Wall Street banks face hurdles as they rush to cover the suddenly booming marijuana industry

Key Points
  • Both Goldman Sachs and Bank of America Merrill Lynch analysts were interested in cannabis companies in the past 14 months, a source tells CNBC.
  • Wall Street faces a unique set of hurdles when it comes to the cannabis industry, ranging from lending regulations to volatile stock moves.
  • Goldman Sachs analyst Judy Hong ran into the company's firewall when she tried to research cannabis companies, a source says.
  • Analysts and cannabis company management see the marijuana and hemp business growing to more than $80 billion.
Canopy Growth operations in Smiths Falls, Ontario.
Tom Franck | CNBC

Goldman Sachs star beverage and tobacco analyst Judy Hong was hoping to do some early research into the multibillion-dollar cannabis industry — that is, until she was stopped by the investment bank's firewall blocking certain content.

Among the companies the 20-year Goldman veteran tried to review was KushCo Holdings, a California-based business that sells packaging, containers and other supportive products to the world's largest cannabis producers. And though no part of KushCo's business actually touches a marijuana or hemp plant, Hong found herself nonetheless barred from the company's website, said a KushCo executive familiar with the matter.

Bank of America Merrill Lynch's consumer analyst is also researching KushCo and the space, the person added. Both Goldman Sachs and Bank of America Merrill Lynch declined to comment about their plans for future marijuana-related research coverage. The KushCo executive said it's fielded calls and met with representatives of both banks.

Three things to watch out for in the pot space this year
Three things to watch out for in the pot space this year

Wall Street is discovering a unique set of hurdles as it explores the possibilities in cannabis. Those hurdles are in the form of lending restrictions, disagreeing local laws and their own internal company firewalls as banks rush to cover that new and growing market. It is a market that could one day be worth $150 billion globally when including the different derivative products like CBD-infused beverages, according to Tilray CEO Brendan Kennedy. Tilray is a medical marijuana grower based in British Columbia.

Other challenges for Wall Street include the flurry of federal regulations that currently deter banks from working with legal dispensaries in the U.S. and mandate that banks and other financial firms file "suspicious activity reports" to help monitor money laundering. Others have brought the just-say-no attitude to Wall Street, steering clear of any services related to the marijuana business for fear of federal prosecution.

Reputation risk?

Martin Landry, a Canadian equity analyst at GMP Securities, told CNBC that his first interaction with the cannabis industry came in 2013 when his firm helped Canopy Growth conduct a round of private financing. Canada became the first Group of Seven country to approve recreational use of pot when Ottawa passed legislation in October.

"I was covering consumer and some pharma names and [my company] asked if I would look at the sector. And I said 'no,'" Landry said Friday.

The analyst explained that he shied away at first for fear that the other consumer and pharmaceutical companies under his coverage wouldn't take him as seriously and that the new venture could damage his existing reputation. It was later that he eventually decided to explore coverage on Canopy, Cronos Group and other industry names.

But for those willing to take a chance, the cannabis industry could represent a sizable revenue stream. Some experts, such as Cowen's Vivien Azer, see the U.S. marijuana market growing to $80 billion by 2030. The up-and-coming market has attracted investments from a range of people and companies looking for the help of big banks. That is a group including venture capitalist Peter Thiel and the globe's largest alcohol companies looking for a strategic partnership.

Azer is one of just three analysts from a major brokerage covering the space currently.

Investment banking

Goldman acted as financial advisor to $32 billion Constellation Brands last year when the Corona beer owner increased its investment in Canadian marijuana producer Canopy Growth. Bank of America Merrill Lynch, meanwhile, provided committed financing for Constellation's $4 billion bet on the weed company.

"The global cannabis market presents a significant growth opportunity and Canopy Growth is well-positioned to establish a strong leadership position in this fast-evolving category," outgoing Constellation CEO Rob Sands said in November.

Even traditional tobacco companies have taken note of the powerful uptrend in legal cannabis sales. Marlboro maker Altria said in December that it had agreed to buy a 45 percent stake in leading cannabinoid company Cronos Group for about $1.8 billion.

Such bets have often made lucrative, albeit volatile, investments. The stock price of medical marijuana giant Tilray is up more than 250 percent over the last six months, while rival Canopy Growth is up 86 percent. The ETFMG Alternative Harvest ETF — which tracks the stock performance of companies that are engaged in the legal cultivation of cannabis — is up 40 percent in 2019 alone.

Analysts "have to decide if it's value added," said Pat Hearns, director of research at Longbow Research. Though Longbow does not cover cannabis, Hearns said any sell-side analyst must ask themselves a number of questions before launching coverage. Some things to consider: is there an appetite for such research and if the analyst has any background knowledge that would lend unique insight.

But ultimately, the decision over whether to cover a basket of equities comes down to profit and whether a group of equities is under-covered, Hearns said.

"That's usually the case with an emerging industry. That could be true with cannabis," he added. "I don't think coverage of cannabis — it won't be a moral issue — but [rather]: can you be one of the first to provide some real insights and understand the regulatory backdrop."

Longbow does not cover cannabis because the brokerage is still too small to cover an additional industry, Hearns said. Starting marijuana or hemp coverage "would mean pulling someone from supporting another industry vertical, which I can't do at this time without sacrificing some productivity" elsewhere, he wrote.

Meanwhile many analysts will likely keep their eyes on federal legislation and announcements from the U.S. Justice Department.

The recent U.S. farm bill removed hemp from the federal government's list of controlled substances, a move many in Canadian and American corporate suites believe sparked interest in CBD, cannabidiol. Some who infuse products with CBD claim it can be used to ease a wide range of medical ailments, including epilepsy and arthritis.

Marijuana remains illegal on a federal level in the United States, but 10 states and the District of Columbia have allowed its use for recreational purposes. Michigan became one of the latest to OK marijuana in November.

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