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Wednesday, June 12, 2019

SPECIAL EDITION: The Next Threat to Big Marijuana Companies Comes From Way South of the Border

The Next Threat to Big Marijuana Companies Comes From Way South of the Border

There used to be more than 180 rose growers along the highway in California’s Monterey County. Now they’re almost gone. The flower industry went south to the lower-cost country of Colombia.
With marijuana legalization in California, Monterey’s greenhouses have shifted from growing roses to growing cannabis. But Paul Henderson—whose Salinas-based company Grupo Flor was instrumental in Monterey’s marijuana revival—isn’t waiting for North America’s cannabis growers to suffer the same fate as its flower producers. So Grupo Flor is preparing to plant its first crop a couple of hours outside the Colombian city of Cali.
“When the industry starts to move toward commoditization over the next decade,” says Henderson, “Colombia is the only place that makes sense.” An equatorial climate and low-cost, skilled labor give Colombia a clear advantage in agricultural trade. And that makes the nation a threat to North American companies like Canopy Growth (ticker: CGC), Tilray (TLRY) and Aurora Cannabis (ACB). These firms have invested hundreds of millions of dollars in building the climate-controlled grow-operations needed to grow weed in cold latitudes.
Most Canadian companies nurse the long-term hope of getting their production costs below two Canadian dollars per gram of cannabis. Colombian producers say their costs will start well below 50 cents a gram—and go down from there.
“It’s pretty darn difficult to compete with Colombia,” says Kyle Detwiler, whose Northern Swan Holdings has almost a million square feet of greenhouse and extraction facilities under construction there. “The only difference between us and Tilray is that we can cut our price 90% and still make money.”
In response, a Tilray spokesperson said: “Our state-of-the-art facility in Portugal is well-positioned to efficiently and sustainably cultivate indoors and outdoors with room for expansion to service the global market.”
Colombia allows production of medical cannabis oil and extracts, both the psychoactive form and the nonintoxicating cannabidiol used in increasingly popular CBD products. It doesn’t allow the sale of the dried marijuana flower used for smoking, so bales of pot won’t be traveling north. Producers need licenses for growing, manufacturing and export.
Colombia is already one of the world’s top exporters of coffee, cut flowers, and bananas. Now it’s betting that countries that have legalized marijuana—like Canada and Germany—will allow imports of legally-produced cannabis products. Whether it becomes a cannabis powerhouse will depend on the temperature of today’s trade wars and the pace of legal changes around the world. But if Colombian cannabis is allowed to freely compete with the products from expensive greenhouses in North America and Europe, the big companies that built those greenhouses may face some write-downs.
Companies starting production in Colombia include well-funded private outfits like Grupo Flor and Northern Swan, as well as small publicly-held entities likePharmaCielo (PCLO.Canada or PHCEF) and Khiron Life Sciences(KHRN.Canada and KHRNF). Some big marijuana companies are hedging their bets, too, with investments in Colombia, including Canopy, Aurora, Aphria (APHA), andCronos Group (CRON).
The cost of producing cannabis isn’t a number defined by accounting standards, so it’s hard to compare across companies, let alone countries. Canada’s OrganiGram Holdings (OGI) said automation and high yields allowed it to grow cannabis at a cash cost of 65 Canadian cents a gram in the February quarter—85 cents, including depreciation and stock options. Packaging and shipping cost extra. Aurora said its cash production costs were C$1.42 a gram, not counting product sourced from third-party growers. Tilray’s were C$7.54 a gram, excluding sales of accessories and food products.
Because Canada’s producers each count their cash costs differently, Barron’s created the nearby chart using each company’s cost-of-sales (as defined by International Financial Reporting Standards), divided by the grams of cannabis sold. Industry leader Canopy hasn’t yet reported its March quarterly results, so we used the December period. At Canopy, December costs were swollen by the expense of facilities that weren’t yet producing.
It’s clear that if the numbers from Colombian growers are to be believed, they can grow cannabis for a fraction of Canada’s costs.
Colombia’s history of illegal drug trafficking fueled a civil war whose ending won a Nobel Prize for the country’s former President Juan Manuel Santos. To provide rural jobs for the demobilized guerrilla fighters, the Santos administration in 2015 joined the many governments around the world that were legalizing marijuana for medical use.
One of the first companies to get a license in Colombia was PharmaCielo, a Toronto-based venture backed by international investors. In the flower-growing town of Rionegro, outside of Medellin, PharmaCielo has large, open-air greenhouses and a processing plant that it plans to get certified as meeting European standards for Good Manufacturing Practices. PharmaCielo has nearly 200 strains of cannabis in its seed bank, says chief corporate officer David Gordon. But it will start by producing crops for the extraction of the nonintoxicating ingredient CBD, which the company thinks will be accepted more quickly in the export market than the buzzier derivative known as THC.
PharmaCielo isn’t a threat to North America’s industry yet. It didn’t have any revenue when it reported its March quarterly results. Trading on Toronto’s TSX Venture Exchange since January, the company’s C$7 a share stock values the start-up at about C$675 million.
Also just a sprout is Khiron Life Sciences, whose C$2.50 stock values the Toronto-based company at about C$250 million on the TSX Venture Exchange. Khiron has raised about C$60 million to build out production and distribution facilities in Colombia and Uruguay, the country that was the world’s first to legalize cannabis for recreational use. Khiron boasts very low production costs, saying its Colombian operation can make cannabis oil for 35 Canadian cents a gram.
Detwiler, the CEO of Northern Swan, says he’s not growing cannabis in Colombia for the Latin American market. An investment fund, Northern Swan has raised almost US$100 million for portfolio companies like Clever Leaves, a Colombian operation Detwiler says can produce cannabis products for 25% the cost incurred by Canadian firms.
Detwiler’s company is the first to get authorization from Colombia to grow psychoactive cannabis for commercial sale. It’s also the only Colombian producer that has obtained import permits from Canada and Germany. Northern Swan’s processing facility is closer than any in Colombia to getting a European Union GMP certification.
“We have a long term competitive advantage down South,” Detwiler says. “That’s why there aren’t any avocado farmers up in Canada. It’s just too expensive to operate.”
Back in California, Grupo Flor’s marijuana operation is already bigger than many North American cannabis companies. Henderson, Grupo Flor’s chief, says the company’s revenues could surpass $100 million this year. When the world’s big consumer product companies look for inexpensive, reliable cannabis extracts, Henderson wants to be their supplier.
“If we can grow it for ten cents a gram and sell it for five dollars a gram, that’s what we’re chasing after,” he says.
Canada’s producers haven’t overlooked the opportunities for growing the stuff outside Canada.
Last year, Aphria lavished C$280 million on what it said were cannabis businesses in Colombia, Jamaica and Argentina. But a hedge fund’s investigation alleged undisclosed involvement by Aphria insiders in the purchased entities. The company defended the value of the deals, but the scandal resulted in the resignation of Aphria’s chief executive.
In July 2018, Canopy bought a couple of Colombian companies in exchange for Canopy stock that could be worth US$100 million. About $37 million of that total will go to a company controlled by Canopy’s Latin America manager, Antonio Droghetti, while the rest would go to the owners of a 500 acre farm licensed to produce and export cannabis derivatives. Droghetti is an experienced executive from Brazil, who in 2016 turned up in the notorious Panama Papers, with an offshore company administered by the now-shuttered Panama law firm Mossack Fonseca.
Droghetti said his offshore company was a tax structure for owning a house.
The Colombian operation will become Canopy’s regional hub, Droghetti says, supplying medical cannabis products across Latin America. “We will have one of the best costs in the world,” Droghetti says.
Meanwhile, Canopy founder and co-chief executive Bruce Linton has told investors to focus on what products are being made with cannabis ingredients. If you’re only focused on costs and not products, he said at a recent London conference, “you’re dead.”
Write to Bill Alpert at

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