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For Investors, Marijuana Remains a Cloudy Bet

It’s hard to deny the appeal of investing in legal cannabis. After all, how often do you get the chance to participate in a bona fide gold rush, with an ever-shifting market, few established players and consumer demand that is all but waiting to explode?

The recent, historical approval of marijuana for recreational use in Colorado and Washington state adds a brand-new element to the business. For investors, the smell of a once-in-a-lifetime opportunity is in the air. And who doesn’t want to add “drug kingpin” to their resume?

“Cannabis is really already a structured and mature market, it just exists in the black market,” says Derek Peterson, CEO of Terra Tech (TRTC), a startup that manufactures hydroponic growing systems. “It’s moving to the white market, or at least the gray market, but we still didn’t have to make the market, it already exists. We’re just taking it out of the hands of the cartels and putting it in the hands of legitimate business.”

And the upside potential is huge.

“It’s an industry that has a lot of problems, but that’s part of the opportunity,” explains Brendan Kennedy of Privateer Holdings, a Seattle-based private equity firm that’s focused on legal cannabis. “The companies are immature, the managers are unprofessional, it’s highly fragmented, there are no standards, the branding and marketing bar is very low and there are no established players. There are not even any Wall Street analysts that study this industry yet.”

Bigger than corn

Still, despite these problems, the sector has annual revenues in the neighborhood of $40 billion, which Kennedy says makes the cannabis market even bigger than corn. “How many people trade corn as a commodity?" he asks. "How many sub-industries are focused on corn? There will be a desk at Goldman where you have analysts studying cannabis. It’s going to happen and it’s going to happen faster than anyone thinks.”

Of course, the reality is that marijuana remains very much an illegal product in the eyes of the federal government, despite the rulings in Colorado and Washington and the fact that it's legal for medicinal purposes in more than a dozen other states. As an investment, it doesn’t get much riskier than that.

“The first thing I would point out to a prospective investor is that these companies are still breaking federal law,” says Irvin Rosenfeld, a South Florida-based stockbroker and author of the pro medical marijuana book, “My Medicine.”

“While Obama has said that the federal government has bigger fish to fry," Rosenfeld continues, "that hasn’t stopped the feds from going into states like California and telling dispensary owners that their tax dedications are disallowed, or the DEA from shutting down dispensaries that are near schools or parks.”

[Slideshow: Marijuana-Related Stocks: Companies and Products]

Money to Burn?

But that’s not to say there isn’t money being made in cannabis. The key, says Privateer’s Kennedy, is being very, very careful.

“We avoid all public companies in this space,” he says, “as that’s not something that interests us at all. And many of the reasons these companies are public is they couldn’t raise private money. We’re mostly interested in businesses that serve growers and dispensaries, and then consumer products -- entities that serve the legal consumer market.”

Privateer, which holds no investments in cannabis growing or distribution operations and is in the process of closing a $7 million round of funding, is focused on mainstream brands, such as the marijuana review site Leafly.com, which it bought last year when the site's revenues were effectively zero. Leafly.com finished 2012 with about $400,000 in revenues and is forecast to reach $1 million by the end of this year.

“It was the perfect company for us,” Kennedy says. “It has that mainstream look and feel. So you could be a 30-year-old professional or a 40-year-old soccer mom or a baby boomer and could embrace that brand.”

Troy Dayton, CEO of The ArcView Group, a venture-funding network for legal cannabis companies, is likewise focused on ancillary marijuana businesses such as point-of-sale systems, inventory-tracking services and even insurance. The key for him is finding a business that has mainstream counterparts that are not yet involved in the cannabis sector.

“I think staffing is an area where we’re not seeing much action but I see huge opportunity,” Dayton says. “For example, trimming has notoriously been an ad hoc sort of thing that’s time consuming and difficult. But as the industry professionalizes, it would be great to be able to outsource that kind of work to a team that’s already together and knows what it’s doing. But a lot of the regular staffing companies aren’t into the idiosyncrasies of this industry yet, and may be staying out of it for reputational reasons, so that’s an opening.”

The public option

For retail investors, however, the pickings are still slim. THCBiz.com only has 16 publicly traded companies on its list of cannabis related companies, all of which trade OTC or on the pink sheets and represent a range of ancillary industries like grow-room hardware, lighting, pharmaceuticals and general business services. Only a handful report any sort of financial information or give potential investors insights into their business prospects.

That is slowly changing, however. Terra Tech, for example, has been fully reporting since day one and is shooting for an American Exchange or Nasdaq listing in the next 24 months. And the company's CEO, who also owns Blum, a marijuana dispensary in Oakland, Calif., says he has been able to recently secure funding for his venture via more traditional means: investment bank Midtown Partners in New York.

Cannabis investing may still be the Wild West, but at least some law and order is starting to come to the industry.