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INSIGHT FROM CALIFORNIA

January 14, 2019

 

 

Following cannabis related events in California is the best to learn the ramifications of an evolving industry without burning capital.  What happens in California does not stay in California.  Tracking the numbers and the noise doesn't always give you the facts.  Only in the trenches can the truth be discovered.
In California, state lawmakers have allowed a slow process of moving an estimated 68,150 cannabis farmers into the legal market. From the beginning, there was a concern the legal market would be undercut by the massive black market that has existed for decades. And that's what's happening. Nowhere is it a bigger problem than in the state's most significant legal local marijuana market: Los Angeles County. The number of outlaw dispensaries in the county dramatically outnumbers about 150 licensed storefront retailers. Legal pot shops are losing customers who can get products more cheaply at illegal outlets that don't charge or pay taxes. An unfair competitive situation for licensed businesses has compromised profitability. One of the selling points for legalization was it would generate a tax windfall for state and local governments. However, during the first three quarters, the state reported only $125 million from cultivation and excise taxes, putting it on pace to fall well below the $308 million forecast for nine months.
Notwithstanding black market competition, changes in the state regulations add a new cost: New testing and childproof packaging regulations took effect on July 1, has caused additional financial and logistical challenges for marijuana companies, and are efficiently run into the tens of thousands of dollars monthly. Indeed, the testing regulations will lead to increased consumer safety–all cannabis products, including flower and edibles, must be tested for pesticides, pathogens, and potency. The problem is that there are 31 labs licensed to test cannabis products for more than 400 licensed dispensaries, leading to a bottleneck in the supply chain and causing product shortages. Nowhere are problems caused by licensing delays more evident than they are in Los Angeles. Licensing has been broken down into three parts. During the Phase 1 licensing period, the city issued 156 retail permits for existing medical marijuana dispensaries. Those 156 retail operations hold a cumulative 950 licenses for medical and recreational retail, cultivation, manufacturing, and distribution. Because the first round of application approvals were for existing medical marijuana businesses, it would make sense that there would be a well-established infrastructure. After all, California was the first state to legalize medical marijuana way back in 1996, so growers, retailers, and manufacturers had already been working together for more than twenty years. Unfortunately, with legal adult-use sales, California prohibited licensed cannabis operators from doing business with unlicensed operators, fracturing business relationships and leading to gaps in the supply chain. The Phase 2 licensing period runs from Aug. 1 through Sept. 13, and only non-retail cannabis business that has been operating since at least December 2015 will be issued permits. Of those eligible to apply for Phase 2, they’ll also have to meet the requirements for the city’s social equity policy. The policy requires that for every nonequity license, two equity licenses must also granted. There’s a lot of confusion surrounding the application process and who is eligible. Everyone who doesn’t meet the criteria for Phase 2 will have to wait for Phase 3, and there’s currently no timeline set. Most local jurisdictions, including LA, require applicants to have physical locations before applying and given the delays in licensing, that means paying large sums of money for months on end for a space that can’t legally operate.
Canadian Model is not a  bargain:  In Canada, many emerging U.S. operators seek vertical integration, where a retailer grows pot that it sells as brands its own stores. Cannot work in California; it’s unlikely that vertically integrated cannabis companies will survive unless they have isolated specific brand names catering to an identifiable market.  There is little to no advantage to such a business under its current business model, and only doing so because they are forced to by regulations. It’s more efficient to have all of the participants in the market specialize in retail, cultivation and so on.
Growing pot is also a massive challenge that will eventually see tight margins and require enormous scale to make money doing it. Look at greenhouse tomato or pepper growers, the margins are thin there, and they make money at only with an economy of scale.  As our proprietary Subjective Probability+Game Theory (SP+GTM) algorithm expressed,  cannabis will become a commodity crop in the long run, whether n greenhouses or outside.  Additionally, in more mature cannabis markets, consumers tend to move away from dried flower or pre-rolled joints into concentrates, such as edibles --- markets that FJ National Brands has considered.

 

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