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Marijuana Companies Lied to You, Major Pot CEO Alleges

Sean Williams, The Motley Fool

In case you haven't noticed, the green rush is well under way. Having long been considered a taboo industry, the legal marijuana industry is stepping out of the shadows and into the spotlight. After generating $5.4 billion in legal worldwide sales in 2015, according to Arcview Market Research and BDS Analytics, one Wall Street firm is forecasting $75 billion in annual sales potential by 2030. If accurate, this represents a compound annual growth rate of more than 19%, and it'd undoubtedly make legal weed the growth story of our generation.

It's also an industry with increasing breadth. Mexico looks to be on the verge of recreational legalization within the next couple of months, while a number of U.S. states are pushing for medical or recreational legalization. Altogether, more than 40 countries worldwide have given the green light to cannabis in some capacity.

A man holding a stack of hundred dollar bills behind his back with his fingers crossed.

Image source: Getty Images.

Are marijuana companies lying to you?

But the industry also has a dark side, according to Tilray (NASDAQ: TLRY) CEO Brendan Kennedy. In a telephone interview with MarketWatch, Kennedy suggested that marijuana companies essentially lied to investors, and each other, about how much cannabis they could produce to support inflated market valuations. 

In particular, Kennedy homed in on the industry's use of "funded capacity" -- i.e., the aggregate cultivation square footage cannabis growers could construct without needing an additional infusion of capital. Whereas a few reasonably large players existed in the very early stages of Canada's medical marijuana rollout, the only tangible means of expressing size and success was by analyzing the number of registered medical marijuana patients each company had. But this wasn't possible for early-stage small-cap companies that had no registered patients and were still in the process of gathering capital or constructing their grow farms.

According to MarketWatch, a number of cannabis industry insiders have blamed premium pot grower Supreme Cannabis (NASDAQOTH: SPRWF) for the advent of the phrase "funded capacity." Said Supreme Cannabis CEO Nav Dhaliwal in a telephone interview with MarketWatch in November 2018, "Talking to analysts, investors, and bankers -- we said we're going to build out this capacity in terms of financing." But the CEO now believes that "funded capacity is too broadly accepted as a metric" and added: "It's relevant to a point; it's a foundational metric. But once you start scaling, it becomes less relevant."

An up-close view of a high-quality cannabis plant flowering.

Image source: Getty Images.

The problem, according to Tilray's CEO, is that cannabis companies misrepresented their actual growing potential by touting funded capacity. Now, with adult-use weed legal, a large number of growers, especially premium flower growers, are unable to meet their obligations. Tilray foresees a shortage of premium-quality pot for 18 to 24 more months.

This has been particularly irritating to Kennedy, who said the following to analysts during Tilray's first-quarter conference call this past week:

If I can go back 18 months, 12 months ago, I would have invested another $100 million, $200 million in terms of Canadian cultivation. That was a -- that was a mistake. But we believe, we believed all the hype 18 months ago.

This is only part of the blame

But is this the case? Are marijuana company lies the real reason behind existing shortages and Tilray's frustrations? I'm inclined to say maybe, but it's far from the only reason.

There's no denying that regulatory red tape is at least partially responsible for Canada's existing supply shortage. Health Canada is responsible for reviewing and approving cultivation, processing, and sales license applications. In January 2019, Health Canada had a backlog of almost 840 applications, all while having approved only around 160 total applications at the time. Recent changes that will require cultivation facilities be complete before submitting a cultivation application should help expedite the review process and eliminate a good portion of this backlog, but the damage has already been done to Canada's supply chain.

A cannabis leaf laid within the outline of the red maple leaf of Canada's flag, with rolled joints and a cannabis bud to the left of the flag.

Image source: Getty Images.

Compliant packaging solution shortages have also been to blame. Before the legalization of recreational marijuana, Health Canada laid out a laundry list of regulations that packaging would need to abide by if growers wanted to get their product onto dispensary shelves. These regulations have clearly constrained the supply of compliant packaging solutions, leaving raw cannabis sitting on the sidelines awaiting processing.

I'm also not sold on the idea that Tilray indirectly blames Supreme Cannabis and others growers for failing to meet their production forecasts. First of all, Tilray didn't have $100 million or $200 million to invest in capacity expansion before raising more than $170 million from its July 2018 initial public offering.

Furthermore, Kennedy announced in March that the company would be shifting its strategy and focusing on investments in Europe and entering the U.S. market, rather than investing heavily in Canada. That seems to be an odd decision, given that Canada's recreational weed industry is still in its nascent stages. To me, it looks to be more of a concession that Tilray was outmaneuvered in its home market and waited too long to IPO and expand its capacity than anything else.

I don't deny that Tilray is having a hard time meeting its premium cannabis needs and to some extent would fault growers for putting out pie-in-the-sky production figures. But, ultimately, I also blame Health Canada, packaging shortages, and Tilray for relying on third-party production rather than building out its own cultivation facilities.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.