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Paul Rosen, CEO of PharmaCan Capital, has visited dozens of medical marijuana firms to decide which one to invest in. (Peter Power For The Globe and Mail)

The question flickered through Paul Rosen’s mind: “Is this the day I die?”

The 50-year-old merchant banker was on his way to tour a medical marijuana facility two years ago, when the men driving him to the site made an unusual request. They handed him a blindfold and told him to put it on.

Mr. Rosen had been on dozens of these trips before, crisscrossing Canada to evaluate the prospects of fledgling medical marijuana firms and deciding which ones his company, PharmaCan Capital, would invest in.

Ever since Health Canada unveiled plans to open up the market in 2014, upstarts have been popping up everywhere, opening factories, setting up greenhouses, and wooing investors, each trying to land a coveted federal licence.

It is a boom in every sense of the word. But Mr. Rosen had never been driven to a site blindfolded. The CEO of PharmaCan started to wonder exactly who he’d gotten in the car with.

“I thought, this is either a great story, or the worst day of my life,” he said. “I had just been watching the fifth season of Breaking Bad. I was nervous.”

When the blindfold came off, Mr. Rosen stood in the middle of a facility under construction, somewhere on the outskirts of Toronto. The company wanted to highlight just how protective it was of the site. Mr. Rosen had no idea how he got there – it was all part of the show.

Welcome to Canada’s new medical marijuana industry. It’s barely begun, but already there is enough froth, risk, and questionable showmanship to supply people like Mr. Rosen with years of stories.

Since the federal government began issuing licences to companies this spring, allowing them grow and sell medical marijuana to an estimated 37,000 patients, Health Canada has been flooded with requests for permits. Only 13 companies are licensed now, but according to federal documents, an average of 25 new applications are submitted each week.

And with good reason – Health Canada projects that the number of patients seeking medical marijuana for everything from glaucoma to pain relief for cancer treatment will climb to 400,000 in a decade.

Today’s $100-million industry could be tomorrow’s multibillion-dollar bonanza, especially if the political winds ever blow in the direction of legalizing marijuana for recreational use, making it as accessible – and no doubt as profitable – as alcohol is today for brewers and distilleries.

Not surprisingly, the money is already starting to fly as speculators, penny stock promoters and get-rich-quick investors flock to the sector, and companies try to turn hobby science into something resembling Big Pharma. In just a few months, there have already been two product recalls over fears of contaminated pot, suggesting quality control is still an issue.

Cannabis seedlings at the Tilray medical marijuana grow-op. ( John Lehmann/The Globe and Mail)

On the investment side, things appear just as rocky. The hype surrounding this new sector has seen junior mining companies rebrand as medical marijuana firms almost overnight. Amid a flurry of press releases from companies touting future production, stock regulators in Canada and the United States took the unusual step of warning investors to tread carefully around medical marijuana stocks, fearing a bubble is forming and that stock manipulations among small companies on venture exchanges and over-the-counter markets may be taking place.

The burgeoning sector is drawing comparisons to the dot-com boom of the late 1990s when investors rushed in to take advantage of a hot sector, and were duped by bold promises of future earnings that never materialized, while companies with Internet-related businesses cashed out on their inflated valuations.

Not surprisingly, the dot-bong era in Canada, as it’s been dubbed, comes with a healthy dose of investor-beware.

The way Mr. Rosen sees it, Canada’s medical marijuana sector is a land of opportunity that’s also fraught with risk. With each site he visits – more than 100 and counting – he must figure out which companies are worth investing in, which will go on to become licensed producers, and which firms should be avoided.

There will be winners who emerge from the pack. In trying to pick them, Mr. Rosen’s job is not unlike any investor sitting on the sidelines wondering whether they should join the marijuana boom. Of more than 200 companies PharmaCan Capital has examined up close or from a distance, the firm has chosen to invest in just five, on behalf of clients that include large hedge funds in the United States.

“There is a real industry here that is emerging from the flurry of activity, and if you can find those companies, I think the opportunity for investors is tremendous,” Mr. Rosen said. “But good luck finding those companies if you have to wade through the 985 that you may not like to find the 20 you do.

“We say no a lot more than we say yes.”

The trimming room at the Tilray medical marijuana grow-op. ( John Lehmann/The Globe and Mail)

Birth of a market

Health Canada has only grudgingly allowed the industry to exist.

Although Canada has bathed in glowing international reviews from pot proponents for loosening its restrictions on medical marijuana, the federal agency hasn’t exactly been happy about it.

As Health Canada points out in bold letters atop its regulations and industry correspondence: “Dried marijuana is not an approved drug or medicine in Canada. The government of Canada does not endorse the use of marijuana, but the courts have required reasonable access to a legal source of marijuana when authorized by a physician.”

Under legal pressure to provide a stable, affordable and safe supply of medicinal marijuana for patients who need it, the federal government announced in June, 2013, that the market would be privatized and companies would be allowed to apply for licences to grow the plants and sell the product directly to patients.

That system, brought in April 1, replaced a regime where the government allowed patients to buy from approved growers who were limited in how much they could produce (enough for a few patients) or from Prairie Plant Systems, a federally sanctioned grow-op. However, concerns that PPS’s product was too weak, and quality control issues from the smaller growers, led to calls for that system to be scrapped. Contaminants such as mould or pesticides can be harmful for patients with immune deficiencies, critics worried.

Mr. Rosen suspects the old system – which Ottawa called the “Medical Marihuana Access Regulations (MMAR)” – was rife with corruption. Some operations he’s visited in recent months were small growers under the old system who are looking to get licensed in the new regime. A few of them seemed to be growing quite a lot of product for just a few patients.

“The amount of abuse in the MMAR [system] is surprising to me. I’ve gone to facilities in British Columbia where they had licences for 700 plants for four patients, which is just a preposterous, preposterous quantity,” Mr. Rosen said. He hopes the new system will get it right.

“The most shocking thing for me was how unregulated the old system was. The most reassuring thing for me now is how incredibly well regulated the new system is.”

Between June, 2013, and February of this year, Health Canada received 454 applications from companies looking to become sellers of medical marijuana. It has approved just 14 of those licences. However, one company – B.C.-based Greenleaf Medicinals – was removed from the list this summer after it was forced to recall a batch of Purple Kush marijuana “due to issues with the company’s production practices,” the government said. The culprit was mould in the marijuana.

It is one of two product recalls to hit the young industry so far. In May, Ontario-based Peace Naturals Project Inc. recalled a batch of its medical marijuana, after testing found a higher level of bacteria than acceptable. The 55 clients who received the product were instructed to return the weed, or mix it with cat litter and dispose of it with household waste.

Health Canada hopes those recalls are merely early glitches, not a sign of more to come.

Tilray vice-president Philippe Lucas, forefront, and Christian Groh, a partner in Privateer Holdings, the private equity investor in Tilray. (John Lehmann/The Globe and Mail)

It remains unclear how many more licences will be granted – and at what pace. To obtain a licence, companies must go through a series of site examinations, background checks and security tests to ensure the facilities are secure. It is not an easy process.

For investors, the number of licences that will ultimately be issued is the big question. Will they be limited, like in the telecom sector? Or will the industry be left open to all companies who demonstrate they can meet the government’s standards?

Speculation within the industry has run rampant that the government has a finite number in mind, which would make existing licence holders the owners of a lucrative permit. But a Health Canada official told The Globe and Mail that the government has no specific target. Rather, Ottawa will let the market dictate how many companies survive.

The group of 13 licensees has a head start on getting established, and several of them have emerged with operations that resemble high-tech laboratories and look nothing like a basement grow-op. Among the names are Tweed Inc. of Smith Falls, Ont., which took itself public this year in Canada’s first medical marijuana stock offering, and Bedrocan Canada Inc., a Toronto-based subsidiary of a Dutch company that is one of the few established international names in the business.

Nanaimo-based Tilray has constructed a large, pristine operation on Vancouver Island, backed by Seattle private equity player Privateer Holdings, which has pumped considerable dollars into the U.S. tech sector over the years. The sprawling, brightly-lit facility is a testament to medical marijuana’s sanitized future, where staff wear white polyethylene suits and blue gloves when handling the plants.

Shlomo Booklin holds a cannabis seedling at the Tilray medical marijuana grow-op in Nanaimo, B.C. (John Lehmann/The Globe and Mail)

Tilray vice-president Philippe Lucas said the two product recalls at other firms were not good for the sector over all, but show that there is oversight. “On the good side, those things are being caught,” he said, noting that Tilray has not had any issues with its product.

Every detail, right down to the way the marijuana is packaged, is under scrutiny. “The packaging has to be child proof, smell proof, and maintain the integrity of the product,” Mr. Lucas said.

As companies like Tilray, Tweed and others build their businesses, a growing line of companies is waiting for the door to open.

Leamington, Ont.-based Aphria, which is headed by Vic Neufeld, the former CEO of vitamin giant Jamieson Laboratories, has been growing plants for the past few months, but is awaiting its licence to sell. Like many companies in the space, Aphria also has plans for an IPO.

With the industry so untested, Mr. Neufeld said he believes trying to draw up a business plan several years into the future is pointless. Although he is confident Aphria can become a significant player in the market, he’s not about to make bold long-term proclamations about growth.

“Anything forward from three years is really hot air,” Mr. Neufeld said. “So when you look at the core of where we want to go, the goal is to be a consistent high-quality, low-cost producer. And that’s just stealing right from [the model at] Jamieson.”

Not everyone is as cautious. Regulators have expressed concern about wild predictions made by companies rushing into the market in an attempt to lure investors before the boom cools off. In particular, firms trading in the over-the-counter market, or pink sheets, have drawn the the attention of the Canadian Securities Administrators and its U.S. counterpart.

“CSA is urging investors to be cautious when considering investing in medical marijuana stocks,” said the regulator, which represents securities regulators of each province.

“While some have touted medical marijuana as a significant new sector for investment, the CSA has observed a number of small or inactive reporting issuers announcing medical marijuana business plans. In many of these cases, just the announcement of intent to develop a medical marijuana business has resulted in an immediate rise in the company’s stock price.”

Shlomo Booklin with a tray of cannabis seedlings at Tilray. (John Lehmann/The Globe and Mail)

Numerous junior mining companies have taken the sudden plunge into medical marijuana, no doubt hoping for a bump in their stock prices. Supreme Resources renamed itself Supreme Pharmaceuticals this year, while Affinor Resources Inc. changed its name to Affinor Growers. Junior miner Thelon Capital Ltd. also made the switch, while Satori Resources, which happened to have the ticker symbol BUD, also decided to explore the new line of business.

If investors needed further evidence of froth, former Canadian Olympic snowboarder Ross Rebagliati provided it in July with an announcement that he was getting into the medical marijuana industry with a branding and licensing company. Mr. Rebagliati, who briefly lost his gold medal at the 1998 Winter Olympics after testing positive for marijuana, is selling his name to companies interested in branding their best stuff under monikers such as Ross’ Gold, Silver and Bronze.

His company, Green & Hill Industries Inc., is traded on the over-the-counter market in the U.S., hoping to capitalize on the hype surrounding the business. The lesson? There is money on the table, and there is no shortage of entrepreneurs willing to grab their share of it.

With all the uncertainty over how the sector will develop, Christian Groh, partner in Privateer Holdings, the private equity investor in Tilray, said he doesn’t believe the Canadian medical marijuana business should be courting mom and pop investors in the public markets.

“I know some [companies] are legitimate players. But there’s no data, no metrics. This is a new industry, a new regulatory environment. The mechanics aren’t completely fleshed out yet,” Mr. Groh said.

“The demand [from investors] is there – we all understand that. But you’re talking about basic business fundamentals that aren’t even established yet. And for people to go out on an exchange and to put out press releases, or to say they’re going to do something. It’s disingenuous … Quite frankly I think it hurts the industry.”

Big promises

Among the companies that are given to making bold statements is Creative Edge Nutrition, a Michigan nutritional supplements maker that is setting up a facility in Lakeshore, Ont., near Windsor. Its Canadian medical marijuana subsidiary is called CEN Biotech.

Creative Edge proclaims that it is building the “world’s largest and most advanced legal cannabis production facility.”

Whether the CEN facility will ever be constructed depends on a few factors, such as whether the company can get approvals to build it. That hasn’t stopped it from issuing press releases touting its future industry-leading size. Its public relations people refer to the company as a future “super grower.”

But Creative Edge, which doesn’t yet have a licence to sell medical marijuana, has faced pushback from the community in Lakeshore, where some residents are uneasy about having such a large facility in their backyard.

The company’s CEO, Bill Chaaban, said he expects the licence by the end of this month. The application calls for 600,000 kilograms a year of marijuana production, which would put CEN ahead of the field in Canada, he said. “We would be larger than all of them combined.”

Mr. Chaaban then clarifies that number a bit. “We don’t expect to be growing [all of it] in the first year. It’s something you scale up to. We have a 10.5-acre site and it’s something you build up over time.”

Simply put, CEN has a few more steps to go before it can claim to be the biggest in the world.

Those types of proclamations are reminding some of the dot-com era, which produced inflated stocks, some investment winners, but left a lot of carnage.

Mr. Chaaban says he supports the regulator’s warnings, “I think they’re absolutely essential,” he said. “There’s a lot of people trying to capitalize on investor-get-rich type of schemes. You have mining companies [penny stocks] that are now wanting to get into medical marijuana and I think it’s absolutely ridiculous,” Mr. Chaaban said.

“If it’s an attempt just to capitalize … I think they need to be halted and addressed.”

Joey Arsenault uncovers cannabis seedlings at Tilray.( John Lehmann/The Globe and Mail)

Some observers have wondered, quietly, what CEN plans to do with all the marijuana it claims it will grow, since 600,000 kilograms is a lot to dump on the Canadian market. Mr. Chaaban said the company’s ultimate goal is to ship outside Canada to foreign markets as more jurisdictions change their laws. “We intend to export the product,” he said, adding that Health Canada allows for that, as long as the domestic market is served. “You’re not going to be able to export until you satisfy the demand of the domestic market.”

Currently, Health Canada regulations restrict licensed producers from selling any other kind of product beyond dried marijuana, but Creative Edge also wants to get into other marijuana-related businesses. “You need to be more than a one-trick pony. I think if you’re going to have staying power, you’re going to be able to make money in other divisions in other things,” Mr. Chaaban said.

“There also has to be research done into new delivery mechanisms because I think it’s going to be hard to get physician support behind a medicine you have to smoke.”

Risk and reward

Despite the unusual warnings from regulators, not everyone is against the stock market froth. Some see it as just part of the way a new industry works out the kinks.

Sure, there are bound to be bad companies, but there will also be good ones, argues Scott Gardner, chief investment officer at Verdmont Capital, a Panama-based investment firm that is keeping tabs on the unfolding Canadian market. Smart investors can make good money by finding the legitimate players, he figures.

“As with all emerging sectors attracting capital, there will be scammers looking to capitalize on some of the misinformation floating around,” Mr. Gardner said.

“There are many companies pitching their stories with certain ‘facts’ that really can’t be backed up by any hard data. For example, no one knows how many strains will be needed in the marketplace and the efficacy of these strains in treating different ailments.

Shlomo Booklin trims cannabis plants at Tilray, a medical marijuana grow-op in Nanaimo, B.C. ( John Lehmann/The Globe and Mail)

“We have also heard companies discussing various projections with a high degree of confidence, with limited visibility on end-demand, and a yet-to-be-determined industry cost curve. Most projections need to be taken with a grain of salt.”

However, that doesn’t mean the industry shouldn’t be courting the markets, Mr. Gardner said. Investors who stay on the sidelines are missing the point, he argues.

“Where we disagree … is that investors should avoid investing in the space until the dust settles. ... For educated investors with some risk capital to deploy, now is a great time to get involved. The risks are higher for sure, but then the potential returns are there if you can identify the right teams and companies to get behind.”

When the dot-com bubble burst, the collapse of high-flying stocks like, and the cratering of even more well-known tech stocks such as, left a bad taste for investors. But Mr. Gardner argues the dot-com boom also brought forth some hugely successful businesses that have changed the world. He sees the medical marijuana sector the same way.

“Ultimately, the tech boom left us with some amazing companies,” he said. “There will be winners and losers. The sooner we find out who they are, the better. The market will only assist this process.”

Growing pains

Mr. Rosen laughs in disbelief when he thinks of how many grow operations he’s visited. But the work is crucial.

“When I see a good company now, they jump off the page in a way that maybe they wouldn’t have six months ago, because I didn’t have enough of a context,” he said.

Investors should be able to draw their own conclusions when a penny stock claims to be part of the rush, he argues. Still, Mr. Rosen fears a stock scandal could tarnish the good companies, along with the bad. “That’s the challenge right now… we’re so nervous that opportunists and people that are not committed towards long-term governance are going to impugn the reputation of the sector at a fragile time.”

In the time he has spent touring wannabe medical marijuana facilities, Mr. Rosen has noticed how far the industry has come. Things are getting more professional, he hopes.

“I think today we would say we’re not putting a blindfold on. We’re not getting in your car. It was a different industry back then. It was a bit more of the Wild West.”

Editor's Note: An earlier version incorrectly identified Mr. Gardner. This version has been corrected.