As an investor, you have no doubt noticed the emergence in America of an entirely new legal industry, the marijuana industry—well done, there is one. You may also have noticed that it is tiny—again, congratulations—and you may be assuming that it is poised for spectacular growth. The case for rapid, exponential growth in the marijuana industry is compelling: since marijuana is already America’s biggest cash crop, the industry, once fully legalized, will surely tower over the rest of American agriculture, and those few perspicacious investors who get in on the ground floor will be made into wealthy weed tycoons and spend their retirements spitting from hazy penthouse windows on anyone stupid enough to have remained invested in tired old agriculture companies like Archer-Daniels-Midland (ADM) and Monsanto (MON).
Compelling, as I said, but very, very wrong. How so? Well, let’s start with the fact that marijuana is not the US’s largest cash crop and never was. This comes from a new book, Marijuana Legalization: What Everyone Needs to Know on the Economics of Pot, by Jonathan Caulkins, Angela Hawken, Mark Kleiman, and Beau Kilmer. The book has been widely praised—and attacked—for debunking many myths propounded by both sides: those for and those against legalization. Looking for real facts in a field where both sides notoriously cherry pick their data can yield startling results, and that seems to be the case here.
For those interested in the medical potential of THC, the active ingredient in pot (or one of its active ingredients, depending on who you ask), there is at least one public company to invest in. What it is and whether it’s a good buy are things I’ll be getting to shortly.
But first: The elephant in the room.
Dude, there’s like — wow! — an elephant in the room, or something
It seems clear that pot was never as big as its proponents claimed, at least not in business terms, but serious investors don’t really care how big the legal market is, only how fast it’s growing. With eight states, including California, now having voted to make pot legal it would seem that it must be growing very fast indeed. The problem: there is no legal market for pot in the United States. State legalization has only made pot mostly legal. Mostly legal is fine for those who want to buy and smoke pot, extremely inconvenient for those who want to sell pot, and an absolute show stopper for those who want to invest in it—assuming, that is, that they are wise and informed.
Marijuana is a schedule one substance in the US, meaning that Federal law bans it’s production, distribution, transportation, and use for any purpose—even research. The DEA sites a lack of research on the effects of marijuana as one of the reasons it cannot be moved out of schedule one, and thus, Federal pot laws are nailed in place by a perfect Catch-22. Don’t imagine that the Federal law is significant only in that it keeps pot farmers from having bank accounts (though it does). The law means that growers and distributors can be thrown in jail, and that any and all of their assets can be seized.
It’s hard to imagine a pot company having a successful IPO when its prospectus would include under risks: “All our assets could be seized by the feds (and all our employees thrown in jail) at any time, subject only to the whim of the President of the Unites States.” But might the president actually move to quash legal marijuana through such means? Might he use the MOAB option? Such action would be rash and constitutionally questionable—of course he might.
Even putting the MOAB option aside, other problems in the pot industry make investment a practical impossibility. Of course, these are also the things to watch, because if they change, the marijuana business might become worth looking at, and change they might, particularly if pro-legalization sentiment continues to rise.
Taxation of marijuana, both medical and recreational is subject not only to state taxes, but to a huge variety of local taxes. Some of these are reasonable, others burdensome, and still others unapologetically aimed at keeping legal marijuana as far away as possible. In all cases, however, they are subject to change based on local whim. How are investors to feel safe with their money in a business that will pay some high, but essentially unknown amount in taxes each year?
Even in Colorado, where the experiment with legal recreational weed is in its fourth year, taxation is so complex as to be essentially opaque to anyone not in the industry. Here’s what the state of Colorado’s website says about retail marijuana taxes: |
When purchasing retail marijuana, the purchase is subject to the 10% state marijuana, 2.9% state sales tax plus any local sales taxes. A complete list of state, city, county and special district tax rates is available through Revenue Online. The rates are also available in the publication Colorado Sales/Use Tax Rates (DR 1002).
Here, by the way, is the link to DR 1002. Fair warning: you don’t want to look at this if you’re high.
Capricious taxes may disappear, but it makes sense that marijuana taxes will probably remain high for some time. Tax revenue is a major reason why state governments like legalized pot, and when the government gets its hands on a source of revenue, it is extremely unwilling to let go. Whether the added tax revenue is the reason people vote for legalized weed, however, is hard to say. More likely, the public has come to view the harm and expense of the drug war as a greater burden to society than pot is ever likely to become.
But pot businesses face a far more serious problem than taxes. Because pot is illegal at the federal level, all the money raised from its sale is dirty, which is to say that the FDIC could seize it. Furthermore, banking for the marijuana industry could be considered a form of money laundering or even, potentially, racketeering. There are a few small banks that are making an effort to serve the industry, but it isn’t enough. For the most part, all the cash that’s made selling pot remains in cash until it is spent. Even the IRS gets paid in cash.
So what’s the problem with that? First, it’s dangerous, and yes, pot growers and distributors get robbed all the time. But of more practical concern to investors is the fairly obvious fact that no business operating on a cash only basis could ever possibly meet the transparency requirements of a major stock exchange. That’s why today’s pot companies trade on the far less demanding over-the-counter (or OTC) markets. There is a reason why experienced investors don’t play with the OTC markets. The pink sheets (as we used to call them) will burn you every time.
INSYS made a medicine called Syndros that was really just liquid THC. Then, in July of last year, they got the drug approved by the FDA to treat anorexia and nausea in AIDS and cancer chemotherapy patients, which was remarkable to say the least. It could easily have been the best thing in the world for Marijuana growers, (who could, they hoped, ride the coat-tails of THC to federal legality) but instead, it may have been the worst. That’s because of INSYS’s other big drug, Fentanyl.
In December, INSYS’s former CEO Michael Babich and several others were arrested and charged with running a kick-back scheme that allegedly induced doctors to overprescribe the incredibly potent opioid, even while the nation was in the midst of an opioid addiction crisis. If the allegations prove true, no one on Earth will have much sympathy for Babich, and, very probably, no one will trust INSYS to sell its THC product responsibly. In fact, given the publicity surrounding the scandal, most of INSYS’s avenues for selling Syndros will likely disappear. Frankly, this company is in big trouble. Big enough that even it’s current price of $10.42 is too high.