This Post will cover the current trend of operator failure in legacy states, as well as the related trend of successful operators moving east with IP licensing contracts and co-packing agreements.
Current State of the Industry
The Cannabis industry in California is in turmoil. Total sales are down YOY, while the cost of labor and materials continues to climb. Operators are failing at alarming rates and the lack of access to the protections afforded under the federal bankruptcy code exacerbates an already untenable situation.
However, there is hope, there are successful operators in the State that are using the circumstances to their advantage, buying assets for pennies on the dollar while moving their brands east through IP licensing deals. These circumstances also pose an intriguing opportunity for those with capital and a desire to operate.
California might just be one of many states that allows its residents access to cannabis recreationally, but it is the State which leads the country in sales and cannabis culture. It also has the most established industry, with the greatest pool of both experienced talent and genetics of any legal jurisdiction. Consequently, California tends to dictate the trends that end up reverberating throughout all of the legal markets. If that trend-setting status remains, California should serve as a dark portend to operators in other States[1].
The State, for its part, is attempting to aid its cannabis industry by reworking some of the most burdensome of policies. While they continue to impose operational restraints while exacting exorbitant fees, the California Legislature has eliminated the flat Cultivation Tax and capped the excise tax at 15%[2].
This move, sadly, has been too little too late. In years past operators could have secure equity investors to provide capital for operational expenditures, but cannabis investors are seeing returns dry up, and have shown they have little to no appetite to continue down the road they have. Operators therefore have to rely on expensive debt to bridge the gap.
Downward Spiral
However, many have already begun to default, having been saddled with leverage for too long during a retraction in the market. As these operators watch their businesses fail, they do what anyone would do given the circumstances, they liquidate their stock. As more operators are forced to liquidate, high-performing operators will have to drop their prices in order to compete, thus forcing more of them into default. This vicious cycle has just gotten started, and it will continue to feed into itself until enough operators fail and the landscape begins to thin out.
Clearly, the set of circumstances operators find themselves in in California presently are quite abysmal, and likely getting worse[3]. Although, there are green pastures.
How to Win in This Market
The relatively closed markets of the limited license states pose a unique opportunity for established California brands. If they can pick the right partner in another state, one that will follow their guidance and produce a uniformly quality product, they can license their IP into that state and take advantage of a dearth in retail brands, coupled with a smaller playing field with substandard genetics.
Scant few California brands have the requisite standing in the industry and financial bedrock to push east however. Only those Operators that are producing positive EBITDA, who have winning SOPs gained from years of hard work and failure, as well as enough brand equity to push their product east and sell volume at a premium. Capital-light growth is the only path to success when capital is nearly impossible to come by. The operators that can jump states, must do so quickly, and KLV Consultancy can help.
[1] https://www.cannabisbusinesstimes.com/article/surviving-is-thriving-california-cannabis-market-graham-farrar-glass-house-brands/
[2] https://www.natlawreview.com/article/california-governor-signs-law-cannabis-tax-relief-bill
[3] https://mjbizdaily.com/regulatory-changes-threaten-californias-ailing-cannabis-industry/
