This is a copy of the July 14th edition of our weekly Newsletter, which we have been publishing since October 2015.
While the recent decline in the entire sector has depressed stock prices across the board, the Canadian Cannabis LP Index remains up 14.6% in 2019 while the Global Cannabis Stock Index is up 17.2%. The divergence that we have noticed is the American Cannabis Operator Index, which has lagged the other two indices, is down slightly at -0.09%. We wanted to take a closer look at this divergence, which is illustrated in the chart below:
We think that the two negative surprises out of Canada this month from Canopy Growth and CannTrust have played a role in the weakness indirectly, but there are several factors that are also contributing. First, as we have pointed out previously, several mergers have been delayed due to anti-trust reviews. We continue to think that these large mergers will go through, but the market appears to be concerned that they may not as evidenced by the massive 27% discount for Origin House relative to the terms of its merger with Cresco Labs. The other delayed large transactions include Curaleaf, Harvest and MedMen. 4Front opted to withdraw its filing the Federal Trade Commission after determining that it wasn’t necessary to have filed in the first place, and it expects to close its reverse-merger with Cannex this month.
While we view the anti-trust concerns as overblown, we see a potential negative in the sector at the state level. Last week, Massachusetts initiated the hiring process for a consultant that will be tasked with “implementation of a financial and corporate structure investigative program” in order to prevent companies from circumventing the statutory cap on licenses. A Boston Globe article in March had accused Acreage Holdings and TILT Holdings of doing so. Also this week, the Cincinnati Enquirer reported that Acreage Holdings and Harvest Health & Recreation are being investigated by Ohio regarding their licensing. Harvest also is dealing with some regulatory issues in Pennsylvania. The big takeaway is that getting big may be harder for the MSOs than the market has been anticipating.
Another potential driver of negative sentiment was the failure of New Jersey and New York to legalize, as many MSOs were prepared to capitalize on that opportunity. We remind our readers that despite the disappointment on the East Coast, Illinois and Michigan are legalizing in 2020. The MSOs have good exposure to these states.
A final fundamental reason for investor concern is supply, which is coming in two forms. First, many of the MSOs have very tight floats, and concerns about insider lock-up expirations are widespread. Additionally, we continue to see new deals that aren’t performing very well. Greenlane, an ancillary company that conducted a NASDAQ IPO, has lost more than half of its value. Also trading on the NASDAQ, Akerna, the parent of MJ Freeway, has sold off dramatically after its big advance following the closing of the deal. In the MSO space, Columbia Care has lost more than half of its value from the close on the first day of trading. AYR Strategies has performed poorly as well since it closed its five transactions, a decline that is being exacerbated by the company providing incentives to warrant holders to exercise. The number of outstanding warrants is a large multiple of the average number of shares traded each day.
Beyond these several factors that are serving to put pressure on the index, we believe that there is a structural issue. The index has 29 names currently, and most of the largest names in it in terms of market cap or revenue are up double-digit year-to-date. The index also includes some smaller companies, and they have weighed heavily on the index. The six largest names in terms of revenue, each reporting more than $15 million in sales during the March quarter, are up on average approximately 20%, with only MedMen posting a negative return and the balance ranging from 12% to 42%. The weakness in the smaller names has been profound, with some of the stocks declining more than 50%. Additionally, volumes have been weak for some of these smaller companies.
The weakness in the index has been significant, though it remains about 9% above its December low. The technical impact of an expanding float for many of the stocks will continue to be a challenge, and we think that the pushback from several states against the MSO certainly bears watching, but clearly investors continue to support the largest MSOs. While sentiment is negative currently, perhaps the market will have a more favorable view when these companies report what is expected to be robust growth during the June quarter next month.
As American cannabis operators grow larger, so does the industry’s leading ancillary provider, KushCo Holdings. This is evident by the company’s latest Q3 financials, with the company reporting $41.5 million revenue and updating their full-year guidance to $145-150 million. KushCo produces products and services specifically for cannabis and hemp industries, without growing an ounce of actual cannabis. On July 8th, the company announced it has filed an application to list its common shares on the NASDAQ.
To learn more about KushCo Holdings, a client of New Cannabis Ventures, visit the company’s Investor Dashboard that we maintain on its behalf and click the blue Follow Company button in order to stay up to date with their progress.
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Alan & Joel
Written by Alan Brochstein, CFA
New Cannabis Ventures