The U.S. cannabis industry has been experiencing rapid growth over the past decade due to changing public attitudes and legislative changes at both the state and federal level.
Marijuana Business Daily forecasts that by 2023, retail cannabis sales will total $25 billion-$30.4 billion, with the hemp CBD market adding up to an addition $7.5 billion. Other data outlets predict CBD may even triple that.
Given the skyrocketing demand for cannabis and its newly found legitimacy, we anticipate increased government scrutiny and a need for more testing.
All that means there’s going to be a good opportunity for investing in those who analyze the plant – not just those who grow and process the plant.
Lab testing in the cannabis world can be grouped into two categories: safety and quality.
- Safety tests seek to answer the question, “Will consumption make people sick?” Such tests look for contaminants such as heavy metals, pesticides, residual solvents, yeasts, molds and water activity.
- Quality tests answer the question, “Are consumers getting what they pay for?” These tests examine stability of the product over time and the potency of compounds such as THC, CBD, flavonoids and terpenes. Essentially, does the label match the ingredients?
As investors, we look to invest in the labs that can thread the needle on this complex sector.
That means we seek out labs with experienced management teams in similar industries, because the best predictor of future behavior is past behavior. Rather than investing in a risky, untested startup, we target companies that have a proven track record and need capital to grow their footprint through acquisition or expansion.
Problems in the Lab and Testing Space
At Cresco Capital, we believe that rigorous analytical testing will be essential to the growth of the cannabis industry, so we are on the hunt for top-tier lab companies.
Unfortunately, we often come up short.
Why? Lack of a federal regulation standard and the fact that legalization is still in its infancy at the state level means that testing is highly fragmented.
Small, local labs haven’t had to achieve the level of consistency consumers have come to expect from mainstream products. As a result, quality ranges from passable to terrible among arguably even the most recognizable cannabis brands.
Traditionally, quality assurance has been left up to cannabis companies and state regulations. There has been little incentive for labs to grow or combine, as financing options have been few.
Since testing can be done only in places where marijuana is legal, most labs are in states such as California, Colorado, Oregon and Washington.
However, legalization broadly means revenue is likely to move out of these states to more conveniently located labs and eventually to whomever will be the LabCorp of cannabis.
As the industry matures and consolidates, the most successful companies will be those that can provide product consistency across state and – eventually – national boundaries.
In other words, the mature cannabis industry will look like other industries that provide food additives, dietary supplements and pharmaceuticals – and we anticipate that the rules and regulations that are developed will be similar to those segments.
Why Cannabis Needs a Lab Rollup
Cannabis needs a lab rollup if it is to become profitable and able to meet rising production requirements and legal standards.
As the industry trends upward and increases in regulation – for example, when the U.S. Food and Drug Administration begins setting federal standards – small labs will be unable to meet scale and rigor requirements from increased demand and, thus, will struggle to stay in business.
By merging, smaller labs will create efficiencies and make them more competitive as larger production companies begin to internalize testing capabilities.
Larger firms such as Eurofins Scientific and PerkinElmer can remain competitive through acquisitions that increase their size, scale, expertise and reputation.
Theoretically, every lab should be able to provide the same services and testing results as all the rest. As a result, differentiation is likely to occur primarily through price leadership created by economies of scale and innovation.
Labs that can provide the fastest, most reliable service will be the most successful.
So the question becomes: Where are the future industry titans in the lab world today? We’re looking for you.
