Speaker 1: Americans have changed their minds about weed. It's estimated that
Speaker 1: demand for recreational marijuana.
Speaker 2: Could be as big as forty five billion dollars a year.
Speaker 2: That's bigger than both wine and chocolate.
Speaker 3: It's no secret marijuana is no longer a budding business.
Speaker 3: It's booming. Sales in North America totaled six point seven
Speaker 3: billion dollars in twenty sixteen and unprecedented thirty percent increase.
Speaker 4: Absolutely, and this is the headline everybody wants to hear.
Speaker 4: The marijuana market could be about to boom big time.
Speaker 4: The new Frontier data says that legal cannabis could expand
Speaker 4: the national market to about twenty one billion dollars by
Speaker 4: the year twenty twenty. That's up from five point seven
Speaker 4: billion dollars last year, and I'm expected seven point nine
Speaker 4: billion dollars this year.
Speaker 2: That was the buzz leading up to twenty eighteen, when
Speaker 2: investors around the world were caught up in the craze
Speaker 2: for cannabis stocks. Pot was on its way to being
Speaker 2: legalized in Canada, and there were rumblings of a similar
Speaker 2: move in the US. Shares of companies like Tilray, a
Speaker 2: Canadian pot company, soared by more than one thousand percent
Speaker 2: that year before crashing down to Earth soon after.
Speaker 5: We will soon have a new system in place, one
Speaker 5: that keeps cannabis out of the hands of our kids
Speaker 5: and keeps profits away from organized crime. Today, I'm also
Speaker 5: pleased to announce that the new recreational cannabis regime will
Speaker 5: officially come into force on October seventeenth of this year.
Speaker 1: In October of twenty eighteen, Prime Minister Justin Trudeau announced
Speaker 1: that cannabis was legalized in Canada. Since then, numerous states
Speaker 1: in the US have taken steps toward legalizing a drug
Speaker 1: that was once vilified literally as the devil's let us.
Speaker 1: But despite all these tailwinds, podstocks are still struggling and
Speaker 1: there is huge question marks over just how the rollout
Speaker 1: of this brand new market is going to go.
Speaker 2: This is our cue to welcome you back to Potlots,
Speaker 2: our deep dive into what's going on the legalized marijuana market.
Speaker 2: In our last episode, we talked about what was happening
Speaker 2: in New York and the tension that currently exists between
Speaker 2: the illicit market for weed and the new legal one.
Speaker 2: On this episode, we'll dive a bit more into the
Speaker 2: business model of legalized marijuana before getting into the efforts
Speaker 2: at creating social equity in our third and final episode.
Speaker 1: It's not every day that you get to witness the
Speaker 1: birth of a new market and all of the pains
Speaker 1: and hiccups and weird logistical and existential issues that come
Speaker 1: with it. And that's what really interests us here. What
Speaker 1: is the state of the New York cannabis industry right
Speaker 1: now and where is it headed? Is it being designed
Speaker 1: in a way that's fit for its purpose? Will legal
Speaker 1: cannabis sellers be able to make money, will be able
Speaker 1: to compete with the illicit market guys who have been
Speaker 1: in this business for a long time, And will investor
Speaker 1: still be interested? Can the market live up to the hype.
Speaker 2: To understand where things are going, we are going to
Speaker 2: begin by checking up on what's happened so far. Remember,
Speaker 2: not that long ago, there was once a ton of
Speaker 2: investor excitement around cannabis. We had a bunch of new
Speaker 2: companies created, several cannabis focused exchange traded funds were launched.
Speaker 2: Joe and I recorded a couple episodes on the industry.
Speaker 2: But all that excitement and the share prices as well,
Speaker 2: they seem to have stagnated. Since then, the lines on
Speaker 2: the chart have moved down into the right.
Speaker 6: It's been about a couple of years for the cannabis space.
Speaker 6: You're talking about a lot of operators, a lot of pioneers,
Speaker 6: a lot of entrepreneurs who have been working for four
Speaker 6: or five years have not gotten paid.
Speaker 2: That's Todd Harrison, the founding partner and chief investment officer
Speaker 2: of CB one Capital, an investment firm specializing in cannabis.
Speaker 2: He describes what the mood is like amongst pot investors
Speaker 2: and the big cannabis companies known as multi state operators
Speaker 2: or MSOs after a tough few years.
Speaker 6: For some reason, cannabis entrepreneurs, the MSOs, the pioneers are
Speaker 6: viewed with disdain by some politicians and others in small business.
Speaker 7: It's a bit oxymoronic.
Speaker 6: Right, These are entrepreneurs that figured out and are working
Speaker 6: toward building a US based industrial complex, right, US supply chain,
Speaker 6: home grown, and something that I think we can all
Speaker 6: agree should not be illegal, should not be a reason
Speaker 6: that people are put in jail, and should not be
Speaker 6: something that's used against somebody, whether they want to get
Speaker 6: a job or whether they want to run for office.
Speaker 1: Todd's own interest in cannabis was formed during a big
Speaker 1: moment in New York in US history. He worked on
Speaker 1: Wall Street for more than three decades at Morgan, Stanley
Speaker 1: and Gallian and even Jim Kramer's old firm, and he
Speaker 1: was working on Fulton Street the morning of nine to
Speaker 1: eleven when the World Trade Center towers came down.
Speaker 3: How to do?
Speaker 6: We were a few blocks in the World Trade Center.
Speaker 6: It was really the time after nine to eleven where
Speaker 6: I explored it. After personal use with the PTSD associated
Speaker 6: with nine to eleven, havn't been down there. I really
Speaker 6: did a deep dive into the science, into the history
Speaker 6: and to the benefits, the efficacy, and became fascinated with
Speaker 6: the opportunity and ultimately the market opportunities that it would present.
Speaker 6: And that's really what started this journey sung ten eleven
Speaker 6: years ago. There's such a wide chasm between the popular
Speaker 6: perception of cannabis's advice and history and cultures have demonstrated
Speaker 6: for ten thousand years that cannabis is a wellness solution.
Speaker 2: But even if attitudes towards pot are changing, as evidence
Speaker 2: by the fact that twenty one states have now legalized
Speaker 2: its use, there are main challenges to the actual business
Speaker 2: of legal weed. One of the very things that's driving
Speaker 2: cannabis legalization, the potential for tax revenue, is also arguably
Speaker 2: hindering the industry's growth.
Speaker 1: Pot is still classified as a Schedule one drug at
Speaker 1: the federal level. The DEA defines this as drugs or
Speaker 1: substances with no currently accepted medical use and a high
Speaker 1: potential for abuse. Some other substances that are in the
Speaker 1: same bucket as cannabis are heroin and LSD, but not cocaine.
Speaker 1: Interestingly enough, that's Schedule too, and so that means even
Speaker 1: if you're growing and selling pot legally within a state,
Speaker 1: federal law treats it as an illegal business.
Speaker 7: Yep.
Speaker 2: And Section two ade of the Internal Revenue Code prohibits
Speaker 2: taxpayers who are engaged in the business of trafficking certain
Speaker 2: controlled substances, which in this case includes marijuana, from deducting
Speaker 2: typical business expenses associated with those activities. That amounts to
Speaker 2: an extra tax on the business, even if the state
Speaker 2: says it's legal. Here's todd again, the two.
Speaker 8: Eighty tax code, which paradoxically is going to end up
Speaker 8: hurting the competition for a lot of the US cannabis players,
Speaker 8: because it's going to ultimately create an environment where social
Speaker 8: justice and small business can't compete. Because there is an
Speaker 8: effective tax rate of seventy percent in the cannabis space,
Speaker 8: we don't know if that's going to go away anytime soon.
Speaker 6: There is speculation that it's being addressed. But if it
Speaker 6: does not go away, if strong will get stronger.
Speaker 1: This was something we heard from a lot of investors
Speaker 1: in the space. The combination of the tax code and
Speaker 1: the patchwork of different laws between states and at the
Speaker 1: federal level makes it difficult for players in the pot
Speaker 1: industry to really scale their businesses effectively.
Speaker 2: Emily and Morgan Pasia are a brother and sister duo
Speaker 2: who founded the cannabis investment company Poseidon. As they point out,
Speaker 2: a seventy percent effective tax rate has done some interesting
Speaker 2: things to legal cannabis companies so far.
Speaker 9: When I look at these companies, I see strong fundamentals,
Speaker 9: and there is this thing called twoade is a tax
Speaker 9: code that's applied to this industry, and just to be
Speaker 9: very broad about it, these operating companies see tax rates
Speaker 9: effective tax rates of about seventy plus percent. In spite
Speaker 9: of that, though you're seeing really strong gross margin profiles,
Speaker 9: really strong ebadah profiles, and growth, and so you have
Speaker 9: the fundamentals of these businesses that are almost running in
Speaker 9: a completely opposite direction of their stock charts. So it's
Speaker 9: been a really extraordinary time when you see some of
Speaker 9: the top ten MSOs retraining back to their IPO price,
Speaker 9: and yet these companies have quadrupled in sizes over these years.
Speaker 1: There are ways for states to mitigate some of the
Speaker 1: impact of Section two ADE, and Morgan points to Michigan
Speaker 1: is an example of a state that's building a less
Speaker 1: onerous tax regime even in the face of federal restrictions.
Speaker 10: Michigan has I think one of the better tax codes
Speaker 10: we've seen in our industry. So it makes it more
Speaker 10: economical right to build a business like say versus like
Speaker 10: a California that is a very expensive state. It's also
Speaker 10: a lower cost state from a real estate perspective, so
Speaker 10: it allows these businesses to get built and scaled in
Speaker 10: a much more high ROI kind of way, even with
Speaker 10: a lower price point at the flower level. You know,
Speaker 10: that's kind of like a metric we look at for,
Speaker 10: you know, kind of get a sense of where the
Speaker 10: wholesale pricing is, so I think that's an advantage for them.
Speaker 10: One unique thing about their tax code some of the
Speaker 10: other states are doing this too, is at the state level,
Speaker 10: they actually have a two ade offset, so they're trying
Speaker 10: to help limit some of that federal burden.
Speaker 1: That's translated into lower pod prices in Michigan in a
Speaker 1: growing market.
Speaker 10: Michigan is one of the most interesting states in this
Speaker 10: whole journey of the legal the adult use cannabis industry
Speaker 10: in the United States because they've had some of the
Speaker 10: most significant price compressions. So in September twenty twenty two,
Speaker 10: year over a year, wholesale prices were down forty six percent,
Speaker 10: but total adult use sales growth was positive twenty six percent,
Speaker 10: So that tells you how strong the unit growth was.
Speaker 10: But because prices have reached such a low level, we
Speaker 10: think that is a high conversion rate from the illicit
Speaker 10: market coming into the legal adult use market.
Speaker 2: But that isn't the only issue, stemming from the fact
Speaker 2: that pot remains federally illegal. While Michigan's state level two
Speaker 2: ade offset has helped, New York so far doesn't have
Speaker 2: a similar tax code when it comes to facilitating the market,
Speaker 2: there's still a huge question mark over banking services for
Speaker 2: cannabis businesses and also custodying shares of cannabis companies. For
Speaker 2: a normal business, this will be done by big custodian
Speaker 2: banks like BNY Melon or JP Morgan, but since there's
Speaker 2: so much confusion around federal versus state laws for weed,
Speaker 2: there are very few banks willing to provide these services.
Speaker 9: From what we hear from investors, it's the banking laws
Speaker 9: that really need to change, or the banking position our
Speaker 9: federal government takes toward the industry. So this plays out
Speaker 9: in a number of ways. We were just talking about
Speaker 9: the stock action around these companies, and a lot of
Speaker 9: that has to do with the lack of liquidity because
Speaker 9: they're generally on the bulletin boards right they're not on
Speaker 9: the listed exchanges, So not having access to the listed
Speaker 9: exchanges is an incredible limitter. And then there's also a
Speaker 9: lack of custody for these assets, and so that's what
Speaker 9: really keeps the institutional capital on the sidelines. We do
Speaker 9: have a very enthusiastic individual investor or retail investor base,
Speaker 9: and we know there's institutional capital sitting on the side,
Speaker 9: but that's really what they're waiting for on two ade.
Speaker 9: The way I view that is if these companies can
Speaker 9: build strong businesses, And Morgan was just talking about it
Speaker 9: with me frequently about how these companies are moving toward
Speaker 9: a free cash flow profile. That's a new thing we're
Speaker 9: going to be looking for going into twenty twenty three
Speaker 9: and twenty four. If they can achieve all of that
Speaker 9: with those tax rates, these businesses are going to look
Speaker 9: tremendous once two eighty egoes away. So I view that
Speaker 9: as just optionality to the upside.
Speaker 10: So we're looking up from a federal perspective, you're talking
Speaker 10: about banking access, which also brings custody and potentially exchanges,
Speaker 10: and then we're talking about social justice. Late in twenty two,
Speaker 10: we did see President Biden make a big step forward
Speaker 10: at the federal level, at the executive level moving forward
Speaker 10: with some of the social justice pieces. So that really
Speaker 10: does help the industry stay very focused with the legislative
Speaker 10: branches to get some kind of banking reform done. And
Speaker 10: if that should be resolved from our perspective, as just
Speaker 10: mentioning about valuations being so low, they're under priced like
Speaker 10: it is structurally at a discount, and if we have
Speaker 10: access to banking and exchanges and more institutional capital. We
Speaker 10: think there's just even repricing just to get it back
Speaker 10: to even a fair value. That is pretty significant.
Speaker 2: Of course, the scaling problem isn't just about the discrepancy
Speaker 2: between state and federal taxes or banking regulation. When it
Speaker 2: comes to growing cannabis legally, each state also has different
Speaker 2: rules and requirements that make it pretty hard for multi
Speaker 2: state operators in general to keep their costs down, since
Speaker 2: each individual state might have its own regulation about everything
Speaker 2: from growing to transporting to selling marijuana.
Speaker 3: YEP.
Speaker 1: This is something that came up back in twenty nineteen
Speaker 1: when we spoke to Craig Wiggins about how the Canadian
Speaker 1: cannabis market was developing and what that said about the
Speaker 1: potential for the US market. Craig has been a close
Speaker 1: industry observer for a long time and ran a trio
Speaker 1: of analyst called the Cannabists, and he contrasts a multi
Speaker 1: state marijuana operator with the classic conglomerate of the consumer
Speaker 1: goods industry, like Coca Cola.
Speaker 7: The regulations that have been brought in, especially in the
Speaker 7: United States, different from Canada. Canada has a fully federally
Speaker 7: legal system, so all the rules are set out. In
Speaker 7: the US, what's happened is it's been a state by
Speaker 7: state battle, usually first for medicinal cannabis and then for
Speaker 7: adult use cannabis. And the problems arise that if you're
Speaker 7: a what's called a multi state operator in the states
Speaker 7: where you're in multiple states, you've had to replicate your
Speaker 7: cultivation in every single state. You're processing in every single
Speaker 7: state as well, So it's very tough to get economies
Speaker 7: of scale when the product that you're making can't travel
Speaker 7: outside the borders. Think of Coca cola. A Coca Cola
Speaker 7: in Florida from a seven eleven tastes exactly like the
Speaker 7: Coca Cola in California from that seven eleven. The cannabis
Speaker 7: grown in Florida, the exact same cultivar strain grown in
Speaker 7: Florida and grown in California are not going to be
Speaker 7: the same. So trying to figure out what works in
Speaker 7: your state environment, and Florida's very humian, California isn't. When
Speaker 7: I look at the complexity of it, think of what
Speaker 7: you have to do in a company to change the
Speaker 7: gross margin of a large company when you have thirty
Speaker 7: five different production facilities and thirty five different cultivation facilities
Speaker 7: selling into thirty five different markets with all different pricing,
Speaker 7: it becomes very difficult. You have to steer one state
Speaker 7: at a time to your destination. So what we've seen
Speaker 7: is as these states launched, there's a lot of money
Speaker 7: to be made very early, but the decay starts right
Speaker 7: away as well.
Speaker 2: So because of the patchwork of state regulation around legal
Speaker 2: cannabis use, you can't really have a Coca Cola of
Speaker 2: cannabis because a company can't grow one product for an
Speaker 2: entire country or even a region. Each state is different,
Speaker 2: which means each market it is different. Let's go back
Speaker 2: to Florida and Florida.
Speaker 1: As Craig points out, you have to be completely vertical,
Speaker 1: which means owning every process in the pod supply chain,
Speaker 1: from cultivating to processing and selling only for your stores.
Speaker 7: Even though there's another store down the street that's fully legal,
Speaker 7: you can't ship your product there. So Florida, so this
Speaker 7: is the most extreme one. Florida is the most extreme.
Speaker 7: I think North Carolina is looking to come in like
Speaker 7: Florida right now too, which would be a shame. So
Speaker 7: there's only about fifteen major companies in Florida limited competition.
Speaker 7: Think of the capital you need to not only run
Speaker 7: your own cultivation, but run all your processing and then
Speaker 7: all your stores. And this product, as I mentioned, is
Speaker 7: not homogenious. So you're selling a product in your store
Speaker 7: your competitors selling, say it's blue Dream. You're selling Blue
Speaker 7: Dream in your store that you've cultivated the competitors selling
Speaker 7: Blue Dream in their store. It's not the same Blue Dream.
Speaker 7: And at the end of the day, the amount of
Speaker 7: money you need to fund a fully vertical operation is huge.
Speaker 7: Florida is really an outlier right now. They have zero
Speaker 7: social equity. I don't think there's been a license, a
Speaker 7: vertical license given to a social equity firm. Yet then
Speaker 7: you have Illinois. Illinois has more cultivators, and Illinois has
Speaker 7: been locked in a battle for almost three years to
Speaker 7: get the next set of licenses out. So Illinois went vertically,
Speaker 7: but you could sell your product Polesaley to another retailer.
Speaker 7: So there are more retailers in Illinois than just the
Speaker 7: vertical companies. And one hundred and eighty five licenses have
Speaker 7: been held up in court for social equity for over
Speaker 7: two years. So Illinois has been stuck at one hundred
Speaker 7: and ten licenses for almost two years there. Finally next
Speaker 7: year we should start seeing the opening or maybe even
Speaker 7: this year, the opening of those one hundred and eighty
Speaker 7: five new social equity licenses. But if you can imagine
Speaker 7: the constraints, there's a store in northern Illinois that's disclosed
Speaker 7: through one of the MSL that's doing eighty million dollars
Speaker 7: a year out of one store seventeen miles away from
Speaker 7: the Wisconsin border. Why because Wisconsin isn't legal, so you
Speaker 7: get people rolling down from there. So you have all
Speaker 7: these different models.
Speaker 2: Craig can go into the weeds for each individual state,
Speaker 2: but for many new players in the industry, it's not
Speaker 2: so simple. In New York, for example, retailers must be
Speaker 2: separate from producers, essentially banning vertical integration in the cannabis space.
Speaker 2: We'll get into this more in episode three, but for
Speaker 2: right now, it's clear to see how messy things can
Speaker 2: get for someone trying to enter and navigate the space
Speaker 2: as an operator or a grower. Since everyone's working with
Speaker 2: different laws and regulations, it has been and will probably
Speaker 2: continue to be a bumpy ride.
Speaker 7: So it's really been interesting because each state depending on
Speaker 7: what their REGs are. It's either been a sprint or
Speaker 7: it's sort of been like the Godfather, where you only
Speaker 7: have five licenses and you can do what you want
Speaker 7: as long as everyone plays nice with everybody. So it's
Speaker 7: really been a tough industry as an analyst to take
Speaker 7: a look at. Each state is absolutely different, and because
Speaker 7: you can't scale, if you're doing well in Massachusetts, it
Speaker 7: doesn't mean you're doing well in Nevada. It's really a
Speaker 7: struggle for all these companies to get into the market
Speaker 7: make their money before more competition arrives and the decay starts,
Speaker 7: and the decay usually starts when supply starts creeping up
Speaker 7: to demand.
Speaker 1: Aside from regulation, there's a more technical reason that the
Speaker 1: legal cannabis industry has been tough to crick, and that
Speaker 1: has to do with the actual growing of the weed.
Speaker 2: Now, neither of us have any personal experience doing this,
Speaker 2: but the cliche throughout recent history has been, you know,
Speaker 2: small scale growers in a basement or a closet and
Speaker 2: a set of grow lights, and the plants that thrived
Speaker 2: were the ones most suited to those conditions, and they
Speaker 2: tended to pack the most potency. We spoke about this
Speaker 2: a little bit in our first episode with Jason Wild
Speaker 2: who runs an MSO, and he described how different growing
Speaker 2: locations can create vastly different products.
Speaker 1: If something is illegal, you're not going to really do
Speaker 1: it out in the open. It seems like there's a
Speaker 1: lack of experience and larger growing operation. And while it
Speaker 1: seems hard enough to grow weed in a closet, Craig
Speaker 1: Wiggins points out that the history has had a lasting
Speaker 1: impact on the ability of the industry to scale up
Speaker 1: the actual growing of cannabis.
Speaker 7: Folks often wonder why it has been so difficult to
Speaker 7: scale the cannabis plant, and that's really because for the
Speaker 7: last three decades before it was legal, you had to
Speaker 7: grow cannabis plants fairly clandestinely if you didn't want police
Speaker 7: knocket on your doors. So you had people out there
Speaker 7: growing small batches that they like in a container, in
Speaker 7: a sea can or in a small warehouse, nothing big
Speaker 7: that would attract attention. For decades and decades, the plant
Speaker 7: has had to be grown clandestinely, and the focus of
Speaker 7: the plant has been on producing THHC or CBD, because
Speaker 7: those are the two elements that were desirable for the
Speaker 7: end consumer. So there's another one hundred cannabinoids in the
Speaker 7: plant that really haven't been bred into the plant in
Speaker 7: any meaningful way, and we're starting to see that right now.
Speaker 7: But because of the clandestine fashion, anyone who's good at
Speaker 7: growing is good at growing a certain amount. Now, when
Speaker 7: the greenhouses came along and the bigger facilities, it takes
Speaker 7: at least two years to dial in, Okay, what cultivar
Speaker 7: is going to work in this greenhouse or in this space.
Speaker 7: So you run five crops a year indoor, so you're
Speaker 7: learned five times a year, so it's always an iteration
Speaker 7: and you might have to go back to the beginning.
Speaker 7: If that particular cultivar which was really good in that
Speaker 7: sea can hidden in a forest in British Columbia, it's
Speaker 7: a little different when it's in a million square foot greenhouse.
Speaker 7: It's just not going to react the same way. So
Speaker 7: it's really about genetics, and the genetics were designed to
Speaker 7: breed smaller quantities high thhcrcbd plants until genetics catch up,
Speaker 7: and it takes time for those genetics to catch up.
Speaker 7: Until genetics catch up, the scalability will be very difficult.
Speaker 1: On the next episode of Potlots, we'll take a closer
Speaker 1: look at the illicit market for pot in New York
Speaker 1: and what it means for the states to allow legal
Speaker 1: cannabis sellers and its goal of using those licenses to
Speaker 1: make rights some of the injustices of the past. Potlats
Speaker 1: is hosted by me Joe Wisenthal. You can follow me
Speaker 1: on Twitter at The Stalwart and.
Speaker 2: Me Tracy Alloway. You can follow me on Twitter at
Speaker 2: Tracy Alloway.
Speaker 1: Follow our producer Carmen Rodriguez. She's on Twitter at Carmen Arman.
Speaker 2: Dash Ol Bennett is our associate producer. He is at Dashbot.
Speaker 1: Our sound engineers, Maples Sage Bauman is our head of
Speaker 1: podcasts and Special Things to Moses ad them.
Speaker 2: For more Bloomberg coverage at the legal marijuana industry, you
Speaker 2: should definitely check out The Dose, Tiffany Carrey's weekly newsletter
Speaker 2: about the business of cannabis and psychedelics. You can subscribe
Speaker 2: at Bloomberg dot com. Thanks for listening.