substances Act could be a huge windfall for the MSOs.

Election

With regards to the upcoming election, we could see cannabis regulatory initiatives as a means for politicians seeking election to garner support and votes. Topics such as the SAFER Banking Act, rescheduling, and Section 280E should be at the forefront of cannabis political discussions. Although such initiatives by election candidates may just be political tactics to persuade voters one way or another, continued discussion around these topics is always welcomed, in my opinion, as some traction is better than no traction.

Additionally, related to the political elections, several states have ongoing campaigns to push for the legalization of adult-use cannabis. Notable states pursuing ballot initiatives with the potential to have a large adult-use market include Florida and Pennsylvania. As we have seen over the years, when new states open up, it creates a new market for operators to move in and stake their ground. The prospect of adult-use cannabis new states has the potential to deleverage operators throughout the course of 2024 who seek to expand into these unchartered markets.

M&A

The cannabis M&A market in 2023 was riddled with distress. We mostly saw small M&A transactions, with buyers seeking to expand present operations with small add-ons. Operators with the capital available were able to take advantage of distressed and financially unhealthy companies and, as a result, profited on higher-equity valuations. We also saw several players deciding to exit the cannabis market altogether, and some buyers took advantage of equity holders who are just trying to wash their hands and walk away from cannabis altogether.

We expect much of the same in 2024 that we saw in 2023. Distressed operators will continue to be snatched up by those buzzing along as the regulatory landscape remains unclear. The future of the cannabis market and the next big shift will likely come after sweeping regulatory changes. Until then, we will likely remain in murky waters.

Additionally, even if we see Section 280E go away due to a successful rescheduling process, we expect operators to take some time to bolster their balance sheet, instead of immediately seeking to spend their additional capital in an acquisition frenzy. We imagine that most buyers would wait for the regulatory dust to settle a bit before diving head-first into large-scale transactions.

Pricing Stabilization

Cannabis wholesalers and retailers alike should continue to benefit from continued price stabilization in 2024. As it is unlikely that a significant influx of capital will enter the cannabis sector in 2024 without sweeping regulatory changes, new entrants into the industry should slow, and companies struggling to hang on will likely be forced to shut down operations. This should allow wholesalers and retailers who can sustain the depressed market to benefit in the long run from the smaller field of competition.

Conclusion

2024 has the potential to be a groundbreaking year for the industry as a result of regulatory changes. Rescheduling and the elimination of Section 280E taxation will be transcendent on not only plant-touching operators in the event it occurs but also the entire industry as a whole. The ancillary, non-plant-touching companies that provide goods or services to plant-touching operators will benefit from having healthier customers. Investor confidence will be stimulated with new potential for investment returns, and investors will (hopefully) infuse the industry with new capital. Such regulatory progress could revive the spirits and excitement in the cannabis industry and open the door for an influx of equity. If this is the year that sweeping regulatory changes come to fruition, the future of the cannabis industry forecasts well for a healthier and more sustainable ecosystem.

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