February 25, 2020

Is there a Viable Way to Play the Entire Cannabis Sector?

Midas Letter
Midas Letter
Is there a Viable Way to Play the Entire Cannabis Sector?

420Investor and New Cannabis Ventures Founder Alan Brochstein joins James West to discuss the direction of the public cannabis market halfway through the first quarter of 2020. The pair discuss the driving force for the downturn in both US stocks and Canadian large and small cap weed stocks. Mr. Brochstein gives his opinion on HMJUS ETF absorbing HMMJ Horizons ETF and the noble idea of having one investment represent the entire sector. The CFA believes “the main problem, I think, has been anybody that wants to invest in the sector should want to have at least some of their exposure in the United States, and it’s really hard for these ETFs to get that done.” Watch the full interview to also hear Alan’s thoughts on the future of US multi-state operators (MSO’s).


James West: Alan Brochstein joins us now. He’s from 420Invest.com. Alan, welcome back.

Alan Brochstein: Hey, it’s good to be here, James.

James West: Alan, here we are just approaching the, I guess we just passed the middle of the first quarter of 2020, and the stocks in the cannabis sector – both US stocks and Canadian stocks on the large cap side – seem to be finding a bottom, while the small cap, the smallest cap, let’s say the micro micro caps, are changing names and disappearing before our very eyes. What’s the driving force there?

Alan Brochstein: Yeah, so I think access to capital is really driving this. And you know, it’s a dangerous game, you know, to raise capital the way some of these MSOs are in terms of, you know, we’re not going to sell our equity, it’s too low. We’re going to sell our assets in the sale lease-back, or we’re going to take on debt while we’re not quite cash flow positive.

So, and I’m not saying that’s the wrong thing to do. I actually think there’s a strategic understory here, but that’s what we see the largest MSOs doing, is, it’s become harder to raise equity. And that leaves the smaller companies in a really tough spot, because the big guys – and this is where it gets strategic – I think they’re taking capital just to keep other people out, maybe. Interesting conspiracy theory.

But you know, you do the sale leasebacks and you take on the debt when others can’t, and nobody can sell equity. And so you know, I think a lot of companies face some very tough choices in terms of their financing right now.

And so anyway, we’re seeing the four or so largest MSOs, and you can probably extend it a little bit deeper…it actually goes deeper. I mean, companies like Harvest, which just under that, seem to be finding a bottom, too. So you know, I know everybody wants these stocks to go up. First, they have to stop going down. So that’s a start.

And when you look up in Canada, you know, Canopy Growth, Aphria and Cronos Group – three of the big five – found bottoms in 2019 have held them so far. Tilray and Aurora may have found bottoms; it sure looks like it was a little bit later, and these two have had active ATMs and a little bit more stressed on the balance sheet. So I think it’s shaping up for, you know, if you’re investing in these small companies, you’ve kind of got to root for the large companies to find their footing first, and that’ll give people confidence to put some money into the smaller ones, would be my guess, James.

James West: Sure. I saw an announcement that the HMMJ, Horizon’s ETF, was going to be absorbed by the HMJUS ETF.

Alan Brochstein: I think you have more money than that ETF has, James, just in your own personal account. So I wouldn’t sweat that too much, and I think – I was really critical of all these ETFs that came out. Thankfully, HMMJ, the big one, got better. When it first came out, it was really concentrated and was really just something that would have been really easy for people to replicate on their own; it was just a few LPs, really. Like, five names made up 50 percent.

That’s gotten better, and you know, kudos to those guys. But they drank their own Kool-Aid and they started these other funds, and they’ve just never been able to get the assets up. You know, there’s only one other ETF that really hit critical scale, and that’s at MJ. And then after that, it’s really all downhill, and we’ve seen, there was another fund complex that decided to close theirs. I don’t even remember, just never even hit scale. I think Evolve? I don’t want to say the wrong one, but I’m pretty sure that was it.

So, look: the idea of having one investment represent the sector is a noble idea, and I get it. It’s just been very challenging, and the main problem, I think, has been anybody that wants to invest in the sector should want to have at least some of their exposure in the United States, and it’s really hard for these ETFs to get that done.

James West: Yeah, you bet. Okay, so, some companies in the US MSO space have continued their downward spiral. You know, MedMen comes to top of mind. I guess a little bit rudderless right now, with the departure of Adam Bierman, and quite the eating of humble pie on their part to, you know, have to take away that super-voting structure, which is a plus. But still, the market doesn’t look like they’ve forgiven them, or it hasn’t changed the interest of the market. Why do you think that is?

Alan Brochstein: You know, I think people are going to be slow to embrace certain names. I put MedMen and Aurora as maybe the poster children of, it’s funny – I used to always think MedMen is the American Aurora. It’s really turned out to be, unfortunately, true, and both these companies, you know, they – and they’re not the only ones, by the way – but they’re kind of at the extreme of empire builders, and build it at any cost. And, you know, we can make no mistakes.

Yet, both companies made a lot of mistakes. So now it’s time to see if they survive, and I think both of them will. But the question is, how much dilution will have to absorb. I think it’s easier to fix Aurora than MedMen, mainly because it’s federally legal for Aurora, and you know, I’ve been doing some just basic math. If there were a strategic buyer that wanted to invest $2 billion to take a 50 percent or 60 percent stake in Aurora, it would be a little bit dilutive, but I think the stock would go up 50 percent just on that news.

For MedMen, a little bit harder to get a strategic buyer because of the Federal illegality, so that’s not happening. It’s going to be more of a slow build. I actually, I think it’s a high-risk, high-reward opportunity. I feel like they were a little bit late to address the concerns, and I don’t think Adam Bierman was really the right person to lead that kind of company. You know, a lot of times we find founders with vision are really good at that part, but they’re not necessarily good at running a company, and I think that was the case here.

So I think anybody looking at the situation has to realize, you know, the shares have been coming unlocked, and that puts pressure on the stock, and those people that hold those locked-up shares don’t like MedMen. They’re happy to sell, probably at any price, and that’s been part of the story. But, you know, stay tuned; the company has a very strong presence in California, as well in Nevada. They have a strategic asset in Virginia, a small asset in Illinois. I think they’re selling another of their assets in Illinois.

That’s what I’m looking for, James, a little update on what they’re getting rid of. Because I think it’s a company like you said: Humble pie, and now they have to retrench a little bit. You know, I can see them exiting Florida, even. We’ll see.

James West: Right, right. There’s been some companies, you know, that seem to be, like, they’re not necessarily – the stock hasn’t taken off, but they’re treading water and their corporate developments continue to be evident in the announcements that they’re making. And so, do you think that we could be at the point where, after a period of sort of reconciliation, if you will, that there might be some new interest in the investing in cannabis deals again?

Alan Brochstein: So I’m not sure which market you’re talking about – Greater North America, or Canada, or the US? You want to narrow that?

James West: I’ve become less enthused about the United States because Donald Trump has been making increasing noises about taking away the protections for states.

Alan Brochstein: Ahhh.

James West: You don’t see that happening?

Alan Brochstein: No, no. That’s nothing new, and Congress will stop that. So I guess you were talking about Canada on that question?

James West: I was, yes.

Alan Brochstein: You know, I’m not sure I’m seeing that. But I think Canada, you know, a lot of people have gotten very down on Canada because they’ve lost a lot of money there, and obviously the rollout has not come anywhere close to meeting expectations. And you know, even now, you know, you see things like Ontario talking about studying things and doing consultations, and it just continues to be very slow to develop. And you know, we’ve seen it with the 2.0 rollout has been anything but impressive so far.

But I think things will get better as the year plays out. Again, I think the big companies stabilizing is an important first step, and when I look deeper beneath that list, there are some really good values, and one can imagine if the market starts to show some growth again, some of these companies will do very well. And I think, you know, it’s really hard for us as investors, because you know, we don’t necessarily see things as they really are. And it’s like this: if you go back, for instance, Canopy Growth barely grew from a year ago in its sales in adult use. And so, why?

So there was a loading up of the channel, and then as the year played out, and obviously not just Canopy Growth; we saw a whole bunch of other companies that have had to – Canopy Growth did it in the prior quarter, not this one they just reported – but we saw companies like Organigram and Supreme and many others have to deal with, and Aurora, have to deal with returns and recalls and things like that. That’s because the retail pace didn’t keep up with the ordering that the provinces had done. The provinces, you know, have to order very blindly. They didn’t know what the demand would be. And it turned out that, you know, the markets learned that the Canadian legal market buyer just doesn’t care for low-THC product, and that’s been one of the biggest challenges of the market.

So you know, I think investors can get trapped into looking out of the rearview mirror, especially retail investors, but institutional investors succumb to that, as well. And I do expect that we’re going to see some pretty substantial top line growth in the Canadian markets as the year plays out, from new stores and from Cannabis 2.0, and just better alignment of the products in the stores with what people want, which is the third thing – people don’t talk about that, that much.

So you know, it’s been tough. You go into a store in Canada and they’re out of all the good stuff, and all they have for sale was low THC product. And so that’s been a deterrent. So the summary of that is, look for some of these smaller companies to maybe recapture investor attention as the year plays out and we see top line acceleration.

James West: You bet. All right, Alan, great update as usual. Thank you very much for the contribution. We’ll see you next week.

Alan Brochstein: All right, take care.

James West: Bye for now.


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