OPINION: Steady hand needed for Ontario’s race to cannabis retail

Provincial budget proposal promotes transition to an open and competitive cannabis marketplace

By Jean Lépine, BlackShire Capital

April 26, 2019

In the recent 2019 Ontario Budget: Protecting What Matters Most, the provincial government announced it is developing a process to allow the Alcohol and Gaming Commission of Ontario (AGCO) to pre-qualify cannabis retail operators looking to enter the market.

Among other expected financial and operational requirements, including a standby letter of credit and background checks, the pre-qualification criteria could include information confirming lease or ownership interests in potential retail store locations. These important pre-qualification criteria signal that the government did learn a thing or two from the not-so-successful lottery approach whose “payoff” to date has been the lowest per capita density of cannabis retail stores in Canadian jurisdictions that permit retail. The lottery approach has put Ontario at the back of the bus.

What are the benefits of pre-qualification?

BlackShire Capital—which has an investee company, cannabis retailer mīhī—has been a strong advocate for the pre-qualification of operators and welcomes the government’s stated commitment to this process. In our view, it’s an important step forward for the industry and begins the transition to an open and competitive marketplace with professional operators at the helm.

With a stepped return to its previously designed open private retail cannabis network, Ontario could become Canada’s largest recreational market. New research released by ArcView Market Research and BDS Analytics estimates the total recreational market in Canada is expected to grow to US$5.2 billion by 2024, up from US$569 million last year.

If the potential for this industry is so clear, then why is Ontario handling this market with kid gloves? Provincial finger-pointing persists, with the province continuing to blame its retail starts and stops on the federal government’s inability to reliably deliver sufficient cannabis supply. It is an argument that has not convinced all.

For example, a report by a Bank of America analyst, released Apr. 17, tells a different story. The report puts Ontario atop one of the least glamorous metrics used to measure the evolution of cannabis retail in Canada: the province is the best of the worst when it comes to retail store density per capita. Ontario had only one store for every 1,006,984 residents above the age of 15 (the report’s age baseline, as opposed to 19, the age of majority for cannabis in the province) compared to top-rated Newfoundland and Labrador, which boasts one store for every 18,337 residents.

Not to kick sand in Ontario’s face, but Quebec is only half as bad as its westerly neighbour, at 447,180 residents per store, with B.C., very surprisingly, running third at 244,715 residents per store. With 77 stores—equating to 45,800 residents per location—Alberta is well ahead of most of its nearest provincial competitors.

Though not perfect, the province doesn’t appear to be experiencing long-term, significant, licence-stopping, supply challenges. Although the province instituted a moratorium on issuing new licences, Alberta Liquor, Gaming and Cannabis has just announced it is adding another 26 licences to bring the total issued to 101. That’s four times what Ontario has green lighted so far despite having a population more than three times larger.

Guiding the way to retail success

Any way you cut it, Ontario is simply out of whack. So how is it that a province whose new slogan could become “open for business” continues to lag so far behind on cannabis retail? The tepid progress is born of the government’s chosen route for marketing cannabis products. Clearly, the new government—elected in June 2018—faced significant challenges with an Oct. 17, 2018 deadline for recreational cannabis staring it down. So, the decision to offer a private retail model deserves recognition.

That said, a critical, but fixable, bottleneck remains. As the wholesaler, or middleman with the cannabis warehouse, the Ontario Cannabis Store (OCS) acts as the broker of cannabis and, given apparent supply pressures, it may feel as though it is sandwiched between two strong private interests—licensed producers (LPs) and prospective retailers. If that, indeed, is the case, it is understandable that Ontario’s finance minister has been extremely cautious in the handing out of retail licences despite repeatedly reaffirming an open allocation in Ontario. Having cannabis retail stores licensed by the province clamouring for product when warehouse shelves are bare is clearly not desirable.

Smoothing out supply and demand

However, the supply quandary can be bypassed with a few simple manoeuvres. First, with respect to the proposed operator pre-approval process, retail operators should indemnify the OCS on supply issues. It should sign on the dotted line that it can withstand supply ups and downs. Retailers could get organized and work with LPs and Ottawa on continuing supply challenges. If retailers did this, Ontario’s finance minister and attorney general would be able to fulfill their stated goals and open it up.

From an investor’s standpoint, it’s more important for retailers to have certainty on licensing than certainty on supply. Successfully operating in a highly regulated industry requires that businesses have the operational and financial wherewithal to overcome early-stage obstacles. Let the operators take the risk—the professional ones will do just fine.

Second, the Ontario government should take a page from Saskatchewan’s playbook and eliminate its middleman status as soon as possible. Such a move would alleviate the need to manage the market, small batch licence allocation or lottery allocation. With a larger and more robust retail network in the province, LPs would assuredly pay more attention to the Ontario opportunity and retailers could enter into legal supply agreements with LPs directly, thereby allowing competitive forces to dictate the market’s evolution.

As long as the federal government licenses LPs and the provinces license retailers, everyone will see safe product entering an efficient market, with plenty of tax revenue to go around. Other than that, it’s likely best for Ontario to get out of the way.

The budget proposal could help chart a new path for the cannabis industry in Ontario. In our view, the road to retail is only a few quick turns away from a true private “open for business” retail model.

Jean Lépine is executive vice president of BlackShire Capital, a cannabis-focused investment firm. He was a member of the Ontario Chamber of Commerce, Cannabis Working Group, that recently published the new report, Supporting Ontario’s Budding Cannabis industry, and is also the founding chairman of the Organization of Independent Cannabis Entrepreneurs.

Celine Chang