May 17, 2019

Alan Brochstein on CannTrust’s (TSE:TRST) Public Offering & Cronos Group’s (TSE:CRON) Valuation

Midas Letter
Midas Letter
Alan Brochstein on CannTrust’s (TSE:TRST) Public Offering & Cronos Group’s (TSE:CRON) Valuation

420Investor and New Cannabis Ventures Founder Alan Brochstein discusses recent trends in the cannabis space. He notes that there has been an increase in shelf registrations, most recently by Charlotte’s Web Holdings Inc (CNSX:CWEB) (OTCMKTS:CWBHF). Brochstein is critical of CannTrust Holdings Inc’s (TSE:TRST) (NYSE:CTST) (FRA:C9S) recent public offering. He suggests that by offering shares below market price, the company mishandled its financing. He addresses the importance of tracking revenue, but stresses it is not the only valuable metric when evaluating cannabis companies. Brochstein cautions investors to be mindful of large discrepancies between a company’s revenue and valuation. He notes that Cronos Group Inc’s (TSE:CRON) (NASDAQ:CRON) (FRA:7CI) revenue is far below its valuation and merits additional scrutiny. On the flip side, he observes that TILT Holdings Inc (CNSX:TILT) (OTCMKTS:SVVTF) (FRA:0T01) has impressive revenue numbers but complicated narratives continue to bog down the company’s valuation. He believes that retailers are currently undervalued, and highlights Alcanna Inc’s (TSE:CLIQ) (OTCMKTS:LQSIF)Nova Cannabis-branded store, which opened in Toronto in April.


Fraser Thoms:  Joining us now is Alan Brochstein of New Cannabis Ventures. Alan, how is it going?

Alan Brochstein:    It’s going great, good to be here.

Fraser Thoms:  Well, great. Thanks for coming on. I just want to kick things off by maybe talking about trends that happen within the investing space. So, we’ve, at first it was funded capacity, and now there’s a bunch of talk about MSOs, multi-state operators, and extraction is becoming much more of a focal point right now. In your view, how much does that drive actual investing?

Alan Brochstein:    Well, I think these things are important to watch. There’s another trend right now that’s front of mind for me, and that’s all these shelf registrations that are open. We saw  Charlotte’s Web hit the market this week, CannTrust I guess late last month, so there are a lot of these, and I think it pays for investors to pay attention to who has the shelves, because these companies are able to raise capital quickly. And over the last several years, there’s been a little mini-cycle in terms of capital raising, and what happens is, prices go up, a couple companies start to sell some s tock, and eventually more and more pile on, and then the market gets saturated.

And the last time we saw that was when a lot of the MSOs went public in the fourth quarter, but we’re seeing it a little bit  again. I t’s not so bad yet, but clearly, you know, you look at the action in Charlotte’s Web yesterday and CannTrust in late April, and you get the sense that there’s some short-term downside to stocks when they come to market.

Fraser Thoms:  So can I ask if it’s, is it just short term, because personally when I saw the CannTrust raise, I think it was 30 percent lower than the share price was? I mean, if I’m a shareholder, I’ve lost a lot of trust moving forward. Like, I don’t know if I would feel comfortable investing, because you know, maybe as soon as the stock starts to show some life, boom, you get a raise way under what it could have been. Perhaps they could have done it, you know, not so aggressively.

Alan Brochstein:    Yeah, I think they really mishandled that. I’ve been a big, and I remain a supporter, of CannTrust.

Fraser Thoms:  Me too, yeah.

Alan Brochstein:    I’m not sure what happened, there. That was a very big deal. They probably got some bad advice from Bay Street and Wall Street on that – I mean, that was Wall Street, too. It was definitely a fail for the investment bankers, and you know, in hindsight, it was a very large transaction; hopefully they deployed the capital smartly, because I think the good thing is, a lot of companies come to market with a little here and a little there, and they’re always coming back. And those are the companies that, I think, hurt themselves by that frequency as opposed to maybe CannTrust in the end will say, Well, it was painful, but it was smart to get a one and done.

I don’t know if it was the smartest thing – right now, it’s not looking that smart, but hopefully, eventually, because they shouldn’t need to raise more capital. That was a lot.

Fraser Thoms:  Yeah. And speaking of cash while we’re on the subject, speaking a little bit off air about revenues and the correlation to market cap and so on, I mean, some of it is, we talked about Cronos has a $6 billion market cap and 6 million in quarterly revenues, I believe, or something close to that. How do you evaluate a company beyond revenues? Because some of these numbers just seem so extreme. You have companies that aren’t doing very well in the stock market, yet they seem to have really healthy revenues. How do you account for that?

Alan Brochstein:    So I think revenue is an important thing to track; it’s definitely something that we’ve been focused on at New Cannabis Ventures, and you know, with my subscribers at 420 Investor, but it’s not the only metric. And I like to give a really extreme example, because I used to cover, I used to do health care and technology stocks in general on the buy side for an investment management firm, and so as I covered technology companies, I kind of had to answer this question that you’ve just asked me.

So at one extreme, you have companies like Ingram Micro or Tech Data, nothing to do with cannabis, but these are companies that are distributors of IT. So it’s a good way to kind of play the IT space; you’re getting a lot of exposure through these names, potentially. But they traded at really tiny multiples of their revenue. Like, less than 1 times, and really low PEs as well, by the way. and I’m going back in time; I haven’t looked at these in years.

But the idea was, not all revenue is the same. You know, if you’re an unique company with 80 percent gross margins and profits are really high growth, as opposed to a more mature company with low margins from distribution, like these two that I mentioned, these are different animals. So when you apply it to the cannabis space today, you know, it’s amazing when we – we started this revenue tracker sometime I think in early 2018. It’s become very popular, one of the most popular pages at New Cannabis Ventures, and in fact, we recently had to raise the standards; the list was getting a little too long, so we doubled the minimum quarterly revenue required to qualify, and it’s still a nice number of companies with new companies joining, really, by the week, it seems.

And you know, as you track it, I think your observation is great: some of these companies with a lot of revenue are doing kind of poorly in the market, and I think there’s a couple of reasons for that. And at the same time, some companies that really aren’t there in terms of revenue, like you mentioned Cronos Group, that are doing really well.

And I would say, one, keep in mind that you’re always looking – you should always be looking forward. It’s not about what you did for me today or yesterday, it’s what are you going to do for me tomorrow? And that’s the way people invest in stocks. So you take a story stock like Cronos, you know, with the ties to Altria and the early biosynthesis play – that excited investors, so it’s a lot on the come as opposed to where they are right now.

And you know, you and I were talking about TILT Holdings earlier, is another example: there’s one with a lot of revenue, certainly on a pro forma basis, that’s not being perceived so well. But I mean, look what’s going on. It’s a confusing story; the company admits that. It’s a very complex story, number one. You’ve had some issues with, you know, any time a company comes public and the stock’s been cut in half, there’s a question, and TILT’s not alone; there’s some other new companies that are kind of suffering with that same scarlet letter, I guess, of trading well below the deal price. And believe me, they’re not alone.

And then you add to it, you know, some concerns about management; their CEO stepped down. He’s going to be Chairman, but they made somebody else interim CEO, which makes it sound like it wasn’t so planned. So, a lot of things to look at, and investors want to be, you know, confident in the future, and they need to understand the story. So whether or not it makes sense to buy Cronos or not to buy TILT, like the market seems to be saying these days, I’m not going to answer that one. I don’t have a great answer, necessarily. I think I have an answer, but that’s not the important thing. I think the important thing is to understand revenue, in and of itself, isn’t the sole criterion.

Fraser Thoms:  No, yeah, for sure. It does make me feel more comfortable, though, that a company is able to generate revenue, like in big numbers, for sure. Because then you look to the future and think, well then, they can – there’s room for more, right? I love that list, by the way – the revenue list that you guys put together. It’s great, because all the big names are sort of – well, actually, it’s not – what I love most about it is, it’s sort of shocking, you know. You have a perception about how big some of these companies are, and then you see the list and you’re like, wow, it at least helps you shift your perspective a little bit.

Alan Brochstein:    Like, some of the market caps are way bigger than the revenue. But I think what’s interesting is, some of the companies that, you know, unfortunately, we lost some of the companies when we raised the standards from $2.5 million USD to $5 million USD, that, you know, take for example MediPharm Labs, which is a client of mine at New Cannabis Ventures, by the way. They weren’t on this list until just a few weeks ago when they reported their fourth quarter, and now if you look in the Canadian section, I think they’re number four, which just blows me away.

Fraser Thoms:  Oh, yeah.

Alan Brochstein:    Not just them, that they blow me away, but the idea that, you know, anybody that was kind of paying attention and saw them come on, and then now they more than doubled their revenue just a quarter later, and it just kind of shows you how quickly things change.

You know, I would say that your observation on revenue is a very fair one. There were a bunch of companies that received licenses from Health Canada in 2013 and some of them, we don’t have to name names; some of them are just, you know, not – I think Midas makes more money than they do, more revenue.

Fraser Thoms:  [laughter] Well…

Alan Brochstein:    It says a lot to me, and I don’t want to be hypercritical of a company like Cronos; I mean, at least they have some revenue now, or – but the fact that they’ve had that license for so long and the revenue is so low, you know, it should make investors ask a question, I think. It’s a fair question.

Fraser Thoms:  No, I agree, and that actually brings us perfectly to perhaps some of the, well, not excuses, but some of the reasons some of the numbers aren’t as high as we might think they could be, which is the Canadian retail space, which, you know, from my perspective especially in Ontario, is just – it’s tough. I mean, there’s bottlenecks, it’s weird, it’s – I can see why it’s hard for companies to make a lot of cash quickly, at least. It’s definitely a process.

Alan Brochstein:    Yeah, so the Canadian rollout of recreational or adult use has been nothing short of a disaster.

Fraser Thoms:  [laughter]

Alan Brochstein:    I was talking about this in advance. I didn’t think it would be even as bad as it is, but you know, to Canada’s credit, they have a Federally legal program, and then it’s pretty easy to get negative after giving a lot of credit for that. And without getting overly negative, because things will get better, I think part of the problem was, for those that remember, it was like a cliffhanger to watch the process. In the second reading of the Cannabis Act, it seemed like it was going to fail, and I think that put the fear of God in a lot of the LPs. The cheque-writers: do they really want to commit to building that extra infrastructure when it’s not a done deal yet?

So when we got to the third reading, it passed, but unfortunately, the transition period from legalization from that point was just a few months. And it really didn’t give the LPs a chance to get ready to ramp up. So you have that short process. And then everybody’s familiar with some of the other problems, like, you know, it’s flower only for the most part, and, you know, limited amounts of extracts, but certainly not the popular products that the black market certainly enjoys, or a lot of the markets in United States where it’s state-legal enjoy. So that’s a problem.

But I think the real problem is the provincial distribution just isn’t that good. You know, expecting the black market buyer to buy on Ontario website is insane. That’s not happening. And then expecting a new type of customer to buy on these websites is also not very realistic. I think websites are great for people who know what they want and want, you know, convenience and all that. But what we’re talking about educating the market, and so I know I’ve talked to James about this in the past: I’m very bullish on the retailers, and this is a space that’s not widely followed. There’s a lot of focus on the LPs, but a tremendous amount of value will be created, in my opinion, by the retail companies, and you know, the LPs kind of got shut out of this. It’s very difficult to have your own point of sale, your retail point of sale, if you’re an LP. You can obviously direct to patient through the medical program, but it’s very limited. You can own pieces of larger companies, or there are certain provinces where you might be able to have a store, but this is something that’s really not so open to the LPs at this point in time.

And you know, if you think about – if you listen to people in the United States – I like to listen to these CEOs – they talk about the real value is being in brands and distribution and retail. So in Canada, the retail part is right now for the most part left to the provincial websites, which are terrible.

Now, I was very fortunate to be able to be in Toronto on April 20thand go check out the Nova cannabis store that opened that day; that’s Alcanna, and I’ve talked about the Alcanna before, I continue to like that story a lot, and suggest that people that want to look at the space consider not only that company  – there’s a handful of others as well, without getting into all the details – but these companies, right now, are struggling with the numbers. They have good numbers, but it’s still – they’d be much higher if they had better inventory, number one, and number two, if they could open more stores. It’s very limited right now.

So I said earlier you got to look not what you’re doing from a yesterday or today, but what are you going to be doing tomorrow. And I imagine over time, these retailers will finally get into a position, everybody talks about oversupply coming, and it’s not coming tomorrow, but we will get to a very healthily supplied market, a market that has more than just flower, pre-rolls and these weak extracts – that’ll include vape pens and edibles and things like that, later this year. And in Canada, where the advertising and packaging rules are so rigid, I think retail is going to play an extremely valuable role.

So I would suggest to your listeners that, start to focus on this. I have a few names in my model portfolios at 420 Investor, and it’s a little early, maybe, but I think you’re better off being early than late on this thing.

Fraser Thoms:  No, I agree. So and I’ll definitely want to check out some of those names. But to me, in Canada, we all know the power of brands; it’s been proven time and time again, and unfortunately – and hopefully those retail players can put some pressure on the government and say Hey, look, we need to be able to show the personalities of our different products, number one.

Number two, the – and you just tell me what you think about this – but I think it’s unfortunate that the way it works when you sell your product to the government, they are bidding on a certain price. So let’s just say for argument’s sake, I have some dried bud that’s three times as good as your dried bud. I’m not – I can’t even put it out there to sell it for twice as much, because they’re not going to pay.

Alan Brochstein:    You can, actually. They have different categories of product, and I forget exactly the jargon that they use, and it’s obviously going to vary from province to province, but some of the LPs have gotten in the premium category.

Fraser Thoms:  Oh, for sure, for sure, but I don’t – I think you’re just handcuffed in terms of what the government is going to bid. You can’t tell them that this is worth a certain amount and then they agree; they say No, the most we’re going to pay is $6.00, and that’s the end of the conversation, right? So…

Alan Brochstein:    Yeah, I think you have a point that you know, unfortunately, you’re limited as a retailer in terms of your buying power and things like that. All the buying power is really at the provincial level.

Fraser Thoms:  Yeah, but so, but you know –

Alan Brochstein:    That hurts sell beats two by the way.

Fraser Thoms:  Oh, for sure, yeah. And I think as you said, you know, there’s a lot of room for things for get better as we move forward, as they can’t really get too much worse. But yeah, thanks for this, Alan. It’s always awesome listening to your thoughts on the space.

Alan Brochstein:    Thank you.

Fraser Thoms:  And we really appreciate it.

Alan Brochstein:    All right. Have a great weekend.

Fraser Thoms:  You too.


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