The goal: to bridge the gap between investors and operators who may not have an easy time speaking the same language when evaluating an operation/opportunity.
The focus: on plant-touching cultivation in controlled environments. This will not apply to outdoor facilities; controlled environments and outdoor environments are too different. The main difference between controlled environments and outdoor environments is the number of harvests per year. Outdoor produces 1-2 crops per year while controlled environments can produce 6 crops per year.
To make sure we’re all on the same page for the rest of the presentation, I ask you to agree on these 5 accepted facts about the cannabis industry:
- Every state and country is its own independent marketplace
- The markets are vastly different
- A small medical market always precedes a larger rec market
- There’s a traditional capital shutout
- Cannabis production should follow a standardized manufacturing process just like other crops in commercial ag
With that said, I look at companies and opportunities on a spectrum –
The focus here is on red flag opportunities which are the companies that fall in the middle of the spectrum. On the far left side is where you’ll find companies I call “tear-downs”, and on the opposite end on the far right side are the “well-oiled machines”.
A great comparison to use is the housing industry. In housing, you have tear-down properties where the house is in such rough shape it’s better to tear it down and start new because the land itself is valuable. The well-oiled machines of the housing industry are what everyone calls move-in-ready. No work needs to be done, just unpack your things. And then somewhere in the middle which account for most of the inventory on the market are the fixer uppers. Now fixer uppers aren’t for everyone and there are many different levels of “fixer-upper”, but from an investment perspective – these are the opportunities that present the greatest chance to multiply your return over time.
Cannabis is the same way. The tear downs may have inherent value because of the license they own, especially in closed markets where there are only a few licenses available and more will not be issued. The well-oiled machines have value for certain types of passive and silent investors, though most will come with a full-price purchase – no one wants to pay full price. So now we have the red flag companies, the cannabis industry’s fixer upper.
I call these “Red Flags of Opportunity” because operationally, they’re huge red flags of inefficiency and risk. From an investors perspective though, they present tremendous opportunity to fix a flaw and multiply a return on investment far more than possible with a well-oiled machine and far more quickly than with a tear down.
Each red flag is presented in question form. Any situation where the answer to the question is no, a red flag of opportunity to add value and maximize returns exist and should be further investigated.
Red Flag #1: Do they forecast production more than 12 months in advance?
There are 3 schools of thought related to who sets and controls the production calendar. I’ve seen many operations where the cultivator is in charge of the production calendar. The cultivator will observe the plants and allow the maturity of the plants to determine when to harvest, thereby dictating the rest of the calendar. In others, the operator is in charge and they typically force harvest on day 60, regardless of what the plants are telling them. And lastly, there’s a few operations that allow collaboration between the cultivator and operator – where the operator will ask for input from the cultivator and make a decision within a few day window.
Until the operator is in complete control of the production calendar that is set at least 12 months in advance, you are leaving money on the table.
In operations where the plants are allowed to dictate the production calendar, the maximum number of harvests you’ll achieve in an average year is 4.3 to 5 in a given space. When the operator controls the production calendar like clockwork, you can guarantee 6 harvests every year.
Now there will be push back on this point…
People with the best intentions will make a case as to why the plants need “just a few more days.” After all, we’re trying to increase yields and get more weight because Weight = Revenue, right?
“If we leave the buds on the vine just a few more days we’ll get a few more grams per plant and we have 450 plants, so we’ll get so much more yield..”
The issue is that extra weight will never outweigh an entire additional harvest. The math never works out.
The production calendar is the most obvious indicator that they are likely slipping up in other areas. Without a solid production calendar, benchmarking and setting metrics becomes impossible to do accurately, and without metrics, accountability of staff is nonexistent and projecting anything is difficult or wildly inaccurate.
Staffing becomes challenging because your tasks aren’t organized in advance, so you have your managers attempting to call in every employee you have just praying you can fill the man hours needed to complete the tasks ahead. Due to the short notice, a smaller staff is common but in this industry, like many others, the task must be completed TODAY, regardless of how many staff are there. This demanding environment often leads to overtime and working unreasonably long shifts which increases risk of injury, greatly multiplying the risk to the organization. I know of a harvest team that worked a 22-hour shift last year; how can that be a profitable decision?
Purchasing of supplies without an accurate production calendar becomes reactionary. Instead of ordering the supplies you know you need for the next few cycles at the same time enjoying discounts on volume and shipping – the cultivation staff informs the cultivation director midway through their shift, “Hey, we’re out of Cal-Mag.” Now the director must overnight a bottle, paying huge convenience fees, or take time out of someone’s day to go pay retail at the store, if that is an option in that area.
And finally, without a consistency in production, how can the customers you produce for know when to expect shipment? Without regularity, relationships at the distribution level are difficult to build or impossible to keep. Remember, that all of these operational red flags can be turned into return multipliers if fixed appropriately.
Red flag #2: Are tasks and roles compartmentalized and structured as an assembly-line?
And I do mean an actual assembly-line. Like an auto-manufacturer who has stations set up in an assembly-line to install bumpers and set windshields and apply paint, a cannabis facility should follow the same principles. In a cultivation facility, the stations should mirror the phases of plant growth like propagation and vegetative followed by flowering, all the way through to the end with a labeled package. An infused products manufacturer should have stations for each piece of their process all the way through to a finished retail product.
What I’ve seen in countless operations across the country is a huge red flag. One or two employees wear 3 or 4 hats each – holding far too much responsibility in their hands and again increasing the risk to the organization. I’ve seen it work at very small scale, but on anything substantial, employees must be siloed. Grouping employees by task and then role increases value in many ways.
First – it greatly reduces risk to the company by spreading the responsibility around to more individuals. Short-term, you may have to hire a few additional people; you likely needed them all along anyway. Long-term the risk of your operation suffering because one of your main managers gets sick or worse, leaves the organization altogether, is eliminated.
Each silo encompasses a few steps in the overall manufacturing process making training easier. You no longer have to take the time to teach the entire production process, only these few steps (for now). Since jobs are a bit simpler and the odds of success at the individual level are higher, employees feel more fulfilled, increasing their retention. Certain jobs are perfect for entry-level teams and more demanding jobs will go to those more experienced. This organically creates a path of advancement for employees, increasing retention further.
Protecting intellectual property is always a priority, and by siloing employees, you reduce the risk of an employee taking many key pieces of your operation if they leave.
The next question relates to all of these things.
Red flag #3: Do they have documented standardization for all aspects of manufacturing?
The emphasis here is on documented. Without written standards for every aspect of manufacturing, consistency is impossible and it’s difficult to develop any semblance of a brand.
Fast food is a great example. If you were craving french fries and wanted long, skinny, salty fries – would you go to McDonald’s or Burger King?
To guarantee those delicious fries are perfect every time, McDonald’s has dozens of specs that dictate everything – details like length and width the fry should be cut, the type of oil that it should be fried in, the temperature of that oil, how long it should sit in the oil and tons more.
Cannabis cultivation and manufacturing should be the same way. Every spec from the barometric pressure of the rooms and hallways, to the length of the clone that is cut, to the exact temperature of the water that feeds the plants, and on and on. In most facilities, it’s not yet that way and training is often completed by word of mouth using no metrics or specs as would be expected in other industries.
Documented standardization reinforces the production calendar. If everyone knows the exact production calendar months in advance, it becomes clearer why the specs everyone must adhere to are so defined and why it’s so important. There’s no margin for error. The plants are getting cut on day 60 no matter what, so cutting that clone exactly 12 CM is crucial.
When everyone follows every documented standard, consistency results. And when your product is consistent, a brand develops and explodes in value. These processes truly define the brand and since in cannabis we can’t patent the processes that define these brands, the brand itself holds all of the value. I’ll let the IP attorneys get into the details, but in short, if you want to expand across state or country lines, the best and most profitable way to do so is to license an establish brand. It’s not the only way, but it is the way most are expanding right now.
The last red flag ties all of this together.
Red Flag #4: Are any parts of the manufacturing, processing, or distribution process automated?
I would go so far as to say that if all of the parts of the manufacturing process are not yet automated, then an opportunity exists. Now I’m not trying to eliminate humans from the operation, but we can all agree that robots are better than humans at repetitive tasks and working 24/7 without needing a break or a sick day or a vacation. Moreover, let’s agree that mature industries automate; they have to.
Up until this point, automation has been used as a buzzword, so let’s dive into a few examples why automation is king in cannabis.
A fertigation system, the one that mixes the nutrients and then feeds the plants automatically, should be the first major system installed in a cultivation facility. Using a common size 40,000 SF facility, the purchase and installation costs of a state-of-the-art fertigation system will run about $200,000 and take a few weeks or months to design and install. Once complete though, in labor savings alone, the return on investment will be realized in less than 15 months. If you factor in the savings from eliminated spillage and wasted nutrients, the return is less than 12 months.
Another even more dramatic example is on the packaging side. Packaging dried cannabis flower accurately is painstaking and laborious. We made the determination that in a facility that relied on two shifts of 40 full-time individuals to package dried flower, installing an automated packaging system was a no-brainer. At just over $160,000, when running at full capacity, the packaging machine would realize a return in 150 operational hours. In this facility, that was just under 2 weeks in the fiscal calendar.
The graph above illustrates clearly, as the size of the overall market grows the wholesale price of cannabis is plummeting, it’s commoditizing. To maintain profitability, companies are increasing scale and automation and driving the costs of production downward.
This is what I refer to as the Call to Automate – a tipping point in each market where operators are forced to a decision, to automate and scale or attempt to maintain a lifestyle business in a rapidly consolidating industry.
So the operator who has to answer no to many or all of these Red Flag Questions stands the most to lose if they don’t act. They’re being forced to one of 3 decisions.
The first option is to enjoy the profits already made and move onto another industry by simply shutting down, while another is to try to sell the company outright; whether for the value of the license as a tear-down or as some type of red flag opportunity. And the last, which is what I’m seeing from the overwhelming majority of operators, is to invest the time and resources needed to scale, automate, and compete in this industry on a larger scale if they weren’t set up for it from day 1.
Here’s where the opportunity for investors lies and here’s where you can put what this presentation has outlined into practice. Operators are looking for a few things to improve operations:
- Private Loans, expecting to pay 12%-20%
- Strategic partnerships to leverage experience and networks of investors
- Path to going public on Canadian Exchanges
Your investment strategy will determine which opportunities are right for you.
We just had a micro look at plant-touching investments and highlighted a few ways to qualify and discover hidden value in plant-touching opportunities in controlled environments. There are a few huge changes looming that could have made this presentation much longer so let’s quickly go through them. I encourage you to stay updated on things like, 280E reversal, Canadian Exchange ruling on US investment, and Rohrbacher-Blumenauer Amendment.
To stay up to date on industry patterns, challenges, and news, follow me on Twitter @BrianStaffa and on LinkedIn @BrianStaffa.