Tobacco Companies Could Make Cannabis Big Business

Medical marijuana faces supply problems that tobacco companies are well-equipped to solve

The retail sale of recreational cannabis began Jan. 1 in Colorado, with 37 licensed retailers offering products to a very thirsty clientele. Lines were long, driving the price of one-eighth of an ounce of high-quality marijuana to $70 — significantly higher than the $25 that medical marijuana recipients paid the day before.

Opponents of Colorado’s move feel price escalation will force users — recreational and medical — back on to the street in pursuit of cut-rate pot from organized crime. The Justice Department has indicated it will stay out of the way as long as Colorado meets eight regulatory points, one of which is preventing the diversion of marijuana revenue to organized crime. If the current supply doesn’t increase, plain-old economics is going to take hold.

The rest of the country will get around to doing the same (for the revenue), but everyone needs to understand that players big and small can participate successfully in the cannabis industry just as craft brewers, distillers and winemakers compete with the big boys like Diageo (DEO) and Anheuser-Busch InBev (BUD).

The time has come to consider the benefits of “Big Cannabis.”

Taxes

According to the Tax Policy Center, state and local governments collected $24 billion in alcohol- and cigarette-related taxes in 2011; Colorado accounted for $237 million of that windfall. State officials estimate it could raise $67 million annually from $578 million in pot sales. That would increase the state’s revenue haul from discretionary items such as cigarettes, alcohol and cannabis by 30% almost overnight.

In 2012, medical marijuana sales in Colorado were just shy of $200 million generating tax revenue of just $5.4 million. A large portion of the estimated $67 million went to drug dealers. By legalizing pot, Colorado’s added more than $60 million in tax revenue while taking some cash out of the hands of organized crime. That’s a win/win for everyone in the state.

Retailers

Until January 1, the 3D Cannabis Center sold medical marijuana to approved users only. Owner Toni Fox generates $30,000 in monthly revenues but reckons she’ll be able to bump that figure to $250,000 once her facility is expanded to accommodate the additional foot traffic that comes with a 700% increase in revenue. The state has issued 136 retail licenses, many of which, like Fox, were previously retailers of medical marijuana. Now that they can sell to anyone over the age of 21 (don’t forget your ID), you can expect most of them to benefit from the legalization of pot.

According to IBISWorld senior analyst Nima Samadi, medical marijuana is a $1.7 billon industry globally expected to grow to $5 billion by 2018. If we see legalization in states other than Colorado and Washington, we could be talking about a retail boom like none that’s been seen before. Investors will clamor for the opportunity to own a piece of the action.

How long will it be before one of Colorado’s cannabis retailers does an IPO? Three years? five? That’s unknown, but it will happen in my lifetime. Heck, Starbucks (SBUX) is headquartered in Seattle. Perhaps Howard Schultz wants in on the action.

I realize it’s a long way off, but there’s no reason a big retailer like SBUX can’t co-exist with entrepreneurs like Toni Fox and the rest of the pot-selling crusaders.

Law Enforcement

America spends more on drug enforcement than any other nation on earth. In a September press release from Law Enforcement Against Prohibition (LEAP), the organization reveals the insidiousness of  law enforcement’s prosecution of marijuana offenses. According to the FBI, there were almost 750,000 marijuana arrests in 2012, 88% for possession. This means 660,000 Americans were arrested for the simple act of possessing marijuana.

The state of Pennsylvania, for instance, defines a “large amount of Marijuana possession” as 30 grams or more punishable as a misdemeanor with a sentence of up to a year in prison and/or a maximum fine of $5,000.

If you’re lucky and don’t go to jail but get the maximum fine, your $5,000 payment might be for possessing as little as $560 worth of pot (based on Colorado’s inflated $70 per eighth of an ounce), the equivalent of maybe 25 joints. It probably seems like a lot to the uninitiated but amongst friends it probably doesn’t get you very far.

Law enforcement spends far too much time running around catching marijuana users when they could be spending it more constructively apprehending those that commit violent crimes.

Big Tobacco

I’m sure there are people out there who can roll joints quickly and efficiently. However, there’s no way they can do so at the pace of the large cigarette companies.

As we’ve already seen in Colorado, there’s a supply issue that could keep the majority of pot sales in the hands of organized crime. The only way to loosen their grip is to increase both the volume and speed of production so more product can get in the hands of legal retailers, allowing natural market forces to lower prices to the point it’s no longer profitable for organized crime.

It’s possible that Colorado’s entrepreneurs can handle this on their own. However, a nationwide push (down the road obviously) is going to require big bucks, and nobody has more of those than the likes of Altria Group (MO), Reynolds American (RAI) and Lorillard (LO). Each of these companies has more than a century of experience with tobacco. You don’t think they’d be able to figure out pot? I believe they’d have a much easier time with cannabis than they’ve had introducing electronic and smokeless cigarette products.

Gerry Sullivan, head of the Vice Fund (VICEX), whose fund I wrote about in December, believes cigarette companies are likely to become the “Budweiser(s) of marijuana.” For this reason he’s maintaining his cigarette positions, which include the three from above plus Philip Morris International (PMI). All are in the fund’s top 10 holdings.

These cigarette companies might not publicly express an interest in the cannabis trade, but it would be far more lucrative than eCigs. Besides, a big push into cannabis would give them the cash flow necessary to make a face-saving exit from tobacco.

Bottom Line

The winner in “Big Cannabis” is America itself. Only the repressed lose out from the legalization of marijuana. The rest can sit back and enjoy the additional freedom the state of Colorado and hopefully many more have conferred upon their residents.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2014/01/big-cannabis-benefits/.

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