The Cannabis Industry has a Credibility Problem

James West
|

Not to be the pointer outer of the obvious, but I think we can all agree that the cannabis business has created a credibility problem for itself.  The recent Aurora Cannabis miss on earnings shortly after telegraphing guidance is an unfortunate and perhaps defining moment. The combined experience of the transition from speculative startups to commercial enterprises has come to be defined by disappointment.

It turns out Wayland Group’s Ben Ward has been raising money fraudulently, according to the OSC. CannTrust is the poster child for breaking the rules, and heads a long list of licensed cannabis companies acting more like black market participants.

The financial reporting of cannabis companies has constantly underwhelmed, and the instances of outright malfeasance are accumulating.

That has led to a fatigue and cynicism among investing pros who don’t even accord the representations of cannabis CEO’s the proverbial grain of salt when listening to new stories. The underpromise and overdeliver mantra has time and again manifest as the opposite.

The fifty percent haircut across the sector now appears deserved…and maybe even insufficient, as yet.

Vast fortunes have been made, and mostly to the impoverishment of small retail shareholders.

Even the Ontario government lost $42 million on sales of $64 million, without having to grow a stick of weed or even pay for it up front. Expenses totalled $106 million. Let’s not even start on the controversy surrounding the safety of  vaping.

Is it time to lower the green flag to half mast and declare the legal cannabis industry an unmitigated disaster?

Its not all rotten tomatoes…

While it is easy to give in to cynicism and mass all cannabis companies into the same category, the majority of licensed cannabis companies are following the rules and trying to deliver a quality clean product to consumers.

But unfortunately, none are able to deliver impressive financial results.

The situation is emblematic of an industry that is transforming en masse from one that has been valued speculatively on its future performance into one that is valued on its actual performance; the expectation is unrealistic in terms of the time it takes to make the transition in full.

But the compounding factor in the downward valuation of cannabis companies is the release of more shares to founders and employees as lock-up and escrow agreements mature. The supply of paper to the market is growing, while the supply of value in the market, less so.  The market has nowhere to go but down until this process runs its course. And considering that founder’s and seed shares are issued at pennies usually, the price at which they can be sold for a profit is commensurately lower.

Right now, nobody is willing to finance any new start-up cannabis deal on Bay Street. The atmosphere is as doomy and gloomy as the junior gold market in 2014; it seems like the misery will never end.

But just as in the case of natural resource stocks, the cyclicality governing the contours of supply and demand will always eventually reassert themselves, and a more risk tolerant ambiance will materialize in due course.

Early Stage Opportunities Still Abound

The silver lining in a depressed cannabis market is the financial discipline that the next generation of startups will have built in to their DNA as a result of much tighter availability of capital. There will also be a declining volume of cannabis stocks going public of the “wing and a prayer” variety, where generating revenue is distant concept and profit an intangible ideal.

Already, the number of companies raising money has dropped off significantly, as would-be cannabis entrepreneurs find the appetite for private early stage deals on the wane.

This will all ultimately lead to two realities, both of which are as inevitable as fleas on a dog.

One, the quality of companies and the management teams who operate them will bottom, and then rise, leading to a better financial performance of the sector.

Two, there will be less and less companies competing for the available capital pool, which in and of itself will engender a tertiary bull market phase.

And let’s not forget about that big catalyst on the horizon somewhere, US Federal De-prohibition. That will probably be the event that starts the next bull market phase. The only question is when, not if.

Horizons ETFs Management (TSE:HMMJ) Opportunity to Scale into Top Marijuana Companies

James West

James West

Editor and Publisher

James West founded Midas Letter in 2008 and has since been covering the best of Canadian and US small cap companies. He covers global economics, monetary policy, geopolitical evolution, political corruption, commodities, cannabis and cryptocurrencies. As an active market participant, James is not a journalist and is invariably discussing markets...
More Info...

[email protected] | |

Midas Letter is provided as a source of information only, and is in no way to be construed as investment advice. James West, the author and publisher of the Midas Letter, is not authorized to provide investor advice, and provides this information only to readers who are interested in knowing what he is investing in and how he reaches such decisions.

Investing in emerging public companies involves a high degree of risk and investors in such companies could lose all their money. Always consult a duly accredited investment professional in your jurisdiction prior to making any investment decision.

Midas Letter occasionally accepts fees for advertising and sponsorship from public companies featured on this site. James West and/or Midas Letter may also receive compensation from companies affiliated with companies featured on this site. James West and/or Midas Letter also invests in companies on this site and so readers should view all information on this site as biased.