• Ted Ohashi

'Red Flags' surrounding Aphria

If Canopy Growth triggered bull markets for cannabis stocks, then Aphria is at the heart of turning the cannabis group into a bear market dive. Not that the market is off trend. We have been pointing out for many weeks that the cannabis group has been looking quite weak. The events surrounding Aphria have turned a correction into a rout.

This week saw the publication of a report by Hindenburg Research titled “Aphria – A Shell Game with a Cannabis Business on the Side” (read full report here) and a presentation by Gabriel Grego of Quintessential Capital Management (QCM) at a short seller’s conference on December 3, 2018. (see presentation here) On the theory that smart people learn more from stupid people than stupid people learn from smart people, it behooves us to pay attention to such developments. Especially when the jury is still out on who is smart and who is stupid.

Here are some observations:

  1. There are investment businesses that make a living doing “hatchet-jobs” on companies by taking a short position (a position where you benefit if the stock price falls) and follow that with an effort to talk the stock price down. In other words, after they go short, these people pound the table trying to convince other investors the stock is overpriced and contribute to a decline in price they are looking for. There’s nothing wrong with this. It’s similar to people who own a stock then go public with reasons to buy it. Hindenburg and QCM fall into the category of groups that take a short position and act on it. They have an axe to grind.

  2. The second lesson is that sometimes the first clue is the best clue. Seeking Alpha followers will know that the Aphria acquisition of Nuuvera for $826 million quickly reduced to $425 million is what first turned me off Aphria back in January 2018. It seemed to me the price paid was way too high and there were also rumours that Aphria insiders had bought cheap stock in Nuuvera which later proved to be true. It seems that transaction was integral to the research published by Hindenburg and QCM. What goes around often comes around.

  3. Next, short sellers have to go against the ideas of company managements and their sometimes supportive shareholders that resent anyone trying to lower the value of their investment. This means they know they face the potential of lawsuits every time they put out a report. They probably have their lawyers vet every report ahead of publication. So when one of these companies makes a claim(s) they are fairly certain they can defend it.

  4. Also Hindenburg said on Tuesday, they were coming with more red flags on Thursday, remembering the U.S. markets were closed to honour President H. W. Bush. When it was posted, the report was more a direct indictment of Liberty Health (CSE: LHS) and Vic Neufeld, Chairman than it was on Aurora that rebounded sharply and rose further on Friday riding the coattails of the news that Altria (NYSE: MO) was going to invest U.S. $1.8 billion in Cronos (NASDAQ: CRON).

  5. If anything, the response from Aphria has added to the problem. If Aphria had done proper due diligence and the fairness opinion of Cormark Securities had been a reasonable report, it should be able to refute some of the allegations made. Simple case in point: the claim that the Jamaican acquisition had in 800 square meter herb house in Unit 51 of what now appears to be a 50 unit building. Is there a Unit 51 or not? What about Aphria’s claim Dr. Janice Simmonds-Fisher was one of two scientists associated with the Jamaican company. Dr. Simmonds-Fisher is a doctor in Jamaica and says she was never a director of the company? How about the other director/scientist Ray Anthony Chin listed as a “Genetic Engineer” who doesn’t live at the address listed and cannot be found in any scientific journals or anywhere else for that matter? These are the kinds of allegations that should be easy to refute. But so far Aphria has not.

  6. A subsequent response from Aphria is they are setting up a committee made up of the company’s independent directors to review the governance procedures. This is also problematic. They may be independent directors of Aphria but they aren’t independent when it comes to reviewing the governance procedures. If they are going to do this, they should hire a major accounting firm to conduct the review. Second, it comes off as an attempt by Aphria to justify what they have done by hoping to reach a conclusion that all of these things may have happened but we complied with our governance rules. This is just not an acceptable answer. Third, they are dealing with the U.S. Securities and Exchange Commission and the SEC is far more difficult to deal with.

  7. Others who rushed to support Aphria, such as Scott Willis of Marijuana Investing and Grizzle, argued that the South American assets are only worth $194 million and not $280 million as claimed in the report. He argues if Aphria overpaid then Canopy and Aurora also paid too much. These arguments miss the point. If the allegations are substantially correct, words like misrepresentation and fraud come to mind and that is where the problems lie.

  8. I warned Canadian companies they should not apply for listing on the New York Stock Exchange if they had skeletons in the closet. I said only the companies know what they have done and should proceed accordingly. The two companies that had announced the intention to list on the NYSE, (Canopy was already listed on the Big Board), were Aurora and Aphria. My conclusion was a warning to be careful what you wish for….”

Conclusion: I don’t know what the ultimate outcome will be for Aphria. But I believe there are so many “red flags” as Hindenburg calls them, I can’t believe that there are no skeletons. If the transgressions are serious, they won’t be dealing with wrist slaps from Health Canada or the Investment Industry Regulatory Organization of Canada (IIROC) in Canada. The U.S. Securities and Exchange Commission (SEC) is a different animal with claws and teeth. So if there are problems, Aphria and management may end up paying a far more severe punishment.

An old saying goes, “When a man with experience meets a man with money, the man with experience ends up with the money and the man with money ends up with experience.” In this case, the man who started with experience seems to be Andy DeFrancesco and the man who started with money looks like Vic Neufeld and the Aphria shareholders. If the Hindenburg report is accurate, Neufeld might be both at the same time.

Vic Neufeld, CEO of Aphria has promised a line by line rebuttal on Wednesday December 12th and indicated Liberty Health plans to do the same on Monday December 10th. The markets will be waiting anxiously to consider the responses.

On November 23, 2018 on these pages I said “When I spoke to the Canadian Cannabis Capital Markets Conference last month, my remarks were rather cautious. One of the issues I warned about was the possibility of a scandal in the industry. Little did I know that the source of a scandal was one of the other presenters at the conference – Ascent Industries (CSE: ASNT). On the Canadian Stock Exchange following this news, Ascent became descent.” Aphria was a presenter at the same conference and if it devolves into a scandal, it will make the Ascent losses appear insignificant. Although Aphria shares have recovered some of their losses, I don’t think it’s over yet.

Now let’s see....what other companies presented at that conference?

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