Alternative Market Briefing

Opalesque TV: Chicago Atlantic finds golden opportunity in cannabis market

Wednesday, August 02, 2023

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B. G., Opalesque Geneva for New Managers:

Chicago Atlantic stands out for one particular expertise: secured lending to the cannabis industry in the U.S. And because they provide capital to an industry that finds it hard to find any, this expertise has been paying off. They also loan to out-of-favour industries that banks do not generally like, such as health care staffing, project finance of air pumps at gas stations, and diversified portfolios with complicated collateral but with great terms.

The Chicago-based private markets asset manager, which is focused on opportunistic lending to North American investment opportunities, has closed more than 50 loans over the past four years comprising about $1.8bn in total credit, says Andreas Bodmeier, Ph.D., one of the three founding partners, to Matthias Knab during an Opalesque TV interview.

The key to Chicago Atlantic's success is its "special sauce", that is, a key team of credit specialists with actual business operating experience.

He met his partners at the University of Chicago while he was completing his PhD in Finance. The three of them could not be more different, he says. John Mazarakis has a background in real estate and hospitality. "Because of his past as an operator, he is very effective at connecting with prospective borrowers who are also operators." Tony Cappell's background is in traditional specialty finance and includes roles in both bank and non-bank asset-based lending roles in which he "learned the benefits of great credits and the pains of not-so-great credits, so he brings an institutional credit perspective to our team."

After university, Bodmeier started a consulting firm focused on FX hedging and quantitative consulting. "I first came into contact with private investments when I was underwriting litigation finance transactions," he says. "John and Tony approached me with the idea of lending to state-licensed cannabis operators."

Now, they have a team of 50 investment and back-office professionals.

An opportunity for alpha and scale

The partners pinpointed the cannabis industry when they realised there was an unlimited number of deals but only a very limited supply of capital chasing these deals. That was an opportunity for alpha as well as scale.

"Cannabis is the only novel industry where we know that demand already exists," Bodmeier explains. "It's about $100bn in retail revenues in the U.S. but most of it is still in the illicit market. The legal state-licensed market currently is about $25bn in top-line retail revenue and a multiple across the whole value chain. It is expected to grow to about $100bn by the end of the decade, driven by continued state-level legalisation as well as increased consumer adoption. But cannabis is still prohibited at the federal level, which means that most banks and most institutional lenders cannot lend in this space, which creates this opportunity."

With Republicans taking over the U.S. House, any prospect of legalisation has gone far into the future, he adds. But the growth and the momentum of this industry are undeniable, and that growth requires capital. The cultivation and retail facilities are very capex intensive. With the limited supply of capital and the industry's year-on-year growth, this is a great opportunity to capture.

Since its inception in 2019, his firm's private lending strategy has delivered net returns of over 16% annualised. They have more than 500 LPs that include domestic and international HNWIs, private wealth managers and family offices.

Outlook

We may be in a recession already even though it has not been officially declared, Bodmeier says, and rising interest rates certainly have an effect on the macro economy. But "we think that cannabis is very resilient and has a low correlation to broader financial markets because if you look at the underlying cash flows of our borrowers, they are driven by state-level legalisation. And, medical cannabis is used as a pharmaceutical, and the pharmaceutical industry is typically very resilient in a recession. As for the non-cannabis loans, we have always evaluated them through the lens of recession resiliency."

The cannabis market

The global cannabis market size is projected to grow from $57bn in 2023 to $444bn by 2030, at a compound annual growth rate (CAGR) of 34% during the forecast period, according to Fortune Business Insight. The United Nations estimated that 192 million people globally used cannabis in 2018, making it the most-used substance worldwide.

In the U.S., the cannabis market size was valued at $13.2bn in 2022 and is expected to expand at a CAGR of 14% from 2023 to 2030. There, cannabis is often used in the cosmetic, pharmaceutical, and food & and beverage industries, says a report from Grand View Research. The key driving factors of the expansion are the increasing legalization of cannabis and the rising acceptance of its use for medical purposes. Indeed, the research on the use of cannabis and its medicinal properties has led to its increased use to treat various chronic conditions. The medical segment accounted for the largest revenue share of 77% in 2022. North American cannabis companies raised more than $1.6bn in January 2021 alone.

Source: Fortune Business Insights report, published July 2023