• Ted Ohashi

When will Sunniva (CSE:SNN) deliver for investors?

QUESTION: Sunniva doesn't seem to be getting any love from the market or from a decent writer in the cannabis sector. You comment briefly each week and still seem to be a believer. Can you provide an update on their progress at splitting Canadian and U.S. assets and do you still believe in their overall plan and ability to execute? When will they be delivering on any milestones?

C.H. from Pennsylvania, U.S.A.

ANSWER: I think investors have put Sunniva (CSE: SNN) (OTCQX: SNNVF) in the penalty box. All they have done that might be considered wrong, in my opinion, is to be a little too aggressive and optimistic about how quickly some milestones would be attained. But I don’t think they will miss any targets and this is important.

When I say repeatedly that strong management is the key to a successful investment, this is the reason. When problems arise along the way as they inevitably do, good management doesn’t quit. They don’t give up. That is what I see with Dr. Anthony Holler, Chairman, Co-Founder, Chief Executive Officer and Director, Leith Pedersen, President, Co-founder and Director, David Negus, Chief Financial Officer and other members of the management team. So when investors are unhappy or the markets are down, these are the key guys who are going to work every morning, moving the company forward and turning off the lights when they go home at night.

Let me review the plan to split up the assets so all readers are up to speed. TMX Group that owns the Toronto Stock Exchange (TSX) and Toronto Venture Exchange (TSXV) took the position that companies investing in assets in the U.S. that are in conflict with federal laws are not in compliance with the listing requirements of the TSX and TSXV. The reason is because cannabis is a Schedule 1 drug and illegal according to federal law. As a result, the larger Canadian cannabis companies such as Canopy Growth, Aurora Cannabis and Aphria have been forced to create structures that allow them to invest in the U.S. cannabis market while meeting the listing requirements of the TSX/TSXV. From my perspective these comply with the letter of the TMX Group regulations but not the spirit. As far as I’m concerned, the TMX should simply abandon their position and save everyone money they are spending with lawyers and accountants.

The smaller Canadian Stock Exchange (CSE) has adopted the view that their listed companies can invest in the U.S. cannabis industry provided they make full disclosure of the risks involved and leaving investors to made their own investment decisions and risk assessments. As a result, smaller companies engaged in the U.S. cannabis growing industry choose to list on the CSE.

SNN has decided to take a different approach that I think better satisfies both the letter and the spirit of the regulations. SNN proposes to put their Canadian assets in a separate company and spin out ownership to existing SNN shareholders. When this happens, the company with the American assets, that is, the existing SNN (call them SNN.US), will remain listed on the CSE. The Canadian assets (call them SNN.CAN) will then be completely Canadian and will list on, say, the TSXV and perhaps the NASDAQ Exchange in the U.S. This should unlock values for existing SNN shareholders on many levels particularly as the TSX and TSXV provide much greater liquidity and capital raising opportunities.

As of my discussion with SNN President, Leith Pedersen, a couple of weeks ago, this plan is still in place and will proceed. In the meantime, SNN engaged Canaccord Genuity to prepare a consulting report outlining the best ways to proceed. It is impossible to say exactly when this report will be ready or what it will say with certainty but I think it is fair to expect everything to be on the table before Christmas. At the same time, I think work at the Okanagan Falls site, the Canadian campus, has been dialled back since one cannot assume at this stage what the consultant’s report will recommend so it is prudent to go slow in case Canaccord comes up with and management agrees with an idea that doesn’t fit with what is being done.

In the meantime, the California campus located in Cathedral City, California is nearing completion a few months behind schedule. Phase I will be 324,000 sq. ft. and is now scheduled to have its initial harvest in the first quarter of 2019. Although this has been delayed, steps toward vertical integration have continued. SNN has signed a binding Letter of Intent to acquire an indoor grower with an onsite genetics laboratory. This is important because management acquired with the transaction will be responsible for all of SNN’s cultivation in California. Meanwhile the Sun-Oil Extraction facility in Cathedral City is now operational and is generating revenue in the current quarter. The flagship dispensary on site at the purpose built grow facility in Cathedral City and is ready for the launch of SNN branded products in Q1 2019. An attractive feature is windows afford a look into the growing area. At the same time, SNN has commenced branding for a “house” of products including: beverages, concentrates, extracts, flower, pre-rolls, vape cartridges and vaporizers. The advantage of branded products is a much higher profit margin in comparison to the cannabis input. The spinout plan is for the American assets to remain in Sunniva that will remain listed on the Canadian Stock Exchange.

The Canadian model parallels the U.S. It begins with a 759,000 sq. ft. purpose built grow facility at Okanagan Falls in Canada. For the time being, construction has been put on temporary hold pending recommendations in a consulting report from Canaccord Genuity. It is now expected that the first harvest from Phase I will be delayed to Q3 2019. Part of the plan for this facility is an onsite extraction plant. SNN has taken steps for distribution of product by signing an offtake agreement with Canopy Growth. In addition, subsidiary Natural Health Services, is now the largest chain of clinics in Canada with close to 100,000 patients. In terms of branding, a suite of products is expected to be introduced in the first half of 2019.

Conclusion: based on multiples of Enterprise Value (EV) to 2019 and 2020 sales and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), Sunniva is substantially undervalued relative to its peer group. With a market cap of less than $200 million, SNN is a potential “Canopy of California” and an important operator in the Canadian market with a valuable asset in Natural Health Services. I believe the market’s investment assessment of SNN is grossly below a fair value and investors should take advantage of current stock prices to establish or add to positions.

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