Ontario's Pot Restrictions Have Producers Seeking Workarounds

(Bloomberg) -- Ontario wants to keep marijuana retail in the hands of the little guy. The big players are already identifying ways around it.

The province, which will become the second-largest pot market in the world after California when Canada legalizes recreational use on Oct. 17, is restricting licensed producers to just one retail location. This means major players like Canopy Growth Corp. and Aurora Cannabis Inc. will only be allowed to operate one store on the site of a production facility, while the rest of the market will be opened to independent retailers.

However, the province has not yet clarified whether affiliated companies will be able to avoid the one-store limit, providing a potential workaround for the producers. For example, Aurora holds a 25 percent stake in Alberta-based liquor retailer Alcanna Inc. and it remains up in the air whether Alcanna would be able to open additional Aurora-branded stores under the new rules.

“There could be potential for them to be strategic in how they roll out more than one store,” said Matt Bottomley, analyst at Canaccord Genuity Group Inc.

Franchise System

Cannabis company shares dipped after the news with Canopy down 4.5 percent to C$64.43 at 3:50 a.m. in Toronto, Aphria down 6.1 percent to C$17.85 and Aurora Cannabis Inc. down 4.3 percent to C$11.70.

Ontario is scrambling to get ready as Canada becomes the first country other than Uruguay to legalize recreational marijuana next month, a market forecast to be worth C$4.3 billion ($3.3 billion) by 2019, according to Deloitte LLP. A June election brought the Progressive Conservatives to power under Doug Ford, who vowed to remake the province for the “little guy.”

One possible model could be a franchise system, said Frank Robinson, a partner in the franchise law group at Toronto-based Cassels Brock.

“As the big producers are going to be shut out of Ontario’s recreational cannabis retail system, limited to a single store, the only way they will be able to get their logos and brands on storefronts is to license or franchise all of these small business people to which the province wants to allow access,” Robinson said in an email. “This will create fertile ground for franchising by licensed producers.”

In a press release Thursday, Canopy pointed out that it could potentially take advantage of its Tokyo Smoke retail platform and its affiliated investment arm, Canopy Rivers Inc.

“As a cannabis business with multiple licenses and a variety of diverse subsidiaries, we feel we have a distinct advantage at this stage in the game,” Mark Zekulin, co-CEO of Canopy Growth, said in a statement.

Lower Margins

MenMen Enterprises Inc. is not a licensed producer but has a retail joint venture with Cronos Group Inc., which is. “We continue to explore our options in Canada and are in talks with our partners at Cronos Group,” Daniel Yi, a spokesman for MedMen, which has pot stores in California, said in an email. “We will seek clarification from the authorities and adapt our plans accordingly.”

The move is a “net negative” for the licensed producers because they’ll generate lower margins if they’re selling through third-party retailers rather than their own stores, said Bottomley. “This is definitely a step back from what most were expecting.”

In addition to lower margins, the licensed producers will also have to invest in a sales force, said Martin Landry, analyst at GMP Securities.

“It will create more work for LPs to travel to these stores, to create a sales force that will need to be onsite, make sure they educate the clerks in the stores about their products, make sure that the shelf placement is there, make sure that the point-of-sale promotions are working,” he said.

The province plans to have bricks-and-mortar stores open by April 1 and will operate an online-only sales model until then. It will begin accepting retail applications in December.

Ontario won’t cap the total number of licenses in the province but does plan to introduce ownership concentration limits.

©2018 Bloomberg L.P.