Fear of commoditization is driving many legal pot growers to move into value-added, higher-margin extract products. Some, such as Kelowna, B.C.-based Valens GroWorks, are betting their entire business model on extract-based products such as edibles and vape pens. Everett Knight, executive vice president of strategy and investments at Valens, spoke to Cannabis Professional about how he came to the cannabis industry after a previous portfolio management career, how the company is preparing for the coming second phase of recreational cannabis legalization without getting a look at the final regulations, and what level of customization consumers of cannabis extract products can expect. The full conversation, lightly edited for length and clarity, is reproduced below.
Cannabis Professional: You joined Valens in January, but previously you spent several years as a portfolio manager with Calgary’s Matco Financial. What led to your move?
Everett Knight: We really became very fascinated in the extraction business and the value-added process, one because it was the highest EBITDA part of the business but it has the best margin stability as well. We ended up analyzing extraction companies all over North America and we came across Valens, where the guys at Valens really were doing things that no one else was… we ended up becoming one of their biggest institutional investors and I guess I got too close to it and ended up liking it too much because I’ve come on side since Jan 1.
CP: What was it Valens was doing in the extraction space that, as you say, was different from its competitors?
EK: The unique thing, if you look at Valens, is first of all the five different types of extraction we are going to be doing in-house. We are going to offer every different type of extraction, not just… the most common method of extraction in Canada right now which is CO2 extraction, both supercritical and subcritical. We do that in-house, but we are also building out ethanol, hydrocarbon, solventless and terpene extraction and we really have proprietary technology across that suite where we have taken it from places all around the globe to try and get our efficiency rates up. With those five different types of extraction methods, what we can do is produce any different end product, so we can become a one-stop shop.
CP: So the value proposition you give to actual cultivators is they sell you their dried cannabis and that can be the end of their involvement in the product creation process?
EK: We are not only the largest extraction company in Canada right now. We are really the first co-lab. What I mean by that is we collaborate with our customers to create brands and products. The reason we have all five different types of extraction is because it really allows us to create any product and customize it for our customers.
CP: When you say “any” product, do you mean any type of extract, or are you planning to go a step further and actually take in another producer’s dried cannabis and put out finished vape cartridges or infused foods and drinks?
EK: Exactly the latter. We want to be one of the largest third-party manufacturers of vape pens in Canada. Our model is really changing. We did start as just an extraction and processing company, where that is still a lot of what we are doing, extraction services where we charge a fee to take [dried cannabis] and return to the producer a product that they can them make into something value-added, but now our business model has expanded and the conversation has expanded to ‘Oh, you helped us with extraction, can you also help us with our vape pens’ or ‘Oh, can you help us with our cannabis-infused beverages’. I mean, with the experience of our guys, I’ve really never seen guys be able to make every different type of product; we have 53 people in our company and we have seven people on our R&D team, so you can see how much of a focus that is from a product creation standpoint.
CP: From a regulatory standpoint, the draft rules that were released in December, assuming the final rules are similar, will they allow you to execute a strategy like that?
EK: Well you may look at legalization happening last year, but for us, our legalization is really this year. That draft is a great baseline for what products you should expect, but everybody in their business plan also has to expect there to be some changes to that, even if you look at our preparations for the market, we have five different customizations [but] we’re only expecting to use many three of them. Maybe Health Canada comes out with a need for some sort of child proof button on the vape pen or something like that. I think you have to expect different things coming out of Health Canada, so you do need to be flexible with your business plan but you should plan around a variety of different areas to make sure you’re ready day one for that market coming up.
CP: Does that mean following say, the Canopy Growth approach where [co-CEO] Bruce Linton has often talked about the process of setting up a bottling plant across the street from his headquarters with every conceivable way of putting a cap on a bottle to ensure they’re in line with the rules, or does it mean taking the opposite approach and holding off buying expensive equipment until the rules are finalized?
EK: It is both, really depending on what product line. For example, you can order some of the base equipment but maybe you just don’t order the molds, right? There are different ways of doing it. There is certainly a sense that you have to be ready to a certain extent but then you have to watch and say, okay we can be flexible on this based on this anticipated wait time, or if there is a wait time perhaps you do prepare to have some equipment in house but you can return it within 60 days if you don’t use it. Bruce is right in that you do want to be ready and you want to have a few different options to ensure that you’re ready, but you also want to be flexible in the sense that you hold on to some capital so that when the rules do come out you can say ‘ok, we can now do this.’
CP: Then would it be accurate to picture a massive industrial facility that is sitting idle until the [extracts] regulations are finished, then a proverbial switch can be flipped and it will whir to life?
EK: Yeah, I would say that we actually significantly increased our capacity to 240,000 kilograms per year and if you look at what that is, it is because we are preparing for the edibles market and for our customers preparing for that edibles market as well. So the reason we expanded that so significantly was to get ready for that next step of legalization this year.
CP: How significant does the extract market need to be for your business model to work? Are you counting on Canada replicating what has happened in some U.S. states where extract-based products have cannibalized the market for dried flower?
EK: Exactly, that is actually our core believe at Valens. It is really, if you look at a few years ago in the U.S. and look at the data, it was 75 per cent dried cannabis and if you look at the market data for last year it was probably about 50:50 depending on the state and we believe it will eventually be 75 per cent oil-based edibles, concentrates, vape pen-type products and only 25 per cent dried cannabis. That is really our belief and that is the backbone of our business and the reason we are on this side because we do not grow cannabis today, we come in every day and focus on how to be the best at extraction.
CP: Sounds like you’re a big believer in the rapid commoditization of cannabis argument?
EK: We are very data driven so if you follow the state trends and look at the margin profiles, you see compression in dried cannabis, you see less compression in the oils where a producer could actually have greater margin today if it is also an oil producer because it can buy its dried cannabis from itself. But once you get into the actual end products, you have even greater stability as brands come to market. It is kind of like Lay’s potato chips, you buy them and they will be the same price every time but the ingredients all fluctuate.
CP: How do you see the extraction business itself evolving in the next few years?
EK: I feel like when the coffee industry got started, everyone was probably fine with black coffee. And then they developed different tastes and Starbucks came around and now we’ve got your caramel macchiato. It is very similar to the cannabis industry where everyone used to just want the highest THC to get the biggest high but now we’re learning to formulate and customize feelings based on cannabinoids and terpene profiles. If you look the price of Starbucks, I don’t think I’ve ever seen their prices go down and I think that is where you have to be, in the end product. We also do that, we focus on our [intellectual property] and cannabinoid isolation and purification and actually isolating for certain terpenes and then putting them back into the end product and I don’t think that is a part of the market that people have even thought about yet. But if you look at the consumer trend in the U.S., it is probably the biggest market you can have to actually customize different effects. That is where our co-lab comes in, we want to customize products with our customers to have them have a successful brand.