The Industry Wagons are Loaded Up and Moving East

May 2, 2023 · MG Magazine

Map of the East Coast of the USA with focus on New York and Washington D.C.

The West Coast always will be known as the birthplace of the modern cannabis industry, but the past decade has proved being a first mover doesn’t always result in a long-term advantage.

When Colorado and Washington opened their doors to adult use in 2012, followed by California and Oregon a few years later, the West Coast seemed destined to carve the landscape of the modern American cannabis industry. In many ways, West Coast companies have been an influential force, albeit not a profitable one. As more large multistate operators (MSOs) and regional startups double down on investments in the Midwest and on the East Coast, companies on the West Coast are struggling to survive a years-long slump that shows little sign of abating.

In January, an ominous press release from one of the biggest cannabis companies in the United States went out over the wires: “Curaleaf, a leading international provider of consumer cannabis products, today announced the proactive closure of the majority of its operations in California, Colorado, and Oregon, beginning this month.”

Was this a canary-in-the-coal-mine moment for West Coast companies or simply an MSO looking to “streamline its business” and invest more of its resources into operations elsewhere? Whatever the case, if current trends continue, the East Coast is poised to take the lion’s share of the legal U.S. market while the West Coast continues to battle an entrenched illicit market, exorbitant taxes, overproduction, and a highly competitive, overcrowded marketplace.

For companies big and small, the West Coast has become a tenuous environment in which to do business. While some companies are packing their wagons and heading east, others are digging in, slimming down operations, and hoping better days lie ahead.

On the national stage, analyst firm BDSA predicts legal spending in the combined medical and adult-use markets will increase from $30 billion in 2022 to more than $40 billion in 2026. The question is, how will the pie be divided between the West Coast, Midwest, South, and East Coast?

As Cali goes, so goes the nation

Despite being the biggest cannabis market in the world, California also has become the poster child for everything challenging and misdirected in the legal industry.

“California certainly is not an easy place to make a profit,” said Vince Ning, chief executive officer at Nabis, a San Francisco-based software platform that allows brands to manage their shipping, collections, payment processing, and customer relationship management (CRM) operations. “It’s a huge market that is highly competitive, and it’s certainly not a winner-take-all market. It’s a consistent slog. So if you don’t live in California and don’t continue to monitor the day-to-day movements within the market, it’s really difficult to compete with California-specific brands in such a highly competitive space.”

More than 300 brands use the Nabis platform to ship $400 million worth of products in California each year. Ning, who recently moved to New York City to focus on new opportunities on the East Coast, said his company reached profitability this year, even as many of its clients struggle to survive.

BDSA recently released its forecasts for the U.S. and international markets, and the firm sees only a modest revenue increase for the next few years in California. Analysts predicted total revenue in the state will grow from about $5 billion in 2023 to $6 billion in 2026. By comparison, the eleven-state northeastern market is expected to grow from $6.4 billion in 2023 to nearly $12 billion by 2026. For investors and operators alike, the East Coast presents a much rosier picture, especially if you’re looking at it from the perspective of a brand seeking optimized growth potential.

The limited market growth out west is one of many reasons companies are redirecting resources to more attractive markets in the U.S. and abroad. In a prepared statement, Curaleaf CEO Matt Darin explained the rationale behind his company’s decision to leave the West Coast and shift its focus to emerging markets. “We believe [West Coast] states will represent opportunities in the future, but the current price compression caused by a lack of meaningful enforcement of the illicit market prevents us from generating an acceptable return on our investments. … We remain excited about our future growth prospects both domestically and internationally, and now can devote greater resources to tangible growth opportunities in emerging markets such as Europe.”

Some of the unique factors that have contributed to cannabis companies’ struggles in California and other markets in the western part of the country include:

  • High taxes: With tax rates as high as 40–50 percent, California is a nightmare scenario for companies looking to turn a profit.
  • Product glut: The oversupply of flower and other products has precipitated a pricing race to the bottom in both the legal and illicit markets.
  • Strong illicit market: From rogue grows to unlicensed delivery services and retail shops, California has done little to diminish the size and strength of the illicit market.
  • Strict regulations: The licensing and regulatory environment for cannabis businesses always has been strict, and keeping up with changes requires diligence.
  • High business costs: When you factor in rent, labor, and compliance costs, California is one of the most expensive markets in the country to operate a business.
  • Brand saturation: With so many established brands already on the shelves, persuading a retailer to bring in a new brand means somebody else has to go.
  • Local bans: The passage of Proposition 64, which legalized recreational sales in California, allowed cities and counties to ban cannabis operations. As a result, more than half the state’s cities and counties do not allow any type of license-holder to operate in their area.

Nate Bradley, a longtime cannabis lobbyist and former executive of the California Cannabis Industry Association, said local bans present one of the biggest challenges for the industry because they prevent expansion. “I am really nervous, because the industry hasn’t done much the past four years and, honestly, they haven’t been able to expand access,” he explained. “While there are other issues, the biggest is all the local bans.”

Aside from Curaleaf, other major national brands that have left Cali recently include Florida-based MSO Trulieve and Colorado-based edibles maker Wana Brands. Even some of the most high-profile California brands have decided to put the state on hold.

Flow Kana was one of the largest operators in the Emerald Triangle, launching in 2015 with much fanfare after out-of-state investors came in with a $200-million war chest and a promise to champion small, legacy farms and outdoor-grown, full-season flower. Local growers were skeptical from the beginning, and the company never managed to hit its stride. Making matters worse, several high-profile snafus damaged its reputation with both growers and consumers. In late 2022, the company announced it would mothball its operations and look for a buyer.

Garcia Hand Picked, on the other hand, was a popular, well-respected brand that sourced from legacy farms in the Emerald Triangle. The family-run brand planned to open a Jerry Garcia-themed consumption lounge in San Francisco, but that and other projects never came to fruition as the legal market continued to struggle. In early 2023, parent company Holistic Industries announced it would begin closing its California operations and focusing instead on expansion in states including Colorado, Maryland, Massachusetts, Michigan, and Oregon.

Looking at the bigger picture on the West Coast, market analyst Headset reported the basket sizes and frequency of purchases at retail stores have been declining in the west since the summer of 2021.

Even among companies that are sticking it out, the financial picture is not pretty. TPCO Holding Corp (parent company of Jay Z’s Monogram, among others) was created through a special-purpose acquisition company in 2020. Backers Caliva and Left Coast Ventures projected combined pro forma revenues of $185 million in 2020 and $334 million in 2021. When TPCO delivered its financial results for the quarter ending June 30, 2022, it reported approximately $27.4 million in revenue during the period. In November, TPCO reported it lost $134.6 million in the three months ending September 30, bringing losses for the year to $196.6 million. The company also laid off about one-third of its employees throughout the year.

“There’s probably about 5 percent of brands on our platform with significant volume that sort of retracted their investments in California,” said Ning. This is notable, considering any brand using the Nabis platform has enough capital to invest in high-end services. “A lot of the MSOs, because they have multistate strategies, have the option to pull back from California and then enter back in at a later date. But that’s harder to do if California is your only revenue stream.”

In addition to the problems West Coast companies are having with the illicit market and burdensome regulations, it’s never been harder for them to raise the capital they need to survive the current slump. Capital raises are down more than 60 percent compared to 2021, according to financial analysis firm Viridian Capital Advisors. Likewise, the AdvisorShares Pure US Cannabis ETF—an exchange-traded fund that serves as a popular gauge of the industry’s health—is down roughly 50 percent since the start of the year.

Struggles in the Pacific Northwest

The difficult environment for cannabis companies in Oregon resembles that in California, where overproduction and a well-established illicit market have combined to cripple the legal market. Retail and wholesale prices are at all-time lows, according to the Oregon Liquor and Cannabis Commission, with prices for flower dropping to about $4 per gram on average. The year-over-year decline in prices for retail is 16 percent, while wholesale prices have fallen nearly 25 percent. BDSA Retail Sales Tracking data show legal sales in the Oregon market totaled $991 million in 2022, down from the 2021 legal sales total of $1.19 billion.

In Washington, a 2022 study by Seattle-based data-analytics firm Headset found the frequency of marijuana purchases at retail stores has been declining in those states since the summer of 2021; the average consumer cannabis purchase dropped from $34.14 in July 2021 to $31.41 in July 2022.

“No matter what license type you look at, it’s very tough right now, and there are a lot of reasons for that,” said Aaron Pickus, a public affairs analyst and spokesman for the Washington Cannabusiness Association. “It’s even worse than what the general revenue projections are currently showing, because cannabis operators have higher expenses [than other businesses] and our tax rate in this state is the highest in the country by far. The tax revenues generated in Washington from cannabis are second or third only to California, even though our state’s economy is far smaller, and that’s because of the tax rate. So, unfortunately, it’s a race to the bottom in a couple of different areas.”

Pickus explained one of the most pressing issues for Washington operators is the restriction on out-of-state investors as part of the state’s regulations. “The top priority as far as what would have the greatest impact on [license-holders] and those who work in the industry would be removing our state’s ban on access to capital,” he said. A bill to address the issue was introduced in the state’s legislature this year, but it didn’t have enough votes to advance. “Right now, Washington and Alaska are the only states that have this in place where you have to be a resident in order to have equity in a licensed cannabis business. It’s already a very economically challenging market where it’s difficult to access capital for research and development, expansion, and investing in facilities.”

Although cannabis companies and their lobbyists have spent considerable time and resources trying to reverse or amend restrictive regulations and crippling taxes, they also have discovered even small changes at the state level are difficult to negotiate due to the loss of tax revenues and other complications.

Lobbyists need to get  on the same page

Over the past few years, lobbyists on the West Coast have been busy trying to convince legislators to give cannabis companies tax breaks and other life preservers—notably, the 2022 suspension of the cultivation tax in California—but there are very few issues companies and their lobbyists have managed to rally around. And therein lies a problem.

Bradley believes one of the keys to saving the industry in the western states is for companies and their lobbyists to have a more unified vision and voice as they press politicians on specific legislation that will help operators survive the current conditions. One of the biggest issues in California is the dearth of legal retailers around the state, which has allowed illicit-market operators to claim more turf. In 2022, the California Department of Cannabis Control produced an interactive map that shows 44 percent of cities and counties allow the licensing of at least one cannabis business type, while 56 percent of cities and counties prohibit the licensing of all cannabis business types.

“If a local government isn’t listening to the will of their voters, then they should be able to have access in those towns,” Bradley said. “There should be something in place where, for example, if a city doesn’t want to allow cannabis operations, they should be forced to have a ballot initiative. I think that’s only going to happen if there is a unified voice and everyone decides we’re all going to work on this one thing.”

Bradley also explained many cities and counties are apprehensive about allowing cannabis into the mix because they are under the false impression they need to create their own set of local policies and regulations for operations. “All the consultants love to get hired to help craft these local ordinances,” said Bradley, who noted it takes one to two years and significant resources to develop local ordinances. “But right now, cities can do it like they have with alcohol, which is basically issuing businesses a conditional-use permit. And that’s good enough and saves them a lot of work.”

Looking eastward

A recent report by analysts at the Brightfield Group laid out the opportunity for cannabis companies on the East Coast and offered some tantalizing data. “Between April 2022 and January 2023, five of the nine states in the Eastern U.S. began adult-use cannabis sales, joining Massachusetts (November 2018) and Maine (October 2020),” the report notes. “With such a short amount of time between market launches, legal East Coast cannabis will have an explosive 2023, with adult-use market value expected to nearly double year over year to $3.8 billion. The growth in the east will contribute to 40 percent of the total cannabis sales growth expected in the country over the next year.”

There’s no doubt the East Coast and Midwest have become the most attractive markets for new companies, investors, and MSOs looking to expand or scale up their operations. Compared to the West Coast and states such as Oklahoma with liberal licensing regulations, the Midwest and East Coast offer numerous advantages for companies focused on turning a profit in both the short and long terms. Brightfield projected although western markets have become more mature and saturated, most of the future growth in the industry will happen to the east: “Nationwide, adult-use markets that have yet to launch are expected to account for 40 percent of adult-use sales in 2027.”

But as we’ve seen in New York, some of these states are taking an ultra-cautious, methodical approach to licensing and regulations. So all the rosy market projections might be taken with a grain of salt.

“Everybody has been given great pause by New York,” said Tom Adams, CEO of Global Go Analytics. “They’ve all been told, ‘In three years you can start selling [adult-use products], but only three stores.’ So I’m sure many of those companies will get some benefit out of being in New York, but it’s going to be much tougher than in Illinois, for instance. I think it really is a long game, and whoever thought it was going to be quick and easy, I would caution about how fast this is going to happen.”

As the East Coast markets ramp up over the next few years, companies looking to expand also will have to factor in the prospect of federal legalization. While it remains an elusive goal, federal legalization would create both new opportunities and challenges for regional and national companies, with some unexpected consequences along the way.

Currently, states on the West Coast are preparing for interstate commerce by adopting “trigger laws” that will go into effect once some form of federal legalization happens. However, some states may want to protect their in-state industries from out-of-state competitors such as mass-production flower companies in mature markets.

“With the end of federal prohibition, whether it’s tax rates or regulations—which have their own costs—it’s not going to be a switch that gets flipped overnight,” said Pickus. “People are going to see it coming, so how are the regulators and lawmakers in each state going to best help prepare the businesses in their state so they’re ready to compete across state lines? It’s going to be different in each state, just like it’s different now. In Washington, it was both a benefit and a challenge to go first, where people got to learn from things we did wrong and things we did right.”

Bradley noted federal legalization might be a panacea for West Coast cultivators that have been eager to ship their abundance of greenhouse and outdoor flower to hungry markets in other regions. But for distributors and retailers, it could be a much more complicated situation that largely will play out in the halls of Congress. So in addition to preparing for interstate commerce, the bigger challenge will be preparing for the 800-pound gorillas from other industries looking to swoop in and dominate certain segments of the market, starting with retail.

“When they eventually legalize in the next couple years, the industry is not going to be in any sort of strong place in [Washington D.C.],” said Bradley. “So when Amazon comes in and starts running bills, the big bill they’re going to run first is to clarify that people who sell alcohol can also get a cannabis sales license. Once that happens, you’re going to see Amazon come in, and the convenience stores are going to get in too. And while this might help manufacturers, the retailers are going to go. It’s going to kill everybody. You will see Amazon buy out folks left and right. And if the industry is not ready for this, if they don’t have a strong presence in D.C., they’re going to get rolled. That’s my biggest fear right now.” (Full Story)

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