CCI March 2020
This month we investigate the challenges of incorporating small growers into LPs' commercial production, we speak to Andres Fajardo of Clever Leaves and assess two recent ministerial appointments
Will Colombia’s Small Growers Benefit from Commercial Cannabis?
A special provision to include Colombia’s small growers in the country’s nascent cannabis industry is failing to deliver on the goals it set out to achieve.
When Juan Manuel Galán wrote the first drafts of Colombia’s cannabis law, he wanted to include a feature that would guarantee participation of small rural farmers and indigenous communities that had been battered by drug-fueled conflict. It was only fair that those who suffered under prohibition should benefit from the legal trade.
A clause was included requiring that major cannabis companies source 10 per cent of the high-THC content they process must be sourced from small growers: those with plots of half a hectare or less, registered with the Ministry of Justice. But as the first companies approach commercial production of THC product, the complications and deficiencies inherent in the clause are becoming glaringly obvious and what could have been an opportunity for rural development and strong company-community relations is at risk of becoming a headache.
Private firm Clever Leaves, is currently developing its own program to work with growers close to its cultivation site outside of Bogota. “The quality requirements in terms of the flower is tremendously high – you need significant microbiological testing and to avoid issues with metals and pesticide use – and at the same time your ability to control production is low,” says Andres Fajardo, the company’s CEO. “How can we ask someone to invest $150,000 in half a hectare of greenhouse that meets our specifications? We have no issue sharing a piece of the pie with small growers, but we need to find a model that guarantees quality and consistency under a workable financial model.”
The law is also complicating matters of intellectual property rights and supply chain security, says Pilar Acosta of Somos Nacua, a group that consults on community relations for cannabis companies in Colombia. The protocol for precisely how to show your company is sourcing 10% from small producers is vague as well.
There are approximately 1,500 small producers on the ministry of justice list. A quick glance shows emails and contacts of small producers from Antioquia to Huila to Guajira. However, there’s a glaring problem: the overwhelming majority of small producers are not fully licensed. “The law actually doesn’t guarantee the social responsibility results that were originally envisioned,” says Acosta. “Less than 20% have done the licensing and paid for it out of their own pockets. The tragedy is that a lot of small producers thought they would make some good money off of this – but that’s not the case. A lot of them are going broke.”
The law poses significant challenges to large export-focused companies. In order to produce standardized cannabis oil, companies must control the genetic composition of their flower output. “I’ve heard big cannabis companies say, ‘how can I pass all my genetic info and know-how to another legal entity jus like that?’” says Acosta. “So, when it comes to seed genetics, there are real intellectual property concerns.”
Maintaining quality standards of supply from across multiple small producers would seem like another headache. “GMP certification is really expensive,” says Santiago Ciurlo, Product Development Manager and Co-Founder at Huicanna. “But I don't see how all of these small producers are going to be able to afford that certification and supply large-scale producers who need to meet those standards for their clients.”
Companies who want to intervene in small-producers’ genetic quality and screen for security issues cannot legally impose themselves. At least three industry sources have told CCI that companies have reportedly bought and burned dry flower from small producers, meaning they effectively show compliance with Colombian regulations but toss out the biomass when it fails to comply with internal quality standards.
Those costs could perhaps be absorbed by successful companies operating at thick margins, but it would make a mockery of the goal of becoming an efficient, low-cost new industry. And successful partnerships with neighbouring growers also desireable from a community relations standpoint.
One example of the 10% rule as CSR initiative is Pharmacielo’s model. The Toronto-listed firm built an alliance with Caucannabis, a 63-member co-op of cannabis producers in Cauca department, where the illicit drug trade has flourished for decades. In exchange for helping Caucannabis farmers gain licenses and understand the necessary technology for quality cannabis production, the company will secure their 10% quota from one single co-op. That means uniform quality, compared to multiple small producers with varying levels of cultivation success.
One Medellín-based cannabis grower insists they would love to do what Pharmacielo is doing, but note that it’s extremely capital-intensive. To secure supply, a secondary wholesale market could be the eventual answer.
Acosta thinks the 10% provision could get reformed out of Colombia’s cannabis law. It’s also possible, she says, that big producers will keep their CSR initiatives and continue buying from co-ops modeled after Caucannabis. But provided that even as a small producer, you have to hold all the required licenses, there is very little incentive to go small when you could go large – and companies are picking up on that.
“I’m pessimistic that the 10 per cent rule stays put,” laments Acosta. “It’s possible it gets reformed and disappears. Don’t get me wrong, there are a lot of companies out there with very good intentions. But many companies view this as a headache that’s difficult to manage. And remember that this is a highly-regulated industry with lots of other problems to solve.”
Another option would be for the 10 per cent rule to be extended into low THC, high CBD based products. “If you’re doing CBD (cosmetic) and THC (medicinal) the smart thing would be to put your 10% sourced from small producers into your cosmetic line because it can be lower quality,” says Juliana Salazar, an independent consultant.
There have been rumours circulating the market that CBD production could become subject to a quota system similar to that levied on THC products. It would make sense, in this instance, to open the door to the less exacting standards of CBD production even if LPs would have to remain very vigilant against THC content exceeding 1 per cent.
Ethically, the motivations behind Galan’s 10 per cent rule were well intentioned, but it increasingly looks like a rushed clause that doesn’t achieve its aims. For a start, a large proportion of small license holders aren’t campesinos or indigenous people, they are often upper-middle-class Colombians looking to profit on a rural property (singer Carlos Vives’ cousin is a registered small grower).
At a more fundamental level, the push for an inclusive industry is at loggerheads with the current government’s drive for a tightly controlled, highly regulated cultivation and the international market’s demand for GMP certifications. The wide gap between these two positions risks opening up opportunities in the black market. Weed that doesn’t make pharmaceutical grade would still be happily – and profitably – received in the recreational market. The 10 per cent provision is turning out to be another regulatory headache irritating the sector – instead of a thoughtful law that might strengthen it.
CCI speaks to Andres Fajardo, CEO of Clever Leaves
How did the 2019 bear market in cannabis stocks affect Colombian operators in terms of operations and financing?
AF: Obviously access to capital markets has become a challenge and we have also seen regulators become stricter on compliance issues. But the most important impact has been on company strategy. Our focus has shifted from expansion to EBITDA generation. Last year we ramped up production to 15 hectares and planned to finish the year with 25, but we decided to stop at 18. We have invested over $50m in building our infrastructure and our extraction capacity will reach 324,000 kilograms of dried flower in the next three or four months. In August 2019 we became the first INVIMA GMP certified laboratory for cannabis derivative products and we are pursuing an EU GMP certification the first half of 2020. However, we were building capacity before we had unlocked demand. We know how to expand efficiently and can do it when we need to, but now the focus is overcoming challenges around demand.
What needs to be done to unlock that demand?
AF: The main challenge is regulatory. Producing cannabis products and sending them to other countries has proven to be more complex than many companies anticipated. In Colombia, the slow pace at which things are happening is not fostering the development of the industry. Clever Leaves received one of the largest THC cultivation quotas last year, but it’s a time-consuming and cumbersome process. We’ve also seen more and more Colombian regulators becoming involved in the process. That may be fair, but it´s adding to delays, affecting the ability of companies to generate cash. But things are beginning to fall into place and we expect to be in positive EBITDA territory before the end of the year.
How has Clever Leaves’ international strategy evolved other the last two years?
AF: Originally we were a Colombian company and now we are a global company. At the end of last year we combined with our financial partner, Northern Swan. We’re now one of those companies that combine strong operational and finance teams. We now have one of the first five cultivation licenses in Portugal and have over 3,000 plants in the ground on our first hectare. Portugal allows for the sale of medical grade dry flower, which still makes up significant proportion of demand.
We have also been investing in our Frankfurt operation, where we are focused on importing and commercializing our line of pharmaceutical products, under the brand IQANNA. Originally we focused on Germany and Europe for our pharma products, but now it’s Germany first. We’ll develop products in one of the most demanding markets in the world, then expand to the rest of Europe. The US has always been a big but fragmented market, but we are starting to see windows of opportunity where our products could meet the regulatory guidelines. Another country that is very interesting is Brazil. Regulation there has developed in a way that could allow us to enter the market with the right local partners given our INVIMA and future EU GMP certifications. Brazil could be one of the largest markets in the world.
Successful companies have the ability to understand where regulation is going, to help shape its formation through the right arguments and to be able to react quickly when the framework changes. If you’re not nimble, you won’t be able to adapt to the constant changes in cannabis regulation.
How sustainable is Colombia’s cost advantage in the long term?
AF: Colombia has a great geography and a great location, but I don’t think it will be the cheapest country to produce CBD commodity products in the long term. Eventually China, East Africa and others might be able to produce at around 1 to 2 cents per gram instead of Colombia’s 3 to 5. We’ve been focussing on building a company with value added products, registered strains and certified production facilities. We want to send to markets with the highest requirements. We need to focus on product differentiation and getting closer to the end consumer in order to capture margins. We can either be the coffee-grower of we can be Starbucks, we should aim to be the latter.
Will the vertically integrated model become popular in the Colombian cannabis sector?
AF: Clever Leaves’ vertical model was based on us being amongst the first to market. I do not think that the model will be sustainable for many others. You need scale, money and a first mover advantage. Companies will start to have to differentiate themselves, find the things that make them special. I think even at the global level, there will be few vertically integrated companies. I imagine that twenty years from now there’ll be companies from different industries entering the cannabis space: pharmaceutical companies acquiring medical cannabis brands, consumer product companies adding cannabinoids to their mainstream brands and specialist operators taking over the production of ingredients.
Is there room in the Colombian market for new players?
AF: When people come to me with a plan to convert their grandfather’s finca into a cannabis project to sell isolate and become rich, I tell them, “let me help you with the math”. There are already a lot of licenses and the value of the license itself – once around $1 million – is no longer there. It takes a lot of resources to build a cannabis company and I think we will see lots of companies fail. There might be some consolidation amongst the mid-sized players given the challenges raising funds on the capital markets.
What would represent success for Clever Leaves in 2020?
AF: Firstly, to become EBITDA and cash flow positive before the end of the year. Next, to begin sales of our pharmaceutical products in Germany before year end and to get our Portuguese facility ready to sell dry flower. If we achieve those three things, that will be success.
Two new figures step into Colombia’s cannabis policy universe
A medical surgeon with a masters in public health policy from Harvard University is one of two new chiefs in Colombia’s cannabis policy world.
Fernando Ruiz, who was close to Vargas Lleras during his presidential campaign, will take over as minister of health for president Iván Duque’s government after Juan Pablo Uribe left the spot vacant with his December 2019 resignation. Ruiz, a moderate figure close to aspiring presidential candidate Germán Vargas Lleras, said shortly afterward his appointment went public that he believed Colombia should maintain its leadership in medicinal cannabis.
“We have to move forward with cannabis regulations because Colombia has a strategic advantage in the production of cannabis,” Ruiz told reporters in an interview.
The professional history of Ruiz is closer to an academic policy wonk than that of a businessman, meaning his support for the industry might be more focused on patients over profits. But there’s no doubt he wants to push the sector forward and improve regulations.
Asocolcanna, Colombia’s cannabis producer association called the naming of Ruiz a “100% success.” Rodrigo Arcila, director of the association told CCI, “Ruiz knows the health sector like no one else and he has all the personal, technical and intellectual capacity needed for the role.”
Separately, at the agriculture ministry, where Colombia’s cannabis firms must register their seed strains with regulatory agency ICA - the government has put Rodolfo Enrique Zea at the helm. Zea is an economist from the Andes university in Bogotá with a track record in public financing. Under former president Juan Manuel Santos, he worked for national development bank Findeter and more recently Fiduagraria, a fund that structures capital for agro projects.
According to Asocolcanna, Zea first showed interest in Colombia’s cannabis sector during his tenure with Fiduagraria. Arcila thinks Zea’s “first order of business has to do with the sector’s search for competitiveness by acting quickly on financial leveraging companies with access to credit and foreign funds.”
The two appointments also reflect Duque’s negotiations with political party Cambio Radical to form a center-right coalition. That coalition could mean an exit from gridlock in Colombia’s legislature where Duque has struggled to pass key laws. Though no doubt it raises the tension between the more moderate president and more radical elements of his party, Democratic Center. While Duque might have consolidated an alliance with congress, it remains to be seen how well he can reel in the hard right and finish the work his administration has barely started.
Sources in the industry tell CCI that Duque’s administration has been slow to respond to companies who want more clarity on medicinal cannabis regulations. No doubt these two new figures in Colombia’s cannabis world - Ruiz and Zea - will be key for addressing key for carving out the pathway ahead.
Khiron Life Sciences plans to report 4Q 2019 earnings in late April.
Deals, Licenses & Financing
Ikanik Farms in Colombia passed its EU pharma test
Passing the pesticide and heavy metal test pushes Ikanik Farms’ local subsidiary Pideka one step closer to its goal of distributing cannabis in Europe markets by Q3 2020, the company reported at the end of January. Ikanik acquired Colombian cannabis producer Pideka in October 2019. Brian Baca is the CEO of Ikanik.
Toronto’s Flora Growth agreed to an acquisition of Colombian Cronomed
Cronomed is a nutritional supplement company with a line of 10 products. The transaction involves taking a 100% equity stake in Cronomed, Flora Growth reported on 23 January. However, the value of the stake was not revealed. Damian Lopez is the CEO of Flora Growth and is originally from Bucaramanga, Colombia.
Pharmacielo signs agreement to distribute CBD into Europe
The Colombian CBD producer will sell broad spectrum CBD to European wholesalers and targets 2,000 kg in the first year of a three year agreement, according to a 24 January press release. German XPhyto Therapeutics is one of the importers.
Toronto’s Leviathan enters Colombia with Rio Negro hydrangea farm buy-out
The company is in the process of finalizing a US$1.11 million deal for a 22.43 acre property located outside the city of Medellín, Colombia. The property and facilities will be converted into a hemp operation. Leviathan has budgeted US$3.9 million for the facilities rehabilitation and to date the company has spent US$500,000. Payments for the property will be made in five installments over 18 months. Leviathan also runs operations in Tennessee, United States and Canada.
Seeking balance sheet strength, Cansortium to partially exit Colombia
The Miami-based company on February 13th said it will return shares for cancellation and plans to keep a 50% equity stake in its Colombian partner Vision Science, which holds cultivation and manufacturing licenses. Cansortium is divesting assets in order to improve its balance sheet and focus operations on US states Florida, Texas, Michigan and Pennsylvania.
Avicanna to sell Santa Martha cannabis into Australian market
The pharmaceutical company said on February 24th that it would start exporting medical grade products to the Australian market after signing an agreement with Cannvalate Pty Ltd. The import and distribution agreement involves supply of Avicanna’s Rho Phyto products as well as active pharmaceutical ingredient volumes.