Limited license versus open-license environments is critical distinction when considering cannabis investments. I studied economics in college and the most lasting concept I took is that assets trade off of supply and demand. In the cannabis investing world, the importance of supply and demand is apparent when comparing open and limited-license states.
Caps on licenses can be applied to cultivation, packaging, distribution, and retail. The fewer licenses issued, the more each license is worth. Let's look at an example
Santa Barbara vs. Lompoc
To illustrate the difference between open and limited-license environments, we’ll look at two cities in California. I live outside of Santa Barbara and we are an open license state. But, each city is able to decide if they want to allow cannabis businesses and how many. The city of Santa Barbara decided to allow cannabis and started with three retail dispensaries. The population is about 90,000, so that is one dispensary for roughly every 30,000 people.
Up the road 45 minutes, the city of Lompoc is ground zero for the open license model. This city of 43,000 people has approved 64 cannabis licenses, of which 33 are for dispensaries. If they all open, that is one dispensary for every 1,300 people. Lompoc has the potential to have 10x as many dispensaries as Santa Barbara, with less than half the population.
Currently, about half the retail licenses in Lompoc have opened—roughly 16 stores. In some cases, stores are literally next door to each other. Most are nice spaces, carry similar products and are staffed with knowledgable-enough employees. This leaves one key differentiator—price.
In Lompoc, price wars began immediately. The deals section on Weedmaps always had one whole store 25%…or daily deals like 30% off all edibles on Munchy Monday. Most stores have “happy hours” where, for example, from 3-5pm everything is 20% off. It’s cut throat, and several stores have already come and gone, but due to the open license policy of the city of Lompoc, more new applicants can apply and new stores still open regularly.
Santa Barbara has one store for every 30,000 residents and does not have these price wars. You see specials, but it’s similar to what happens in other industries. The stores in Santa Barbara are relatively spread out—several miles versus several yards in Lompoc—and each has established their own clientele. The prices across stores in Santa Barbara are relatively similar. The restricted license model allows businesses to compete on experience, location and client service, rather than making low prices a necessary condition.
The choice is obvious
With what we have learned so far, would you prefer to be an investor in a store in Lompoc or Santa Barbara? Would you rather compete where there is one store per 1,300 people or one per 33,000? The answer is obvious—restricting supply makes each license much more valuable.
This distinction I showed you on the city level in California is also taking place at the state level across the U.S. Remember, cannabis is federally illegal, so states get to design their own programs. Broadly speaking, the west coast has largely followed the open-license model, whereas the east coast has more limited-license states.
Pennsylvania is an excellent limited license example. With a population of almost 12.8mm, they have issued 25 grow, 50 retail, and 8 clinical registrant licenses thus far. Each retail license allows for three locations, so take 150 retail locations in a state of almost 13mm people and it is one store for every 85,000 residents. Imagine the difference in revenue between a Pennsylvania store serving 85,000 people, versus a Lompoc, CA store with an audience of just 1,300. All things equal, it should be 65x as profitable. (The math is intended to be illustrative and subject to change as markets evolve.)
The message is very clear—investing in limited license markets is more profitable. Demand will continue to accelerate across cannabis, but this is something we can’t control. It’s an upward trend and we’re just along for the ride. Supply is different; there are choices to be made. To maximize the opportunity we will emphasize supply-constrained, limited-license situations. In the long term, the classic conditions of rising demand and limited supply will make our assets appreciate.
While working with Ken Fisher, I learned to always know you may be wrong. Humility is crucial in investing. So, the Green Giants portfolio has exposure to open-license states as well. However, the majority of the assets are in limited-license environments and we expect this theme to be a lasting and meaningful differentiator in our success.