Weeding Out the Weak

Businesses consolidate and diversify as cannabis industry matures.

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In the small city of Independence, Jeff Ruiz is preparing to harvest the first batch of cannabis plants at his recently opened grow facility. He is also supervising the buildout of an on site retail space where he plans to sell marijuana products.

Although this is his first cannabis venture in Oregon, Ruiz is no stranger to the sector.

The CEO of Emerald Evolution, a marijuana grower in Skagit County, Wash., Ruiz applied for an Oregon marijuana grower’s permit as soon as the state started approving licenses in the spring of 2016. Ruiz finds Oregon’s cannabis regulations less restrictive than Washington’s.

For one, he can grow and sell cannabis in Oregon, a term called vertical integration in industry parlance. In Washington, businesses are restricted to either selling or growing.

“There is a huge advantage to selling our own product,” Ruiz says. “In Washington the stores tell us what they want to sell and the price.”

Taxes are also lower. Washington has an excise tax of 37% on sales of marijuana. In Oregon, the rate is 17%. The cannabis industry only became legal two years ago, but the number of pot businesses that have obtained licenses has exploded.

The Oregon Liquor Control Commission, the industry regulator for recreational cannabis, has given out more than 500 licenses to marijuana growers since it started approving permits in April 2016. More than 400 retailers have received licenses.

Demand for the product has far exceeded expectations. The state has collected $74.4 million in sales tax receipts since February 2016, more than double its original estimate.

On the face of it, the marijuana sector is booming. But the industry is also facing headwinds. Costly new testing requirements and a backlog of licensing has slowed sales since the end of last year. Anecdotally, dispensaries and growers of recreational cannabis are struggling financially. No hard data exists on the number of bankruptcies or closures, but observers expect to see an increase in companies folding or being acquired.

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To survive in this market, marijuana businesses are diversifying into other product lines, and acquiring competitors to build brand and absorb costs. Possible oversaturation is also leading businesses to be cautious about growing too fast in a potential boom-and-bust environment.

“We are just starting to see consolidation,” says Claire Kaufmann, Northwest regional director at BDS Analytics, a marijuana research firm. “We will start to see more.”

In October 2016, the Oregon Health Authority introduced new rules requiring marijuana products to be tested for pesticides and solvents. The agency struggled to keep up with a rush of applications from laboratories seeking to become accredited. The backlog created lags in marijuana products available for sale in stores.

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Around the same time, the Oregon Liquor Control Commission took over control of recreational licensing from the Oregon Health Authority. The transfer created more delays in licensing, causing retailers to miss out on sales.

Nectar Markets, a grower and retailer, is taking advantage of the financial turmoil among retailers. It wants to buy dispensaries and has reached out to owners interested in selling their businesses. The company has received more than a dozen inquiries from dispensaries seeking to sell.

“We are on a buying spree,” says Devra Karlebach, Nectar’s chief operating officer. “The more dispensaries you have, the bigger your brand.”

She claims the company has 5.8% of the recreational marijuana sales. Her goal is to own 20%-25% of the market.

Being a large player is critical to the company’s ability to absorb compliance costs and taxes, says Karlebach. The bigger you are, the more you can benefit from “economies of scale,” she says.

“People who own one or two dispensaries can’t keep up with the costs.”

Smaller businesses are looking at ways they can broaden their portfolio to survive in a consolidating market. Sarah Whitehouse, CEO of Holy Child Farms, a small marijuana grower, is planning to expand into other business lines to boost her company’s brand, such as making cannabis oils or edibles.

“As a smaller grower, it is difficult to keep up with larger players coming in,” says Whitehouse.

Licensed in July 2016, with 20,000 square feet of land used for outdoor cannabis cultivation, the business had a “rocky beginning,” says Whitehorse.

The company harvested cannabis in time for October 2016, but couldn’t find any vendors until January 2017, when the OLCC started licensing retailers. Now that there are more vendors to sell cannabis and the market has stabilized, Whitehouse is hoping to capitalize on her brand as a sustainable grower and look for ways to boost revenues.

The OLCC’s criteria for approving licenses is surprisingly flexible. It does not require businesses to have a minimal amount of capital to start a cannabis venture. Instead, the agency is more focused on checking for criminal activity and that the applicant conforms to local land-use planning laws.

The large number of growers the OLCC has licensed is already stoking fears. Growers expect prices will soften for certain strains. Ben Nadolny, owner of Fox Hollow Farms near Eugene, expects to see a glut of indoor- and outdoor-grown cannabis at harvest time in October and November.

“You will see price ticking down,” says Nadolny. “By then we will also see more indoor producers.”

But not everyone is concerned about oversupply. The OLCC has no plan to impose a cap on the number of licenses it approves, says Mark Pettinger, an agency spokesperson.

“We realize there is a finite market, but the boundaries have yet to be determined,” he says.

The demand for marijuana licenses is so high, the OLCC has sought permission from the Legislature to double the number of staff on its cannabis team.

“To continue the pace of licensing, we need to increase our staff,” says Pettinger.

The agency has 37 employees doing cannabis-related work. Ruby McConnell, operations manager and co-owner of Full Circle CO2, a maker of essential cannabis oils, says dispensaries are “hungry” for product.

“The market is nowhere near saturated,” McConnell says.

As a cannabis processor, Full Circle CO2 is in a less competitive area of the sector than growers and retailers.

The OLCC has so far licensed 92 processors, less than one-fifth the number of growers. After all the industry upheaval there are signs the market is starting to mature. As business owners start to understand the costs of running a marijuana venture, those that are moving forward are doing so step by step, say observers.

“There is a cautioning. People are starting to move more methodically,” says McConnell.

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Yerba Buena is another business taking it slow. The Hillsboro cannabis farm was a grower of medicinal marijuana before the plant became legal for recreational use. It received a recreational grower’s license in April last year. Now the company is waiting to see how the market will evolve before planning to expand.

“We have only been able to sell flower since October, so we’ve essentially only been in business for six months,” says Laura Rivero, operations manager. “While we may expand strategically in the future, for now we are focused on day-to-day execution and refinement.”

In a market where everyone is a startup and relatively cash poor, businesses will inevitably fall by the wayside. Those that survive will be the ones that can provide consistent and quality product. Time will tell which businesses get weeded out and which ones flourish.

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