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With the inauguration of the Joe Biden Administration and a so-called “blue wave” taking over three levels of the U.S. government — Congress, the Senate and the Presidency — there is a general optimism that cannabis may see its status as a Schedule 1 narcotic repealed. Should this happen, it may create an opportunity for North American exchange-listed cannabis companies to potentially expand their revenue.

The promising regulatory prospects for cannabis growth in the U.S. has resulted in a significant rally in the cannabis sector issuers since the November 7, 2020 presidential election. While this excitement may be reminiscent of the fever we saw in Canadian cannabis sector issuers in late 2017 after federal legalization was announced, it may be driven by some real growth potential opportunities for the sector.

The MORE Act – A U.S. Policy that Benefits Canadian Producers?

On November 29, 2020, Democratic House Majority Leader Steny Hoyer announced that the U.S. House of Representatives will vote on the Marijuana Opportunity Reinvestment and Expungement (“MORE”) Act.

The MORE Act is far more progressive than the previously contemplated Strengthening the Tenth Amendment Through Entrusting States (“STATES”) Act. MORE proposes to legalize cannabis nationwide, removing it from the U.S. Controlled Substances Act. The Bill was passed by Congress on December 4, 2020. It awaits Senate and Presidential approval in 2021.

Of the utmost importance to the cannabis sector investors, the MORE Act would allow Canadian firms to buy and build assets in the U.S. It would also feature record expungement and the implementation of a federal sales tax.

In our last update, we highlighted how the biggest challenge for Canadian licensed producers (“LPs”) was that they were “trapped in Canada.” These companies have the ability to tap into larger investor bases since they typically have listings on larger stock exchanges or even dual listings in the U.S. and Canada. However, the majority of their revenue currently comes from the Canadian market. The Canadian market generally exceeded growth expectations in 2020; COVID 19 and the work-from-home environment helped drive significant growth in the use of cannabis-related products. Still the size of Canadian market, is paltry compared to the revenues being generated in the United States.

Adult-use Cannabis Sales by month in Canada

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Source: MjBiz and Statistics Canada as at October 30, 2020.
*Adult use cannabis sales began October 17, 2018

At this rate, Canadian recreational cannabis sales are projected to surpass C$2 billion in 2020, which is an impressive feat considering that key markets, such as Ontario, continue to have distribution challenges. Canada is not where global growth is going to come from for the larger LPs; sales are expected to be primarily driven by the U.S. Over the longer term, BDSA, a leading marijuana analytics provider, predicts global cannabis sales will reach US$47.2 billion by 2025, a compounded annual growth rate (“CAGR”) of 22%, with the bulk of this growth coming from the U.S. market, which they expect to reach US$34.5 billion by 2025, a CAGR of 18%.

Canadian LPs have access to equity markets and investment from large financial institutions, including some of the large Canadian banks, but what they cannot do is take their capital reserves and go directly into the U.S. to invest.

Instead, multi-state operators (“MSOs”) have generated strong earnings growth by building a patchwork network of seed-to-sale operations in leading states where adult-use marijuana is legal at the state level, including key populous states such as California, Colorado, Nevada, and most recently, Arizona and New Jersey in 2021. Altogether, this has created aggregated diversified sales from the U.S. market that is probably somewhere between US$15 billion and $18 billion, according to estimates by MJ Biz Daily, even without federal legalization in place.

The valuations of the MSOs vs. the Canadian LPs are quite stark, with CIBC World Markets highlighting in their 2021 Equity Outlook that the MSOs are generating positive EBIDITA vs. negative EBIDITA for Canadian producers. In fact, CIBC estimates the MSOs will generate nearly $9 billion in sales alone in 2021 versus an estimated $3.6 billion in sales for Canadian LPs, and will trade at a much lower 4.4x enterprise value (“EV”) to sales versus 7.7x for the LPs.

Why the high relative valuations for the LPs? In a nutshell, it is investor access; these are the issuers that retail investors can easily purchase. Now an additional path to profitability exists; if these LPs can get access to the U.S. market during the rollout of legalization, they could start to generate sales potential in line with their valuations. This underscores why the Horizons Marijuana Life Sciences Index ETF (“HMMJ”), which currently doesn’t have any exposure to U.S. MSOs, was up 42.05% during the month of January 2020.

Scaling Up: Preparing for U.S. Entry

In mid-December, the merger of Aphria and Tilray was announced. The proposed merger would create the largest marijuana cultivator and distributor in the world, with revenue that could exceed US$1.2 billion, according to CIBC World Markets.

The main goal of this merger is global expansion, with a heavy emphasis on European and eventually U.S. expansion. In fact, Aphria will de-list from the Canadian stock market and only maintain a U.S. listing for the newly merged entity upon completion of the merger.

The two charts below provide some context on what Aphria and Tilray are trying to achieve. If you look at the average sales growth of the holdings of HMUS, which is primarily comprised of U.S. MSOs, you can see the average is much higher, with an average sales growth achieved by the top underlying holdings of about 124% as at the end of December 31, 2020, versus about 93% sales growth for holdings of HMMJ. Look at companies like Aphria, which had about 60% sales growth, and Tilray, which had about 48% growth. While on their own these are strong sales growth numbers, the price to sales of the stocks are lower than U.S. counterparts; if there’s a way to access the U.S. market or at least highlight the potential of growing U.S. sales, it provides a lot more momentum for the Canadian issues.

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Source: Bloomberg, as at December 31, 2020.

While the growth in the U.S. market would likely be reflected more acutely in HMUS, HMMJ could also benefit from further legalization in the U.S. for a couple of reasons.

HMMJ could add U.S. MSOs that partake in cannabis cultivation and production (which are currently included in its underlying index but not within HMMJ’s holdings) if and when federal legalization is allowed.

Large holdings in HMMJ, such as Canopy Growth, have potential exposure to the U.S. marketplace. For example, Canopy would be able to fully acquire Acreage Holdings, a large MSO, upon any implementation of U.S. federal legalization, based on existing agreements.

Either way, we could see a lot of convergence between the two regional sectors in 2021 in what might end up being a huge milestone for the global cannabis industry.

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Source: Bloomberg as at December 31, 2020. *Performance since ETF inception of HMMJ on April 04, 2017, and HMUS as at April 17, 2019 for the period ending December 31, 2020.

The indicated rates of return are the historical annual compounded total returns, including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.

Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the “Horizons Exchange Traded Products”). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the Horizons Exchange Traded Products. Please read the relevant prospectus before investing.

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

HMUS is expected to invest in the Marijuana industry in certain U.S. states that have legalized marijuana for therapeutic or adult-use, which is currently illegal under U.S. federal law. HMUS will passively invest in companies involved in the marijuana industry in the U.S. where local state law regulates and permits such activities, as well as in companies involved in the Canadian legal Marijuana industry. Neither HMMJ nor HMUS will be directly engaged in the manufacture, importation, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the respective prospectus before investing.

HMMJ will not knowingly invest in any constituent issuers that have exposure to the medical or recreational marijuana market in the United States, unless or until it becomes legal. HMMJ will not be directly engaged in the manufacture, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the prospectus before investing.

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Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their value changes frequently and past performance may not be repeated. Certain ETFs may have exposure to leveraged investment techniques that magnify gains and losses and which may result in greater volatility in value and could be subject to aggressive investment risk and price volatility risk. Such risks are described in the prospectus. The prospectus contains important detailed information about the ETF. Please read the relevant prospectus before investing.

The Horizons Exchange Traded Products include our BetaPro products (the “BetaPro Products”). The BetaPro Products are alternative mutual funds within the meaning of National Instrument 81-102 Investment Funds, and are permitted to use strategies generally prohibited by conventional mutual funds: the ability to invest more than 10% of their net asset value in securities of a single issuer, to employ leverage, and engage in short selling to a greater extent than is permitted in conventional mutual funds. While these strategies will only be used in accordance with the investment objectives and strategies of the BetaPro Products, during certain market conditions they may accelerate the risk that an investment in shares of a BetaPro Product decreases in value. The BetaPro Products consist of our Daily Bull and Daily Bear ETFs (“Leveraged and Inverse Leveraged ETFs”), Inverse ETFs (“Inverse ETFs”) and our BetaPro S&P 500 VIX Short-Term Futures™ ETF (the “VIX ETF”). Included in the Leveraged and Inverse Leveraged ETFs and the Inverse ETFs are the BetaPro Marijuana Companies 2x Daily Bull ETF (“HMJU”) and BetaPro Marijuana Companies Inverse ETF (“HMJI”), which track the North American MOC Marijuana Index (NTR) and North American MOC Marijuana Index (TR), respectively. The Leveraged and Inverse Leveraged ETFs and certain other BetaPro Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These BetaPro Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, among other risks, which are described in their respective prospectuses. Each Leveraged and Inverse Leveraged ETF seeks a return, before fees and expenses, that is either up to, or equal to, either 200% or –200% of the performance of a specified underlying index, commodity futures index or benchmark (the “Target”) for a single day. 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Due to the high cost of borrowing the securities of marijuana companies in particular, the hedging costs charged to HMJI are expected to be material and are expected to materially reduce the returns of HMJI to unitholders and materially impair the ability of HMJI to meet its investment objectives. Currently, the manager expects the hedging costs to be charged to HMJI and borne by unitholders will be between 10.00% and 45.00% per annum of the aggregate notional exposure of HMJI’s forward documents. The hedging costs may increase above this range. The manager publishes on its website, the updated monthly fixed hedging cost for HMJI for the upcoming month as negotiated with the counterparty to the forward documents, based on the then current market conditions. The VIX ETF, which is a 1x ETF, as described in the prospectus, is a speculative investment tool that is not a conventional investment. The VIX ETF’s Target is highly volatile. 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While Bitcoin Futures are traded on a regulated exchange and cleared by regulated central counterparties, direct or indirect exposure to the high level of risk of Bitcoin Futures will not be suitable for all types of investors. An investment in any of the BetaPro Products is not intended as a complete investment program and is appropriate only for investors who have the capacity to absorb a loss of some or all of their investment. Please read the full risk disclosure in the prospectus before investing. Investors should monitor their holdings in BetaPro Products and their performance at least as frequently as daily to ensure such investment(s) remain consistent with their investment strategies.

Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits that can change over time.

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