Global marijuana stocks up 1% for the week, driven by M&A in Canada
The global marijuana stock index had a volatile week, but ended up slightly for the week. Results were driven by M&A buying in the licensed Canadian space with MedReleaf bouncing on the announcement they would be bought out by Aurora Cannabis. Canopy Growth was also up strongly after announcing the stock will begin trading on the New York Stock Exchange by the end of May.
In Canada, large caps were up 2.5%, mid caps up 2.3%, and small caps increased 1.9%.
Grizzle’s Take
Dealmaking reached a fever pitch this week in the marijuana market. Looking back we think some of these deals will mark the peak of insanity in the great marijuana bubble.
All stock deals, stock raises from investors done at a 20% discount, related party transactions galore and even invites to parties where you can only get on the guest list by not selling your shares for 90 days (looking at you Namaste).
Grizzle thinks the industry will require legal supply bottlenecks and higher prices after legalization to push the stocks any higher at current valuations. The stock price gains would only be temporary, however, and if instead prices begin falling soon after legalization, the only direction stocks will go is down at current valuations.
WEEKLY PERFORMANCE OF THE TOP 75 GLOBAL MARIJUANA COMPANIES
Source: New Cannabis Ventures
Aurora Cannabis Buys MedReleaf for $3 Billion
After both companies admitted they were in talks last week, a deal finally was announced Monday. Aurora is paying for MedReleaf 100% in stock, and will have almost 1 billion shares outstanding once the deal closes.
What this dilution means is that a share of stock entitled to $1 of earnings in 2016 now is only entitled to $0.15 today. Aurora has to make ~$7 per share in 2018 for your stock to be worth the same as if they made only $1 in 2016. This is the negative power of dilution.
Our full thoughts on the deal can be found HERE.
Aurora is paying $21.30 per gram of funded capacity (140,000 kg). To make a 10% return on this kind of premium, Aurora will have to sell MedReleaf volumes (dried and oils) for $12 per gram for the next 10 years. Given that dried flower is selling for $4.50 to the provinces and oil is already selling for about $12 per gram to medical consumers, but falling in price every quarter, we don’t see how blended pricing will come anywhere close to $12 per gram.
The deal was also expensive looking at future cashflow. Aurora paid 22x expected EBITDA 3 years from now. Even the wine and spirits industry, popular with analysts as a proxy, trades at 15x EBITDA only 1 year forward.
MedReleaf Deal Multiple Compares to Industry Peers
Source: Bloomberg, S&P Capital IQ
What This Deal Tells Us About Marijuana Stock Prices
It’s plain to see that industry consolidation is not being driven by valuations. Management teams want to grow bigger and faster than competitors and they don’t care what it costs. If you’re thinking about buying into the marijuana hype the following exchange between Aurora’s CEO and a Wall Street analyst should be a huge red flag.
Newfoundland and Labrador government offering 8% gross margin to retailers
The retail framework in Newfoundland and Labrador is to offer retailers an 8% gross margin. The margin is low enough that an independent retailer who was approved for a sales license decided to turn down their license because they didn’t think they could make enough profit to stay in business. Rumours are swirling that B.C. could be negotiating an even lower margin than 8% based on negotiations at this stage.
Say your store has 2 employees making $15 an hour and working 8 hour days. To make $500 of profit a week with an 8% gross margin after paying your employees, utilities, and rent you would need to sell almost 2 pounds a week even if you can sell a gram for $7.50. The average successful store in US legal states sells 1 pound a week.
What this means for Canada
As more information comes out about the profitability of selling marijuana within the provincial system, we’re seeing that margins will be much lower than where they are currently.
Licensed producers currently generate gross margins of $6.50 per gram, but under the provincial rules that will kick in after legalization, gross margins will be $2 per gram in provinces that run their own retail and serve 75% of the population.
Aphria Signs Partnership to Distribute Marijuana Throughout Canada
Aphria announced a distribution agreement with a subsidiary of Souther Glazer’s Wine and Spirits, a company that distributes and transports wine and spirits through 44 states in the US and throughout Canada. Southern Glazer’s will be the only company licensed to distribute Aphria’s marijuana products to retail outlets and potentially to government-owned retail stores in Canada.
What this Deal Means for Licensed Producers in Canada
This is an important deal as it signals that Aphria has chosen to partner with a logistics partner to distribute marijuana nationwide instead of building a supply chain from scratch.
Aphria will have to pay Southern Glazers a negotiated percentage of profit to compensate them for moving the marijuana to market. This is the first distribution deal announced in the marijuana space and signals that not every company is choosing to build an entire supply chain from scratch.
Only time will tell if paying someone else to move your marijuana around vs building your own supply chain will be the more profitable move. It will be very interesting to see what the other large licensed producers choose to do.
Vic Neufeld, CEO of Aphria, has decades of experience distributing health products all over Canada so if he has chosen a pay vs build model, other producers may want to take note.
Namaste Technologies “The Pledge” Signals a Bubble is Here
Click HERE for the full story, but to make a long story short, Namaste management is throwing a private party for any investor who pledges not to sell their shares for the next 90 days.
So far 40% of outstanding shares have been pledged to the cause with 60% of those coming directly from company insiders by our calculations. Even with the high participation rate, Namaste shares are down 4% since the pledge was announced Monday.
What This Tells us About the State of the Industry
Historically, when management teams in an industry resort to unorthodox methods to support their stock price, it points to inexperienced companies operating in an overly inflated sector. When money is flowing freely, companies with inexperienced management teams can borrow their way into an industry that they may not be able to compete in longer term.
A management team that blames “malicious short sellers” for the weakness in their stock price likely has a fundamentals problem. Growing, profitable companies let their financial results speak for themselves when sentiment turns negative, instead of resorting to publicity stunts to artificially support the stock price for a few months.
Marijuana Users Consume Less Alcohol and Medicine According to New Survey
High Yield Insights, a market research firm surveyed 795 marijuana users over 21 in California, Colorado, Washington, Nevada, Oregon, and Michigan and found that consumption of alcohol and medicine for pain, sleep, and depression decreased for 10%-20% of smokers. More smokers decreased their consumption of alcohol (~20%) than prescription medicine (~11%), but the decreases were still significant.
What This Means for Big Pharma and Alcohol
Big Pharma and the Alcohol business should be afraid. Growth in Alcohol consumption in developed markets is already slow, so even a small change in consumption could have a large effect on beer and spirit company financials.
You better believe that big pharma, beer and wine & spirits players are watching the marijuana market closely. If it becomes too much of a threat they will likely start buying their way in, which would be music to the ears of the current wave of marijuana investors.
Aphria Buys German Hospital to Expand Marijuana’s Role as a Pain Management Tool
Aphria paid 1.2 million Euros for a 25% stake in a German hospital. This deal is an attempt by Aphria to increase doctor education about the benefits of using marijuana-derived pain medicine instead of prescribing traditional opioid painkillers.
What this means for Aphria
We think it’s a smart move on Aphria’s part to start with doctors instead of patients as it tries to take market share for pain management away from traditional pain killers.
The other licensed producers in Canada are signing deals with pharmacies, but when a patient comes into a pharmacy to fill a prescription the decision of which product they’re getting has already been made by their doctor.
Better to target doctors who are the ones choosing if a patient should be prescribed medical marijuana or a painkiller like Oxycodone.
Colombian Growers Look to Canada to Raise The Money Needed to Compete Against Canada
At least two licensed marijuana producers in Colombia will imminently list themselves on a Canadian stock exchange in an attempt to raise needed expansion capital. Khiron Life Sciences will start trading in a week or two on the TSX Venture Exchange, while PharmaCielo, the largest grower in Colombia, has almost completed a reverse takeover of a Canadian shell so it can list shares in Canada as well.
Impact on Canada
Colombia is emerging as the primary competitor to Canada in the fight to supply the rest of the world with legal marijuana. The PharmaCielo CEO says they can grow marijuana for 5 cents per gram, 20 times cheaper than the $1 per gram growing cost in Canada.
The top three producers in Colombia will have capacity of at least 330,000 kg by the end of 2019 and a mandate from the Colombian government to eventually export as much supply as possible to the rest of the world.
READ THE MARIJUANA EXPORT MIRAGE FOR AN IN-DEPTH REPORT ON THE STATE OF DEMAND FOR MEDICAL MARIJUANA OUTSIDE OF CANADA
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