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Why Did California Suspend Over 400 Cannabis Businesses, and What Does That Mean for the Industry?

By David Jagielski - Nov 23, 2019 at 1:00PM

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The state is a big one for the industry and crucial to its long-term success.

California is one of the hottest markets for the cannabis industry in the entire country. According to research company BDS Analytics, the state is already expected to hit $3.1 billion in sales this year; that number is expected to reach $7.2 billion by 2024. That's even more than the $5.2 billion that BDS estimates the cannabis market in Canada will be worth five years from now.

California presents a tremendous growth opportunity for the industry. And so when investors learned that the Bureau of Cannabis Control (BCC) and the California Department of Public Health suspended more than 400 marijuana licenses, it raised some questions. After all, the cannabis industry has been riddled with scandals lately, from CannTrust Holdings growing pot illegally to companies being too aggressive when it comes to advertising. There have been many reasons for investors to push "pause" on investing in cannabis, at least for now. 

Why have businesses been suspended?

The reason for the recent time-outs in California isn't tied to any illegal activity. Instead, it looks to be due to administrative issues more than anything else. A variety of cannabis businesses, including retailers and distributors, failed to complete training and other steps necessary to enroll in the state's track-and-trace system. Those are crucial pieces allowing regulators to stay on top of the industry, and the supply chain in particular.

A cannabis greenhouse

Image source: Getty Images.

Regulators suspended the businesses after they failed to complete the tasks in a timely manner. As of Nov. 7, 407 suspensions were imposed on businesses, which is roughly 5% of the nearly 7,400 cannabis businesses licensed in California.

The good news is that the moratoriums are not permanent and the licenses can be reinstated.

Why the impact could be felt for a while

A lot of pot is grown in California, so any disruption there will affect the industry for quite a while. New Frontier Data estimates that 17.3 million pounds of cannabis are cultivated in California, which amounts to 57.9% of the total supply in the U.S.

While it's important to note that only 13 manufacturing licenses were suspended, cannabis retailers and distributors can have an indirect impact on cultivators as well. Many cannabis companies are struggling to generate free cash flow as it is, and these suspensions could make things even worse. Cannabis producers need to be able to sell their products in order to be able to fund their operations, and the suspensions could have a significant impact on sales and cash flow. And if less pot is grown, that could lead to a snowball effect that impacts retailers, distributors, and other types of cannabis businesses along the way.

Neither the BCC nor the Department of Public Health released lists of the businesses that had their licenses suspended. One company that could be impacted by these suspensions is MedMen Enterprises ( MMNFF -2.15% ), which has a large footprint in the state with a dozen stores located throughout California.

Businesses that are still operating could stand to benefit

Although the pauses are bad news for the industry as a whole, they could be beneficial to individual companies. With less supply available, the price of cannabis products can be pushed up, which will improve margins. One company, in particular, that could benefit from this is Origin House ( ORHOF ).The company is a key distributor in the state, delivering products to over 450 dispensaries in California. Origin House distributes products for more than 50 different brands. And with fewer distributors with licenses, for the time being anyway, Origin House's position in California just got that much stronger. 

The longer the suspensions are in effect, the better it could be for Origin House and other companies that are operating in the state. The cannabis industry has gotten very crowded in recent years, with many companies looking to get a piece of the pie, and taking away licenses means that other businesses could get a boost. However, there's also the likelihood that with legal supply options being reduced, some consumers may opt to buy their pot on the black market instead.

Trust is important in the industry, now more than ever

Long-term, these issues are not likely to persist; even if there's a void in the state, there's likely to be no shortage of potential companies trying to fill it. But in the bigger picture, the companies that are able to avoid running into trouble with regulators will be able to build trust with consumers and other businesses. And for Origin House, trust is a big part of the company's strategy, as on its website it calls itself "the home for trusted cannabis brands in California." 

With many investors warier than ever of cannabis companies, having a trusted name can be a big differentiator in the market. That's why Origin House and other established marijuana stocks could be a lot more valuable as a result of the recent suspensions in California.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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