Liberalization is dead: navigating a post SAFE cannabis world

“Never let a crisis go to waste.” Winston Churchill

So much for third time lucky.  In December, SAFE failed to pass in the Senate.  It’s hard to remain optimistic in the face of this ongoing legislative irrationality.  Time to face the reality that there will be no federal liberalization and regulatory harmonization in 2023-24 to come to the industry’s rescue. 

The barriers are just too strong:  intense congressional partisanship, Biden’s lukewarm interest in legalization, a ‘good enough’ state-driven legalization roadmap, strong lobbying by anti-liberalization forces and the fact that cannabis is not a hot button issue for most Americans.  

In the meantime, sector prospects are ominous.  Firms need to batten down the operational and financial hatches, for:

Deep price declines
Think wholesale and retail prices are low now, just wait another 6 months when cultivation space increases, inventories pile up and companies cut prices to keep market share. No legal markets have avoided the hangover of over production and too many growers.  And the lack of meaningful brand differentiation across the sector decreases producers and retailers’ ability to mitigate downward price pressure.

Sharply higher costs
The cost of capital has effectively doubled.  According to Viridian Capital Advisors, the average cost of debt for many cannabis companies has jumped from 9% in Q2 2022 to 13-16% right now – and often higher. That is, if you can raise capital; new equity funding has dried up, institutions continue to shun the industry and debt is difficult to come by.   Meanwhile, wage, inputs and energy inflation have risen to levels not seen since the 1970s.

Consumer pullbacks
There are early signs that recessionary effects are impacting adult use cannabis spending.  Same-store sales in December 2022 fell 5.3% versus year ago according to Fyllo industry data. Point-of-sale software provider, Flowhub, reported that cart size declined 12.7% to $55.  Flat/low growth is now a fact of life in older legal markets such as Illinois, Michigan and Colorado.

Illicit market resurgence
To maintain their market share, underground operators will compete even harder with legal players behind their lower costs, greater operating flexibility and high-quality product. Anecdotally, I have spoken to several frustrated legal growers who will move back into the illicit market in order to survive.  

A detailed remedy for struggling MSOs is for a later post.  In general, I will continue to advise my clients to fix up their balance sheets & cap tables, pick a strategic go-to-market lane, look for and secure capital at the best terms possible, and continuing refining their operations and capabilities.

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