January 21, 2019

Canaccord Genuity Group Inc (TSE:CF) Analyst Matt Bottomley on Justifying Cannabis Valuations in 2019

Midas Letter
Midas Letter
Canaccord Genuity Group Inc (TSE:CF) Analyst Matt Bottomley on Justifying Cannabis Valuations in 2019

Canaccord Genuity Group Inc (TSE:CF) (OTCMKTS:CLORF) Analyst Matt Bottomley warns that this year cannabis companies are going to have to justify increasingly lofty valuations. While Bottomley believes that all cannabis companies need to back fill to match valuations, he indicates that the domestic space is much more appealing in the US than in Canada. He suggests that US MSOs are going to show positive EBITDA before Canadian LPs. On the other hand, Canadian LPs have international opportunities that their American counterparts cannot currently match. Bottomley indicates that Canadian LPs will need to see meaningful revenue from international markets to justify valuations. However, Bottomley cautions that the global cannabis rollout is still in its infancy and estimates that it will take a decade for the international market to mature.


James West:   Matt Bottomley is here. He’s a research analyst with Canaccord Genuity. Matt, welcome back.

Matt Bottomley:    Good to see you again.

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James West:   You too. Matt, it’s 2019, different crop of cannabis stories out there though some are the same. What is the main thrust of your interest in 2019 in the cannabis space?

Matt Bottomley:    Well, a lot of the companies that came to market in Q3/Q4 2018 that are U.S. operators I think are going to have a ton of news flow, a ton of new licenses that are going to be issued in the U.S. Execution is going to be a big story.

So, obviously the Canopies of the world and those companies have a ton on their plate as well and they still are the largest cannabis companies in the world. I expect them to continue to execute internationally as well as giving more color on what they’re actually selling into the Canadian recreational markets, but there’s another 20 or 30 sub markets within the U.S that’s very, very difficult to follow and it’s kind of what takes up a lot of my time now.

There’s probably five, six or seven companies that have come to market on the U.S side that are all clamoring for positions in markets like Florida and New York and Pennsylvania and Ohio. I think those are the stories that are that are going to get a lot of traction this year. I think the relative valuations of many of these U.S cannabis operators that are listed in Canada are a lot more compelling and I think you’re going to see a lot of very impressive revenue and EBITDA run rates sooner with these U.S names compared to the Canadian licensed producers.

James West:   Hmm, interesting. Some of the larger U.S MSOs came to market with the valuation that you might think they would have to backfill with actual, you know, real estate and sales and dispensaries and key markets. Do you think that some of them are going to find that challenging? Or, do you think that for the most part the U.S MSOs are well-positioned to fan out across the available marketplace and dominate?

Matt Bottomley:    Well, I think all cannabis companies regardless of the markets that they’re going after, there is that element of backfilling where execution is going to be a very, very, very significant element in order to justify any valuation in the billion-dollar plus club and there’s many companies that fit that bill now. But if you add up the aggregate market capitalization of all the U.S players right now, it’s probably in Canadian dollars somewhere in the realm of 15 billion or lower.

On the Canadian side and admittedly there is international optionality to huge medical markets where we still need more clarity on, but the Canadian licensed producers have an aggregate market cap of 75 billion.

So, if you look at just the domestic opportunity in Canada versus the domestic opportunity of the U.S it’s much, much more attractive South of the border. We’re having some of the hemp businesses start to open up now with the passing of the Farm Bill and the Canadians are not precluded from that but really you have seven eight or nine or whatever the number is of large-scale multi-state operators that right now could rewrite from that 15 billion in aggregate potentially as high or higher than where the Canadian names are now.

So, I think execution as I said is going to be critical, but I also think there might be a natural valuation rerating as U.S companies might be the first ones to say, hey, we’re at 500 million dollar revenue run rate or whatever the number is well before the Canopies of the world. I think a rerating is much more likely in 2019 for the U.S players.

James West:   Well, so I think it’s safe to say that from the case of the Canadian incumbent large caps, this is the year that they’re rated on the balance sheet more so than the speculative value that has characterized their valuation increase to date?

Matt Bottomley:    Sure, I mean the intangible value of all the markets are going to get into is very, very important. I mean, we have licensed producers right now with valuations of you know, 15 billion plus. We can see Constellation with 5 billion plus on the balance sheet, Canopy rather with 5 billion plus on the balance sheet. Altria made an investment into Cronos.

So, there’s very, very strong balance sheets right now. I expect there to be more strategic players coming into the space, but you’re absolutely right in order for the aggregate market capitalization, I mentioned of let’s say it’s 75 billion in Canada to be justified and then also have further upside, you’re going have to see a ton of execution in Canada. You’re going to have to see pricing maintained and you eventually in the next two or three years are going to have to see meaningful contribution come from international markets else the valuations just aren’t justifiable.

James West:   You bet. So, this is one of the areas where I hear from a lot of people that suggest that the real discount is in the U.S MSOs listed in Canada. Then on the other hand the Canadian, well that they’re not multi-state operators but multi-country operators, which is an opportunity that’s generally the U.S MSOs are excluded from because of the federal prohibition restrictions.

Do you think that these like for example Canopy, Aurora, Aphria, CannTrust, to a lesser degree some other ones, are very sort of well position now in terms of the global opportunity and is 2019 going to see a situation where those international opportunities do start to become major contributors to the balance sheet in your opinion?

Matt Bottomley:    Yes. I don’t think it’s about 2019. I think it’s about 2019 to 2029 in terms of this entire global opportunity starting to roll out. Some countries will be sooner rather than later. Germany, although it’s been delayed for some time wow, will probably the one of the first major countries that have Europe to start having meaningful contributions and domestic cultivation awards and production awards given. But I think you have to look at the international market as you know, you have Canadian medical that’s sort of you know this big then you have rec and then the global and it’s all going to take you know, much more time the bigger the opportunity is.

So ,2019 is going to be much more important than 2018 when it comes to execution because now we’re going to see real revenues. We’re going to see profitability. It’s a bit of the show me story but in terms of there being, you know, I say Canopy as an example just because they’re the largest. In terms of Canopy having a revenue line that’s 50% Canada and fifty percent international, I think it’s going to take several years for that to happen.

James West:   Sure. We had Namaste as a guest here earlier. Sean Dollinger was here and he’s sort of made this case that they’re in a, you know, sort of separate track and that they’re pursuing this technology online marketplace sort of angle of the whole cannabis thing. Do you think some of those other business models are going to be able to sort of keep up with the mega evaluations that are being allocated to the multi-state and multi-country operators?

Matt Bottomley:    Well, maybe it’s a case-by-case basis, but at the end of the day particularly with the can of the companies that are selling cannabis product directly that translates at some level to an EBITDA that translates to a cash flow and that is what’s going to support the valuations. There isn’t going to be a lot of subjectivity or ambiguity once the market starts to mature or at least not as much because at the end of the day, you know, this sector is going to trade something like a consumer branded market once it transitions to that and that’s a 12 times, maybe there’s a premium because there’s higher barriers to entry so maybe a 15 times multiple ultimately at maturity.

So, it’s going to be the fundamental underlying EBITDA cash flow that support that. If there’s another company like Namaste or others that are doing, you know, parallel plays whether its technology whether it’s delivery whether it’s you know, data analytics, whatever it is you know, I think it’s to the same regard all boats are going to float to a degree and then it’s going to be those who executes and those that can actually show it in there quarter over quarter results.

James West:   Sure, and finally the proliferation of companies focused on the biopharma or pharmaceutical opportunity, whereas, you know in the context of GW Pharma who is focusing on extracting certain molecules, concentrating them and applying them towards specific remedies for the human illnesses and creating value through that sort of pharmaceutification of cannabis how much of an opportunity is that relative to the recreational and otherwise medicinal?

Matt Bottomley:    Well, I mean, it’s the Golden Goose to a degree. It’s a significant opportunity if you can get, you know FDA-approved backing and you can get IP and exclusivity on certain things. It’s very hard with the plant right the plant itself. You can’t patent. My opinion is everyone is likely working on this very diligently, but I think it much like we saw a Constellation from big alcohol and Altria from big tobacco come into space. I think it’s going to be the strategic investors in the pharmaceutical company that bring that over the over the goal line.

So, at some point and I think they might even be the last to the party when it comes to investing. At some point in the next year to two whatever it is, I believe you’ll see big pharma come into this space and I believe their infrastructure, their global reach, their you know decades and decades of experience doing clinical trials is likely what’s going to bring that over. So it’s a huge market opportunity. But it’s also the most speculative in a speculative industry.

James West:   Sure, Novartis put a big chunk of money into Tilray. Do you think that the biggest of the so you kind of got to exclude Canopy from that potentiality because they’ve already got their big dance partner in Constellation, but Aurora in particular has yet to sort of demonstrate a solidifying partnership across a mega cap player in any of food and beverage biopharma or consumer packaged goods. Do you think that makes Aurora a prime target for some of these mega cap companies?

Matt Bottomley:    Well, I think Aurora is by far the next target on the list if I had to handicap who’s next. When you think of the big players in the spacers, there’s kind of five, right? You have Canopy that as a partner. You have Tilray that kind of has a partner. There could be still others they bring in some joint venture form. Then you have Cronos that got a dance partner. Aphria that right now obviously is going through what it’s going through, leaving Aurora.

I think with Aurora there’s a lot that they’ve done. I mean they had an acquisition this week as well of Whistler medical cannabis, you know, there’s a lot of acquisitions that that company’s done. There’s a lot of integration of seven or eight deals.

So, that might complicate it when it comes to a strategic coming into the market, but if I had to guess who the next likely candidate would be or who the most attractive candidate is that does not have yet a global strategic partner, my bet would be on Aurora.

James West:   You bet. All right, Matt. We’re going to leave it there for now and come back to you soon again. Your insight as usual is much appreciated. Thanks for joining me today.

Matt Bottomley:    Thank you.


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