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Regulators - Mount Up

January 15, 2019

Greetings,
 
Happy New Year! Before plunging into 2019 (border walls, Fiji water, and Bird Box memes, anyone?), let’s celebrate another momentous year in the cannabis industry. 2018 began with California’s launch of recreational cannabis, creating one of the world’s largest such markets. Later, we saw a series of industry “firsts”, including a cannabis-derived, FDA-approved drug; a cannabis IPO on a major U.S. stock exchange; and a midwestern state legalizing recreational use (Michigan). Finally, the year ended with hemp – the low THC “cousin” of cannabis – being removed from the DEA’s list of banned substances.
 
As we gaze into our crystal ball for 2019, let’s revisit one of 2018’s most exciting stories – the recreational legalization in California. A recent article in the NY Times offered a harsh rebuke of the rollout, citing declining sales in 2018, bitter disputes over regulation and taxes, and a thriving black market. Similarly, the LA Times reported on the slow and tedious licensing process as well as the large number of municipalities that banned cannabis sales outright. To put it simply, they think California mucked this up royally.
 
After reading these articles and tallying our own experiences, we sadly could not agree more. Furthermore, we’d like to pile-on with our own grievances, especially the fluctuating rules on packaging, product formats, testing, logistics …OK, you get the idea.
 
But, before we quit and open an avocado toast stand, let’s consider the case for California cannabis again. First, the “disappointment” cited above needs context. The year-one targets ($1B tax revenue; 6,000 retail stores; etc.) were political campaign promises, not business forecasts. Second, to us, the cannabis industry has always been a long-term investment opportunity, as new and highly-regulated industries take time to find a balance among consumer, government, and corporate interests. This is further complicated by California’s sheer size and enormous black market (e.g. 15.5M lbs produced annually versus 2.5M consumed). However, we believe the regulatory wind is now at our backs, with slow and incremental improvements likely. Third, California has global cache as the “home” of cannabis (+90% of the world’s popular strains originated within the state). This, plus its long history of production and consumption, gives California a unique advantage from which new, powerful brands will emerge. Fourth, unlike so many industries today, the strict regulations of cannabis have prevented both over-the-top technology platforms from swiftly dominating the market as well as high retail concentration. This, in turn, has left tremendous market power/influence with individual store owners, creating a big opportunity for suppliers willing to do the “hand-to-hand combat” of grassroots brand building. Fifth and finally, the slower year-one results may cause enough heartburn for investors and entrepreneurs not truly committed to the industry to tap out. We wish them good luck with their avocado toast stands.
 
Add this all up and we think California is still the most compelling place for cannabis investment. For sure, this is not Canada, with fast-moving capital, eye-popping valuations, and quick-flip schemes. Instead, we see California as home to the leading brands of the future; modern and responsible supply chains; and solid brick-and-mortar retail that leverages the state’s unique cannabis culture and know-how. To make this long-term strategy work and survive the inevitable regulatory speed-bumps, however, companies will need knowledgeable and nimble management teams, well-capitalized balance sheets, and, of course, patient investors. This, in a nut shell, is our strategy at Presidio View Capital.
 
Thanks for reading and we look forward to providing you with more industry and business updates in the coming months. Until next time, please hug your local cannabis regulatory official – they’ve got a big 2019 ahead. In the immortal words of Warren G, “Regulators, Mount Up!”
 
Cheers,
Mike and Kip
Co-Managers, Presidio View Capital

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