A New Industry: The Essentials of the Cannabis Business

A NEW INDUSTRY: THE ESSENTIALS OF THE CANNABIS BUSINESS

The legalization of recreational cannabis in Canada represents a rare event: a new industry being created by ending prohibition. This burgeoning
industry presents opportunities for both businesses and investors. However, to properly capitalize on the opportunities, those involved must be
armed with the right knowledge to navigate the rapidly changing landscape.

This primer aims to provide a basic overview of the cannabis industry, including key terminology, the market and participants, regulatory issues and
investment options.

KEY TERMS

CANNABINOIDS The class of chemical compounds that includes the primary components found in marijuana. Cannabinoids act on receptors in
the brain, altering the release of neurotransmitters to produce psychoactive and therapeutic effects.

THC (TETRAHYDROCANNABINOL) The primary psychoactive chemical compound in marijuana, responsible for producing a euphoric high.

CBD (CANNABIDIOL) The primary non-psychoactive chemical compound in marijuana, believed to be responsible for alleviating anxiety and
other therapeutic effects.

EDIBLES Any food or beverage that contains THC, CBD or a combination of both. Due to the way the body metabolizes the chemicals in the
stomach, the effects appear more slowly and can last much longer than they would if inhaled.

CONCENTRATES A wide variety of products that contain extracted and concentrated versions of cannabinoids. This includes oils, waxes and other
forms of the extracted chemicals which may be used to create edibles or other types of infusions for consumption.

THE MARKET

The size of the cannabis market in Canada is in the billions of dollars. However, precise measurements are difficult in the absence of reliable statistical
data. The true scope of the market should become much clearer in the years following legalization.

Various estimates and analyses suggest the total market falls roughly between the $5- and $7-billion range. Statistics Canada estimates the
household consumption expenditure on cannabis reached $5.5-billion in 2017. A Deloitte analysis expects total sales in 2019, including medical,
illegal and legal recreational products, will reach up to $7.1-billion2.

Difficulty in estimating the size of the market stems from the inability to accurately gauge the impact of the illegal marijuana trade. It is likely that
issues surrounding precise data collection will continue after legalization, given that less than two-thirds of regular pre-legalization users plan to
move their purchases to legal channels. However, this does suggest legalization will be successful in drastically reducing the size of the illicit market,
thus making the data more reliable in the future.

Deloitte predicts that legal sales will constitute more than half of the total cannabis market in the first full year of legalization, and that the bulk of
any growth in the market will come from older, educated and more conservative consumers3. It is worthwhile to note that total marijuana sales
in Colorado more than doubled between 2014, the first year of legalized cannabis, and 2017 to more than US$1.5-billion, with millions of tourists
contributing to the cannabis economy4.

CONSUMERS

The consumer base can be split into two groups: current users and likely users after legalization. Surveys suggest the two groups have quite different demographics5.

Research also indicates that consumption levels are unlikely to change radically after legalization. The only notable change amongst current users
can be seen in those who report consuming less than once a month moving slightly into higher-frequency categories, but not towards daily use6 .
These expectations are in-line with the experience of Colorado, where overall usage rates remained stable in the first two years after legalization7.

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An important component to expectations of relatively unchanged consumption patterns may be found in the reported motivations for consuming
recreational cannabis. Nearly two-thirds of current users say they consume cannabis to help relax, sleep and reduce stress8 . Women are more likely
to consume cannabis for relaxation and stress relief for these reasons, which is in line with higher percentages of women reporting that most days are
ā€œquite a bitā€ or ā€œextremely stressful.9ā€ Opening legal distribution channels will give those seeking relaxation and stress relief easier access to cannabis,
but there is little evidence to suggest greater access alone will lead to increased consumption.

Transitioning users to legal challenges will be key for curbing the illegal market. Not surprisingly, current users are much more likely to continue
purchasing cannabis on the illegal market than likely users are. Theyā€™re also much more likely to grow their own cannabis, a legal option in many
provinces and territories10. Businesses will have to stay in-line with consumer demands to foster the transition to legal sales.

Current and likely cannabis users have similar considerations when it comes to making purchasing decisions around marijuana. Both place pricing at
the highest priority when deciding on a product. Safety concerns, reputation, and type of product (plant material, edibles, etc.) all are among the top
concerns. While familiar brand and preferred packaging are uniformly less important to both consumer groups11 .

REGULATORY RIPPLES

PROVINCIAL DIFFERENCES

The use of recreational cannabis will be legal across Canada. However, similar to the treatment of alcohol, provinces will have the ability to regulate
various aspects of cannabis use, including minimum legal age, consumption restrictions, growing at home and distribution. All of these differences
will have some impact on the market and business opportunities within each jurisdiction.

STILL TO COME: EDIBLES AND CONCENTRATES

While the use of recreational cannabis will be legalized as of October 17, 2018, refined products will remain restricted for up to a full year. The federal
government has committed to regulating edibles, concentrates and other derivative products within a year of legalization. This represents perhaps
the greatest opportunity for growth in the cannabis industry.

Cannabis is typically consumed through inhalation, either through smoking or vaporization, which reduces the amount of particulate material that
enters the lungs. However, improved education about the health affects of smoking has created a social taboo around it. Edibles and concentrates
may become the most popular cannabis products among those with a strong aversion to smoking.

Surveys suggest there is a strong appetite for non-smokable cannabis products. More than half of current and likely consumers say they are interested
in trying cannabis-infused baked goods while 43% are interested in trying cannabis-infused chocolate. Indeed, there is broad interest in a wide range
of cannabis-infused products, including candies, beverages, popsicles and even crackers12 .

INVESTING IN CANNABIS

The Canadian cannabis sector has grown rapidly in the last few years as investors are eager to participate in a brand-new industry with unique
opportunities. In 2017, the market capitalization for the five largest cannabis stocks grew by 400%13 . Through the first half of 2018, more than
$1.3-billion in assets under management flowed in to cannabis-focused exchange-traded funds or other investment funds. Investors are embracing
the cannabis space, however, as a burgeoning sector it poses unique challenges relative to older, more established industries.

STOCKS
There is a relatively large number of cannabis stocks available on Canadian stock exchanges and the subsector as a whole has caught the attention
of investors and the media. Some individual stocks have seen rapid and sharp movements and the subsector broadly has been highly volatile. Many
investment professionals believe the subsector has experienced periods of speculative mania, given that the way companies will be analyzed postlegalization
will change once investors can get a better grasp on company financial reports and fundamentals.

Further complicating the analysis of individual companies is the wide scope of businesses operating within the industry. A large number of the
companies involved in the cannabis industry are licensed producers which grow the plant material. A smaller number of companies are involved in
developing refined cannabis products, including concentrates and edibles, while others are focused on pharmaceutical applications. Some of the
larger companies are more diversified in their business, operating multiple units related to the marijuana industry.

In a youthful and evolving space such as cannabis, the performance of individual stocks will vary greatly as businesses compete and discover the
most successful business models. While legalization will eventually lead to more clarity regarding which companies will succeed, the subsector as a
whole will likely continue to experience volatility as it matures.

EXCHANGE-TRADED FUNDS (ETFS) AND MUTUAL FUNDS

ETFs and mutual funds have become popular vehicles for investing in the cannabis space. They typically offer investors lower concentration risk
by holding a basket of cannabis and cannabis-related stocks. These funds also allow investors to focus on more thematic elements such as junior
growers, similar to a fund that invests in small companies in the mining sector.

Many cannabis funds invest passively by mirroring indicies which track marijuana-related companies. This style of investing can pose its own set of
risks in a young and rapidly moving subsector. Cannabis stocks have moved largely in unison with one another as there has been little in terms of
fundamental analysis to distinguish the highest-quality companies. However, as the industry grows, it will become more apparent which companies
will be successful and which will not, and their stock prices will be more likely to reflect the strengths or weaknesses of the underlying businesses.

Passive funds will capture both the good and the bad, and thus are more of a play on the subsector as a whole.

Active funds, on the other hand, seek to profit from the best opportunities while avoiding losses from the lowest-quality companies. Successful
active investing requires an experienced manager who can properly identify the companies with the highest-likelihood of generating returns and the
discipline to lock-in profits rather than chase greater returns. In addition to navigating the volatility in the space, actively managed funds can also
provide access to initial public offerings which are typically inaccessible to retail investors and utiize more advanced risk-management tools.

 

1 Statistics Canada, Cannabis Stats Hub https://www150.statcan.gc.ca/n1/pub/13-610-x/cannabis-eng.htm
2, 3 Deloitte, 2018 cannabis study https://www2.deloitte.com/content/dam/Deloitte/ca/Documents/consulting/ca-cannabis-2018-report-en.PDF
4 Colorado Department of Revenue, Marijuana Sales Reports https://www.colorado.gov/pacific/revenue/colorado-marijuana-sales-reports
5,6 Deloitte, 2018 cannabis study https://www2.deloitte.com/content/dam/Deloitte/ca/Documents/consulting/ca-cannabis-2018-report-en.PDF
7 US National Survey on Drug Use and Health, Comparison of 2014-2015 and 2015-2016 Population Percentages
https://www.samhsa.gov/data/sites/default/files/ NSDUHsaeShortTermCHG2016/NSDUHsaeShortTermCHG2016.htm
8 Deloitte, 2018 cannabis study https://www2.deloitte.com/content/dam/Deloitte/ca/Documents/consulting/ca-cannabis-2018-report-en.PDF
9 Statistics Canada, Perceived life stress, 2014 https://www150.statcan.gc.ca/n1/pub/82-625-x/2015001/article/14188-eng.htm
10, 11, 12 Deloitte, 2018 cannabis study https://www2.deloitte.com/content/dam/Deloitte/ca/Documents/consulting/ca-cannabis-2018-report-en.PDF
13 Bloomberg L.P.
14 Echelon Wealth Partners

 

*****

Purpose Investments Inc.
130 Adelaide St. W, Suite 1700
P.O. Box 83, Toronto, ON M5H 3P5
T 416 583-3850
TF 877 789-1517
F 416 583-3851
www.purposeinvest.com
info@purposeinvest.com

 

The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it
a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any
investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement
or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an
offence. Information contained in this document is believed to be accurate and reliable; however, we cannot guarantee that it is complete or current at all times. The
information provided is subject to change without notice.
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