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Replay Marijuana Legalization: The Debate Begins with Dr. Beau Kilmer

Yesterday we hosted a special call Marijuana Legalization: The Debate Begins, featuring Dr. Beau Kilmer, Codirector of RAND Corporation’s Drug Policy Research Center, to kick off a series of speakers on the topic. 

 

Replay of the call is available here

Supplemental call materials available here

 

Dr. Kilmer walked though a number of key topics on the call, including in the Q&A session that begins at 43’16”on the replay.  Below we’ve spelled out Dr. Kilmer’s “Eight P’s,” his key policy design factors for thinking about Marijuana Legalization. 

 

We recognize that from an investment perspective we are early on marijuana, but we would rather be early than too late – and one day we do believe that marijuana has the potential to be a real business sector. We will not be making any investment recommendations on any marijuana stocks at this time, but we hope that speakers like Dr. Kilmer can help elucidate such topics as policy and legal frameworks, economics of marijuana, and social implications around marijuana legalization and help lay the groundwork for an emerging investment thesis.  We hope you can join us for future calls.

 

Matt Hedrick

Associate

 

 

Dr. Beau Kilmer’s Eight P’s Framework


Production – Where will legal pot be grown: outdoors on commercial farms, inside in confined growing spaces, or somewhere in between? What’s clear is legalization is going to drive down production and distribution costs, which equates to a reduction of risk. As people move away from basement production to industrial cultivation, we’ll also see changes in technology. Initial work shows that if you want to buy 1 pound of farm-grown marijuana from northern California it runs about $2,000, but if legalized and grown at home, the cost could be reduced to $400/pound. However, if it was cultivated like other agricultural produce grown on an industrial scale, production and processing costs would be around $40/pound. Also there are a number of choices that governments have to inflate the price, including taxation, licensing, or outright price controls. Dr. Kilmer clarified that the Netherlands actually is not a model for legalization: personal marijuana use has been decriminalized in the Netherlands, but the “backdoor” (growing, producing, importing, and selling beyond small amounts at a coffee shop) is still illegal.

 

Profit Motive – If marijuana is legalized, states and governments can choose whether private companies can enter this industry. CO and WA are following the “alcohol model,” and private companies are welcome, yet there’s a lot of policy space between prohibition and legalization. The range of policy choices could include limiting marijuana growing to private home cultivation, but could also include non-profits, coops, or even state monopolies.  While a state-run monopoly is probably the least likely in the U.S., there are numerous ways to control marketing and supply, and therefore price and profit incentives.

 

Promotion – What will promotion and advertising regulations look like from state to state?  Will they follow the alcohol and tobacco models? Regulators know that 80% of tobacco and alcohol revenues come from 20% of consumers, the heaviest habitual users, so these industries have great incentives to target youth to turn them into life-long users. At the same time, U.S. jurisprudence against curtailing what’s known as “commercial free speech” could make it tough to regulate the promotion of marijuana.

 

Prevention – If marijuana is legal for adults, how will school and community prevention programs adapt their messages to prevent kids from using?  Both sides of the legal/illegal spectrum agree on reduced consumption among kids, but what type of prevention methods should be used? Dr. Kilmer believes that in order for prevention programs to work, they need to be firmly in place, and the costs associated with them allocated, before legalizing marijuana.  

 

Potency – There are dozens of cannabinoids in marijuana.  THC is the major one, responsible for getting people high, but can also be responsible for panic attacks. An estimated 40-50% of marijuana in the U.S. comes in from Mexico and has a THC level of 4-8%, lower than what’s available from dispensaries that can range from 10 to 25% THC.  In the 1970’s marijuana THC was around 3-4%, so there’s definitely a trend over the years of higher THC.  Policy makers will have to consider that limiting available quantities, or taxing by unit or weight, would probably create incentive to breed higher potency strains.  There’s not enough data yet to determine an ‘ideal” THC content.  There’s talk now to limit THC to 15%, but is that an arbitrary figure? 

 

Purity – It’s clear there must be testing for mold and pesticides.  The other question is whether marijuana can be combined and sold with other products like flavorings, or mixed with nicotine or alcohol. CO has already said no to all of that, but how might other states decide?

 

Price – Research suggests that a 10% decrease in the price of marijuana leads to a 3% increase in use, but there’s no good data about total price elasticity. Current thinking seems to tend towards pricing marijuana per unit of THC, given number of marijuana products and how they’re proliferating. There’s concern that if marijuana is taxed too high, a black market could develop. Conversely, if it’s priced too low, tax revenues may be too light to support the industry and prevention groups. For example, if marijuana is taxed by weight, it could incentivize people to grow/use more potent marijuana.  Government policy around pricing will be critical to how the industry develops.

 

Permanency – early adopter states will suffer growing pains and they’re likely going to want to make changes. This raises questions about how much flexibility to build into these regimes, especially around taxation.  What’s the best way to tax marijuana: Dr. Kilmer believes by percentage of THC. But it could be the case that in 5-6 years, with more experience, this is not the best strategy. States will want to design a flexible regime that will allow them to make necessary changes to regulation. Dr. Kilmer believes it is important that all these laws contain a “sunset clause,” where marijuana laws will have to be put to a vote after a certain period of time.  Sunset provisions offer the citizens breathing space to assess the effectiveness of their policies, and may enable legislators to escape the likely onslaught of lobbyists that accompany any new industry.  As Dr. Kilmer observes, “it’s much harder to put the genie back in the bottle, once it’s been let out.” 


Cartoon of the Day: 1,000 Years

Takeaway: The U.S. housing market is going downhill (just when many economists thought annual sales would be heading up.)

Cartoon of the Day: 1,000 Years - Housing 04.25.2014

 

From Hedgeye's Q2 Macro Themes:

 

#HousingsSlowdown:  We have been big housing bulls over the last 18 months. But the party is ending. Asymmetry in being long has flattened.   Price follows demand on a lag and demand is slowing as affordability declines, regulatory changes drag on liquidity, and institutional interest ebbs.  We will walk through our updated view on the Supply/Demand/Price dynamics prevailing in the housing market and our forward outlook for prices. 

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Video | McCullough to Bartiromo: Europe Is a Better Place to Be Than U.S.

 

Hedgeye CEO Keith McCullough shares his views on European markets with Maria Bartiromo, host of Fox Business' Opening Bell.


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20 Proprietary Risk Ranges

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Under Armour: Brand Heat Has A Price | $UA

Takeaway: UA could not afford even the slightest blemish this quarter, unfortunately.

Under Armour: Brand Heat Has A Price | $UA - ua kevin plank

 

Here are some key takeaways from a research note that was originally sent to subscribers on April 24, 2014 by Hedgeye Retail sector head Brian McGough. Follow McGough on Twitter @HedgeyeRetail.

Key Takeaways

  • Not the quarter a 50-times multiple needed. We remain confident that this company will double – at least – over 5-years. But will continue to spend heavily to achieve that goal.
  • One thing we’ve got to give UA regardless of margin trajectory – this management team is as focused as any we know.
  • Overall, it was a great quarter for Under Armour when viewed in isolation.  Unfortunately, the market does not view things in isolation – nor do we.
  • People obviously did not love UA’s guidance for the upcoming year. UA beat by $43mm in revenue, but only took up full-year guidance by $40mm.
  • There was something about CEO and founder Kevin Plank today on the call that seemed exceptionally mature, seasoned, focused, and not only a great Brand ambassador (which he’s always been) but a flat-out solid leader for Under Armour.

Under Armour: Brand Heat Has A Price | $UA - UA sigma

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