3 July 2016
The Motley Fool reports
The growth of legal marijuana over the past two decades has been nothing short of phenomenal. Following the lawmaker-led legalization of medical marijuana in Pennsylvania and Ohio, half of all U.S. states now have laws on the books supporting a legal medical marijuana industry. Another four states (Washington, Colorado, Oregon, and Alaska) have also legalized the sale of marijuana for recreational purposes.
In the roughly two years since recreational marijuana hit pot shop shelves in Colorado, sales have soared to more than $1 billion on a trailing 12-month basis. In 2015 alone, Colorado wound up raising approximately $135 million via legal marijuana tax revenue and licensing fees. The industry as a whole, according to cannabis market research firm ArcView Market Research, hit an estimated $5.4 billion in sales in 2015 and could grow at an annualized rate of about 30% through 2020. You’d struggle to name other industries with growth potential on par with legal cannabis.
This growth has been viewed as an opportunity for small businesses and sole proprietors to get in on the action. While many states have set limits on the number of licenses issued, Oregon has been the best example of a free market for marijuana. Oregon has chosen to implement some restrictions on who can operate a dispensary — for example, persons with felonies and out-of-state residents can’t get a license for the time being — but otherwise has not set a licensing limit. Presumably, the added competition, in combination with Oregon’s robust medical marijuana infrastructure that existed prior to its 2014 vote to legalize recreational marijuana, could make the state the most price-competitive with the cannabis black market
How big business could take over the cannabis industry
However, investors and small-business owners aren’t the only ones keeping a close eye on the growth of the marijuana industry. Even though big corporations have kept their distance from cannabis thus far and have avoided weighing in on the issue, a 30% CAGR is bound to turn heads. My personal prediction is that the marijuana industry will, at some point in the future, cease to be a small business- and proprietor-based industry and will instead predominantly fall into the hands of big business — which is what most marijuana supporters don’t want to happen.
As it stands now, the cannabis industry has three paths it could take, and they essentially all lead to big business taking over. This “path” will largely be determined by the U.S. Drug Enforcement Agency within the next couple of weeks when it issues a ruling on whether or not to reschedule, or deschedule, marijuana.
If marijuana remains illicit, big business probably wins over the long run
Should the agency choose to keep marijuana’s current schedule 1 status in place — or, in other words, continue to designate marijuana as an illicit substance with no medical benefits — then state-level legalizations would continue, but the chances of a federal legalization would be greatly diminished, even with support for legalization growing among the public.
Keeping marijuana as a schedule 1 substance would leave in place two inherent disadvantages of operating in the marijuana industry. First, predominantly cannabis-based businesses would be denied the privilege of deducting normal business expenses come tax time. In short, they’d be paying federal income tax on gross profits instead of net profits, thus being brutally overtaxed.
The other issue stems from a lack of financial backing. Banks often want nothing to do with the cannabis industry for fear of federal prosecution at a later date. In technical terms, since marijuana is still illegal federally, doing business with the cannabis industry could be construed as money laundering. This means cannabis-based businesses are often forced to deal solely in cash, which leaves them with numerous security concerns and little chance to expand.
Big business, however, has tricks up its sleeve to get the marijuana industry booming. Big corporations have the capital to finance expansion and hiring, and they can set up (normal) complementary businesses, such as caregiving, that can allow a percentage of normal business deductions to be taken. By minimizing taxes and providing much-needed capital, big corporations could make legal marijuana work even as a schedule 1 drug.
If marijuana is rescheduled to schedule 2 through schedule 5
The clearest path for big business to dominate the cannabis industry is if the DEA takes the middle road and reclassifies marijuana as a schedule 2, 3, 4, or 5 substance. Doing so would make medical marijuana immediately legal throughout the 50 U.S. states, but it would also create a world of regulatory problems that would most likely result in high costs for marijuana-based businesses.
Moving marijuana to a schedule 2 substance, for example, would signify that it has medical benefits but is also a highly addictive substance. As such, it would come under the same close scrutiny as opioid-based drugs, turning the marijuana industry into something more like the pharmaceutical industry. With this change comes the likelihood of tight regulations from the Food and Drug Administration, including requirements for packaging and labeling approval, the need to show the FDA that the product being grown is consistent across batches in terms of THC content, and potentially costly clinical trials to demonstrate the efficacy of marijuana in treating select ailments. All of these regulations mean more costs, which could be impossible for small-business owners to absorb.
Big business, on the other hand, has the capital and know-how to work with a tight regulatory environment. A rescheduling of marijuana for medical purposes would open the floodgates for big business to use its capital and clout to dominate the industry.
If marijuana is de-scheduled
Lastly, though most unlikely, the DEA could completely deschedule marijuana and put the plant on par with tobacco and alcohol. Doing so would still place certain regulations on the industry, but costs alone wouldn’t push out smaller cannabis-based business owners. Descheduling would create the closest thing to a free market for marijuana.
However, this free market would be an open door that would allow big business to again use its deep pockets to outgrow and underprice smaller competitors. Essentially, we’d see big business do to smaller shops what retail giant Wal-Mart does to mom and pop retailers.
It’s possible that I’m completely wrong here, and we might instead see big corporations deciding to avoid the controversial cannabis industry altogether. This could create the opportunity for small businesses and proprietors to succeed over the long term. But history has shown that fast-growing businesses often attract bigger entrants hungry for a piece of the pie. While we have no clue who those bigger players might be yet, I believe it’s a fairly safe assumption that big business could come to dominate the marijuana industry in the intermediate future.
For investors, it means that there’s still no clear path to safely making money on marijuana over the long term. That could change with the upcoming DEA decision or a possible move from lawmakers on Capitol Hill (although I wouldn’t hold your breath on that last one). Until such time as we see federal-level changes, I’d suggest avoiding investment in the cannabis industry altogether.