The U.S. cannabis industry is growing at an unparalleled pace. Cannabis sales for 2021 are estimated to finish at $31 billion, an increase of 41% over 2020. And yet, despite this positive sales growth, the outlook for investing in cannabis is mixed.

Cannabis stocks slumped in the second half of 2021 after diminished prospects of near-term U.S. federal regulatory reform extended barriers to broad ownership of cannabis equities by institutional investment managers. At the same time, mergers and acquisition (M&A) activity in private markets reached record levels as the industry grappled with increased competition and other byproducts of its latest expansion cycle.

While near-term federal regulatory reform remains in question, three trends are set to play a critical role for those investing in cannabis in 2022.

Financial Optionality Improves

The Secure and Fair Enforcement (SAFE) Banking Act will not pass in 2021 after it was removed from the National Defense Authorization Act (NDAA). Nevertheless, SAFE's initial involvement in the NDAA shows there is bipartisan support to pass federal banking reform.

While politicians' future actions on SAFE are unpredictable, it would seem the November 2022 midterms represent a line in the sand for political leadership to definitively take or not take action on the bill

Real estate financing will also continue to develop. In October, Pelorus Equity Group, a California-based commercial real estate lender to cannabis businesses, became one of the first in the sector to secure a federally insured line of credit with its $20 million credit line. Better yet, Pelorus is only charging clients an annual interest rate of 4.75%, with no fees, putting its financing on par with average rates for traditional commercial real estate lending.

Credit markets are often a better judge of underlying business fundamentals than equity markets. With industry sales set to soar again in 2022, we expect alternative financing terms to also improve.

Notably for those investing in cannabis: Equities tend to follow credit over time, and as institutional capital gains access to the industry, we expect cannabis will be no different.

Cannabis-sector advisory firm Viridian Capital Advisors says a record $8.5 billion worth of M&A transactions closed as of mid-November, compared to roughly $3 billion last year and $3.7 billion in 2019

• In September, TerrAscend (TRSSF) acquired Michigan leader Gage for $545 million.
• In October, Trulieve (TCNNF) acquired Harvest Health and Recreation for $2.3 billion, creating the largest and most profitable U.S. cannabis operator.
• Over the year, Harborside (HBORF) purchased leading California pre-roll brand Sublime for $43.8 million and announced a three-way merger with retailer Urbn Leaf and operator Loudpack, thus creating StateHouse Holdings. As with landmark deals in other states, these mergers signal the consolidation of California's fragmented market.

Established players have cash on hand, partly due to strong cannabis sales throughout the pandemic, and recent capital raises will help buoy M&A further. Viridian says that as of Q2 2021, the 10 largest U.S. cultivators had an average of $193 million in cash – triple the amount they held last year.

Canadians Bet on U.S. Legalization

Canadian licensed producers (LPs) started investing in U.S. cannabis operators in earnest in 2021. In June, Cronos Group (CRON) paid $110.4 million for an option to acquire a 10.5% stake in PharmaCann upon U.S. federal legalization. Then in August, Tilray (TLRY) acquired convertible bonds issued by MedMen in a deal that would allow Tilray to take a 21% ownership interest if, or when, the U.S. legalizes cannabis federally.

Such investments allow Canadian LPs to take part in U.S. cannabis without breaching restrictions on plant-touching companies listing on U.S. exchanges

Recent news that the Canadian Securities Exchange (CSE) is considering creating a "senior tier" of companies on the exchange to make public LPs more attractive for inclusion in U.S. small-cap or mid-cap indexes bolsters our perspective on Canadian companies using U.S. markets to access liquidity and scale.

Investing in Cannabis? There's Growth Ahead

Federal reforms to cannabis could turbocharge the industry in 2022. But strong business fundamentals and positive trends will see the industry continue its rapid development regardless.

The federal reform holding pattern provides investors the opportunity to structure attractive deals and deploy capital at a compelling entry point. What's more, a longer regulatory timeline provides incumbents an extended runway to cement moats ahead of the tidal wave of competition that federal legalization will inevitably bring.