It wasn't until August that Mark Noble realized what was going on.
As an executive vice president of ETF strategy for Horizon ETFs, Noble had a perfect place to watch cannabis stocks. "This was a bubble that burst," he says. Horizon's Marijuana Life Sciences ETF, which includes names like Canopy Growth, Tilray, and Aurora Cannabis, fell from over $ 20 in 2018 to around $ 7 this month.
He still remembers the day when things have changed. "At the time, we didn't think we were going to drop below $ 15, and it hit $ 14 on August 26 – it just kept going back from there," says Noble Fortune. A series of disappointing earnings reports for the second and third quarters of last year was just the start of a top-out sell-off, with most of the biggest names losing more than 50% of their market cap.
Last year, investors wanted to enter the emerging cannabis industry in a moment of market spirit. A new type of investor has grown up – millennials poured money into the eye-catching new stocks that promised growth and greenery. In fact, Aurora Cannabis was the most popular Gen Z and Millennial Investment App Robinhood trade in June – beating tech giant Apple.
But within six months, these big-eyed investors saw a very different picture. Wall Street got tired when major cannabis companies reported disappointing profits, fired employees, and in some cases were even exposed to compliance scandals. Pop! The bubble had burst.
Big names like Aurora and Tilray fell 70% and 60% respectively from June to the end of the year. The Canadian Marijuana Index (which lists some of the largest public top companies such as Tilray, Canopy and Aurora) has fallen over 77% compared to March last year.
It is an incredible separation from the growing popularity and spread of pot legalization in the United States. And there are many catalysts. However, one thing is certain: a lot of money went up in smoke in no time.
Perhaps no company illustrates the wild ride of the past year better than MedMen.
According to an ongoing lawsuit, James Parker, former CFO at MedMen, alleged that the management, which included co-founders Adam Bierman and Andrew Modlin, the company's former CEO and chief brand officer, was involved in illegal conduct, which forced Parkers to fall in November 2018. The lawsuit alleges that the illegal behavior is "wasteful spending of company funds for their own benefit (the co-founder)", attempts to boost MedMen's shares, and a work culture "full of race, homophobia and misogyny "Contained epithets and blurring," claims Parker's suit. The allegations were contested by MedMen.
According to the lawsuit, MedMen's executives spent corporate funds on "24-hour security guarding (security) for the CEO, the president and their families", private jets and "tens of thousands of dollars each for several extravagant special conferences" from room tables, although according to the lawsuit cash was burned quickly.
MedMen declined to comment on Fortune. In a statement, Bierman denied the allegations by saying, “Mr. Parker's inflammatory accusations are a transparent attempt to get attention for his unfounded lawsuit. "Fortune could not contact Bierman or Modlin for further comments. MedMen's board also made a statement describing the allegations as" unfounded. "
Adam Bierman, co-founder and CEO of MedMen (second from right), with Senator Tick Segerblom (D-NV, second from left).
Wire photo: Bryan Steffy / Getty Images for MedMenBryan Steffy / Getty Images for MedMen
Regardless of the legal situation, there are numerous cash problems. An email displayed by MarketWatch shows (and the company has confirmed this) that MedMen has attempted to offer stocks to cannabis product providers as a form of payment because the company's poor money situation has prompted them to change payment terms, according to a statement by MedMen, " to change" . The share has lost around 90% of its market capitalization since February last year.
But MedMen wasn't the only one that gave investors a bad trip.
During the summer, a regulatory scandal broke out at CannTrust, one of the largest Canadian cannabis companies. The company made headlines last summer when internal communications and emails came to light that indicate that members of the company's C-Suite knew that cannabis was being grown illegally in unlicensed rooms, causing a decline in stocks over 20% led when the news became known.
This was preceded by several violations of Health Canada's compliance requirements in 2016 – including the $ 6 million product confiscated at the time in its vault, four times more than licensed, and mold in the growth rooms, according to inspection results from Health Canada.
Since February of last year, CannTrust has lost over 90% of its market cap. CannTrust said in a statement to Fortune that the company has "focused on remediation and governance activities since the summer" and that "significant steps have been taken to improve the company’s culture and compliance and to refurbish its facilities ".
CannTrust Holdings Inc. made headlines last summer when internal communications and emails came to light showing that the company's C-Suite knew that cannabis was being grown illegally in unlicensed rooms – which resulted in a price drop.
Wire photography: Galit Rodan / Bloomberg – Getty ImagesGalit Rodan – Bloomberg / Getty Images
When working with cannabis companies for the first time in 2014, Maruf Raza, the national director of public company practice at Canadian accounting firm MNP, was tasked with auditing and accounting for public cannabis companies. What distinguished the management? Your products weren't the only thing that was green.
"In the beginning there was a lot more hand gesture," says Raza Fortune, who did accounting and audits with young companies. He says it is not uncommon for younger companies to generally need more support initially with smaller teams, but the challenges of raising capital in the private markets may have brought these companies to the public earlier than others in different industries would.
"The emergence of these companies is that many of them were actually start-ups four years ago," says Raza. "They have gone from zero to now, in some cases, to multinational companies with multi-billion dollar market caps."
But now Raza says that the composition of the boards in these companies is “day and night” four years ago. Fortune 500 company experts have slowly filled places at some of the leading cannabis companies and "driven the bus", such as Canopy Growth (where many of the places are filled by current or former executives from the beverage giant Constellation Brands, which a nearly 40% shares in the company).
David Belsky, founder and CEO of FlowerHire, a cannabis-specific recruitment and recruiting company, believes cannabis companies are in greater demand for C-suites and lower management with turnaround experience. FlowerHire now supports companies in assuming roles in investor relations and communication.
Although there may have been some tense exits in the C-Suite, according to Raza, many founders and management teams themselves realize that they are not the right teams to lead companies into their next phase as large, listed companies.
The revenue problem
In the meantime, supply and demand problems have devastated the holy grail of the delightful Wall Street – earnings estimates.
Despite the introduction of legal marijuana in Canada, many companies struggled to measure demand and product mix amid a weak number of retail stores in Canada, which led to oversupply of products for some. And in the United States, where cannabis is still illegal nationwide, the regulatory climate and a vaping crisis last summer only exacerbated cash problems.
Back in September, Aurora Cannabis, one of the biggest names in the public markets, missed its recently released fourth quarter and full year earnings guidance and estimated net sales of about $ 75 to $ 80 million after deducting excise duties paid. Instead, the company had net sales of around $ 74 million – a failure of over $ 1 million due to forecasts that had been given just five weeks before the report. Another batsman in this area, Canopy Growth, completely missed second quarter earnings estimates for 2020, posting a loss of approximately $ 0.72 per share compared to approximately $ 0.30.
Cannabis producer Hexo was also hit hard after warning of a $ 10.9 million loss in sales in the fourth quarter to around $ 12.4 million, well below street estimates of $ 18.5 million was in October and led investors into a frenzied sell-off.
GreenWave Advisors founder, Matthew Karnes (who describes himself as someone who is not “ra, ra, ra, pot, pot, pot”) says: “There was a lot of hype and a feeling of exaggeration, but when it mattered These companies reported that they couldn't get close. “The reviews plunged for many. "Managing street expectations has been a challenge, and I think it is really due to the lack of experience in many of these organizations," he says.
Another challenge for many cannabis companies was to control the arcane tax and accounting burdens for a product that largely falls into a legal gray area.
A sore point for Canada-based cannabis companies (like Aurora Cannabis and Canopy Growth) is that they have to estimate the market value of their products if they are sold while they are still growing – referred to as "fair value". Or, as Raza suspects, "you effectively capture revenue before you sell the product." Cannabis companies are required to value their growing plants as biological assets as biological assets in accordance with the International Accounting Standard 41 Agriculture (IAS 41) and the International Financial Reporting Standard (IFRS).
The problem with applying this standard to cannabis companies is that unlike other companies that manufacture more traditional agricultural goods (such as wheat or cattle), they have commodity-based prices and futures to help them fairly value their product "Cannabis isn't there yet," says Raza. "As a result, you have a lot of estimates and assessments that go into part of the accounting." While one strain comes on the market for a certain price in one month, it may be more or less worth the next. These estimates and judgments have created somewhat uneven conditions of competition between different pot companies – they are not "apples to apples," says Raza.
But Raza claims that these inconsistencies are not disgraceful: "Most, if not all, of these cannabis companies don't want to use anything more than this agricultural standard," he argues, instead recognizing income when they sell it. Despite the amount of time and resources that value the value of companies' growing products, "according to the standard, they're unfortunately handcuffed," says Raza.
As a chartered accountant, Raza of MNP sees that these companies are trying "to find out what is the right bridge between the actual and the projected", which has made things a bit chaotic for MNP as a chartered accountant and for management Mathematics. "
A typical example: In the discussion and analysis of Aurora Cannabis management submitted to the Securities and Exchange Commission, the company announced that Aurora's net income (in USD 1.9 million) in the quarter ending March 2016 was “mainly on the unrealized gain from changes in the fair value of biological assets ”, while in the quarters ended September 30, 2016 and June 30, 2016, net losses (of approximately $ 4.2 million in USD and $ 5.6 million, respectively ) mainly due to a “decrease” in unrealized profit ”from changes in fair value.
This is a frustrating point for investors as it shows that due to the challenges of estimating fair value, companies may have to report significantly different income or losses depending on how their fair value estimates actually match what they get from the investment It is a challenge for investors or analysts to determine which cannabis companies have the most efficient production (and which perform best).
Sources from the IFRS Board of Directors report to Fortune that investors have raised concerns with the Board of Directors about insufficient information provided by the standard to assess the profit margins of some of these companies. While there are standards under IFRS for fair valuation of biological assets in large quantities, there is no specific literature specifically focusing on the fair value of cannabis (and its requirements for the information that cannabis companies use in their profit and loss accounts deliver at fair value are "not very mandatory"). Sources from the IFRS Board of Directors report to Fortune that there are currently no plans to review IAS 41 regarding cannabis. However, the Board of Directors proposes to require companies (not just the cannabis industry) to report more detailed financial results, including operating profit and non-GAAP transparency.
Tax and accounting complexity
Matthew Karnes of GreenWave Advisors saw a thing or two in his time as a former accountant.
He recalls that he once visited a pot plant and asked an employee (“not just a low-level employee”) who checked the company's books. "(The clerk) says," What do you mean by the library books? "
"So I think to myself: & # 39; Houston, we have a problem, & # 39;" says Karnes Fortune. While inexperience may have been a thorn in the side of certain companies, he claims that there is a major problem – overall overboard – that affects the bottom line of cannabis companies.
Some top companies in the United States are subject to massive tax burdens due to the nature of their product – in other words, the cost of the ban. U.S. pot companies operate in accordance with section 280E of the Internal Revenue Service tax law, which has freed many pot companies from cash.
Section 280E does not allow companies to deduct normal business expenses from gross income related to the “trade” in List I or List II substances as defined in the Regulated Substances Act. In other words, most operating costs for top companies are not deductible (although certain overheads can be attributed to cost of sales, Karnes does offer some companies the opportunity to "go beyond the scope" which could make them targets IRS review).
"Even if they suffer losses, they still have to pay taxes – (that could be) millions of dollars. This is a burden on cash that would otherwise be used as a reinvestment in these companies," says Karnes.
According to an analysis by GreenWave Advisors of US public cannabis companies with a market capitalization of over $ 500 million (excluding MedMen), tax rates among the only three companies that were profitable in calendar year 2018 had different effective tax rates of 30% up to 59% – but depending on the structure of the company, the tax benefit of tax loss carryforwards (which are designed to reduce tax liability by applying the net operating loss of the current year to the net result of the coming years) is generally not allowed for cannabis companies to offset future earnings.
The eight publicly owned, multi-state operators (MSOs) GreenWave that were surveyed from Q1 2018 to Q3 2019 all had net losses of approximately $ 542 million. And of these eight companies, all but one of which operated with a net loss in the first nine months of 2019, GreenWave Advisors' analysis estimates a total loss of approximately $ 114.5 million in lost tax credits for net operating losses. (In short, at worst, these cannabis companies miss over $ 114 million in tax credits.)
What's next for cannabis stocks?
The fallout? Significant job cuts at some of the larger cannabis companies. In the last few months alone, around 2,000 jobs in various companies have been cut in the industry.
Contested medMes cut 190 jobs in November. In February, Tilray announced it would lay off about 10% of its employees to cut costs and improve profitability. Aurora Cannabis followed in the same month, cutting around 500 jobs. Canopy, CannTrust, MedMen and Aurora have all replaced their CEOs.
Raza compares it to public startups: “The reality is that many things that happen in public markets usually happen in the private market. When you think of Silicon Valley, how many technology companies does the Silicon Valley ecosystem fund? Thousands. How many of these companies ultimately survive? "
The over-excited (and often overlooked) sales estimates for 2019 will probably no longer work in 2020 – ”(investors) will come back with a chip on their shoulders and say:“ No, fool me, be ashamed of yourself. Fool me twice, be ashamed of me, ”said Sloane Barbour, FlowerHire's Chief Revenue Officer.
From an operational perspective, MNP's Raza believes that many of these companies may only be operating in the “second inning”. And Morningstar's Kristoffer Inton suggests that cannabis investors need to see themselves as venture capitalists – "They don't think about the time of a year – they think about the market (potential)," he says.
This growth potential is there, experts say. MNP's Raza believes that many will get where they promised, but it is a "function of time and patience, and as we know, public markets will not always be patient," he claims. But like dozens of hopeful startups in emerging industries choked before taking their step, not all cannabis companies are created equal.
"All of the rise and fall of these companies takes place in a public environment," says Raza. "And not all of them will survive."
Horizon's marijuana ETF has not yet recovered. According to Noble, the ETF is trading at $ 7 at $ 3 less than the price at which it started trading in 2017. But Noble hasn't completely lost confidence. He says that he is committed to the potential of space in the long term and that "there is more doom and darkness than it is turned upside down".
In other words, the sector could currently be at a low. But you never know there could always be another high around the corner.
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