California Cannabis Growth Rests On Linking Farms, Dispensaries And Users
While many expect sales of marijuana for recreational use to take off in January when California will allow existing dispensaries to sell to adults, growth should be gradual next year before accelerating over the next three years, according to investors and advisors.
The main opportunity next year lies in building the infrastructure and “freeways” to connect California farms to dispensaries, and dispensaries to recreational users. The biggest challenge for investors and operators is to take the cloak off the stealth connection between dispensaries and financial institutions.
Sales of recreational use marijuana in California are projected to reach $577 million next year, according to BDS Analytics/Arcview Market Research.
Sales of legal medical marijuana in California are expected to approach $2.7 billion in 2017
The modest uptick is dictated by the limited number of licenses to be issued in California, as well as the twisting, undetermined path to approval for recreational use sales, says Tom Adams, Managing Director of Investment Research at BDS Analytics. A dispensary must obtain approval from its local municipality and then the state, says Adams. The guidelines are still being written by all groups.
The more promising BDS forecast calls for California recreational use sales reaching $4.3 billion by 2021, while medical use sales will decline to $1.5 billion by then. BDS modeled the projection following the transition in Colorado, says Adams, where recreational sales became legal in 2014. In 2013, medical sales in Colorado totaled $333 million. This year, medical sales will reach $462 million while recreational use sales in the state will approach $1.5 billion. An estimated 20-25% of all Colorado adults are recreational users.
No one knows for sure what percentage of Californians will toke up once recreational sales are legal. However, Chris Leavy, partner and co-chairman of MedMen and previously chief investment officer at BlackRock, points to Nevada as a cautionary tale. Nevada voters approved recreational sales in 2016 but the state only allowed liquor wholesalers to apply to distribute recreational marijuana in the first 18 months. Few wholesalers applied, and Nevada had to approve emergency legislation in July to correct the shortage, when existing medical dispensaries were overwhelmed because of demand.
Overall, the national cannabis market – legal and illicit – is estimated at more than $50 billion.
Legal sales in California, Oregon, Washington and Colorado have posted a 50% compound annual growth rate in the last three years, says Adams, a former investment banker. The companies that enter the earliest have a five-year head start to lock up market dominance – and to attract bids from major agricultural firms and retailers – before federal law likely will be modified to legalize marijuana sales, according to research by the Washington, DC-based Marijuana Policy Project.
Medical marijuana has been legal in California since 1995 but remains locally operated. Many farms, and greenhouse operations, still can sell marijuana flowers and plants without necessarily reporting the entire transaction. Sales from marijuana farms in the state are conducted almost always through an introduction or a referral, says Regina Unegovsky, an attorney with Regal Tax Law who counsels marijuana producers in the state. As a result, widespread consolidation of farms and dispensaries has yet to occur.
Leavy agrees, explaining MedMen is building its internal freeway by securing “beachfront” real estate locations and recreational use licenses and building state-of-the-art production facilities to meet demand. MedMen is building a new greenhouse facility in Desert Hot Springs. The company operates primarily in Southern California, as well as other states, but is scouting for locations to establish dispensaries in Monterey, the Bay Area and Sacramento.
Location and the ability to win local municipal approval are key, says Leavy. Because of zoning, some cities will not allow sales near schools or other selected areas, he notes. Or the municipality can decide it does not want more dispensaries. For example, Unegovsky points out San Jose is unlikely to increase the number of dispensaries in the city. The eight medical marijuana dispensaries in San Jose can apply for recreational licenses, but San Jose may decide not to approve all of the applications.
BDS tracks legal sales at 1,100 dispensaries and 2,000 delivery services in California. The number of dispensaries is not likely to increase dramatically in California next year, says Adams, but the delivery services, especially the online market, could be a wild card in market growth.
One drawback to the online market and the current medical marijuana market is many adults do not want to be in the “system” as marijuana users, says Nick Kovacevich, CEO of Kush Bottles, which manufactures packaging for marijuana products. These adults eventually may want to run for office or work at a Fortune 500 company and have resisted buying a $40 prescription drug card, says Kovacevich. The same predicament could hold for online sales.
Adams and Leavy say private capital investing in marijuana-dedicated funds is being provided by family offices, personal investments by hedge fund managers, and a sampling of venture capitalists. In addition to MedMen, firms such as Privateer Holdings, Poseidon Asset Management, Casa Verde Ventures and Phyto Partners stand out as cannabis-focused funds.
Eaze, an online delivery company, uses its proprietary software to enhance delivery between dispensaries and homes. The company’s recent $27 million Series B round attracted traditional venture capital firms such as DCM Ventures and Tusk Ventures. Y Combinator and the Founders Fund also have participated in cannabis-focused technology.
Institutions are remaining on the sidelines, says Leavy, because the legal risk is too high for tightly audited investment companies, even for a private portfolio investment. The major obstacle for institutional investors is federal law still classifies marijuana as a narcotic. The probability of that law changing in the next three years is remote, according to advisors.
Leavy sees the market limitations, and the limited market participants, as an opportunity. MedMen opened a $60 million fund to invest in marijuana companies in June 2016 and closed it by April 2017. It’s now raising a second fund of $250 million. More than 3,500 private equity firms are chasing “traditional” investments, says Leavy, and traditional valuations have never been higher. Because traditional investors are absent, the marijuana market offers the potential for an incredible return, he adds. For now, investors are primarily seeking opportunities in marijuana production, testing labs and supportive services. One of Poseidon’s investments, for example, includes a machine learning company, as well as farms.
Of the 25 deals in the last 15 months in North America, 12 buyers were Canadian companies. Most of the Canadian buyers were seeking to increase production capacity, either by acquiring farms, manufacturing facilities or existing specialty suppliers. One example was Canopy Growth’s $9.15 million purchase of Germany-based MedCann GmbH, a provider of cannabis strains used in German hospitals 12 months ago.
The emergence of the Canadian market is not surprising as the federal government in Canada has taken the initiative to control the supply in the country, and banks have agreed to provide financing. Not surprisingly, as a producer, Canopy received the industry’s biggest outside investment in October when Constellation Brands decided to buy 9.9% of Canopy for $191.2 million.
Until the US can sort out how to manage marijuana banking transactions, the market growth is likely to be restricted, says Dustin Edie, CEO of CanPay, an online banking company. The largest legal marijuana businesses in the US may post a maximum of $100 million in sales, says Edie. In Florida, dispensaries with licenses cannot find enough locations to open stores, he notes, and the problem is likely to be repeated in California.
The potential for a large return remains robust, says Adams. In five years, when a ConAgra Foods or Monsanto wants to enter the market, will they build their own facilities or buy existing producers and farms? The size of the return to the early movers may not be known yet, but Adams predicts a ConAgra or Monsanto most likely will be buyers because it will be too late to build.
Source: William Langbein
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