Reefer Madness

It might surprise you to know, but I am pretty big believer in cannabis (though not a personal user). There is a growing body of research that suggests that it has a major role to play in pain management and a variety of severe neurological conditions. I am also a big believer in legalising marijuana because I have seen first hand what the effects are of the drug trade – having “shirt tail” relatives that live in one of the US-Mexico border towns where violence and corruption is nothing short of extraordinary.

However, just because I would rather exchange crime for taxable revenues, doesn’t mean that I think it is a good business to invest in. Sure, there are a lot of people making big bucks in California and Colorado on the back of an accessible (but highly regulated) market for weed. I am sure that in due course we will see industry consolidation in states where recreational marijuana use is permitted and it’s probably just a matter of time before someone like a Diageo or Suntory decides that perhaps philosophically there isn’t much difference between selling scotch and selling dope.

But medical marijuana is a very different beast and – in my opinion – it’s not as exciting as it sounds. Today’s article in The Australian (“high hopes for medical marijuana trials“) about the business opportunity for medical marijuana in Australia does a nice job of highlighting some of the challenges of what is – in my opinion – an over-sold opportunity. The challenges as I see it are:

1) Scaling a business that provides “added value” medical marijuana products (I will elaborate that in a second) is going to be tough unless you really can capture a portfolio of government licenses that aggregate into something significant. The licensing of grow-ops and production facilities is going to be highly controlled and politically sensitive for a while yet, so don’t expect to see a lot of cross-border (including interstate) movement of product. No doubt the desire to capture taxation revenue is already having a major effect on this dynamic. In practice, this means that the ROI for a license can be very tough – for example, a Victorian license might only create a total addressable market of 50,000 patients. That’s a lot for a proprietary cancer drug, but not for something like this.

2) I’m not sure about the added-value part of “technology” solutions. The reality is that we have been packaging, delivering and managing “controlled” substances for a long time and the technology base to support the industry is mature. That’s a plus for patients, by the way, because it means that there aren’t a whole lot of opportunities to jack up the price through proprietary solutions. Or, put another way, there is plenty of technology available to make good quality cannabis products available at a competitive price.

3) “Competitive” is a key word. Governments will have to allow several licenses in order to avoid monopolistic behaviour and to ensure that there is discretion to adversely administer licensing privileges without interrupting supply. This is going to mean that no matter what the demand is, there is always going to be significant price pressure / erosion. Drugs that have long-term use profiles (as would be the case for medical cannabis products) are always more price sensitive anyhow.

4) Regulation is a massive overhead. No matter how you cut it, medical marijuana is going to be essentially a generic drug market from the outset, but it is going to have an additional burden, namely the challenge of growing, extracting, processing and delivering (assuming a fully vertical solution) a controlled substance. This is not an earth-shatteringly new concept, but it is does result in a higher COGS and a higher risk profile.

In my opinion, the correct investment lens for medical marijuana is that of a medium-value agribusiness. I say medium-value because the CapEx, operating costs and regulatory/compliance burden is non-trivial. Can money be made out of it? Absolutely. Can technology help? Certainly. But it also doesn’t mean that a firm like MMJ Phytotech (ASX : MMJ) deserves an eye-watering market cap and pharma-like multiple because it is a “drug company”.

It will be interesting to watch it play out.


Image courtesy of Reefer Madness.

 

One thought on “Reefer Madness

  1. My prediction is that retail investors will love the story and institutional investors won’t touch it. Any drug company of genuine value is a take over target. I can’t see any of the big pharma touching this one. Variants on thc (without hallucinogenic potential ) that can be patented might be another story.

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