Although cannabis licensed producers (LP’s) and even provincial cannabis boards repeat the mantra that more supply and lower pricing is required to drive out the black market, why are big LPs so intent on growing more cannabis and producing more derivatives?

Accounting practice incentivizes producers to grow more marijuana than they can sell and process so that lower unit costs and positive gross margins can be reported, fooling investors into giving them more money. Later, the excess inventory is quietly written off and the cycle begins again. There will be no solution until participants see the industry for what it is: a cash-burning machine.

Companies that have never made a gross, let alone net profit continue to raise capital, mainly from professional stock traders, hedge funds and short sellers that anticipate capital raises and then cover their winning bets with new issues from ailing companies.

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Short sellers have made a bonanza from the promotion of cannabis and don’t want to see the goose that laid the golden egg eaten for Thanksgiving dinner. They incentivize investment bankers who help weak companies raise money, knowing the pros will be there to flip their stocks one more time.

The more cannabis LP’s produce, the lower reported unit cost and higher gross margin per gram, making financial results more appetizing to potential investors and bankers.

Company losses are then funded by raising money via term loans, revolving credit lines, convertible debentures, highly dilutive unit equity deals with warrant sweeteners and “at-the-money equity programs”, whereby companies can sell stock and raise cash directly from the market, fittingly called ATM’s. The capital allows companies to continue expanding into processing and manufacturing, which means oversupply in vape pens and other cannabis extract-based products is guaranteed down the road.

Fixing the dysfunctional industry

The only way to get a lower cannabis supply and higher prices is for governments to initiate constructive structural changes to the dysfunctional industry they created.

We need a reduction in the minimum $1 per gram excise tax, which began at 10 per cent of a $10 gram but now hovers at 25 per cent as cannabis prices have fallen by 60 per cent. We need a cut in the large markup the provinces charge producers for their inventory and distribution services which often requires product to crisscross the province. We need the removal of government wholesalers outright in favor of private market distribution, as is the case in Saskatchewan, where six wholesalers were permitted at the end of fiscal 2020.

We need consolidation in the LP space where over two dozen public companies continue to burn up investor funds to expand production and window dress their financial results rather than invest in clinical trials or product innovation. We need cannabis prices to stabilize at current levels because legal flower is now cheaper than that offered illegally, and a massive store rollout in Ontario and other provinces should finish the job of eradicating the black market.

These measures would make for a healthier industry, get government out of business, reduce the social and personal cost of more addiction to cannabis and allow long-suffering investors to finally partake in the fruit of their investments.

Chris Damas is the president of BCMI Research, investment research and corporate consulting company based in Barrie, Ontario.