Sam Wood

Philly.com

PHILADELPHIA — Harvest Health & Recreation, one of the nation’s largest marijuana companies, gate-crashed into Pennsylvania in April. Moments after announcing a big acquisition, Harvest told investors that it controlled seven permits in Pennsylvania, allowing it to set up 21 medical marijuana dispensaries.

That’s two more permits than the state allows any one company to own, a cap the Tempe, Arizona-based company skirted with corporate sleight of hand.

“This is a land grab, and there are a discrete number of prime license opportunities,” Steve White, CEO of Harvest Health, said in the April call with investors, referring to state permits to grow and sell marijuana.

White sees the cannabis market as “oligopolistic” — one where a handful of companies control production and sales. Such a market would make it harder for smaller businesses to compete and potentially would keep prices artificially high.

If Harvest follows through and opens 21 dispensaries, it will control 14% of Pennsylvania’s medical marijuana market, which was set up with the intention to prevent precisely that kind of market concentration.

Yet companies like Harvest are using loopholes in the state’s law to snap up cannabis properties. Harvest alone has a war chest of $500 million set aside for acquiring smaller cannabis companies.

It’s “a nightmare scenario come to life,” said Chris Goldstein, an organizer for NORML, who advocated for medical marijuana legalization in Pennsylvania.

Since Pennsylvania launched its medical marijuana program in 2018, large multi-state marijuana companies — including Culver City, California-based Medmen Enterprises and Chicago-based Green Thumb Industries as well as AES Compassionate Care and Canada’s Tilt Holdings — have planted their flags in the state or are expanding their footprint through backdoor arrangements.

Regulators say they don’t track ownership changes in cannabis companies in a market that has seen more than 100,000 Pennsylvania residents sign up and had at least $130 million in 2018 sales. With the possible legalization of recreational use on the radar, large marijuana companies are looking at a $22.7 billion national market by 2023.

Unexpected: Pennsylvania lawmakers said they didn’t anticipate the era of publicly traded cannabis companies when the state passed a medical marijuana law in 2016. They certainly weren’t prepared for creative arrangements that well-financed marijuana companies are using to control more permits than the law intended.

“What I wanted to do was create a free market,” said Republican state Sen. Mike Folmer, who led the effort to legalize medical marijuana in Pennsylvania. “The real goal was to have a true medicinal program with an emphasis on research. I don’t want two or three entities controlling the whole market.”

In Pennsylvania, a company can win up to five dispensary permits, each of which allows three separate stores, for a total of 15 retail outlets. In terms of growing marijuana, a permit allows only one cannabis cultivation facility per company.

Harvest has managed to put itself in control of two marijuana growing facilities in Pennsylvania. The company did that by entering into a so-called management service agreement with Agrimed Industries, which has a permit to grow cannabis in southeastern Pennsylvania. Also, Harvest is acquiring CannaPharmacy, the parent company of Franklin Labs, which owns a permit for growing at a facility just south of Reading.

With a management service agreement, or MSA, a multi-state company takes control by giving a smaller firm millions of dollars upfront. The smaller firm retains the permit. But the big company makes the management decisions and takes up to 90% of the revenues for a defined number of years. Such agreements are increasingly common in Pennsylvania.

The state Department of Health said it does not regulate ownership transactions.

“We only approve the affiliation of individuals with the permit,” said spokesperson April Hutcheson. “We regulate their right to operate, not the finances or how the company is going to operate.”

Same firm, different name: Harvest skirted the state cap on permits by applying through firms with slightly different names — Harvest of Southeast Pennsylvania LLC, Harvest of Northwest Pennsylvania LLC, etc. Each application listed the same corporate officers, investors and senior managers. That the companies were different registered corporate entities was good enough for the Department of Health to issue permits.

However, the state regulators balked when The Inquirer wrote about Harvest’s claim that it was going to be Pennsylvania’s largest operator of medical marijuana dispensaries.

“Harvest Health & Recreation Inc. (Arizona-based parent company) did not apply for, or receive, any permits in Pennsylvania,” John J. Collins, the director of the Pennsylvania medical marijuana program, wrote in a sternly worded letter that threatened to revoke all of Harvest’s permits in the state.

White, Harvest’s CEO, said he was caught off guard by the regulator’s reaction.

Initially, he said, regulators had celebrated when his local outfits won state permits. “They called and said congratulations,” White said.

He acknowledges that Harvest Health — the parent company — does not technically own any of the seven permits and that making such a public claim wasn’t smart. “For that, we apologize.”

Still, Harvest does not plan to return the permits that it owns beyond the state’s cap.

Growing pains: East Coast marijuana companies, especially in states including Pennsylvania, New Jersey and New York that analysts say are on the cusp of full legalization, are among the most desirable takeover targets.

Harvest, like many other out-of-state companies, is aggressively positioning itself for a much bigger, lucrative market.

The companies “that are already in place as medical operators will have first-mover advantage in the recreational market,” said Kay Tamillow, director of research for the Brightfield Group, “So in the East, we expect continued mergers and acquisitions activity.”

Though applicants for state cannabis permits vowed that the medical program was their primary interest, “only God would know their heart,” Folmer said. He said he was disappointed that some of the companies may have been licking their chops at the prospect of dominating a future recreational market.

Among the 75 or so companies that won permits in Pennsylvania, several still haven’t grown or sold a single gram of cannabis. And yet, many have entertained interest from multi-state operators such as Harvest.

“The speed at which it’s happening is blistering,” David Z. Tuttleman , a cannabis entrepreneur, said of the consolidations. Tuttleman, formerly of Philadelphia, operates Matrix NV, a craft-cannabis operation on the outskirts of Las Vegas. One of Nevada’s first commercial cannabis growers, Tuttleman twice applied to grow marijuana in Pennsylvania but did not win.

Revenues may look spectacular for many medical weed companies in Pennsylvania. But onerous federal laws, effective tax rates and bank fees in excess of $10,000 a month mean that few firms are making much in profits.

“Many of the original Pennsylvania permit winners had no right to get into the business. It’s expensive,” Tuttleman said. “They over-promised their investors and under-delivered. Now there’s no room for a small operator.”

Strict federal restrictions make it extremely hard for cannabis entrepreneurs to raise money from investors. Industry insiders expect full legalization by 2022 but doubt Pennsylvania businesses will have the money to stay afloat until then.

In the meantime, their Pennsylvania medical marijuana permits — because there are relatively few of them — keep appreciating in value. That makes them ripe targets for multi-state companies loaded with hundreds of millions of dollars raised from investors in Canada, where marijuana is legal.

The roll-ups: The companies that won permits in Pennsylvania spent between $200,000 and $1,000,000 on their applications. Like lucky lottery tickets, those permits’ value have skyrocketed.

“A dispensary that’s open and functional is worth $10 million plus,” said a cannabis industry executive from Chicago, who asked not to be identified because his company is seeking to buy additional Pennsylvania properties. “A grow that’s dormant is worth $15 million. But if the grow is up and running and producing, it could be worth more than $35 million.”

Since the first dispensary opened in February 2018, large marijuana companies have made the following acquisitions:

MedMen, the multi-state operator that describes itself as the “Apple Store of Weed,” acquired Chicago-based PharmaCann in a $682 million all-stock deal. PharmaCann owns a permit for one cultivation site and three dispensaries in Pennsylvania.

GTI Pennsylvania, owned by Green Thumb Industries of Chicago, entered into a “management service agreement” with Pennsylvania’s KW Ventures Holdings. KW Ventures operates Firefly dispensaries in the central part of the state. GTI paid KW Ventures an undisclosed amount of cash to run the Firefly retail stores in exchange for nearly all of Firefly’s revenues. GTI already held a grow license and dispensaries in Pennsylvania.

AES Compassionate Care of Chicago, which does business as Grassroots and Herbology in Pennsylvania, entered into similar “management service agreements” with Dubois Wellness Centers dispensaries and Lebanon Wellness Centers.

Tilt Holdings of Canada in January finalized the acquisition of Standard Farms, a cultivator based in Luzerne County, in a $40 million stock and cash deal.

With the uncertainty in the long-term market, it’s hard to fault the small companies for cashing out.

“Tilt gave us money to double our capacity,” said Standard Farms co-founder Jonathan Goldrath. “These facilities cost so much. You can’t get mortgages or loans from banks. If you want to grow, I don’t know where else you’d get the money.”

Elsewhere: Pennsylvania is not the only state struggling to regulate out-of-state marijuana companies. Massachusetts and Maryland are similarly overwhelmed.

In Massachusetts, where a medical marijuana program exists alongside recreational sales, the state Cannabis Control Commission last month promised a crackdown on the “corporate shenanigans” that led several multi-state operators to brag that they had control over more marijuana permits than the state allowed.

“The ownership limits are being tested. We have an ongoing investigation,” said Massachusetts Cannabis Commissioner Shaleen Title.

In Maryland, ownership had been limited to only one cultivation or dispensing facility per company. But Green Thumb Industries, which also operates in Pennsylvania, found a way to take control of four outlets through MSAs.

“We should routinely expect the industry to follow the letter of the law, not the spirit,” said Jonathan Caulkins, a professor at Carnegie Mellon University who authored a book on legalizing marijuana. “Well-meaning people wrote a law with loopholes that the industry exploits.”