Cannabis Distribution Key to Dominating California Cannabis Market

California is the largest cannabis market in the world and the key to dominating that market is the cannabis distribution license.

With a population of nearly 40 million, a thriving tourist industry and the largest economy in the country, California is the epicenter of the US cannabis industry. After generating sales of US$2.5 billion in 2018 — nearly half the country’s legal sales — the Golden State’s legal cannabis market is expected to exceed US$5.1 billion by the end of 2019. The target for 2025 is pegged at US$6.5 billion.

In April, California cannabis distributor Origin House became the subject of the largest ever public company acquisition in the history of the US cannabis market. The US$1.1 billion buyout of a cannabis distributor is a clear sign of the value to be had in California’s cannabis distribution industry.

Adam Szweras, co-chair of the board for Nutritional High (CSE:EAT,OTCQB:SPLIF,FWB:2NU), called the acquisition a vote of confidence. “(It is a sign) that the market values companies who are able to control shelf space and realize greater margins and market penetration through ownership of the distribution pipeline.”

High hurdles, high margins

California’s Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA) requires cannabis businesses to obtain a separate license for each segment of the cannabis industry supply chain, including cultivation, manufacturing, distribution and retail. The MAUCRSA operates under a dual-licensing system at the state and local level. Regardless of the licensed category, cannabis businesses must first obtain a local license before applying for a state license. In addition to this high hurdle, local regulations can differ from one jurisdiction to the next, which makes navigating California’s licensing process all the more difficult.

The restrictive nature of California’s licensing regime is creating a hyper-competitive landscape for cannabis businesses. The supply of zoned, permitted areas for cannabis cultivation are few and far between — and demand is high. To make matters worse, the patchwork of local regulations has hampered the opening of retail operations in the state. “The retail sector has been primarily restrained by city and county governments restricting retail and delivery businesses within their jurisdictions,” notes a recent report from Vessel Logistics.

These high barriers to entry give a clear advantage to established players in the market. Unlike regulatory framework in states like Washington, for example, California’s MAUCRSA does permit companies to hold more than one license type, allowing for vertically integrated business models.

A vertically integrated approach to the cannabis business

Recognizing the opportunity, forward-looking cannabis companies in California are bypassing the licensing gauntlet by acquiring or partnering with fully licensed operations across the entire seed-to-sale cannabis supply chain. As part of a strategic buildout of a vertically integrated business model, they are adding cultivation facilities, extraction labs, retail outlets and distribution networks to their asset portfolios.

Vertical integration helps companies capture the best possible margins for their products and sets themselves apart from the competition. Vertically integrated companies have an assurance that there is a market for production and generally exercise a much higher level of control over product quality. By controlling the entire supply chain, vertically integrated companies are in a better position to swiftly respond to changing market conditions, whether it be developing new products or expanding distribution channels.

Distribution in California cannabis

Under the MAUCRSA legislation introduced in 2017, one of the most impactful changes to California’s cannabis industry is that distributors are no longer required to be separately owned entities from cultivators and manufacturers. This regulatory change is a big win for cannabis companies looking to control the entire seed-to-sale process and remain competitive in the Californian market.

In California, both recreational and medical cannabis products must go through a distributor before reaching the retailer. The MAUCRSA makes licensed distributors the exclusive channel for transporting cannabis products in California. Only licensed distributors are permitted to provide transportation for cannabis-derived products in the state. They are also responsible for coordinating third-party product lab testing, conducting quality assurance testing, reviewing product labeling and packaging for compliance as well as collecting and remitting cultivation and excise taxes for the state. The fact that each municipal district can set its own regulations, which may differ from those set forth by the state, may make it challenging to transport cannabis from one municipality to the next, but for those that can build strong distribution networks the high barrier to entry offers another advantage.

In any industry, distributors act as inventory clearinghouses for producers, growing a brand’s footprint through connections with multiple retailers. Quality products and great brands are difficult to sell without shelf space. For cannabis companies in a market that’s experiencing oversupply and limited retail shelf space, strategic distribution channels offer the best route to success in the cannabis industry.

“Own the distribution pipeline and own the shelf space,” said Jim Frazier, CEO of Nutritional High, which develops, manufactures and distributes cannabis-infused products for nutritional, medical and adult recreational use. Nutritional High acquired California-based distributor Calyx Brands in 2017 as part of its strategy to expand the footprint of its brands such as FLÏ, which includes vape pen cartridges, oil syringes and edibles.

Calyx currently has distribution relationships with over 450 licensed dispensaries throughout California out of the approximately 650 dispensaries that currently exist in the state. Through its ownership of the Calyx distribution pipeline, Nutritional High can effectively control which products appear on shelves. “Our diversified approach puts us in a position to take established brands to the next level, as well as nurture the lasting success of emerging up and comers,” added Frazier. Since Nutritional High acquired Calyx, the company has generated US$7.4 million in top-line revenue and incurred approximately US$6.1 million in cost of sales over a six and a half month period.

Because cannabis licensed distributors can pick up, dry, cure, process, package, bottle and sell cannabis products, some are incorporating processing facilities into their business model. Last year, Nutritional High acquired Pasa Verde, a 17,600 square foot cannabis extraction and toll processing facility in Sacramento that is also being licensed as a distribution hub.

Other cannabis companies working to establish distribution channels in California through strategic acquisitions include Orchid Ventures (CSE:ORCD), TILT (CSE:TILT,OTCQB:SVVTF) and TransCanna Holdings (CSE:TCAN,FWB:TH8).

Takeaway

California’s complex cannabis regulatory landscape has created a high barrier of entry for many cannabis companies. But for licensed distributors, the potential for a strong cannabis distribution pipeline in the world’s largest cannabis market is well worth the challenge. Cannabis distributors that can successfully establish large distribution footprints in California could be well positioned for further growth if cannabis becomes federally legal or states are able to legalize cross-border trade.

This INNSpired article is sponsored by Nutritional High (CSE:EAT,OTCQB:SPLIF,FWB:2NU). This INNSpired article provides information which was sourced by the Investing News Network (INN) and approved by Nutritional High in order to help investors learn more about the company. Nutritional High is a client of INN. The company’s campaign fees pay for INN to create and update this INNSpired article.

This INNSpired article was written according to INN editorial standards to educate investors.

INN does not provide investment advice and the information on this profile should not be considered a recommendation to buy or sell any security. INN does not endorse or recommend the business, products, services or securities of any company profiled.

The information contained here is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Readers should conduct their own research for all information publicly available concerning the company. Prior to making any investment decision, it is recommended that readers consult directly with Nutritional High and seek advice from a qualified investment advisor.