Pubdate: Wed, 19 Jun 2013
Source: Worcester Telegram & Gazette (MA)
Copyright: 2013 Worcester Telegram & Gazette
Contact:  http://www.telegram.com/
Details: http://www.mapinc.org/media/509
Author: Peter S. Cohan

PUNDIT POO-POOS POT'S PROFIT POTENTIAL

Wall Street is promoting venture investment in marijuana-related
start-ups.

But Mark A. R. Kleiman, professor of public policy at UCLA and a
consultant to the state of Washington on implementing its marijuana
law, says that when it comes to pot, it's risky to invest in companies
that produce it and to promote investment in those companies.

Unless you attended the June 14 Wall Street conference run by San
Francisco-based ArcView Investor Network, a group of entrepreneurs
looking to invest in legal cannabis companies, you missed the chance
to hear pitches from 18 cannabis start-ups. Those 18 start-ups do not
grow or sell marijuana, but they sell growers the equivalent of the
gold rush's picks and shovels -- providing security, lighting and storage.

Not surprisingly, Troy Danton, ArcView's chief executive officer, is
very bullish on the opportunity to invest in the marijuana industry.
Mr. Danton told the New York Times, "This is a historical moment. [The
cannabis industry now is like dot-coms were in the middle 1990s.]
We're announcing to Wall Street, this is the real deal."

Mr. Kleiman, co-author of a book on marijuana legalization, believes
that promoting investment in the marijuana industry -- while
potentially fraudulent -- at least has the benefit of a more
industry-friendly regulatory apparatus than do those who grow marijuana.

To be sure, Mr. Kleiman noted in a June 15 interview, "Colorado and
Washington State -- representing 6 percent to 7 percent of the total
market -- are legalizing commercial production of marijuana."

The Times notes that a total of 19 states have legalized the use of
marijuana for medical purposes, but Mr. Kleiman argues those 19 are
quite different.

"Colorado and Washington soon will have state-legal non-medical
cannabis. Those two plus California and Oregon (and formerly Montana)
have such wide-open medical access laws as to amount to virtual
legalization. The other medical-marijuana states have tight rules and
relatively few users," he said.

But marijuana is illegal at the federal level -- creating confusion
about whether federal or state law will be applied in different situations.

"There's no legal doubt about which laws apply. Federal legislation is
the law of the land. The question is about how the feds, with sweeping
legal powers but limited manpower, will coordinate with the states
where state law allows what federal law forbids," explained Mr. Kleiman.

Mr. Kleiman thinks marijuana will be legalized at the federal level
"in Hillary Clinton's second term" -- by which he means between 2020
and 2024.

This confusion got a California marijuana grower in big trouble. As
Mr. Kleiman explained, "I know of a grower in California who was
grossing $8 million a year and complying with state law while paying
taxes. Federal authorities stumbled across his operation after two men
were spotted breaking into his warehouse. The police said they smelled
marijuana plants. Federal agents conducted a raid and confiscated
1,962 plants and 200 pounds of marijuana. Now he is facing the
possibility of five years in prison."

The twin risks that grower faced -- the risk of going to prison and
the risk of investing, say, $1 million in a growing operation and
having it wiped out by vandals -- suck the profit out of the growing
business.

Mr. Kleiman believes that there is no legal risk and could be decent
profit potential for operators of industry trade journals and Consumer
Reports-like web sites. An example of such as site is "Leafly, a Web
site that allows users to review medical cannabis strains and
dispensaries," according to the Times.

However, once growing pot becomes legal, most of the profit will be
let out of the bag.

"Marijuana is a $35 billion a year industry at retail. But 99 percent
of that value is the price of buying an illegal substance. Once pot
becomes legal, it becomes a $350 million a year industry based on the
estimated price to growers -- a commodity with thin margins that is
akin to selling tea bags."

If marijuana were legal, Mr. Kleiman's colleague, Jonathan Caulkins,
computed that simply producing the THC -- an active ingredient in
marijuana -- consumed by Americans annually from pot would require
only "35,000 acres on 35 farms in Iowa," explained Mr. Kleiman.

Mr. Kleiman believes that some growers may figure out a way to brand
their pot for which people will pay a price premium.

"Branding pot could be more like the Scotch business where tremendous
profit is made on very high-priced blends. But we don't know yet
whether a similarly big proportion of the profit from marijuana will
be made on premium-priced product."

Moreover, there remain many complex issues for which niche suppliers
could potentially profit. Pot consultants to growers could flourish,
as could testing companies, and suppliers of growing equipment -- but
they face too much legal risk in Mr. Kleiman's view.

And growers need help with "security -- moving cash securely,
depositing funds -- since banks would have to report pot-related
deposits to the Treasury, and in dealing with complex tax
regulations," explains Mr. Kleiman.

Mr. Kleiman does not advocate investing in these ancillary businesses
- -- even though they are relatively safe.

"I believe that investment in ancillary businesses is reasonably safe
and might yield some sustainable profitability. But those ancillary
businesses could become commoditized as well."

Nevertheless, he views it as low-entry barrier businesses which will
wipe out most investors. As he said, "Of course most participants will
go broke, and there's no reason to think there are excess expected
returns available: rather the reverse, given the hype; for every
Amazon there were a thousand pets.coms."

Nor does Mr. Kleiman favor marijuana investment promotion as business
- -- even though it is less legally risky than pot growing.

He explained, "Fraudulent investment promotion is indeed less
strenuously investigated and less rigorously punished than
pot-growing, But I don't actually recommend it as a strategy. I do
believe that some of what purports to be venture funding for the
cannabis business is in fact fraudulent investment promotion."

If you invest in the marijuana industry, chances are good that your
money will go up in smoke.

- -----------------

Peter Cohan of Marlboro heads a management consulting and venture
capital firm, and teaches business strategy and entrepreneurship at
Babson College. His email address is  ---
MAP posted-by: Matt