Pubdate: Sat, 20 Apr 2013
Source: Wall Street Journal (US)
Copyright: 2013 Dow Jones & Company, Inc.
Author: Ana Campoy


DENVER - Like any farmer, Elliott Klug understands the highs and lows
of living off the land. But his crop requires a rigorous effort.

To keep output going, it is harvested every week. It is also grown
only indoors. And though you won't find this tip in the Farmer's
Almanac, his workers believe that blaring Grateful Dead songs boosts

"We were the bad guys," says Mr. Klug, chief executive of Pink House
Blooms, a 70-person operation that produces and sells marijuana to
people who have a prescription for it. "Now we are still the bad guys,
but we pay taxes."

Across the country, the business of growing pot is fast becoming
mainstream. Eighteen states and the District of Columbia have approved
the use and production of marijuana for medicinal use, including two
states, Colorado and Washington, that also allow recreational use.
That has spurred on a cottage industry of professional growers, with
an estimated 2,000 to 4,000 businesses now producing the plant for
legal purposes. Total sales: $1.2 billion to $1.3 billion last year,
according to the National Cannabis Industry Association.

But it turns out that trying to make a profit in this business is
harder than expected. When grown and sold legally, marijuana can be an
expensive proposition, with high startup costs, a host of operational
headaches and state regulations that a beet farmer could never
imagine. In Colorado, for example, managers must submit to background
checks that include revealing tattoos. The state also requires cameras
in every room that has plants; Mr. Klug relies on 48 of them.

Prices for pot, meanwhile, have plummeted, in large part because of
growing competition. And bank financing is out of the question:
Federal law doesn't allow these businesses, and agents sometimes raid
growers even in states where it is legal.

Still, a hearty group of weed producers are coming out of the
woodwork""or their basements, where they used to grow pot""to have a
go at it. That includes outfits in Colorado, which hosts the
first-ever High Times U.S. Cannabis Cup this weekend. The state passed
a new law that next January will allow anyone 21 and older to buy
marijuana from retailers, which is expected to dramatically open up a
market currently limited to some 110,000 patients with prescriptions.
Indeed, the industry publication Medical Marijuana Business Daily
forecasts a tripling in annual sales in the state in 2014 to at least
$700 million.

Already, that potential growth spurt has changed the game for Mr.
Klug, 36, who sports a long mustache and a dragon tattoo that
stretches down one arm. Four years ago, he used to cultivate about 40
plants in his basement, as a side business while he was working in
private equity. Harvests were for anyone with a prescription for pot,
which included Mr. Klug, who says he uses it for pain from a gluten

Today, Pink House Blooms is a $3 million-a-year business, with 2,000
plants in a converted warehouse in an industrial part of Denver.
During a recent tour, he discusses the operation in dry business terms
as his product's distinctive scent fills the air. Stencils of
marijuana leaves and a Pink Floyd poster adorn the walls. Potted
plants take up almost every inch of floor space, hallways included,
while workers listening to piped-in hip-hop music carefully remove
stems and leaves. Their harvest is stored in a custom-made vault, with
walls reinforced with three-quarter inch steel.

To get started on this scale, Mr. Klug says he sank more than $3
million""some of it borrowed from family""into the operation. He
says Pink House Blooms is profitable, with demand up 30% some months.
But the costs of doing business, including a $14,000-a-month electric
bill, and the need to make investments to boost production, have kept
him from making back any of the borrowed money. Producing marijuana on
an industrial level, he says, is "exciting and exhilarating" and "in a
way it's terrifying."

Another outfit, La Conte's Clone Bar & Dispensary, formed a
partnership with another marijuana firm to share some costs. But it
produced a profit margin of only 6% on revenues of $4.2 million last
year, according to Chief Financial Officer Jeremy Heidl, who says he
considers that an unacceptable return given the financial and legal
risks. To expand the business, the firm has branched out to sell
everything from smoke-free dispensers to body salves and brownies
infused with pot. Still, he says, "the economics of cannabis are so

A major drag on earnings for marijuana growers is the labor-intensive
nature of the business. Payroll can make up more than a third of
production costs, says Jason Katz, chief operating officer of Local
Product of Colorado. Managing workers is challenging too, he adds, in
an industry where many learned their trade by growing clandestinely.
His company went through six growers in three years before one worked
out. "They aren't used to being part of regular society," he says.

Costs and management issues aside, the biggest shock to most marijuana
growers has been pot prices. As the industry becomes more competitive
and there is more pot available, the price for a pound of high-quality
weed in Denver has slid from $2,900 at the beginning of April in 2011
to $2,400 in the same period in 2012 to $2,000 this year, according to
Roberto's MMJ List, a service that connects wholesale sellers and
buyers. At the height of summer demand in 2011, a pound sold for as
much as $3,900.

To be sure, some experts say it is possible to do well. Roberto
Lopesino Seidita, who runs the price list and consults for the
industry, says some growers are pulling in double-digit margins by
focusing on price, not just quality. They have developed ways to
produce large amounts of pot cheaply, and offer it at unbeatable
prices, driving hundreds of customers through the door every day.
"It's run like Wal-Mart, " he says.

Illegal growers, of course, have been producing and marketing large
quantities of marijuana""often at a sizable profit""for decades.
Most of the pot consumed in the U.S. is grown outdoors in Mexico by
low-wage laborers, with no need for lights or air conditioning, says
Jonathan Caulkins, a professor at Carnegie Mellon University who
studies marijuana legalization. And street prices for pot in places
where there is no legal outlet for it are generally higher than in
regulated markets, Mr. Caulkins says.

Toni Savage Fox, a former owner of a landscaping business turned
marijuana entrepreneur, doesn't have all those advantages. She and
other legal growers simulate summer in their warehouses with powerful
lights that can run for more than 18 hours a day. Then they move the
plants to a darker environment to encourage flowering and the
formation on the surface of its buds, leaves and stems of trichomes,
tiny resin-filled glands resembling sea anemone. That is where
delta-9-tetrahydrocannabinol or THC, the active ingredient mainly
responsible for marijuana's intoxicating effects, is

As with many plants, spider mites and mildew can wipe out a marijuana
crop. A single mistake in planting can also doom a harvest, or lower
its quality and value.

Ms. Fox says she lost about 100 plants last year when a plan to boost
weed production backfired. Ms. Fox planted about 100 seeds instead of
starting new plants from female-plant cuttings, which are normally
used to prevent pollination. But she overlooked one male seedling. It
fertilized a roomful of plants, causing their flowers to go to seed
and making them unsalable in a market where consumers demand to
examine products under magnifying glasses.

"When you're dealing with a living plant there are so many variables
that can go wrong," says Ms. Fox, who lost some $40,000 in the
operation. "We're still perfecting our growing spaces."

Ms. Fox, who sometimes wears a golden marijuana-leaf pin on her lapel,
is looking for an investor to pump $150,000 into her company, 3-D
Denver's Discreet Dispensary, to ramp up production ahead of the spike
in demand she expects next year. The more than $500,000 of her own
money she invested to convert a dilapidated party hall into a
marijuana factory wasn't enough to set up a reliable production line,
she says. Setting up growing spaces costs at least $100 a square foot,
and often twice that, industry experts say.

Though rarely in Colorado, federal agents still raid growers
regardless of state laws when the businesses are too close to schools
or lax in other ways. Last December, President Barack Obama said his
administration had "bigger fish to fry" than going after recreational
users. A spokeswoman for the U.S. Department of Justice said the
agency is reviewing the new laws in Colorado and Washington state.

There are other legal headaches. After a marijuana strain called
Bio-Diesel won a quality competition in 2009, the name started
appearing in dispensaries around Denver, says Ean Seeb, owner of
Denver Relief, the outfit that produced the prized variety. Prices are
below his, but Mr. Seeb has no way of legally challenging his
competitors; the U.S. Patent and Trademark Office won't register
cannabis-related products, he says.

While copying a name is relatively easy, obtaining the most valuable
pot varieties isn't. The chances of a seed sprouting into a worthwhile
plant are the same as those of winning the lottery, says Mr. Klug of
Pink House Blooms. Bringing in cuttings from out-of-state is illegal,
so he says his company obtained some of the 100 strains it grows from
a local grower named Charles Blackton, aka "The Lemon Man," a six-time
winner of the Cannabis Cup that is held in Amsterdam.

Offering an assortment of marijuana varieties with different flavors
and prices, Mr. Klug says, has been key to building a client base. In
the wood-and-metal displays at one of his stores, Mr. Klug offers
high-end strains such as Phantom OG for $70 a quarter ounce, and
cheaper ones such as Andy's Blue Dream, at $50 a quarter ounce.

But clever marketing can only go so far, so he continues to work on
improving quality. Instead of outsourcing trimming, or the process of
removing leaves and stems from harvested flowers, Pink House Blooms
has in-house workers he has trained to do the job for $11 an hour and
up. (He also keeps employees satisfied by selling pot at cost to those
with prescriptions.) Meanwhile, he says he still can't find a supplier
to provide large amounts of high-quality dirt at wholesale prices. He
pays just a little under retail to a company that won't deliver to his
warehouse""the company's managers don't want to be associated with a
pot enterprise, he says.

His advice for anyone who wants to become rich by legally dealing pot:
"Start with lots of money."

A version of this article appeared April 20, 2013, on page A1 in the
U.S. edition of The Wall Street Journal, with the headline: The Pot
Business Suffers Growing Pains. 
- ---
MAP posted-by: Jo-D