December 20, 2018

420Investor Alan Brochstein Discusses New Cannabis Issuers Post-IPO Weakness

Midas Letter
Midas Letter
420Investor Alan Brochstein Discusses New Cannabis Issuers Post-IPO Weakness

420Investor and New Cannabis Ventures Founder Alan Brochstein, CFA shares his views on why new cannabis issuers have performed dismally this fall. Brochstein emphasizes that the broader market has played a role in this trend, as the downturn since October has weighed heavily on the space. He also highlights that since 2016, significant amounts of capital have been raised in the space and individuals have more options when it comes to cannabis investing. While it is easy for investors to cut their losses right now, Brochstein cautions that they would be wise to pay attention to the immense revenues generated by new issuers, despite stock volatility. Brochstein is happy to see US companies like Harvest Health & Recreation Inc (CNSX:HARV) (OTCMKTS:HTHHF) and Canadian counterparts such as Organigram Holdings Inc (CVE:OGI) (OTCMKTS:OGRMF) (FRA:0OG) providing detailed guidance. Brochstein notes that US investors now have a lot more options to invest in the United States and he believes this will be a big story to watch in 2019.


James West:   Hey, Alan, how are you going?

Alan Brochstein:   Hey, great, James, good to see you again.

James West:   You as well, you as well. So, Alan, you know the market’s been kind of in a tough spot lately, and I guess the best way to describe it is all the new issuers that have been coming to market have been absolutely dismal performers, and I’m curious as to your perspective on why that is.

Alan Brochstein:   Yeah, so, you know, I’m not able to confirm this precisely, but I’ve heard from another people it kind of started with the Curaleaf deal. And apparently, they had a big, you know, they were out there representing that the book was even bigger than it was, and people upped their orders, and then they ended up getting full allocations on the upsized orders. And so it left a bad taste in people’s mouth, apparently. I’ve heard that from a number of sources.

So the reality is, we’ve seen, in very weak overall market conditions, a lot of supply raised. And I’ve been watching, you know, the capital raising in the cannabis sector for the last several years, and we go through these cycles, and at the beginning of 2016, the beginning of 2017, we saw a lot of capital raised in Canada, and it pressured the stocks ultimately. And I think, you know, we’re seeing that, we’re seeing a little bit of a jam job for some of these issuers, perhaps, and I blame that likely on Canaccord, the underwriter.

But I think that that’s part of it, and I think we were talking about this last week: with all the losses across the sector this year and some early in the year gains, maybe late in the year gains for certain names, it’s just really easy for people to throw in the towel, take their tax write off, clean up their books, and come back and play again next year.

So I think we’re kind of in that mode. I would point to the immense revenues that are being generated by a lot of these new issuers, specifically Trulieve isn’t a real new issuer; they came public, I believe, in September, but they kind of lead the list among the MSOs, or multi-state operator, in the United states. But some of these other guys, like Curaleaf and Harvest and Cresco, and MJardin, they have very substantial revenues relative to their Canadian counterparts.

So in 2016, people were piling into the Canadian LPs, these businesses were not that advances; they were very speculative at the time, hard to tell who was going to be the leaders, and ultimately, those that raise the capital have become the leaders: Aurora, Canopy, Aphria come to mind as really good capital raisers. Here in the United States, a couple years later, maybe almost three years later, it looks different, and investors are able to judge companies that actually have very substantial operations already, generating revenue, with a pipeline. And something your readers and listeners may not appreciate, you know, I’ve been following Canadian LPs for more than five years you know, roughly five years, and they never have given guidance.

Organigram just gave guidance – this is the first time I can recall ever seeing guidance out of Canada, and they guided for Q1 revenues, that’s the quarter that just ended November 30th, that would exceed the whole year last year, $12.6 million CDN.

In the United States, we’re seeing these new companies give guidance, and I want to call out one in particular, and that’s Harvest. Harvest is based in Arizona, and that’s really where all their revenue comes from right now. And I think it was page 27, if I’m not mistaken, of the 46-page deck, 13 pages of which were risk factors and three pages of which were disclosures. If you look at that slide, it laid out in detail how they’re going to go get to, I think it was 566 million revenue, in 2020.

So I don’t know if these companies are all going to achieve their goals; I love that they’re sharing them, and I love that some of them are actually giving substantial detail. And I just published an article for 420 Investor subscribers detailing, I think, nine companies, including Organigram and harvest that I just mentioned, but seven others, that have provided guidance. So that was a long answer, James, but I think that is what’s going on with the MSOs.

James West:   No, I like a long answer. What’s the symbol on Harvest?

Alan Brochstein:   So in Canada it’s HARV, not to be confused with Harvest One, but HARV, H-A-R-V, and then in the United States it has, it’s not a real listing yet, but HTHHF.

James West:   Mm-hmm. Okay, so do you think that the era of the massive private placement and egregious valuation relative to what the balance sheet expresses is now becoming a thing of the past because there’s a more cynical sort of jaded American appetite coming to bear on this where, you know, sure you’ll get speculative value built into a share price in the form of a premium, but not at these, not at those crazy multiples where it’s just like, oh my gosh, things valued on a speculative basis at 10X, go-forward revenue, it’s like, still makes no sense! So is that, do you think that’s kind of like those days are gone?

Alan Brochstein:   I’m not sure. I have to be quite honest – I saw, so I don’t always see these things early. It’s the private placement investors that see them, and I’m not privy to that, necessarily. So on CuraLeaf, for instance, they – I’m trying to remember what the point I wanted to make, the deal. So I looked at the deal after it was priced, and I was like, wow! This just seems like in the wrong ballpark.

So for whatever reasons, people were scrambling to get into Curaleaf and some of those other names in advance. To be fair, a lot of the weakness came with weakness in the overall market and weakness in the cannabis sector, so it’s not like these deal prices were necessarily egregious. They ended up looking more egregious than they might have been just because by the time the deal was priced and announced, you know, there’s been two weeks to four weeks, perhaps, and you’re looking at it today when everything has already declined.

But to your question about what’s it mean for the future, I think we’re just getting started, and it’s unfortunate that some of these investors have taken some lumps. We saw MedMen do something kind of odd in a bought deal, and they talked about courting new investors that they wanted to make sure that these investors weren’t hammered, and basically, they let everybody get hammered, and you know, you saw the re-price of their bought deal, and that was their rationale.

I didn’t agree with it, but at the same time, I respect where they’re coming from. They put a lot of time apparently into developing these new investor relationships, just as many of these MSOs have done. And you know, it’s unfortunate: we can all point our fingers at Canaccord, maybe, I don’t know. I don’t know the cause, but I do know this: you could have given up on, to bring back organigram again, you could have given up on Organigram after they went public. They opened up at $2.40, and the next thing you knew, a year and two months later, they were trading at $0.20, and it was a total storm of some sort.

And I don’t even remember now if they were able to raise more capital on the way down, but I would just remind everybody, let me give a more recent example: at the end of 2016, at a just a terrible time, in my opinion, to go public, Innovative Industrial Properties, that’s IIPR, did something spectacular. This is a 100 percent cannabis-focused REIT, and they listed on the New York Stock Exchange at a bad time of the year in a bad, it wasn’t the worst market, but it was like after a little bit of a bull market run in the cannabis space related to the elections.

And you know, nobody does these IPOs on Thanksgiving Day like or whatever they did, and the stock came out at 20; next thing you know, it’s trading at below 15 briefly, spent all of 2017, or most of it, below $20, and it’s above 50 now. So to all you who got slammed with MSO stocks at high prices, here’s the good news: these companies are performing fundamentally, and they have a great chance of recovering. I’m spending a lot of my time trying to differentiate between these different companies. There’s not really an effective way to buy them all at one time.

I’ve talked about – and full disclosure, client of mine – KushCo Holdings, and I’m mentioned this to you before – they may be an interesting way to play that whole theme of these large cannabis companies forming or extending in the United States, you know, swallowing up licenses left and right, because they work with all these companies, so they’ll be able to ride that wave. And there may be some other companies like that, too.

But for now, investors are kind of stuck, and there will be some new issues, James; maybe they’re going to get hurt on their pricing because of the bad experience, but I don’t see this as a serious setback for the industry.

James West:   All right, so – I wonder to what extent, though, I’ve noticed as you have that the cycle of raising big chunks of capital, like so when the markets are hot, everybody tends to rush in and announce a big wave, and that puts an immediate overhang on the market four months down the road. And so I’ve seen, as I’m sure you have, that these cycles emerge, and it’s, as you said in the last couple years, the year starts off strong, everybody rushes out and raises money; well, by the end of spring, all that paper is free trading, and so the market drifts into a discounted condition throughout the summer, until, you know, everybody’s gotten off the majority of their paper and everybody comes back from summer and the markets are sort of frothy again and the prices go higher and everybody piles in, and then, you know, the influences of tax law selling happen. And this year, you know, tax law selling, combined with, you know, the fact that there’s a lot of geopolitical and macroeconomic sort of fragility out there.

So I mean, I look at this market and I agree with you: I think it’s early days, and that these long waves are actually ultimately just part of an ongoing cycle of, you know, market capitalization on premium, as new interest comes in, follows by market discounting mechanism on, you know, liquidation of those financings. And rinse and repeat. And it’s like, you could almost set a clock according to this stuff. Ike I mean, investment season starts in January, and it’s over by the end of May, and then it starts up again in September/October and it’s over by December to start again in January.

And if you can actually, you know, align yourself with that sort of macro level thinking, then you’re going to do a lot better than guys who are chasing those waves.

Alan Brochstein:   Yeah, I always say, don’t chase the waves. But you know, it’s been interesting, because we started this year, and I shared an observation with my members of 420 Investor that in each of the past two years, you could set a clock to it. You sell the LPs early in the year, and you buy them back in the summer, and it’s worked out really well.

But I warned that this year might be different, because it was based on only two years, and there wasn’t necessarily a calendar reason; I thought it was more of a coincidence. So this year, we started off very strong in January, and the prices just kept, you know, shot up, and I think that was because of California and the two ETFs in the United States that a lot of Americans were buying, and they didn’t realize they were buying Canadian LPs, silly as that sounds, but that’s what happened.

And so, in any event, we got a little bit of a summer rally this year, but you know, I think the idea of setting your clock to that calendar did not work this year at all. We’re seeing, you know, a lot of the LPs are down 50, 60, 70 percent this year. Many people focus only on the largest ones; if you take the four largest Canadian LPs that are listed in Canada, which would include Canopy Growth, Aurora, Aphria and CannTrust, only one of those is up. Only one, and that’s Canopy Growth, so it has not been a good year.

So I’d be careful about extrapolating exact months and time frames, and I think, you know, this year’s rather interesting. There was a big rush, as you pointed, to go public, so we saw a lot of these companies go public, and sure enough, it weighed on the market. And for those that don’t understand what happens, it’s pretty broad; people sell maybe Canadian LPs to buy into Harvest or into Cresco or something like that.

I think there’s just a lot of factors. So when I look into next year, I’m not that concerned about the supply/demand dynamics. These deals don’t have lock-ups, for the most part. These newer deals did not have lock-ups on the new issue, so they’re free to sell from day one, so we don’t have that overhang. And I would say that unlike Canada, which has under 40 million residents, the United States is a much bigger market, and you know, I would just point to, well, we always talk about he risks being greater in the United States because of the Federal illegality; but the margin, there’s the opportunity to swing that Federal illegality towards legality, which is really well received. So there’s some upside potential from that.

And then the valuations, as we often talk about, are so low, yet the revenues are so low relative to the Canadian LPs. So it’s not so much that this is bad for the Canadian LPs, it’s just that a lot of US citizens that are interested in cannabis, I think, are going to go not necessarily into Canadian LPs, which was really their only choice in the past if they wanted to be in legitimate companies; now they have a lot of options in the United States.

James West:   You bet. And I guess we’re going to see more of that evolve and unfold as we go along. Alan, we’re going to leave it there for now. Thank you very much for joining me today.

Alan Brochstein:   It’s great, James, thanks.


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