Barbarians at the Gate

Powerhouse companies in other industries are eyeing the profits and potential of cannabis, laying down plans to enter – and forever change – the business

by Tony C. Dreibus

Brace yourselves, cannabis business owners: They’re coming. Big industries ranging from tobacco, pharmaceuticals and agriculture to alcohol, technology and even insurance are poised to enter the marijuana space. In fact, some large companies are reportedly quietly drawing up cannabis business plans for the future or kicking the tires on the marijuana industry in preparation to do so down the road.

While a company may one day emerge as the Marlboro, Pfizer or Anheuser-Busch of cannabis, one hasn’t yet stepped forward. That shouldn’t come as a surprise considering cannabis is still federally illegal, few banks will do business with marijuana companies and less than half of U.S. states have legalized it for medical or recreational use.

But it’s not a matter of if some of these industries will invade, it’s a matter of when, experts say.

Cannabis sales hit an estimated $2.1 billion to $2.6 billion in 2014 and are expected to double in the coming years, according to estimates in the Marijuana Business Factbook. With a billion dollars in revenues expected in Colorado alone this year, large corporations will eventually follow the money and turn what is now mainly a highly fragmented craft industry into one where big companies rule and smaller players get pushed out.

When they do, the mom-and-pop shops that populate the cannabis space will find it challenging to remain small and independent – but they’ll also have new opportunities to grow into larger companies, partner with big firms or sell out to the highest bidder.

“When they come in, they’re going to come in big and strong,” said Patrick Basham, a Cato Institute senior fellow, former leader of the Fraser Institute’s tobacco research and the executive director of the Democracy Institute, a non-partisan public policy organization. “There’s research going on and there’s money being spent.”

Secrecy and Denial

Companies in other industries often won’t even admit that they’re interested in cannabis. Big Tobacco, for one, flat-out denies it wants anything to do with the marijuana industry, an assertion that Basham says is nonsense. The reason these companies deny their interest in cannabis is because the nascent industry is still considered a “public pariah,” he said.

Outwardly, tobacco giants and other large companies don’t want to be seen making a move into an industry that is still out of favor in many circles. But what they can’t deny is the potential for profitability and the ever-improving public perception – the exact opposite of where tobacco is heading, especially if marijuana is in some form decriminalized federally.

“They correctly see in a number of years the entire country is going to either have legal or de facto legalization of marijuana, so there will be, in effect, a national business and a national customer base that’s above-board, and they don’t want to miss out on that,” Basham said. “They’re astutely planning for the future but for PR reasons they’re terrified of letting the world know that’s what they’re looking toward.”

Tobacco companies vehemently denied interest in cannabis in the 1970s, when legalization appeared a possibility. But recently unearthed documents reveal that some of the largest players were indeed developing plans to enter the industry.

Not everybody is convinced marijuana will be invaded by tobacco companies. Instead, alcohol or pharmaceutical firms are more likely to move in, said Zack Hutson, a spokesman for the private equity firm Privateer Holdings, which just added PayPal co-founder Peter Thiel to its list of investors.

“We actually don’t think that (tobacco) will be interested in the space the way alcohol or pharma might,” Hutson said. “Tobacco companies are in the addiction business and that’s not what cannabis is about.”

But even alcohol and pharmaceutical firms are reluctant to discuss the cannabis industry, let alone reveal any interest in it.

Still, experts and those close to other industries say these companies are indeed exploring opportunities – and in fact that they’re making a huge mistake if they aren’t.

“The tobacco companies may deny even thinking about it, but they have to think about it,” Gerry Sullivan, portfolio manager of a fund that invests in alcohol and tobacco stocks, told The Los Angeles Times in 2014. “It is an opportunity to diversify their business and help benefit shareholders”

That doesn’t mean they’ll come in overnight. It will likely take the government decriminalizing marijuana before a large corporation moves into the space, as none are willing to put up with so much risk for, in relative terms, a marginal return, Hutson said.

Instead, it’ll be institutional investors such as Thiel’s Founders Fund that will move into the industry. As they do, Wall Street will take notice, analysts will begin covering the industry to determine worthiness for their investors, and then larger corporations will arrive.

“It’s inevitable that a Fortune 500 company will move into this space but it’ll take the end of federal prohibition,” Hutson said.

The Evolution of the MJ Industry

Founders Fund partner Geoff Lewis said in a Forbes article that the marijuana industry “will shake out similar to the alcohol or soft-drink industry, where economies of scale are very important.”

Because of that, the first investors into the space are very well-positioned, he said.

While it may look like the alcohol or soft-drink industries, it’s unlikely soft-drink companies will delve into the market, however. At the Consumer Electronics Show in Las Vegas earlier this year, rapper Snoop Dogg said during a panel discussion that by investing in or allying with a marijuana company, large mainstream firms could keep their brands fresh.

A Pepsi executive on the panel, when asked if the company would be entering the marijuana space, simply said the business produces non-alcoholic (and therefore non-intoxicating) beverages and snack foods.

The cannabis industry may develop more like the alcohol trade, in which states regulate distribution and consumption laws. The burgeoning cannabis space already draws parallels to alcohol.

Their beginnings were the same – during Prohibition in the 1920s and early 1930s, people brewed beer and spirits in their basements or in outdoor stills, much like the illegal marijuana trade has done for decades. After Prohibition ended in 1933, the people who made alcoholic beverages in the shadows emerged, creating a bit of a cottage industry, also similar to today’s cannabis industry.

Under the 21st Amendment, which repealed Prohibition, the alcohol industry was set up as a state-based system, which means every state has different rules. The alcohol trade also is divided into three sectors: production, distribution and retail. Producers must sell to distributors, which then must sell to retailers.

Craft brewers in the 1930s were stymied by government regulations that restricted trade, much like what small cannabis growers are facing today, said John Conlin, the president of Conlin Beverage Consulting Inc., which provides management consulting services to beer, wine and spirits distributors across the country. Conlin is also in the process of co-founding a cannabis-infused edibles company.

“Most of the craft brewers were home brewers and hobbyists who did it out of love,” Conlin said. “They saw some opportunities and started small brew pubs … and said ‘This is our industry.’”

Sound familiar? Eventually the liquor industry was incorporated by large conglomerates that are despised by today’s home brewers. Still, a state-regulated, three-tiered market is better than a prohibition market, Conlin said.

Given time, that same thing will probably happen to the cannabis industry, but there will be differences.

For one, the marijuana industry will leave out the middle-man – the distributor – because there’s no need for someone to store marijuana and ship it in large trucks like beer. In fact, some states require growers to sell a percentage of what they grow and retailers to cultivate a certain amount of what they sell.

Also, it’ll likely never be sold in convenience stores despite some overly optimistic forecasts, Conlin said.

“People are saying ‘We just want to bring marijuana to the masses,’ but it’s a regulated product and it should be a regulated product,” he said. “It’s not a can of peas, and it shouldn’t be treated like a can of peas. The thought that it should be sold in convenience stores does a lot of damage to the industry because the anti-cannabis crowd grabs hold of things like that.”

Pharmaceutical Already In

While big tobacco and alcohol companies could potentially move into marijuana, pharmaceutical firms already have. It’s a natural fit, considering cannabis is legal in medical form in nearly half of U.S. states and the District of Columbia, and the federal government has now essentially said it won’t spend money interfering with states that have legalized marijuana.

GW Pharmaceuticals, a U.K.-based company listed on the Nasdaq, is developing medical marijuana strains to treat certain diseases and ailments. Its products include Sativex, approved to treat pain caused by multiple sclerosis in 27 countries. The United States is not one of them, but the drug is going through Phase III clinical trials in the country for treatment of pain caused by cancer.

Several other small pharmaceutical companies are making cannabinoid-based treatments for various diseases and illnesses.

Big companies aren’t far behind, said Judi Grupp, the managing partner at HealthAtlas Innovation Inc., who analyzes the impact of MMJ on medical models and develops auditing systems for state medical-marijuana oversight. Grupp has more than 25 years of product and program development for pharmaceutical manufacturers and pharmacy benefit managers.

Large pharmaceutical companies will eventually seek FDA approval for various drugs. They already have a leg up on their smaller competitors because they have billions of dollars to invest in product development and the technology to grow the plant in a large-scale, sterile environment. They also can synthesize plants rather than grow them live, making for a more consistent product. And they’ll be able to use successful research studies, setting them up for success, Grupp said.

First, however, these companies will need to successfully replicate plants in the lab and see some successful trials, which will require rescheduling by the government of cannabis from a Schedule I to a Schedule III drug, she said. And market adoption will be key, of course.

In general, pharmaceutical companies are seeking “blockbuster” drugs that treat pain to really gain acceptance.

“Pain is the blockbuster market,” Grupp said. “Healthcare is experiencing an epidemic of opioid issues and health plans are demanding help.”

Enter cannabinoids.

While some large companies may be wary about working with marijuana, the dollar signs will eventually become too attractive for them to simply ignore its medicinal properties.

“Pharma has struggled to find new blockbusters recently,” Grupp said. “They need this.”

Big Ag Waiting, Watching

Technically, the cannabis industry is agriculture. The fundamentals are the same: Plant a seed in soil, add water, nutrients and sunlight … and voila, marijuana plants sprout.

But it’s not even close to being on the same level, with regards to growth, as commercial agriculture. And that probably won’t change for a long time, said Jon Kozlowski, a sales team leader at Growers Supply in South Windsor, Connecticut, a maker and seller of greenhouses for agriculture production.

While suppliers of items such as greenhouses and grow lights are already in the field, it’s unlikely multi-national firms including John Deere and Syngenta will jump in at this point because there are simply too many risks involved. They will join the fray eventually, Kozlowski said, but it’s going to be a long time down the road thanks to an unfriendly regulatory environment and a lack of efficiencies.

“They’re waiting for a company to perfect the technology, and right now we’re so far from perfection of growing this crop that there’s too many question for big businesses to hop in with both feet,” said Kozlowski, who has farmed fruit and vegetables and made wine for the past 15 years. “Everybody I talk to has 10 different ways of growing and they’re using 10 different nutrients and 10 different lights. The industry is in such a stage of infancy, it’s literally coming from underground into the light.”

Because the industry is so young, commercial cannabis cultivators lack efficiencies and automation found in more established agriculture and horticulture ventures such as tomato and flower production.

Yet that’s not a bad thing, especially for small businesses, because it offers a lot of room for growth, Kozlowski said.

Eventually, growers will find better, less-expensive ways to make higher-quality medical or adult-use marijuana, he said. When that happens, those cottage growers will likely be purchased by a larger company that’d been waiting for the industry to develop, and those companies will then be purchased by the largest agriculture companies.

“We have to wait to hit that level in the industry, and when we see that level of efficiency and automation, and see some changes in legislation, big business is going to look at it and say ‘We can use this model and these techniques and it’s going to be a safer investment for us,’” he said.

Parallels in Organic Industry

Ben Cohen, the co-founder of Ben & Jerry’s Ice Cream, sees cannabis shaping up like organic foods. Similar to the marijuana industry, organic food had humble beginnings, with a few small farmers cultivating crops on small plats of land. It was started by what he calls “true believers” who had entrepreneurial aspirations.

Eventually large multinationals moved in, acquiring some small businesses along the way. It’s now a massive industry: revenues last year topped $35.1 billion, according to the Organic Trade Association.

Some small organic companies have stood the test of time thanks to a loyal customer base, unique products and a strong business model – and that’s the way marijuana is shaping up, Cohen said.

“At first the big food companies were fighting it, then they realized ‘oh man, there’s money to be made here,’ and they ended up buying out these small entrepreneurs,” Cohen recently told Marijuana Business Daily™. “That’s what I see happening in your industry.”

But it won’t happen overnight.

Large corporations aren’t going to risk money on products that can only be sold in a few states. Instead they’ll probably wait until cannabis has been legalized more broadly, he said. And big companies aren’t innovative. They tend to take time to make a move into a new industry and would rather buy up some small companies rather than wade into untamed waters.

“I would tend to think that’s the way it’s going to go in the marijuana industry,” Cohen said. “One of the small companies that’s based now in Colorado or Washington (State) is going be successful, or likely more than one will be successful, and a few will rise to the top. I think that those companies will just start distributing product in other states as it becomes legal, and eventually they might get acquired by a bigger company.”