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Legal Medical and Recreational Cannabis Industry Overview 2017

Table of Contents

2…………Disclaimer

2…………History

3…………Legal Status

3…………Medical Uses

5…………Recreational Cannabis

6…………US and Global Market Size

8…………Canada Market Overview

8…………Europe Market Overview

8…………Israel Market Overview

13…………Challenges and Opportunities

16…………Key Ingredients for Success

18…………Charts

Prepared by Daniel Horowitz – IPB Intern

Edited by Cobi Bitton | JUNE 2017 | www.integritas.co.il

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Disclaimer

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History

Cannabis has been used medicinally for thousands of years by cultures around the world to

treat a variety of ailments. There are historical records of its use in ancient China, ancient India,

ancient Egypt, and medieval Islamic culture, among others. Irish doctor, William

O’Shaughnessy, was credited with introducing cannabis to Western medicine in 1842. Cannabis

and treatments derived from it were widely prescribed in the US until it was fully outlawed in

1941. In the history of the world, only in the past century or so has there been any kind of

stigma or illegality associated with cannabis, and now public opinions are shifting back towards

positive support for the plant and the many medicinal benefits it provides.

The US government declared cannabis a Schedule 1 narcotic in 1970, asserting that it has no

accepted medical use. However, 29 out of 50 US states have legalized it for medical use in some

form in the past 20 years, and an additional 17 signed legislation allowing for use of CBD

treatments, which are extracted from cannabis. Eight states and Washington D.C. have fully

legalized cannabis for recreational use. Although it is technically still federally illegal, the

government has thus far not chosen to enforce this, and the general consensus is that the

federal government will legalize it in the near future.

Colorado and Washington were the first to pass recreational legislation in 2012, so there is

already significant data that we can use to inform future projections. The results have been

overwhelmingly positive, even in ways that were completely unexpected. For example, since

legalization there has been a decrease in car accidents, and no increase in teen use.1 There are

also very substantial expected effects such as a drop in violent crime and opioid abuse, and tax

revenue and job growth.2

1 Business Insider. http://www.businessinsider.com/marijuana-legalization-public-health-colorado-traffic-fatalities-

2016-11/#recreational-legalization-doesnt-seem-to-make-kids-more-likely-to-use-marijuana-1 2 Think Progress. https://thinkprogress.org/5-states-weighing-marijuana-legalization-would-reap-enormous-

economic-benefits-study-suggests-cb06831d154b

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Legal Status

Cannabis has been approved for medical use in many countries, with varying degrees of legal

restriction. The major countries that have legalized it in some form include Argentina, Australia,

Brazil, Canada, Chile, Colombia, Croatia, Czech Republic, Germany, Greece, Israel, Italy, Mexico,

Netherlands, Philippines, Poland, Spain, Turkey, United Kingdom, United States, and Uruguay.

Notably, cannabis is still completely illegal in China and India, despite their long and rich

histories of using it as medicine. With the general attitude shift regarding cannabis, it is possible

that they will soften their laws, especially India, where there is a significant movement pushing

for legalization. China and India’s inclusion would greatly expand the market, as they combine

to account for more than a third of the world’s population.

Medical Uses

Cannabis is used to treat a wide variety of diseases and symptoms. It is favored by both doctors

and patients because it is much safer and has less severe side effects than many of the drugs it

replaces, such as heavy painkillers. Some of the conditions that are successfully treated by

cannabis include AIDS, ALS, Alzheimer’s, arthritis, cancer, chronic pain, depression, diabetes,

epilepsy, glaucoma, migraines, MS, Parkinson’s, PTSD, and Tourette’s.3

3 NORML. http://norml.org/library/recent-research-on-medical-marijuana

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It is also widely used alongside other treatments either to enhance their effects, or to combat

negative side effects. For example, cannabis is very effective at reducing nausea and increasing

appetite among chemotherapy patients, making the excruciating treatment more bearable. It is

also used in combination with traditional opioid painkillers, which allows patients to

significantly reduce the dosage and frequency of opioids, and also provides greater pain relief.

Side effects can include tiredness, dizziness, increased heart rate, increased appetite, and

psychoactive effects. Patients generally develop a tolerance for the effects within a few days or

weeks. No negative long-term effects have been identified among adult users. Among people

who used cannabis heavily in their teen years, minor learning and memory issues have been

observed in the long-term. 4

4 American Psychological Association. http://www.apa.org/monitor/2015/11/marijuana-brain.aspx

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Recreational Cannabis

As of now, recreational cannabis is a niche market compared to medical cannabis. It is only legal

in a few relatively small countries, most notably Netherlands and Uruguay. A few US states

have fully legalized it in recent years as well, including Colorado, Washington, California, and

Massachusetts, although it is still federally illegal in America. However, support for legalization

is gaining strong momentum in the US, as well as Israel and much of Europe. The majority of US

citizens believe it should be fully legal and regulated just like alcohol and tobacco. This would

generate billions of dollars a year in tax revenues, as Colorado and Washington are already

seeing. They are also seeing numerous other benefits, as discussed earlier in this report.

According to Marijuana Business Daily, the US legal recreational market will surpass the medical

market for the first time in 2017, despite only being available in a few states. In Colorado, there

are more cannabis dispensaries than McDonald’s and Starbucks locations combined.

Recreational sales were $1.8 billion in 2016, an 80% increase over the previous year.

Washington and Colorado combined to account for $1.5 billion of that total. Marijuana Business

Daily also estimates a total economic impact multiplier of 4x, meaning that for each dollar of

retail sales, another $3 go into the economy.5 This money goes toward real estate/construction,

job creation, taxes, and tourism.

5 Marijuana Business Daily. https://mjbizdaily.com/wp-

content/uploads/2017/05/Factbook2017ExecutiveSummary.pdf

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Recreational cannabis is a major opportunity in the US, as well as the rest of the world, and its

market is widely expected to surpass the medical market shortly after its legalization in a given

country.

US and Global Market Size

The 2016 World Drug Report estimated the number of global cannabis users in 2014 at 182.5

million. Given the rapidly shifting attitudes and legal environment, it is safe to assume that this

number has grown significantly higher in the past three years. According to New Frontier

Financial, the US medical cannabis market will surpass $10 billion annually by 2020. This

estimation does not even take into account additional states passing legislation, or the federal

ban being lifted. The RAND Corporation estimated the illegal cannabis market in the US at $40

billion in 2010, compared to $100 billion for the tobacco industry.

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Ackrell Capital estimated the total US legal medical and recreational market in 2015 at $4.4

billion, and projects growth to $9.5 billion by 2019, without full legalization.6 After full federal

legalization, which they predict will happen in 2020, they foresee a rapid increase in the

market, as well as a large new segment of cannabinoid-based pharmaceuticals. They project

that within five years of legalization, the medical/recreational market will total $37 billion

annually with 22 million consumers. After 10 years, they project $50 billion annually with 30

million consumers, and the cannabinoid-based pharmaceutical market will add another $50

billion with 20 million consumers for a total annual market of $100 billion.

Globally, Ackrell forecasts a total potential market of $500 billion per year, with over a billion

worldwide consumers.

6 Ackrell Capital.

https://static1.squarespace.com/static/549b3ffae4b06f75a6e748bd/t/56cd718b1d07c05967a1caf2/1456304532096/Ackrell+Capital+US+Cannabis+Investment+Report+2016.pdf

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Canada Market Overview

According to Deloitte,7 22% of adults use cannabis recreationally in Canada, including 33% of

millennials. An additional 17% say they would try it if it were legal, totaling a base retail market

of 40%, estimated at $4.9-$8.7 billion per year. The ancillary market, including growers,

producers, and testers, is estimated at $12.7-$22.6 billion, and additional upside - such as

tourism revenue, business taxes, and licensing fees – is conservatively projected to surpass $20

billion. It is very possible that the total economic impact in Canada could be over $50 billion

annually shortly after legalization.

Europe Market Overview

There is no reliable data for the potential market size of recreational cannabis in Europe, with

estimates ranging anywhere from 10-60 billion euros per year, but with a population of over

500 million and an economy almost as big as that of the US, it is fair to assume the market will

be very large. Cannabis use is fairly widespread in the five major European economies of

Germany, Italy, Spain, France, and the UK, as well as other large countries such as Poland, Czech

Republic, and Netherlands. These countries are all at different stages of the legalization

process, but all are moving toward full legalization and support is strong across Europe.

According to the European Monitoring Centre for Drugs and Drug Addiction, over 20 million

people used cannabis on a regular basis in 2014.8 Netherlands reports over 2 billion euros per

year in retail sales.

7 Deloitte. https://www2.deloitte.com/content/dam/Deloitte/ca/Documents/Analytics/ca-en-analytics-

DELOITTE%20Recreational%20Marijuana%20POV%20-%20ENGLISH%20FINAL_AODA.pdf 8 EMCDDA. http://www.emcdda.europa.eu/publications/insights/cannabis-market

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Israel Market Overview

Israel is the leading country in the world in terms of cannabis research, and has one of the

world’s most progressive regulatory environments. Delta-9 Tetrahydrocannabinol (THC), the

primary compound of cannabis, was first discovered and isolated by Dr. Raphael Mechoulam at

Hebrew University in 1964. Since then, Israeli scientists have made numerous breakthroughs

and conducted many crucial clinical studies. Israel approved the use of cannabis for the

treatment of cancer, multiple sclerosis (MS), Crohn’s disease, post-traumatic stress disorder

(PTSD), and chronic pain in the early 1990’s, before California became the first US state to do

so. In 2004, the Israeli army began using cannabis to treat its soldiers for PTSD. In 2016, there

were 25,000 registered medical cannabis patients in Israel. Breath of Life Pharma, a leading

cannabis research and production company, estimates growth to 200,000 patients and 1 billion

shekels per year spent on medical cannabis, and planned a 10x increase in its greenhouses and

production for 2017.9

Many US companies choose to conduct clinical studies in Israel, due to the more favorable legal

conditions and advanced scientific infrastructure in place. Multiple hospitals in Israel are FDA-

approved for clinical trials. Hebrew University holds a plethora of critical and valuable patents

in the area of genetically modified cannabis, a promising field which will be discussed in greater

detail later in this report.10 Another advantage Israel has in the emerging cannabis market is its

unparalleled emphasis on efficient and sustainable farming. One of the crucial components of

success will be a producer’s ability to efficiently grow a high-quality, consistent product without

using too many resources. In response to Israel’s desert climate, the country has developed the

world’s most advanced technology for drip irrigation and innovative farming techniques. This

technology and expertise will provide a major advantage for Israel in the race to gain significant

market share. Teva, one of the biggest pharmaceutical companies in the world, has an

9 Bloomberg. https://www.bloomberg.com/news/articles/2016-12-12/medical-marijuana-research-takes-off-in-

israel 10

Israel 21C. https://www.israel21c.org/5-reasons-israel-is-dominating-the-cannabis-industry/

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agreement with Syqe Medical to distribute the company’s cannabis inhalers in Israel.11 This is

the first distribution deal for a cannabis-based product from a major pharmaceutical company.

Thousands of protesters attended a rally in Tel Aviv in February, calling for full cannabis

legalization in Israel. Knesset members from Likud and Meretz spoke at the rally to voice their

support. The main arguments are the wide prevalence of cigarettes in Israel, which are widely

accepted to be far more harmful, as well as the massive tax revenue legalized cannabis could

bring. Projected taxes would be billions of shekels per year, as opposed to the millions of

shekels per year that the government collects in fines from arrests. 12

Currently, possession and use of cannabis are decriminalized, following a ruling in March. Public

Security Minister Gilad Erdan called for Israel to follow the ‘Portugal Model’, and treat cannabis

use as a health issue rather than a criminal issue. The policy in place mandates a 1,000 shekel

fine for the first offense. The fine is doubled for a second offense, and third-time offenders are

put on probation. Only after a fourth offense are criminal charges brought.

According to a national survey conducted by the Anti-Drug Authority, 27% of adults in Israel

used cannabis in 2016, the highest recorded rate of any country in the world, although updated

data is not available from every country. The number is way up from the last survey in 2009,

when the rate was just 8.8%. 22.4% of Israelis think cannabis is a low-risk or risk-free substance.

This figure is higher among men than women, and highest among people in their 20’s. The

survey showed that 19.1% of adults had used cannabis in the past month, also the highest

recorded rate in the world.

Even with these rates, Israel’s retail market will never be very big, due to its population of just

8.4 million. As mentioned earlier, the medical market potential is estimated at 1 billion shekels.

The recreational market will be larger than that, but still won’t approach that of the top 20-30

markets. Rather, the major opportunity in Israel is in technology and exports. Due to Israel’s

advanced cannabis research, efficient farming prowess, and entrepreneurial/high-tech culture,

it is ideally positioned to grow many extremely valuable companies in the cannabis space.

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Financial Times. https://www.ft.com/content/3dc71502-eeee-11e6-ba01-119a44939bb6 12

Times of Israel. http://www.timesofisrael.com/thousands-call-for-full-weed-legalization-at-tel-aviv-rally/

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There is also a further factor that will allow Israel to build a significant competitive advantage

over the next few years, and dominate the medical cannabis export market for the foreseeable

future. Israel is the only country in the world that can perform all four stages of producing a

cannabis-based medicine: cultivation, extraction, encapsulation, and delivery.13 Countries in

Eastern Europe and Africa may have the cheap land and labor necessary to compete in the

growth of cannabis, but don’t have the necessary expertise to complete the other three stages.

Even if they did, most governmental drug departments would not accept products of these

countries. Other countries like the US and major European countries have the resources to

produce the drugs, but have laws that severely limit the amount of cannabis that can be grown,

and also severely limit the research and development of cannabis-based drugs. Israel’s ability to

perform the full process will give its companies a huge edge in the global market, and they

should also gain the first-mover advantage if the pending legislation allowing exports is passed.

Israel

Legal/Regulatory Environment -most friendly environment in the world for

medical research and clinical studies

-first-mover advantage with research, Israeli

institutions hold more useful data and patents

than those of any other country

-progressive medical cannabis laws,

decriminalized possession, and on the road to

full legalization

-government committee approved export of

cannabis, waiting for Knesset approval

Agricultural Innovation and Climate -world leader in efficient farming techniques

such as drip irrigation

-world leader in genetic crop breeding

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Jerusalem Post. http://www.jpost.com/Israel-News/A-new-harvest-for-the-harvest-festival-494322

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(tomatoes, potatoes, etc.)

-innovator in other areas crucial to cannabis,

such as greenhouse farming and pest control

-the southern region of Israel is ideally suited

for cannabis farming, with abundant sunlight

and very low humidity

-this greatly reduces costs from expensive

lighting and climate control equipment

Start-up Culture -Israel is one of the greatest start-up hotbeds in

the world, rivalling Silicon Valley in its

concentration of start-ups and tech innovation

-numerous $1 billion+ exits, abundance of

extremely talented entrepreneurs

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Challenges and Opportunities

There are many unique challenges across the landscape of the cannabis industry, all the way

from cultivation to sale, and these challenges present great business opportunities to those

who are prepared to solve them and capitalize on them.

The main problems with cultivation are energy and consistency. Cannabis is the most energy-

intensive crop grown in the US,14 and among the most energy-intensive in the world, due to the

high amount of water and light that it needs, and the specialized climate-control equipment

that indoor growers use to maximize their output. Energy costs can amount to 50% of the

wholesale price, and this percentage will grow even higher if prices continue dropping unless a

solution is found. Israel has an advantage here, as its innovative farming techniques could

reduce energy inputs, and the sunny climate is ideal for outdoor greenhouses. The other

problem is consistency of product, meaning that it is very hard to grow a large number of plants

with the exact same chemical composition. This is more important for medical applications,

where doctors demand very precise doses of each specific cannabinoid, and need a consistent,

reliable product. The major opportunity here is for genetically modified cannabis. This is a

promising, emerging field in which scientists can engineer a cannabis plant with the exact

measurements of each desired compound, and then produce hundreds or thousands of

identical clones. There is no restriction on patenting new cannabis strains in America, despite

its illegal status. However, one cannot patent something that has been sold for more than a

year, so the popular strains sold in dispensaries cannot be patented. High-CBD, low-THC strains

such as Charlotte’s Web or Tikun Olam’s Avidekel have been very successful, especially in the

treatment of epilepsy. The advantage of these strains is that they effectively treat epilepsy

without producing the psychoactive effects that come from THC, making them safe for children.

They are subject to far less legal restriction than traditional cannabis, and will likely gain even

wider acceptance before cannabis. 16 US states currently allow CBD treatments but not

cannabis. It seems that there is a major opportunity for scientists to develop a similar drug

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Press Herald. http://www.pressherald.com/2017/01/15/whats-the-most-energy-intensive-crop-in-america/

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derived from certain cannabinoids that targets another disease, and can be marketed

specifically towards children.

The next challenge that cannabis producers encounter is testing. Before it goes to market, the

plants must be rigorously tested to determine the quantities of each compound that is present.

Again, this is most important for medical applications. There are over 400 chemical compounds

in cannabis, as opposed to one or two, or at most, three, in synthetic drugs, which complicates

the testing process.

Bank of America released a report on the cannabis industry, and was especially bullish on

cannabis testing companies.15 There are currently three methods of cannabinoid testing:

1. Thin Layer Chromatography

-Cheap, fast method for identifying strains

-Estimated $60-$70 million market

-CAMAG has 30% market share, Thermo Fisher has 20%

2. Gas Chromatography

-Quantifies total cannabinoid content

-Estimated $1.8-$2.2 billion market

-Agilent has 40-45% market share

-Other players are Shimadzu, Thermo Fisher, and Perkin Elmer

3. Liquid Chromatography

-Most widely used method for testing cannabinoid concentration levels

-Estimated $4.25-$4.5 billion market

-Waters has 30% market share, Agilent has 20-25%

-Other players are Thermo Fisher and Shimadzu

Establishing industry standards will be crucial for testing companies, and getting government

certification will be key. Also, companies that can develop reliable portable and remote testing

systems will gain an important edge in the market.

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Forbes. https://www.forbes.com/sites/debraborchardt/2015/12/21/cannabis-testing-companies-get-green-light-from-bofa-merrill-lynch/#3a2a2d33497e

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Finally, there is the distribution and retail side of the industry, which comes with its own set of

challenges. Due to the federal illegality in almost every country in the world, ecommerce is not

a viable option right now, although upon legalization it will be a huge potential market. Delivery

across multiple regions will provide price and quality competition, driving innovation and

improvements. The cannabis industry seems suited to a subscription-based delivery model,

both for medical and recreational users. The main challenges will be customer acquisition and

retention, as brand loyalty likely won’t be high with every company providing a very similar

product.

Federal illegality presents a few problems beyond restrictions on delivery:

1. Businesses cannot make tax deductions.

2. It is difficult, if not impossible to borrow from banks to fund cannabis operations.

3. Trademarks and bankruptcy procedures are very limited.

These issues put legitimate businesses at a disadvantage to black market operations, who have

lower costs and do not have to deal with any regulations. Price discrepancies between proper

companies and the black market have been shown to impact consumer decisions, and Colorado

and Washington dispensaries had to significantly drop prices from their initial levels.

There is also a general lack of organization in the industry, which presents three main issues:

1. A lack of universal standards of quality makes it hard to build a trusted reputation.

2. Marketing and distribution is difficult because of strict regulations.

3. Access to capital is very restricted, as banks generally do not lend to cannabis

companies.

These problems will likely not be fully solved until widespread full legalization, but by the time

that happens, there will probably already be multiple established companies holding significant

market share. It is imperative for companies to carve out their place in the market early despite

the challenges they will face, rather than waiting for the full infrastructure to be in place. The

companies that will succeed despite the forces working against them will need to be extremely

efficient, execute their plan to perfection, and develop a unique technological advantage. Most

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of the early pioneers will likely have strong industry knowledge, but not as much operational

experience. It will be crucial for them to have a good group of advisors to make sure they are

making sound business decisions.

Key Ingredients of Success

Vertical integration and scalability are huge assets in the cannabis industry. A company that can

efficiently integrate the full process, from ‘seed to sale’, will be well-positioned to make

significant profits as long as they produce a quality product. However, since certain sectors are

more developed than others, it will be hard to maintain efficiency while integrating platforms.

Automated cultivation with monitoring and control systems will help companies scale their

operations. Companies that can compile large, proprietary datasets will have a big advantage,

as there is currently very little data available.

Meanwhile, there are also ample opportunities for companies to find a compelling solution to a

specific problem, and dominate that space. Targeted niche solutions could be early acquisition

candidates for larger emerging companies, or established corporations that want to enter the

industry. There are many SAAS possibilities, including platforms to manage the cultivation cycle

or test the plants, retail operations/compliance tools, mobile solutions, supply chain

management, CRM, and management reporting/business analytics. Also, companies that invent

advanced lighting equipment or cannabinoid extraction mechanisms will be well-positioned for

a lucrative exit. There have already been a number of multi-million dollar acquisitions, notable

for an industry which is still illegal across most of the world.

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In 2017, 55% of retailers, cultivators, and infused product manufacturers reached profitability

within a year, down from 70% in 2016. This can likely be attributed to the reduced cannabis

prices, but is still a fairly good rate. Profit margins are high in the industry, even after the price

drop.

Charts

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