CBD Up Close

Cutting through the CBD hype

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CBD Industry Hamstrung by FDA’s Continued Lack of Direction

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Recent articles at Axios and the Wall Street Journal lay out the current state of play in the CBD industry. Basically, the CBD industry is at a standstill because the Food and Drug Administration (FDA) still hasn’t come out with rules and, worse than that, the little that they have said is to warn consumers about the potential drawbacks of CBD-infused foods and drinks.

This is beneficial to CBD startups in that the FDA’s warnings will prevent larger companies, such as Coca Cola and Pepsi, from entering the market at the moment but it’s not all positive for startups. The problem for startups will not be in having large food companies entering the marketplace, which is good, but rather the fact that it may become more difficult for startups to find large distribution partners.

Over the holidays, I did see CBD-infused products at Kohl’s while I was returning something from Amazon, so there are at least some retailers that are willing to take a chance on CBD products. Their thinking probably goes something along the lines of “CBD will be a big market and we want to get out in front of that” but if the FDA comes out with something more than notes of caution then you can expect those retailers to at the very least curtail their CBD-infused stock.

Is the CBD Industry Overheating?

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We have talked at length about the upside in the CBD industry since our inception a few months ago. A lot of people agree and a lot of money is flowing into this industry… but is that a smart move?

Here’s a clear picture of the current CBD investment psychology:

“Leading cannabis researchers BDS Analytics and Arcview Market Research, project that the collective market for CBD sales in the U.S. will surpass $20 billion by 2024.

“The convention-goers were more keyed on this figure, and less worried about potential push back from anyone looking to enforce state law or agencies like the Food and Drug Administration.”

Depending on your appetite for risk, this sentiment either makes perfect sense or is a clear sign that the CBD industry is going through something of a mania. What do I think?

I think there will be some pure startup winners all along the vertical but that most of the pure startups will end up failing (this is normal for startups in every industry but I think that the failure rate here will be higher than most industries. Those that are able to survive can realize huge returns on investment, more so than in many other industries.). I still think that the industry will go through an aggressive consolidation phase over the next few years, as can be seen from our story earlier about HeavenlyRx.

Going back to the point of this post, the reported sentiment at that convention does give me pause for concern. There are a lot of people who have no consumer product, much less CBD industry, experience getting into the industry. That’s a risk from an investment standpoint. Some of these CBD companies started by neophytes will work but I think the vast majority of them will fail.

The lack of clarity on regulations is also a risk. Sure, everyone, including us, thinks that the writing is on the wall and that CBD products will be legalized across the board… eventually. In the meantime, we’re not sure what the FDA will do and who knows what each state will do when it comes to regulating CBD products.

A few days ago, the FDA sent a shot across the bow to CBD company Curaleaf telling them that they have 15 days to get in line with FDA requests, including changing their medical claims, or else.

“As a result of this warning letter, which will require Lusardi’s response to correct these deficiencies within 15 days, Curaleaf lost its topical partnership with pharmacy giant CVS Health (NYSE: CVS). As a reminder, CVS Health announced in March that it would carry Curaleaf’s topical products in roughly 800 of its stores in eight states, with CBD expected to be a means for low-margin pharmacy chains to drum up foot traffic to their stores. It’s unclear if CVS will look elsewhere for its CBD supplies, especially with Walgreens Boots Alliance and Rite Aid following suit with cannabis products in their own stores shortly after CVS.”

Scott Gottlieb, a former commissioner at the FDA, has suggested a pathway forward for the FDA regulating the CBD industry:

“The FDA could put the onus on manufacturers to bring forward petitions to demonstrate that CBD can be safely added to products such as food. These submissions can take the form of new dietary ingredient notifications or food additive petitions, which would include toxicity studies to evaluate the safety of CBD. These are the same standards any new food ingredients are held to. Congress can help by passing language saying that the FDA doesn’t need to issue a broad regulation on CBD and can instead rely on petitions filed by individual, prospective producers.”

It’s entirely possible, maybe even likely, that the FDA will do something along those lines. They could punt this issue, allowing limited ways to sell, and wait for clinical studies. Remember, the FDA has no incentive to act quickly here, they only look bad if they approve something that turns out to be unsafe.

Taking all this into consideration, I think you can make a good argument that entrepreneurs and investors are getting a little overly optimistic. I still think that there is tremendous upside in this industry but if the FDA throws a wrench in the machinery then you can kiss those projections goodbye.

Ex-Kellogg President Says CBD Industry to grow to 20+ Billion Dollars in Five Years

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We have talked about this in the past, the CBD industry is predicted to have amazing growth over the next few years, possibly to more than $20 billion in a few years. Now we have the ex-president of Kellogg North America, Paul Norman, saying the same thing: “This market is going to grow four or five fold to 20 plus billion dollars in consumer value over the next five years,” Norman tells Yahoo Finance. “I believe, down the road, CBD will be widely available in all kinds of consumer products.”

Mr. Norman is now the CEO of HeavenlyRx, which is a CBD company that is acquiring and investing in other companies in the CBD industry. According to a recent press release:

“HeavenlyRx’s focus is on hemp cultivation, processing and the manufacturing of a diverse range of traditional CBD products including oils, tinctures, balms, and vape-ready products. Heavenly Rx will also own and operate its own retail locations along with health & wellness related studios where it will generate a repetitive captive audience with a desire for Heavenly Rx’s products to be part of its customers’ daily routine. It is expected that Heavenly Rx’s portfolio will include several proprietary brands across numerous consumer product group verticals such as cosmetics and beauty products, bath and body products, and infused foods.”

Best case scenario, Mr. Norman would want to grow HeavenlyRx into the Kellogg’s of the CBD industry. It’s an interesting strategy, it makes sense on many levels but I have to wonder how many great deals are out there in the CBD space right now. On the one hand, it’s a nascent industry so there are many small brands out there that have a lot of potential and can probably be acquired at a seemingly low price. But how many of these companies will survive for the long haul? How reasonable are the prices considering the fact that just about everyone in the space, including Mr. Norman, think that the industry will grow dramatically over the next few years?

There will surely be brands that are mega winners in this space but there will also be losers. HeavenlyRx is making a portfolio bet here that their winners will more than make up for the losers that they acquire. It’s analogous to the bets that venture capitalists make: Invest in dozens or hundreds of startups with the hopes that the winners will have such outsized returns that it will give their portfolios a high return on their investment. Again, my only concern here would be that there may not be enough “deals” out there for this kind of portfolio bet (a year or two ago would have had better deals available).

When Will Market Consolidation Happen in CBD Industry?

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An article from Barron’s earlier today got me thinking about the CBD industry (and the larger cannabis industry in general) in terms of when there will be consolidation in the CBD industry. And CBD Up Close thinks that there will definitely be consolidation in this marketplace sooner rather than later. In fact, it’s already happening.

How Will The CBD Industry Consolidate?

As illustrated by the Barron’s article about Aurora Cannabis acquiring Hempco Food and Fiber, a maker of “hemp-based foods, hemp fiber and hemp nutraceuticals,” there already is consolidation in the CBD industry. Further on down the article, we find out that the real value in this deal for Aurora is that “‘Hempco provides Aurora with low-cost, high-volume access to raw material (hemp) for the extraction of CBD, which has been increasingly recognized for its therapeutic benefits across a wide range of medical indications and wellness applications,’ [Aurora] said in a statement.”

Vertical integration, which is where an existing company expands into a different part of the supply chain (i.e. Amazon expanding from being an online retailer into manufacturing products as well). This is exactly what Aurora is doing. Yes, they obviously had access to raw hemp before but now with the purchase of Hempco they have more control over their supply.

And, as time goes on, CBD Up Close believes that there will be more vertical integration happening if only so that growing companies can have more control over their supply. We will also start to see more competitors buying each other out as well and, in a few years anyways, we will start to see existing traditional companies make acquisitions in this space. (It’s already happening a little bit now but what we see is something along the lines of a company of the stature of, for example, Coca Cola purchasing a company like, hypothetically, Canopy Growth in order to quickly gain market share in the CBD space. But, again, we think that that sort of type of acquisition is years away.)

CBD Supply Chain

Here’s a good, quick synopsis of the current state of the CBD supply chain from CNBC:

The current supply chain — from plants, to extraction, to labs — is riddled with issues. And the nascent industry is trying to work through the kinks at the same time demand is ramping up, leaving producers frustrated and consumers stuck trying to sift good products from bad ones.

“There are huge challenges to producing the industrial hemp required for meeting the demand,” said George Weiblen, a professor at the University of Minnesota who has been studying cannabis since 2002. ‘It’s not as simple as growing tomatoes. It’s just not. … The possibility of failure to produce quality cannabis extracts is huge.’

“Decades of modern farming techniques have tamed staple crops like corn and wheat. Farmers know what to expect when they plant these crops and can follow a pretty straightforward set of guidelines when they grow them. With hemp for CBD, not so much.”

Basically, what all of this means is that CBD isn’t necessarily good or, to put a more positive spin on it, CBD isn’t as good as it will get once production practices become more refined. This also means that, if current projections of explosive growth for the CBD industry hold true, there is going to be a ton of competition at all levels of the supply chain and that prices are going to go up by virtue of increased demand.

Those companies that are able to introduce more efficiencies into production will be the ones that will experience the most growth. Eventually, these companies will start buying out their competitors, probably for inflated prices since the industry as a whole will be doing very well, and will become prime targets for much larger companies that may be higher up the supply chain.

CBD Up Close also expects private equity firms to continue their expansion into this space. Some will focus on a particular slice of the supply chain while others will try to have an investment portfolio of vertically integrated companies.

Like we mentioned in our recent post about the Carl’s Jr. Rocky Mountain High: CheeseBurger Delight, now is probably the best time to be in the CBD space. It’s certainly a seller’s market and every projection we have seen predicts at least double digit growth for the CBD industry for years to come with the most aggressive predictions saying that there will be triple and maybe even quadruple digit growth for the foreseeable future.

In other words, make sure that you are in this space and try to be better than the competition! Obvious advice but the ROI for companies that are able to do so should be astronomical.

CBD Up Close can’t hazard a prediction about where the industry will be in 25 years, that’s an awful long way out, but what we do believe is that within the next three to five years we will have a healthy percentage of S&P 1,000 companies who have at least one CBD product in their portfolios. And that there certainly will be consolidation in the CBD industry.

CBD Crowdfunding – The Trend to Watch in 2020

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2019 was the year that saw CBD businesses establish themselves as legitimate players in multiple markets. There are CBD companies that make oils and tinctures, CBD beverage companies, CBD food companies, and others. And the reason for this is simple: CBD may yet prove to be a legitimate alternative for addictive prescription drugs treating a number of ailments and CBD has already proven to be helpful in preventing seizures in children.

However, funding CBD companies remains an issue. The industry has not yet reached a level where most investors feel comfortable investing in it yet and that goes for professional investors as well. Even though the CBD market is predicted to eclipse $24 billion in total sales in the next couple of years, the risks are still tangible and the lack of regulatory direction from the federal government, most notably the FDA, and state governments isn’t helping to reduce the industry’s risk profile.

So what are CBD businesses supposed to do in this climate? After all, they still need to raise money to fund their growth.

Crowdfunding may be what the industry needs over the next couple of years in order to meet its growth goals. One such company pursuing crowdfunding is TruBrain and they recently did an interview with Yahoo! Finance discussing their decision to turn to crowdfunding.

“So far we are loving it. This campaign focuses on turning customers into “Investomers,” which has worked very well for other companies building direct brands. We already have VCs backing us. Some have been very collaborative with TruBrain and continue to take active roles on our Board of Directors. We enjoy this institutional support. But just as we believe that the best brain food shouldn’t be reserved for only a select few, we don’t believe that only the wealthy should have the opportunity to invest in growing companies.”

One of the key takeaways from this interview is that crowdfunding is a great way to get your most passionate customers (literally) invested in your business. With equity crowdfunding, which is what TruBrain is doing, every person who puts in money gets an equity stake of the business. In other words, they own part of the business. Traditional crowdfunding campaigns gave people who put in money some kind of award, which usually is a discount on the product the campaign was built for or something else special.

While it is too early to tell how well similar crowdfunding campaigns will fair we can tell you that TruBrain has raised over $1 million for their campaign. This is good evidence that if a company has the right people on their team, a great product, and a good track record of performance and growth then crowdfunding campaigns can work out wonderfully.

So, will 2020 be the year of CBD crowdfunding? It’s certainly possible and it does look like a good way to raise funds in an industry that is still facing regulatory uncertainty.

CBD Mania

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Look at that picture; that’s a really small sample of the news items from Google about CBD. The New York Times just published an article about how the CBD industry has lax oversight; a Former FDA chief says that putting CBD into food is illegal; Ars Technica discussing how the FDA is responding to fallacious claims. Then you go down a little bit further in the page and there are more stories about the legality of CBD, one story about how jumping out of a plane turned a CBD skeptic into a CBD proponent, and a piece from LA Magazine about how CBD marketers have become “snake oil salesman”.

My deepest concern here is that the narrative has drastically gotten away from the companies that are being responsible and trying to make legitimate claims about their CBD products and, instead, has been hijacked by unscrupulous companies that are looking to cash in on the CBD mania while the getting is good. (Check out one of our favorite CDB oils — great price and great reviews on Amazon, if you’re interested.)

And whether that is the case, or, more accurately, how prevalant are the “snake oil salesman”-esque marketers out there? And does that even matter? I ask that last question because the media can latch onto a few key data points or spokesmen and paint whatever picture they want. If you want the CBD industry to look bad there are probably ample examples of companies that are being downright dishonest in their marketing.

What should CBD companies do? Continue to be truthful in your marketing. Push for fair and clear regulations for the industry. Keep the conversation with customers going and bring attention to the successes and the failures.