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Descheduling, discount rates, and Narc of the Week
Programming note: Thursday is for Narcs here at Money Puff. Narcs are empowered by laws they feel the need to enforce, so we’ll also spend time exploring policy and regulatory updates as they evolve. This week, the big one…
Descheduling, the DEA, and discount rates
The biggest regulatory change that can happen in cannabis is federal descheduling. Currently, cannabis is a Schedule 1 drug. That means, according to the federal government, ‘it has a high potential for abuse, no currently accepted medical use in treatment in the United States, and a lack of accepted safety for use under medical supervision.’ That is patently false, and last year President Biden issued a directive to the Secretary of Health and Human Services and the Attorney General to review its scheduling ‘expeditiously.’1
On Tuesday, HHS Secretary Xavier Becerra sent a letter to lawmakers in response to that review, and, oh no. He said it’s all up to the DEA:
In accordance with the process set forth in the Controlled Substances Act (CSA), the Department conducts a scientific and medical evaluation of a drug or substance and submits that evaluation, along with scheduling recommendations, which are binding as to scientific and medical matters, to the Drug Enforcement Administration (DEA) for a final scheduling determination
Consideration of the factors specified in the CSA ultimately leads DEA to make findings related to a drug’s or substance’s relative abuse potential, safety, medical uses, and dependence liability, and to make a scheduling decision in accordance with those findings.
I am basing this solely on the character Hank Schrader from Breaking Bad, but it seems to me that the DEA likes to bust people for selling illegal drugs. Therefore, it would logically follow that they like having more drugs that are classified as illegal, so they can have more opportunities to bust people selling said drugs. The fact that it is all up to the DEA does not bode well for descheduling.
Why is descheduling so important for cannabis? It has to do with something called the ‘discount rate.’
A foundational concept in finance is that a dollar you get today is worth more than a dollar you’ll get in the future.2 But, sometimes you can’t get your dollars today; a business, for instance, knows that it’s going to get dollars in the future — hopefully far into the future if it’s a good business. So what are those future dollars ‘worth’ in terms of their value to me today?
The way you value those future dollars is by ‘discounting’ them by some sort of rate, known as the ‘discount rate.’ For a lot of companies, the discount rate is their weighted average cost of capital, or WACC. A company’s WACC is their cost of debt (the yield on their corporate bonds) plus their cost of equity (the rate of return that stockholders demand). You can think about it as what it costs to finance the business.3
There is inherently risk priced into the WACC.4 But I was a fintech banker in a past life, and when we were forecasting and discounting future cash flows for our tech company clients, we used a discount rate that was a lot higher than most other companies’ WACCs.
Why? Because they carried a lot more risk! They were young, often loss-making, and either trying to disrupt an industry or perhaps create an entirely new one. There’s more uncertainty with that kind of business. So, instead of, say, 10-15% for your discount rate, you’re looking at more like 20-25%.5
You can apply the same concept of uncertainty and risk to cannabis companies today. And a big reason for that is the fear that at any moment the feds can swoop in and shut the whole thing down.
Federal descheduling takes away that risk. Thus, it would lower cannabis’ discount rate and make the entire industry worth more! That’s a big deal, especially as we enter a likely recession.
If you don’t believe me, just take a look at Delta-8/9 and all those other ‘hemp-derived’ products that have sprung up in recent years. The reason those companies are worth anything is because they have the blessing of the federal government, thanks to the wording of the 2018 Farm Bill. Do companies actually want to sell that stuff — and, for that matter, do consumers actually want to buy it — or is it worth it to them because they believe the DEA won’t come crashing through their door?
To be clear, federal descheduling would not impact a state’s ability to enact and regulate their own market. They can even continue to make cannabis illegal; states are cracking down on Delta-8 products even though they’re technically federally legal. But it would allow so many cannabis companies that are operating legally in their state to breathe easier, and lower their cost of capital.
If only it wasn’t up to the f’ing DEA.
Narc of the week
I’m an Irish-American, so March is usually a time of pride for the home of my ancestors. But not if you’re Irish and like weed, because:
Police in the Republic of Ireland announced this week that law enforcement officers seized more than 250 pounds of cannabis as part of an ongoing effort to target organized crime activity in the Dublin area. In a statement released on Tuesday, the garda (Irish national police force) said that the seizure resulted in the arrest of two men, who are being held pending further investigation.
The garda publicized the seizure on social media, noting in a Twitter post that the agency is “#KeepingPeopleSafe.” But other users on the platform questioned the public safety value of the police operation.
“Safe from what?” asked one Twitter user. “There would [have] been a few lads heading to shops for munchies after a few joints, do we really need to be safe from that or do you think there is bigger and more serious crime we should be kept safe from first.”
My writer’s dashboard tells me I have readers in Ireland. Does anyone want to write a guest column on Irish cannabis culture, policy, and politics? Reply to this email if you’re interested! Money Puff continues its global expansion!
That word, unfortunately, means nothing to government officials.
If I received a dollar today, I can, at the very least, put that dollar into a savings account or a money market fund or buy a Treasury bond. With these types of ‘risk-free’ assets, I can be reasonably assured that in a year from now, say, I’ll receive more than $1 back. So I want to get that dollar today, rather than that dollar in a year (even though they’re the same thing).
You’re going to get dollars in the future, but you need dollars today to actually run your business. The WACC is what it costs you to get those dollars today. If it’s more expensive to get today’s dollars, then those future dollars are not going to be worth as much to you.
For debt, that’s your creditworthiness; for equity, that’s how volatile your stock is, and how correlated it is to the rest of the market.
Yes, it’s a finger in the air, but you get the idea.