Investment Opportunities In The Marijuana Business

cannabis-investmentHundreds of Millions of dollars are pouring into the legal (or at least semi-legal) marijuana industry. Is it too much investment for the market potential? Here are the critical issues to consider.

Current Marijuana Users Already Have Their Suppliers

Let’s say that you smoke or otherwise consume marijuana with some regularity, at least once a month. You have a source. It’s always a challenge to get a buyer of any product to change to a new seller. Very few current users will be eager to switch just because the old supplier is not legal.

Lower prices could induce some switching, but legality does not always mean cheapness. In Washington state, the taxes pile on at 25 percent of every sale, all through the supply chain. Think about what would happen if your bread were taxed the same way. The farmer sells wheat to a grain silo and a 25 percent tax is paid. The silo sells to a miller and another 25 percent goes to the government. The miller sells to a baker and another tax is collected. The baker sells to a grocery store and the tax is paid again. Finally the store sells to a consumer and a final tax is paid. That’s 25 percent compounded five times, which amounts to a 205 percent tax (1.25 raised to the fifth power, minus one). It’s no wonder that early reports found that in Washington, legal marijuana cost twice as much as illegal pot.

Other tax structures would not be so onerous. Oregon’s new law is likely to bring prices down by 20 percent, according to estimates from a good report on the subject by Robert Whelan of ECONorthwest, “Oregon Cannabis Tax Revenue Estimate.” This estimate is more a ballpark figure than a finely tuned projection, but it validates the concept that there’s room to bring down prices while the state collects taxes. (Whelan’s report does such a good job of outlining the issues that it should be studied by people outside of Oregon considering entering the business.)

Washington_Cannabis_Estimate

 

A significant price drop will move users from old suppliers to new ones. If the new suppliers are also more convenient, the switch will be faster. That’s likely to be the case, Whelan notes, in larger cities, but less likely in rural areas or suburbs which prevent marijuana stores from locating.

The price reduction will not only shift existing consumption to legal channels, but it will induce greater usage by customers. Think of consumers in three categories. The first will use cannabis with little concern for price. The third group will never use cannabis. In the middle, though, are people who are sensitive to price. On Friday night they ask themselves, beer or weed tonight?

Some current marijuana dealers will cut prices to match the competition, while other dealers will probably go out of business. There’s no doubt that some consumption will switch to legal channels, and tax records in Washington and Colorado verify this.

Potential investors should consider this price drop when valuing business opportunities. Price changes often occur with time lags, so don’t expect today’s pot prices to be tomorrow’s.

There Will Be Some New and Returning Marijuana Consumers

Legality will probably mean some new customers, including some who smoked marijuana in years past and will return to usage. For some, legality may be significant, but for more of them, ease of access will probably predominate. Many of us Baby Boomers have fond (though dim) memories of smoking grass, but we have no clue how to buy it today. Whelan’s analysis rolls through the issues involved, pulling estimates for critical parameters from a variety of research studies. There will probably be some baby boomers who return to occasional use, but it’s unlikely that legalization will mean a huge rush back to pot.

As for the Baby Boomers, don’t forget that they are increasingly active in their gardens. It’s easy to plant some marijuana in between the tomatoes and the petunias.

A number of workers face drug testing at their jobs, 17 percent of Oregon’s population by Whelan’s estimate. (Oregon’s legalization explicitly lets stand current rules allowing employers to test for drug use.) Workers in licensed occupations—30 percent nationally—may be cautious about marijuana for fear of losing their ticket to work.

Legality may attract some brand new users, but given how common marijuana is in high schools and colleges, it’s hard to believe that there are many who would like to give it a try who have not already had the opportunity.

Investment Play

If nobody else were investing in the marijuana business, I’d heartily recommend going into it. However, with hundreds of millions of dollars flooding this sector, it’s a much harder call. The legal business will certainly expand, but it’s unlikely to boom. Current users have their suppliers, who will probably drop price somewhat to get into the ballpark of legal sources. There will be a few additional users—most likely baby boomers—who start purchasing pot for the first time in years, but they will add only a small dollar volume.

Probably the best current investment play would be to anticipate a slow growth period. A company would lay the groundwork to be the preferred brand (either product or retailer or supplier to the industry). Near-term profits would be ignored in order to dominate some aspect of the business, setting up future profits as the legal part of the industry expands. This is a risky bet—it’s hard to ensure becoming the dominant brand, and it’s possible that you would be displaced before the sector really takes off. Nonetheless, it’s probably the best possible play out there.

Finally, investors might consider that the federal ban is going to be lifted. Eventually politicians will recognize that many voters favor legalization, and legality will be devolved to the states. Kansas will probably keep it illegal, but many other states will allow it. That means we’ll have marijuana plantations and national brands. This won’t happen tomorrow, but it’s certainly coming.

Bill Conerly Contributor –  Forbes.com – 3/27/2015