California: Where are the MSOs? Part 1

By Willis Jacobson
Dec 1, 2020

This is the first of a two-part series. Part two looks at some of the biggest MSOs’ California strategies.

California is home to the nation’s largest regulated cannabis market – and, arguably, its richest cannabis culture – but many of the industry’s larger multi-state operators (MSOs) have kept their distance from the Golden State. 

That’s already beginning to change – a trend likely to continue in the coming months and years, according to industry analysts.

California was the first state to legalize MED in 1996, but that largely unchecked market – comprised mostly of nonprofit collectives – didn’t create the business-friendly atmosphere typically sought by large companies. So unlike other states, California has long been home to a massive unregulated market for both large-scale cultivation and retail sales.

When REC sales became legal in 2018, many newly licensed operators saw razor-thin profit margins and had to contend with high taxes and a hypercompetitive climate still dominated by illegal operators. But now, the industry’s biggest MSOs have begun to arrive. 

Changes ahead

Several signs point to a turnaround: Gross sales receipts in the state have steadily improved over the past year – evidence of growth within the legal industry – and residents throughout the state voted in the Nov. 3 election to open or expand commercial cannabis opportunities in more than 30 local jurisdictions. With market maturation expected to stabilize pricing and further cut into the illicit market share, capital is beginning to flow back into the state’s cannabis industry and MSOs are taking notice.

California will be a top target for MSOs looking to expand over the next 12 to 36 months, according to several people in and around the industry, including multiple MSO executives.

“Capital is fluid, so if you have other opportunities in states where you know it’s going to be a home run and you can build it out and the economics are good, that’s where the capital will flow,” said Michael Perlman, EVP of investor relations for Jushi, an MSO that opened its first California dispensary in October. “And that’s why the capital has flowed away from California.”

What factors matter?

So far, just a few MSOs have amassed what could be considered a significant presence in California: They include Cresco Labs and TerrAscend, both of which have an extensive brand portfolio and multiple license types. Curaleaf, the country’s largest MSO, became a major player in the state this year by acquiring the Select brand, which has products in hundreds of California dispensaries. Meanwhile the best-known California-born MSO, MedMen, has struggled.

Other companies, like Columbia Care and Jushi, currently have a minor presence, but plan to expand.

Perlman said his company spent the past few years monitoring California looking for opportunity. One early challenge was “a disconnect between the value of the California assets and what people were willing to pay” – essentially the price of doing business was too high to turn a profit.

This dynamic, he said, led to some MSOs taking on bad debt, while others simply found there was a better chance for a return on investment along the East Coast and in the Midwest, where the markets weren’t already oversaturated and largely overvalued.

Jushi, which has its largest footprint in Pennsylvania and Virginia, entered the California market in October with the opening of a BEYOND/HELLO dispensary in Santa Barbara, where it has one of just three retail licenses. 

Perlman said the company, which also has a retail license in Culver City, where it is looking to open a dispensary in 2021, specifically sought out local markets that: 1) Limit local licensing, 2) Attract tourists, and 3) Have a relatively affluent consumer base.

“We like these limited license markets, where we think we can capture a larger share,” he said.

Nick Kovacevich, co-founder and CEO of KushCo Holdings, an Orange County-based provider of ancillary products and services, suggested that most MSOs, to this point, have found those ideal market shares elsewhere.

“I think the MSOs have said, ‘Hey look, we know California is important, but with limited resources we’re going to go where we can get the most bang for our buck,’” he said. “And right now, they’re making insane margins in states like Florida, Pennsylvania, Illinois, even Massachusetts and Maryland.”

Kovacevich said he expects more MSOs to strategically pick their spots and slowly inch into the state in the coming months and years.

“Some of the things that have scared people about California are improving and the market opportunity is only getting bigger and bigger, so the draw is getting bigger and the risks are getting smaller,” he said. “That’s going to mean more people will start coming in.”

Improving market

After strong sales in 2020, operators are bullish on California’s REC business climate. MSOs appear more willing to join that marketplace.

On Election Day, voters approved 31 local ballot measures, many to allow or expand cannabis commerce, setting the stage for several more markets to open. MSOs are expected to vie for at least some of those licenses, particularly in areas that are limiting the number of licenses issued. 

Because MSOs are typically better capitalized than smaller businesses, they are also better positioned to obtain licensure in limited markets. An MSO’s name recognition can also factor more prominently among consumers in areas with limited access to legal cannabis.

The COVID-19 pandemic has been an unlikely ally to the overall legal industry – and, by extension, the MSOs that help power it – said Jushi’s Perlman:

  • The closure of the Mexican and Canadian borders likely cut down on illicit market supply. 
  • The state collected about $778M in cannabis taxes over the first nine months of 2020, and is on pace to surpass $1B for the year. This total, which does not include local city and county taxes, was driven in part by dispensaries being deemed “essential” and allowed to remain open. Some MSOs have pointed to rising REC tax revenue as a sign of market maturation, a likely harbinger of more corporate interest.
  • Consumers, generally, became more health-conscious, leading many to ditch their dealers in favor of purchasing lab-tested products in sanitized facilities. This is also an encouraging sign for MSOs concerned with getting California’s large consumer base to transition from illegal to legal sellers.

“I think once you have folks who understand and have utilized the legal retail channels, it’s going to be hard to get those people to go back, given the variety and the quality that they’re seeing [in legal dispensaries],” Perlman said.

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