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Portfolio > Alternative Investments > Cannabis

As Marijuana Becomes Legal, a Hedge Fund Looks to Profit

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Leslie Bocskor, one might say, is high on the legal cannabis industry.

Bocskor, who describes himself as an investment banker and entrepreneur, plans to roll out a hedge fund in the fourth quarter that will invest in legal cannabis-related businesses across the country.

The opportunity comes, he said in an interview with ThinkAdvisor, as a number of states decriminalize possession, others create medical marijuana programs and a few have full adult use regulatory frameworks and are currently selling cannabis and regulating it as they do alcohol.

“Gradually the misrepresentations regarding cannabis are starting to come to light as reasonable people have an honest conversation about cannabis’s benefits, issues surrounding it, about the reality of it,” he said.

The investment opportunity is huge. Bocskor, citing research by the ArcView Group of which he is a member, said the size of the legal cannabis industry this year would reach $2.8 billion, up from $1.5 billion at the end of 2013.

According to ArcView, legal marijuana markets comprise individuals who legally consume marijuana as allowed by state laws, together with the businesses that constitute the supply chain to serve those consumers.

Bocskor put the size of the illegal cannabis market in the U.S. at between $40 billion and $50 billion, based on United Nations and Rand Corp. reports.

“If you believe as I do that we will see the drop of federal prohibition and at some point we will see a legal cannabis market in the entire U.S., except for some states that may opt out or be dry, we should expect the industry to grow to approximately $40 billion to $50 billion.”

And that figure does not take into account a nascent nutraceutical market, Bocskor said. “Companies are selling cannabis-based extracts—legally—on Amazon. That’s just the beginning of what will be a nutraceutical market where non-psychoactive components of cannabis plants are going to be put into beverages, vitamins, supplements, etc.”

Hedge Fund

“With that background, I started looking into opportunities,” Bocskor said.

Indeed, he said in an email exchange, “the birth of a new industry is no stranger to me, as I was one of the first to invest in the Internet, and have since focused on the development of new disruptive markets.”

He decided to create a cannabis-focused hedge fund.

Bocskor said he and Gordon Katz, his partner in Electrum Partners, a consulting firm he founded, were dotting the ‘i’s and crossing the ‘t’s on the hedge fund Offering Memorandum, and expected to have it ready around Labor Day. They will then start to raise assets.

He said investors would include both high-net-worth individuals and larger institutions such as incubators and funds of funds. He expected the minimum investment to be $100,000.

The fund, he said, would look to invest in producers, processors and distributors of cannabis, companies that directly handle legal marijuana, as well as ancillary businesses that do not directly handle the plant, covering segments such as consumption devices, product packaging and production equipment.

He said ancillaries might include Surna, which makes liquid-cooled air conditioning units for cultivation facilities; Cannasure, a financial services firm that provides insurance for the cannabis industry; and Heliospectra, a Swedish outfit that makes LED lights for cultivation.

Among companies that touch the product, he said, are Bhang Chocolate and Auntie Dolores, producers of edible products.

Dual Strategy

The hedge fund’s strategy has two components, according to Bocskor. One involves investing in public companies where the fund is able to add real value.

He said that in January of this year, some 20 publicly traded companies were involved in the cannabis industry in some form. By midyear, he had heard that 200 to 300 companies had announced that they were going to be involved in the cannabis business.

These figures could not be independently confirmed, though they appeared to be in line with various media reports.

Bocskor said that perhaps as many 95% of these new cannabis-focused entities were the result of reverse mergers (aka reverse takeovers), and it was here that he envisaged an investment opportunity.

In a reverse merger transaction, a public reporting company with few or no operations, a “shell company,” acquires a private oper­ating company—usually one that is seeking access to the U.S. capital markets. The private company’s shareholders typically ex­change their shares for a large majority of the shares of the public company.

The transaction can close in a matter of weeks.

In the U.S., the private company avoids lengthy and expensive review with state and federal regulators because the public company has already gone through the process. However, the SEC requires the public shell company to report the reverse merger in a Form 8-K filing.

“Many of those reverse mergers are going to present an opportunity for us,” Bocskor said, because the new companies will not have undergone a traditional IPO process that smooths the transition from private to public company over a one- or two-year period.

“As a result, many of these companies will find themselves being tossed about on the very rough seas of the financial markets,” he said. They may start trading at x, then find themselves trading at a fraction of that over time because they do not know how to negotiate issues surrounding being a public company.

“We’re going to look for the companies that have real assets but have capitalization and structural issues, issues surrounding being public because they didn’t understand what they were getting involved in. We’ll look for the ones that could use our help.”

When the hedge fund team identifies a likely candidate, Bocskor said, his turnaround experience will come into play. The fund will help restructure the company, help it attract the right team members and board members, and when it is in better shape, lead a round of investing.

In exchange for the services provided, the hedge fund will receive a large amount of the company’s equity, and this will go into the hedge fund so it can invest in other companies.   “We will have gotten enough equity so that our cost basis will be some fraction of the price everybody else is investing in,” Bocskor said.

“Say if it’s a dollar, we might have a cost basis of 20 cents. So that strategy is to take advantage of the public market and wait for the companies that find themselves challenged but have real assets in them.”

The other component of the hedge fund’s strategy is to work with states to help them establish cannabis-related regulatory frameworks. This would be done through a separate political operations business either associated with the fund or allied strategically with it, Bocskor said.

As those new state markets open up, the fund will invest in their best-of-breed operators, local entrenched interests that have real heft in those local markets.

Bocskor acknowledges the hedge fund is a long-term investment, but said he expected short-term profitability. “Based on all of our research and the data we’ve gotten access to, we think there’s a good likelihood we should see profitability on a fairly rapid basis.”

As to his return expectations for the fund, well, these are early days. “The jury is out in terms of what we think or we would like to see,” he said.

“I think what’s reasonable is returns that are going to be multiples of the original investment. If we’re really good and things go well, we may have some years that give us returns better than we could hope for.”

Avoiding Scams

FINRA and the SEC have recent issued warnings about marijuana investment-related schemes.

Bocskor said their main issue was about the activities in reverse merger public companies, not a commentary on whether the cannabis business was legal or illegal.

“Some of the companies have nothing to do with the plant directly; they’re ancillary businesses. The issue had to do with the trading of the company, the valuations and some of the sales of the securities, I believe.”

He said he had been asked to look at one company whose trading the SEC suspended, Advanced Cannabis Solutions, and had expressed concerns about its valuations.

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