The 16 Cannabis Stock Driving Events of 2018

2018 was an active year in the Canadian and world cannabis industries. Below we list the developments that we believed played an important role in moving stock prices higher and lower. It is important to remember these events because in many cases the impact on stocks will really be witnessed in 2019 and beyond especially when you consider that many of them occurred late in the year.

1. California legalizes adult use marijuana January 1st: California became the world's largest cannabis market at the start of 2018 with a population of 39 million and a Gross Domestic Product of US $2.424 trillion. If California was a country, it would rank sixth largest in the world and Canada would be eleventh. Like other U.S. states that legalized before them and Canada that would legalize after them, California experienced a number of problems in the legalization process. Still these difficulties are being ironed out and 2019 is expected to be a breakout year in the Golden State.

2. Attorney General Jeff Sessions rescinds Cole Memorandum January 4th: Sessions’ anti-cannabis views were known long before he was appointed Attorney General and said, “Good people don’t smoke marijuana. We need grown ups [sic] in Washington to say marijuana is not the kind of thing that ought to be legalized….” James Cole was U.S. Deputy Attorney General in the Obama administration when his policy known as the “Cole memorandum” allowed states voting to legalize marijuana to enact and enforce regulations if they stayed within limitations. The timing of Session’s action is a strong indication that it triggered the selloff in cannabis stocks starting in January 2018 and running almost all year. The good news is Jeff Sessions is gone. (see below)

3. BMO Capital Markets co-leads $175 million Canopy Growth bought deal January 17th: was significant because it marked the first time a “Big Five” Canadian bank, the Bank of Montreal, had led a Canadian cannabis securities underwriting. The other major banks are Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia and the Canadian Imperial Bank of Commerce. This was a major change of heart on the part of one of the most conservative groups in the Canadian business world. We reported in Let’s Toke Business on September 19, 2016, the Royal Bank informed Canopy Growth, Canada’s largest cannabis company, it was closing their bank accounts. To show how fast things change in the cannabis industry, in June, CIBC Capital Markets agreed to be a joint book runner in the Canopy Rivers stock issue and in December, we picked up a story that the Bank of Montreal was reconsidering its involvement in cannabis just as the Royal Bank was planning to become more active.

4. Alliance One International (NYSE: PYX) takes majority stake in Canada’s Island Garden (Prince Edward Island) and Goldleaf Pharm (Ontario) February 9th: in an often overlooked transaction, Alliance One purchased a 75% interest in Licensed Producer Canada’s Island Gar-den and an 80% stake in license applicant Goldleaf Pharm that had its application approved in late September. These investments were low profile because although PYX is a New York Stock Exchange listed company it does not have a well-known consumer brand, the two target companies are not public and the terms were not disclosed. PYX operates one of the largest networks of growers, buyers, processing facilities and distribution operations in the world. We may see more of these types of smaller, less publicized takeovers in 2019.

5. When Prime Minister Trudeau replaced an experienced, competent Health Minister Dr. Jane Philpott with an inexperienced Member of Parliament and first time Cabinet Minister Ginette Petitpas Taylor on August 28, 2017 at a critical time in the cannabis legalization process we asked “Why?” On February 18, 2018, we observed “…Petitpas Taylor is a rookie, inexperienced and seemingly spineless Minister who is being pushed around by Conservatives in the Senate….” The eventual result is that legalization was pushed back almost four months and the mess we are in today is the responsibility of the current Health Minister.

6. Although the Canadian Senate passed Bill C-45, ‘The Cannabis Act’ on Tuesday June 19, 2018 it received Royal Assent on Thursday June 21, 2018, the government was able to turn a positive event into a negative. The reason is passage came with the caveat that actual legalization would be deferred until October 17, 2018. This was yet another disappointment for the cannabis investment community. Still it was a monumental achievement as Canada became the first G-7 country to legalize cannabis. Given the incompetent leadership of the Minister of Health Petitpas Taylor and Prime Minister Justin Trudeau, this was to be simply the first stumble on the path to legalization that continues to stumble as we enter the new year.

7. On September 27, 2018, Health Canada reported it was partially suspending the cannabis cultivation and production licenses of Ascent Industries held through subsidiary Agrima Botanicals. This lead to the announcement from Health Canada on November 21st that the responses from Ascent were not satisfactory to lift the suspensions and a letter was issued to As-cent that Health Canada intends to revoke Agrima’s licenses. This was the first time Health Can-ada had threatened any licensee with revocation of licenses and resulted in three of Ascent’s senior management resigning.

8. The announcement that Constellation Brands (NYSE: STZ) would invest another CAN $5 billion in Canopy Growth (NYSE: CGC) on August 15, 2018 was a blockbuster. If the purchase of 9.9% of Canopy by Constellation announced on October 30, 2017 was the engagement, the acquisition of another 104.5 million shares of CGC at CAN $48.60 per share for a 38% total interest was the wedding. The price paid was a 37.9% premium to WEED’s 5-day volume weighted average price (VWAP) on the Toronto Stock Exchange and a 51.2% premium to the closing price on August 14, 2018. STZ also received 139.7 million three-year warrants to buy additional Canopy shares: 88.5 million exercisable at a price of CAN $50.40 per share, a 43.0% premium to VWAP and 51.3 million exercisable at the VWAP at the time of exercise. Canopy received approximately C$5 billion cash on closing and the exercise of all new and existing war-rants would give STZ over 50% ownership of WEED and provide WEED with at least an additional C$4.5 billion cash. The impact on stock prices was strong and immediate although the negative investor psychology in the market meant the impact was far less than in 2017.

9. Canada legalizes October 17, 2018: was an important date but not nearly what it could have been if we had not had a Prime Minister and Health Minister who seemed to not have a clue what to do.

10. The U.S government will run with two fewer sessions in 2019. First, Representative Pete Sessions (R-TX) lost his seat in the midterm election. As the Chairman of the House Rules Committee for the past two years, Pete Sessions ensured that the House did not vote on any cannabis amendments since 2016. Second, Jeff Sessions, Attorney General resigned as re-quested by the White House the day after the election. Jeff Sessions rescinded the Cole Memorandum issued by Obama’s U.S. Deputy Attorney General James M. Cole in August 2013 that informed all U.S. Attorneys the Department of Justice would not enforce federal marijuana laws in states where medical and/or recreational have been legalized. The Sessions Memorandum directed all U.S. Attorneys to enforce laws enacted by Congress. Although Jeff Sessions had the higher anti-cannabis profile, it is Pete Sessions that did more damage.

11. On December 3, 2018, Hindenburg Investment and Quintessential Capital launched a short seller’s attack on Aphria (NYSE: APHA). This has been widely covered in the press and in this newsletter so we aren’t going to repeat it all over again. For a detailed recap, see Let’s Toke Business, December 7, 2018. The nature of some of the allegations against APHA are, however, ones that need to be answered directly. For example, an 800 sq/m herb house it leases at “Unit #51, Pulse Center, 38a Trafalgar Road, Kingston.” It turns out there is no Unit #51 as there are only 50 Units in the development. Or founding director Dr. Janice Simmonds-Fisher, who denied holding a directorship in any company. Or Ray Anthony Chin, a “Genetic Engineer” who cannot be found. APHA has many allegations to answer but these are not Health Canada issues for the most part. Their problems are with the investment industry regulators: the Securities & Exchange Commission, the New York Stock Exchange, the Investment Industry Regulatory Organization of Canada and the Toronto Stock Exchange. Aphria has responded by appoint-ing a committee of “independent directors” to review Governance Processes related to LATAM acquisition. To my way of thinking, “independent directors” cannot be independent members of such a committee and “review Governance Processes” means “find out how this happened.” I take this to mean there is another shoe to drop and I wouldn’t want to be around when it does.

12. On December 7, 2018, Altria Group (NYSE: MO) invests $2.4 billion for a 45% interest in Cronos Group (NASDAQ: CRON). Altria is the world’s largest tobacco company by sales U.S. $29.6 billion and is probably best known for the brand Marlboro. Altria also has an equity investment in Anheuser-Busch InBev also known as AB InBev (NYSE: BUD). Then on December 19, 2018, MO announced it was buying 35% of JUUL for $12.8 billion. JUUL Labs manufactures and sells a nicotine based, e-cigarette product that has captured a near 60% market share of the e-cig market. This is an important set of transactions, probably more important than the Constellation (NYSE: STZ)/Canopy Growth (NYSE: CGC) deal. This is a move on the part of “big tobacco” and MO is approximately three times the size of STZ by market cap.

13. Tilray (NASDAQ: TLRY) signed an agreement with AB InBev (NYSE: BUD) (see December 7, 2018, Altria Group above) to research non-alcoholic beverages infused with THC and CBD. This is an important transaction at it involves another alcoholic beverage company. AB InBev manufactures and markets and is the world’s leading brewer with Budweiser beer (Bud Light and Budweiser ranked first and third in U.S. beer sales in 2017). However, the deal lacks some of the pizzazz of previous deals: First, BUD is not investing in TLRY that says it did not want an investment, the deal is being done through BUD Canadian subsidiary Labatt, the partnership is restricted to Canada and product development arising from the partnership will be decided in the future.

14. On December 21, 2018, Bonify, a Manitoba based Licensed Producer was alleged to have allowed illegal product to enter the retail stream. An announcement was made by Premier Brian Pallister jointly with the Liquor, Gaming and Cannabis Authority of Manitoba (LCGA) and the Manitoba Liquor and Lotteries (MBLL) of contaminated product. It appears the problem is much worse. A report by Peter Nolan-Smith from the dailyhive.com stated that a whistleblower alleged a “…large amount of cannabis [200 kilograms according to a separate report] being bought from an illegal source [out of province according to another report].” Health Canada con-firmed a complaint was received “…alleging wrongdoing by Bonify.” The Board of Directors stat-ed they have, “…removed company executives and brought in a third-party management consultant to review how unapproved cannabis products were released for sale.” All Bonify products were recalled in Manitoba and are no longer for sale. Both the province and Health Canada reportedly have seized cannabis from Bonify. Although it is not totally clear, this smacks of the al-legations directed toward Ascent Industries (CSE: ASNT). As Bonify is private, it faces possible loss of licenses, fines and even prison for certain executives.

15. To close out the year came a proposal involving Aphria (NYSE: APHA) that would be funny if it wasn’t such a sad comment on attitudes toward Aphria, investment industry and investors. On December 27, 2018, Zanthic Biopharma that trades under the name Green Growth Brands (CSE: GGB) made an all share offer it valued at $11.00 per share.

There is a relatively simple way to judge the stock market’s opinion of an offer called “discount to market.” If a serious offer is made for a public company, the market will arbitrage the price of the target company up to a small discount to the offering price. The discount reflects the market’s judgement of the risk that the offer will not be completed and the time value of money, that is, what could your earn on the cash while you’re waiting. In most cases, the discount to the offering price might be 5% - 10% and will gradually decline to zero on the final day you can buy the stock and turn it in under the offer. On December 28th, APHA was trading at a 23% discount to the $11.00 offer. This means the market’s assessment of the GGB offer for APHA closing is close to non-existent.

Why does the market feel this way? Let me count the ways:

1. Green Growth Brands was founded on February 14, 2018, less than a year ago and commenced trading on the Canadian Stock Exchange on November 13, 2018, just a little over a month ago. In the company’s latest financial statements, assets were around $5 million and liabilities stood at $58 million. Green Growth is going to acquire Aphria in a share exchange? Who dreamed this acquisition up?

2. As alleged by Hindenburg Research and Quintessential Capital (HR/QC) regarding Aphria’s Lat-in American transactions, it appears some Aphria people have one foot on each side of the Green Growth offer as well. Green Growth’s second largest shareholder is GA Opportunities Corp. that falls under the umbrella of Green Acre Capital that features Vic Neufeld, Chief Executive Officer of Aphria as a member of the Advisory Board.

3. Aphria has invested in GA Opportunities Corp. according to their latest Management Discussion & Analysis report (MD&A). GA Opportunities owns approximately 25% of Green Growth. Furthermore, Shawn Dym was a director of both Aphria and Green Acre as recently as October 2018. So was Adam Arviv who Hindenburg Research has linked to Andy DeFrancesco through companies such as Liberty Health and MassRoots. Yes, that Andy DeFrancesco. Perhaps the answer to my question of who dreamed this acquisition up is in here somewhere.

4. Aphria has termed this offer “hostile.” It seems more warm and cuddly to me. Why else would a company make an offer for Aphria that is subject to a short attack by HR/QC that alleges a number of extremely serious points that haven’t been addressed. In addition, Aphria faces four class action lawsuits that have been filed to date. Finally, when Altria (NYSE: MO) chose to invest in Cronos, Aphria was one of the proverbial brides left at the altar. Maybe Altria didn’t like what it saw.

5. At $11 per APHA share, the offer has a paper value of around $2.8 billion. GGB, the company making the offer has a market cap value of around $800 million. I have heard of mice hunting el-ephants but this is ridiculous.

16. The cannabis stocks were down in 2018. Looking at the indexes, the Let’s Toke Business Marijuana Composite Index recorded a loss of 36.0% while the Licensed Producer Index was down 25.7% for the year. The other major cannabis indexes were also down. But as we explained above, if a group is to provide above average returns as the cannabis stocks have, it is necessary for them to have above average volatility. So in a down year (only one of the major market indexes we follow was able to record a gain in 2018) the cannabis stocks will also be more volatile. That is what happened. Looking ahead to 2019, if the cannabis group recovers as we anticipate, that volatility will work in our favour.

Conclusion: clearly 2018 was a busy year. Probably the most important positive was legalization in Canada while the biggest negative was the decline in the markets. But if you review the stories, the plusses outweigh the minuses and this augers well for 2019. As outlined above, we are optimistic in our outlook for 2019 and we see some very positive investment returns ahead.