Is Marijuana the Next Bubble?

NEW YORK (MainStreet) — Investments in the legal cannabis industry are booming as Americans are demonstrating their support to continue legalization with the passage of new marijuana regulations in several states.

The legal marijuana market is estimated to grow by 64% to $2.34 billion in 2014 from $1.44 billion, according to a recent report by The ArcView Group, a cannabis investment and research firm based in San Francisco. The legal market consists of all states which have open sales of marijuana to people are allowed to possess it under their state law.

Six new states recently passed legislation allowing the use of medical marijuana, including Connecticut, Delaware, Illinois, Massachusetts, New Hampshire and Vermont, plus the District of Columbia. There are now 20 states permitting the use of medical marijuana. New York and Minnesota are likely to approve laws for medical use by 2016, according to ArcView's report.

Washington and Colorado passed laws recently which allow adults 21 and older the ability to legally purchase cannabis from licensed retailers. By 2017, seven new states are likely to seek the adult use regulations, the report said.

Legal marijuana businesses are cropping up in many states, but those who have definitive business models and mainstream strategies are able to attract funding from investors, boost their growth and achieve scale.

The potential for the marijuana market to increase to $10.2 billion within the next five years or a 700% increase from the current U.S. market value is very likely, said Douglas Leighton, managing partner of Dutchess Capital, a New York investment firm which manages $125 million in assets, has $200 million in direct investments and made its first investment in the cannabis industry recently. The "real growth" will arise when more states decriminalize the use of marijuana.

"I've never seen it where a market already exists for the product," he said. "The market is already there and it will gain wider acceptance."

Support for legalizing marijuana is widespread as support from Americans rose to an all-time high of 58%, a 10-point increase in a year, according to a Gallup poll last October. Washington and Colorado are expected to add $359 million and $208 million each to their respective markets in 2014 for adult use. Another 14 states are projected to pass adult use regulations in the next five years, including Alaska, Arizona, California, Delaware, Hawaii, Massachusetts, Maine, Maryland, Missouri, New Hampshire, Nevada, Oregon, Rhode Island and Vermont, the ArcView report said.

While there are very few public companies in this sector currently, the demand for them remains high, said Leighton. Some of the stocks appear to be expensive, but have risen substantially in the past six months, he said.

"I think the public stocks have gotten a little ahead of themselves," Leighton said. "There is a large amount of capital chasing a small pool."

Investors should conduct due diligence on companies before they make an investment and to ensure the businesses are operating within state regulations, he said. Investing directly into dispensaries or companies who grow marijuana is not a good option since most of the operations remain smaller because of state regulations, Leighton said.

Depending on an investors' risk tolerance, consumers should consider investing in ancillary companies instead who do not directly handle the cannabis or its related byproducts, he said. Dutchess Capital created http://www.mmjinvest.com/ to connect investors with adult and medical marijuana entrepreneurs.

"If you can take risk and want a better return on your capital, then those companies which control the plant are a great place to be," he said. "If your tolerance for risk is lower, then invest in the other businesses where there is greater growth potential."

Companies which are involved in controlling the cultivation of the core commodity and develop a brand around it "maintain the best opportunity in the industry," said Derek Peterson, CEO of Terra Tech. (TRTC), a public company based in Irvine, Calif. which manufactures agricultural equipment.

"From my perch, there is going to be a value in the companies that own and control state issued permits for retail dispensaries and commercial cultivation throughout the country," he said.

Investing in the marijuana market has the same caveats as allocating money in a startup or emerging market, said Peterson, a former senior vice president with Morgan Stanley Smith Barney. Investors should examine the company's valuations and potential market size, but also the space and location it operates in, he said.

"Investors should look at whether the company has a good product or service and if they are operating in a location that is supportive of medical cannabis-related companies," Peterson said. "There are areas in California and other legal states where the local government is pushing these businesses out through zoning and other restrictions. This industry is unique as it operates in a quasi-legal environment due to the dichotomy between state and federal law."

Companies traded on the OTC QB and QX markets are required to have independent audited reporting requirements, he said.

"When looking at public companies I would focus on fully reporting companies," he said. "I believe this industry is still in its infancy and far away from any level of maturation."

Until marijuana is federally legal, investors should shy away from businesses which are involved in grow operations, said Bill Chaaban, CEO of Creative Edge Nutrition Inc. (FITX), a public vitamin nutritional supplement company which plans to produce marijuana for medicinal use in the U.S. and Canada through its subsidiary CEN Biotech. The market could generate as much as $10 billion in revenue by 2018 and outpace the sales of tobacco and alcohol combined, he said.

"I think it is definitely a lot larger," Chaaban said. "You have a huge percent of the population currently using marijuana that possess medical marijuana licenses who are really recreational users. There are many people who partake in it and it will just become legal. It is definitely mainstream."

The margins for the industry will be shrinking in the future, but investing in the cannabis market is not for short term investors looking for quick gains, said Justin Hartfield, CEO of Ghost Group, a Newport Beach, Calif. operating company that owns and manages marijuana technology companies including Weedmaps, a listings and reviews site for marijuana dispensaries.

"You need to be passionate about the product," he said. "This is going to be comparable to the wine industry and bigger than the tobacco industry in the future. The black market is probably five to 10 times larger than legal sales. There is always demand."

--Written by Ellen Chang for MainStreet

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