California is famous for its cyclical booms and busts: housing, dotcoms, gold mining. Guess which industry is next.
By Dan Mitchell
The dotcom boom of the late '90s is widely considered to have begun in 1995 and ended in 2001, when the boom went bust, companies dropped like flies, and workers were laid off en masse. Back then, people talked about how fast everything moved, constantly referring to "Internet time." How, then, should we measure the duration of the marijuana boom? "Cannabis time?" If we measure the California pot boom from the first day of legal, recreational sales — January 1, 2018 — to today, this boom-and-bust cycle has lasted only one-third as long as the dotcom era.
The year that ended two weeks ago was a rough one for California's cannabis industry. Comparisons to the Internet boom were made with increasing frequency through 2019, as each new piece of bad news — layoffs, companies going under, stocks plummeting — was announced. But there are big differences.
For starters, cannabis is an actual commodity for which there is a known level of demand. During the dotcom boom, nobody knew how many "eyeballs" a website might attract or what, if anything, they might be worth. And nobody knew how many people might want their groceries or pet-care products delivered to their door. (It turned out, not nearly as many as the stock touts and marketing types had promised.) For year after year, investors poured money into companies they knew weren't making any money, and in some cases — as with Pets.com and the online grocer Webvan — when they knew the companies were losing money on every sale.
Cannabis isn't like that. Margins are often razor-thin, but they're still margins — customers pay more for their pot than the retailer paid to obtain it. And the size of the market was more-or-less known before the first legal sale took place, thanks to estimates of the already existing illicit market, as well as the legal medical market. Pot is a real business, not the mere wish of one. Of course, companies that made real products to serve the dotcom boom — makers of microchips and routers, for example — mostly came out of the bust intact, and many continue to thrive. This is much like what happened during the Gold Rush, the original California boom-and-bust cycle, during which a few people made money by finding gold, but many more made money selling food, beer, equipment, or blue jeans.
Bad news about the so-called "Green Rush" rolled in slowly at first, picking up steam around the end of last summer. Stocks started to dive. Layoffs were announced. Executives who just months earlier were forecasting great riches suddenly acknowledged — mostly in whispers — the deepening gloom. Since last August, the North American Marijuana Index, which tracks cannabis stocks, has fallen by half. The problem with pot stocks isn't limited to California. It's continental: too many investors looking for a quick buck creates a bubble, as with Internet stocks in 1999, or housing in 2007. That bubble has now burst.
Some of the biggest pot companies in the world, including many whose underlying business is still growing, have lost enormous amounts of assumed value. From last spring to now, Curaleaf, a major company based in Massachusetts, has lost 56 percent of its value; Canopy Growth, based in Canada, lost about the same; Aurora Cannabis, also based in Canada, lost a swoon-inducing 82 percent.
Closer to home, Oakland-based Harborside, which went public in Canada via a so-called reverse takeover, was valued at $3.80 a share last June. As of Monday, the stock was selling for 61 cents. Edibles maker Plus Products, based in San Mateo, saw its stock hit $5.67 last February. Just short of a year later, it's trading at 90 cents.
The Culver City-based MedMen, which runs dispensaries in several states, has lost about 85 percent of its value over the past year. In November, it announced it would lay off nearly 200 employees, or about a fifth of its workforce, and restructure the company.
It's not just public companies. Right around the same time that MedMen was breaking the bad news, a whole bunch of private California cannabis businesses announced layoffs, including Pax Labs, Grupo Flor, Flow Kana, and CannaCraft. The reasons differ somewhat for each of them. Pax Labs, a maker of vape cartridges, was hit hard after a spate of serious lung illnesses and some deaths were tied to vaping across the country. The fact that most if not all of the illnesses were connected to illicit vaping products didn't matter: people became scared to vape at all, and that hurt big swaths of the industry, including dispensaries.
Etienne Fontan, co-owner of the Berkeley Patients Group and a board member of the National Cannabis Industry Association, thinks things will get worse before they get better. "Medium to small distributors are going to be this year's fallout," he predicts, citing the recent closure of Pacific Expeditors, a distribution operation in Sonoma County. "These collapses fall all along the supply chain but especially impact small farmers and producers," Fontan said. "They feel this and it will cost companies their business permanently."
We'll know things are getting really bad when we see huge implosions that go beyond companies that rushed to the public markets or otherwise overextended themselves. DionyMed Brands, based in the South Bay, was formed in 2017 as a "multi-state cannabis platform" and immediately went on an acquisition tear, borrowing millions of dollars and snapping up companies across the supply chain, from cultivators to manufactures to delivery services, including, among the latter, Berkeley-based Hometown Heart. In the meantime, it went public in Canada, through a reverse takeover. DionyMed had been partners with the San Francisco-based delivery platform Eaze, which announced its own layoffs late last year, but then filed a lawsuit against that company alleging that it was committing fraud by masking cannabis sales in order to retain credit-card services. Eaze denies the allegations and notes that, as a platform, it doesn't itself handle payments, leaving that up to its storefront customers.
To replace Eaze, DionyMed launched its own platform, Chill, to handle cannabis deliveries in the Bay Area. But just months after that operation was launched, DionyMed announced that it was in receivership and that its CEO, Edward Fields, had left the company. All operations were ceased last Monday, and the last workers laid off. It was a spectacular flameout reminiscent of some of the insane business failures of the dotcom era. (You can learn more about this in next week's issue of the East Bay Express).
At the same time, it's not like the entire cannabis industry is imploding. But parts of it are, and the industry as a whole is falling far short of what the forecasts told us. But those forecasts were made by legalization advocates and politicians intent on selling skeptics on legalization and the tax bonanza it supposedly would yield. Legalization proponents insisted that pot would put $1 billion a year into state coffers, starting in Year One. That number turned out to be just $288 million for the first fiscal year. For the second fiscal year, which we are still in, the estimated tax take will be just $359 million. Meanwhile, there are only about 800 dispensaries operating in the state, a far cry from the predicted 6,000.
But whatever the proximate reason for the cutbacks, the underlying causes are the same for the whole industry: taxes, regulation, overinvestment, lack of access to markets, and bad decision-making. Most of the industry's problems are traceable to government action or inaction.
There are two major problems: First a state excise tax of 15 percent, which is added to regular sales taxes and often-high local cannabis taxes. On top of that is the tax that pot growers pay at harvest time. In some cities, consumers are paying effective tax rate of more than 40 percent on pot that's already more expensive than what they can get from their local, law-breaking weed dealer — who has not gone away.
Second, and probably worse for the industry, most local governments remain hesitant to allow legal operators to set up shop. Nearly four-fifths of California jurisdictions have yet to issue a single license, leaving residents who want to abide by the law to either grow their own pot or, if delivery is even available to them, have it brought to their door. There are efforts afoot in the legislature to address both of these problems — to get taxes lowered and, perhaps, to force local governments to allow cannabis in. But the prospects for both efforts are uncertain at best, and it seems likely that the Legislature will seriously consider lowering the tax burden this year.
"The law is deeply flawed," said Debby Goldsberry, executive director of Magnolia Wellness in Oakland and a longtime presence in the Bay Area cannabis industry. Because of this, she said, many of California's small cannabis businesses have been closed or sold off to bigger companies. "And many people have chosen to operate in the underground marketplace, which has been thriving for 100 years in California, rather than to get involved in the complicated, near-impossible-to meet regulatory scheme."
It is now widely agreed by industry observers that Proposition 64, through which voters legalized recreational pot in 2016, was deeply flawed. "Hindsight is a great place to live," said Scott Hammon, cannabis practice leader for MGO|Ello, which provides accounting and advisory services to pot companies.
Not every flaw, though, can be pinned on any particular group of people — not even politicians. "The initiative contained compromise language right from the beginning," Goldsberry said. "It was designed to assuage the concerns of nervous voters and to make sure that big businesses, like the alcohol industry, did not get upset enough to fight it. Some of these compromises lacked common sense, surely, but more so, there were few models to follow at the time, and the designers of the original laws and regulations knew they would need to stay flexible over a number of years to create rules that would really work."
Unfortunately, Goldsberry continued, "the unseen side effect was that the underground market would continue to flourish and that the regulatory complications, and the fees and the taxes, would set the bar higher than most people, other than the biggest and most experienced companies. Lots of California small businesses are gone because of this."
Meanwhile, the continued illegality of cannabis at the federal level not only means that agents could swoop in and shut down a cannabis operator at any moment — highly unlikely now, but that could quickly change — but that it's still hard for the industry to do business. Pot companies don't have ready access to banking services, because banks would be running afoul of federal law by providing deposit services or making loans to pot companies. And of course, interstate commerce is a total no-go; any manufacturing company that wants to sell in another state is forced to "white label" its goods — that is, have their gummies or vape cartidges manufactured by someone else, and then slap their own brands on them.
If California pot companies could ship products to Nevada or Massachusetts, it would make up in a big way for the fact that so many California jurisdictions won't let them sell here.
Still, though, the problems aren't merely exclusive to government. As happened during the dotcom boom, there has been a mad rush of investors and entrepreneurs into the business, often bringing little to no industry knowledge with them. In too many cases, Hammon said, entrepreneurs don't have "real operational skills." There's obviously lots of money to be made in the California pot market, but recognizing an opportunity is not the same as exploiting it. Running a pot business — and especially a dispensary — is incredibly hard, complicated work, and profit margins are thin even in the best of circumstances. Even savvy, experienced operators have a hard time with the costs and burdens of complying with strict regulations on things like testing and labeling.
Part of the problem is that many cannabis boosters drank their own Kool-Aid. Banking on rosy forecasts often produced by them or their industry friends, they spent profligately, ignored enormous start-up costs, underappreciated the burdens of complying with strict regulations, and, in some cases, issued stock to the public too soon, usually by listing on Canadian stock exchanges. (American exchanges still won't let plant-touching businesses list at home — another outcome of continued federal illegality.) "There was a belief among investors," Hammon said. "If we get the license, the money will flow."
Of course, many dotcommers thought the same thing about domain names in the mid-'90s. It was toward the end of the dotcom boom that such hard-to-watch meltdowns started hitting the news on a regular basis. Every week or two, we read a new tale of some company with an iffy business model falling apart. Then came the stories of coke-addled lunatics partying through their workdays while burning through their capital. There hasn't been a lot of that so far in the cannabis industry. But if it starts happening with any frequency, we'll know that things are about to get worse.
No matter what form it takes, though, bad news is likely to keep coming for the next few months. And it will likely come fast. Hammon, the cannabis consultant, doesn't think the speed at which this bubble has popped is in any way endemic to cannabis. It's not "cannabis time," but, actually, Internet time. Technology has sped everything up: the time it takes to set up businesses, secure financing, acquire companies, hire people, and set up supply chains has been radically compacted. There's no reason it won't fall apart just as fast. "The whole thing has been faster," he observed, "so the bust has been faster too."
One thing never changes, however: hubris. "Everyone thinks they have it all until reality shows up," said Fontan, a veteran of the cannabis business. "Seen it for decades."