Why you should invest in Cannabis Growth Opportunity Corp (CSE: CGOC)
QUESTION: “I have been looking for your latest pick. I am a subscriber to The Cannabis Report Model Portfolio and received the information on Cannabis Growth Opportunities Corp. there. But don’t you also publish the same report in the Let’s Toke Business newsletter?”
W.F.I.M. from California
ANSWER: Although I write both, The Cannabis Report Model Portfolio and the Let’s Toke Business newsletter are two different publications. The main difference is that the Model Portfolio is a publication owned and operated by someone else who compensates me as a contributor. Since subscribers to that report pay to receive it, I cannot immediately publish the same report in my free newsletter. So in fairness, I give the Model Portfolio a two week head start at a minimum.
I like Cannabis Growth Opportunity Corp. (CSE: CGOC) (OTCPK: CWWBF) for cannabis investors. For your information, CGOC is going through the listing process on the OTCQB and should be listed there within a few weeks. In the meantime, most Internet brokers seem to be able to trade it as CWWBF. As always I caution readers to use limit orders.
CGOC is a company that invests a maximum of 60% of its holdings in the shares of public cannabis companies and no more than 40% in private companies. When it first came to my attention not all the pieces I was looking for were in place. But I kept it on the back burner. I met with President, Jamie Blundell, later in 2018 and spoke to Bruce Campbell, manager of the private portfolio a couple of times by telephone. My concern at the time was the private company portfolio and I wanted to see what the auditors might say about the valuation of the private holdings. When the audited results for fiscal October 31, 2018 were completed, the auditor recommended a $1 million increase in the book value of the portfolio of private companies. Then private company holdings Whistler Medical Marijuana and Dream Water were acquired by Aurora Cannabis and Harvest One, respectively. There are three other private holdings moving close to liquidity events.
With CGOC trading at $2.13 per share, it is at a 40% discount to the net asset value of $3.54 per share calculated as of April 15, 2019. I believe the public company portfolio of liquid, publicly traded cannabis stocks professionally managed by Bruce Campbell, founder of StoneCastle Management is worth full market value. This means purchases of CGOC at the current price means investors are paying full and fair value for the public companies and getting the private stocks for free. I think as investors come to recognize the value of the private company holdings, they will begin to attribute some value to the privates or, put another way, enable CGOC to trade at a lower discount. In the past, I have seen investment companies with an excellent record (in CGOC’s case, Net Asset Value is up 55.9% since June 2018) that provide an opportunity most individual investors can’t successfully access on their own (investment in private company shares) in a hot market segment (cannabis), trade at a small discount to a small premium relative to NAV. Even if the discount only drops to the 10% to 15% range, investors will benefit from the above average returns from investing in cannabis enhanced by the decrease in the discount.
Investment companies and open-end funds are similar in the sense that both have investment holdings that are professionally managed and diversified according to terms and conditions outlined in a prospectus or other legal document. However, there is one significant difference between the two:
Open-end mutual funds continuously sell new shares to investors and buy back (redeem) and cancel outstanding shares from investors at Net Asset Value (NAV) per share, normally calculated at the end of each trading day. The price at which open-end funds shares are traded is market value at the end of the trading day.
Investment company/closed-end funds sell shares to investors on a prospectus-type underwriting and the shares are listed for trading on an exchange. Unlike open-end funds that buy back or redeem their own shares, investment company shareholders sell to other investors on the market, at the market. So trading in investment company shares is guided by the net asset value but the price is determined by supply and demand for the shares and may be above or below NAV throughout the stock exchange trading day.
Investment companies are not new and, in fact, pre-date open-end funds as a financial security. From studies done on over a century of data, I have some observations about the trading of investment company shares.
The market price of investment company shares fluctuates above and below the NAV per share depending on supply and demand. On average, however, investment company/closed-end fund shares tend to trade at around a 10% discount from NAV.
The discount is attributed to the lower level of liquidity and the sometimes perceived higher risk of the shares relative to the changing values of the underlying assets that make up the NAV.
In the rarer instances when investment company shares trade at a premium to NAV, I have noticed: i. The investment company invests in a “hot” sector that represents a challenge for the average investor making their own investment decisions. Some 125 years ago, it was railroad stocks. In my early years in the investment industry, it was resources such as oil and gold. More recently it was technology stocks that attracted investor attention. ii. Management already has or offers the potential to produce outstanding long-term investment returns in a specialized area. Investors accept they cannot produce equivalent returns. iii. The investment company can access opportunities the investor cannot get on their own.
In the rarest of cases, an investment company will trade at a premium and perhaps a substantial premium for a long period of time. Berkshire Hathaway run by the legendary Warren Buffett, is essentially an investment company.
The concept of an investment company is relatively simple – it is a company that raises money to invest in a particular specialty area(s). Its shares are listed on an exchange and trade like any other common shares. As investors perceive the company has been successful, the discount to NAV will shrink and can actually turn into a small premium to NAV from time to time. If the company has been successful or has a specific purchase to finance, it may come back to investors to raise additional funds.
Cannabis Growth Opportunity Corp. (CSE: CGOC): here is what I like about CGOC:
Management: regular followers know that the key in my investment decision making process is the quality and ability of management.
Jamie Blundell, President and Chief Operating Officer: has over 25 years of experience as a senior-level executive in both the private and public sectors. Blundell has extensive experience with mergers and acquisitions, private equity risk management services and large corporate divestitures. This happens to be an excellent background for his role at CGOC, that is, responsibility for the private company investments. In my due diligence process, my concerns related more to the private company investments. But after speaking with Jamie at length and seeing the performance of the private portfolio, I am confident in his abilities.
Bruce Campbell, B. Comm, CFA, CAIA is a professional portfolio manager responsible for the public company investment portfolio. Campbell, founder of StoneCastle Investment Management has over 25 years of experience in fund management and has done an outstanding job managing the public company portfolio. Bruce is highly respected for his views on investment and the cannabis industry and is a regular guest on BNN’s Market Call and Market Call Tonight as well in the financial media including Bloomberg, the Globe & Mail and Small Cap Power. I have spoken with Bruce from time to time over the past year about CGOC in particular and the cannabis stocks in general. In my opinion, he is an excellent choice to manage the public company portfolio.
Brayden R. Sutton, Independent Director: Sutton is best known on these pages as the President and Chief Executive Officer of 1933 Industries (CSE: TGIF) also a holding in The Cannabis Report Model Portfolio. He has a long and distinguished background in the cannabis industry having been Vice President Business Development of Aurora Cannabis and Executive Vice President and a co-founder of The Supreme Cannabis Company. He is also a Director of Waterfront Capital and First Light Capital. I know Sutton from my due diligence on TGIF and can attest to the fact he is a leader and builder in the cannabis industry and extremely knowledgeable about important trends and developments in cannabis in the U.S. and Canada. He is a valuable resource for CGOC.
There are other members of the management team I look forward to meeting in the future.
Background: On January 26, 2018, CGOC completed its Initial Public Offering of 15,513,250 at $2.50 per share for gross proceeds of $38,783,125. Subsequently, 138,889 shares were issued to acquire an investment bringing the total to 15,562,140 shares outstanding.
The net proceeds were divided into two portfolios: i. Private companies: this portfolio, the “privates,” is managed by Jamie Blundell as described above. ii. Public companies: this portfolio, the “publics,” is managed by Bruce Campbell as described above.
In the first three to four quarters of operations the performance (“heavy lifting”) was borne by the public company portfolio. During this time, some of the private company holdings prepared their “liquidity event,” such as a Reverse Take-over (RTO). Starting in 2019, some of the privates began to go public or in two cases were acquired by public companies in a share exchange. Generally speaking, when a private company goes public, the valuation of the company increases. Sometimes the increase in valuation is substantial. Since the beginning of the year, the private company portfolio has been making an important contribution to the overall results and, reviewing the portfolio, it appears this will continue in the near future. (see more details below)
The Net Asset Value is calculated and published by the managers at the middle of each month. The publics are simply marked to market as with any portfolio of this type. The privates are valued according to a detailed methodology described in public documents. In my due diligence I have found the valuation of the privates is done on an accurate, disciplined and somewhat conservative basis. For example, in the most recent calculation of NAV, the value of one of the privates was increased while the value of another was decreased.
If one of the privates goes public and its shares begin to trade, the holding will typically record an important increase in value and it is transferred by the CGOC private portfolio to the CGOC public portfolio. The responsibility for buy-hold-sell decisions of the holding changes from Blundell to Campbell. If one of the privates is acquired by a public company in a share exchange, the same internal change happens. Campbell effectively receives the public company shares internally and assumes responsibility for managing the position. Both of these transactions have happened in recent months.
My conclusion is the Net Asset Value calculated and published by CGOC is accurate and somewhat conservative. In fact, as part of the last audit, the auditor recommended a $1 million increase in the accounting value of the private company portfolio. The latest published NAV estimate effective April 15, 2019 is $3.54 per share. This was an increase of 10.2% from the $3.21 per share estimated as at March 15, 2019. This is an outstanding result given the general performance of cannabis stocks during this time. The valuation reflects the fact that Vireo Health International commenced trading on the Canadian Stock Exchange under the symbol VREO. This is an excellent example of how the portfolio of private and public investments can complement each other for the benefit of overall performance.
Why Invest in Cannabis Growth Opportunity Corp.? The answer is simple. At current prices, investors are getting dollars at a discount. The following charts illustrate this point:
The first chart plots the closing price of CGOC as a percentage of the NAV per share on the day the NAV is published shown as a discount, that is, the amount by which the market price is below the NAV calculation. A couple of points stand out: i. The stock was significantly underpriced in mid-December 2018 trading at a discount of over 60% to NAV. This was an anomaly. The fact is most Canadian cannabis stocks were greatly oversold during 2018 tax loss selling and clearly that included CGOC. ii. When CGOC initially started publishing a NAV, the stock traded at a discount of 25% to 30%. Since then the discount has increased to around 35% to 40% as shown on the chart. The April 15, 2019 discount at 42.9% is much greater and well above an “average” discount of 10%.
Another way to look at it is how much in NAV do you get for every 1.00 you invest in CGOC? The next chart shows the answer. Here are some highlights: i. If you look at the December 15, 2018 figure you can see investors were getting an incredible $2.53 per share of NAV for every $1.00 invested in the stock. As I pointed out, this was an aberration for CGOC and the Canadian cannabis stocks in general as prices were hammered down by tax loss sellers as I warned at the time. What is worthwhile noting is that CGOC management had received approval for a Normal Course Issuer Bid (NCIB), that is, a share buyback. CGOC was authorized to repurchase 782,607 shares or 5% of their total shares issued as at November 15, 2018. To date 299,800 shares at an average price of $1.34 per share have been purchased and cancelled under the plan. So management took advantage of the year end weakness for the benefit of all shareholders. ii. At April 15th levels, investors in CGOC received $1.75 worth of cannabis securities for every $1.00 invested in CGOC shares. If you buy shares of Aurora Cannabis (TSX: ACB), CannTrust Holdings ((TSX: TRST), Organigram (TSXV: OGI) or Village Farms (TSX: VFF) on the market, for example, you get $1.00 of share value for each $1.00 you invest. But if you invest $1.00 in Cannabis Growth Opportunity Corp (CSE: CGOC), you effectively receive $1.75 worth of these companies for each $1.00 you invest. This is what I mean by ‘dollars at a discount.’ For your information, each of these companies was in the public company portfolio in a recent report.
Here is another way to look at it from an investor’s perspective: most investors realize there are exciting opportunities that are available at the private company or pre-IPO (Initial Public Offering) stage but the issue is how to take advantage of them. The average person is not well equipped to identify and negotiate investment terms with an attractive private company and if they were able to, they surrender liquidity. At current prices for CGOC, you get a free portfolio of private cannabis companies that are performing very well selected by a person with expertise in doing so with an established track record and you retain liquidity because you can sell CGOC shares at the market.
With CGOC, you get this benefit because at current prices and valuations the portfolio of publics is around 60% and the portfolio of privates is around 40% of NAV. The discount of CGOC’s market price to NAV is also around 40%. Assume the value of the public company portfolio is one hundred cents on the dollar. This is very plausible. The holdings are all well known, quite widely followed, publicly listed cannabis stocks. If this was a normal, open-end mutual fund that is what you would pay for them. If they were part of your personal portfolio, that’s what they would be worth. If that’s the case, the numbers just happen to work out that when you buy a share of CGOC for $2.16 per share you are getting very nearly $2.16 per share worth of publicly traded stocks. This means you are effectively getting almost $1.38 per share worth of private cannabis companies for nothing. If you think you would be willing to pay fifty cents on the dollar for this portfolio of privates, the discount on CGOC would be cut in half. The way the privates have been performing, I think they are worth a lot more than fifty cents on the dollar.
Will the Discount Shrink to 10%? I think there is a good chance that it will and there is also a possibility that it will go lower and an outside shot it could turn positive. Here’s why:
Jamie Blundell (privates) and Bruce Campbell (publics) have done an outstanding job in managing the investments. In terms of the private company investments, you usually don’t have a big win until there is a ‘liquidity event,’ that is, the private does additional financings at higher prices, gets taken over, or goes public. It took several months to get liquidity events started by the private investees but now it is underway. So far in 2019, there have been four liquidity events in the portfolio of private companies and there are more underway. In the public portfolio, as we all know, the cannabis stocks have been choppy but Campbell has done a great job with the portfolio. The chart shows that since June 2018, the NAV of the privates and publics together has increased 55.9%. This is an outstanding return for this period of time and CGOC is not given enough credit for this. As the market begins to realize what is happening here, I believe the discount will be reduced sharply to the benefit of existing shareholders.
One of the major advantages offered by CGOC is the ability to participate in a portfolio of pre-IPO (Initial Public Offering) stocks, that is, the ability to get in on the ground floor. CGOC is in a position to see a deal flow that is not available to the average investor and to negotiate an attractive price for its placements because of the potential for an ongoing working relationship. In the private portfolio, recently, Dream Water and Whistler Medical Marijuana have been acquired by Harvest One and Aurora Cannabis, respectively, while Next Green Wave and Vireo have gone public. Another three private companies representing 20% of the private company portfolio by weight are in various stages of Reverse Takeover transactions. It seems likely that at least two out of three of these will have a liquidity event in the next two months at valuations much higher than on the books.
What about future investment returns? No one has a perfect crystal ball and past returns are no guarantee of future results. But what gives me confidence is their thinking is very much on the same page with ours. In Let’s Toke Business and The Cannabis Report Model Portfolio, we have been reducing our Canadian exposure in favour of U.S. and International business opportunities. As the next chart shows, CGOC has been doing the same.
As the chart above shows, both the private and the public company portfolios are more heavily weighted outside of Canada in favour of the U.S. and International sectors. The portfolio of privates is 58% U.S. and International while the publics are 63% U.S. and International. Looking ahead, it seems likely that the portfolio of privates will expand its international assets while the portfolio of publics is more likely to increase its U.S. exposure. Again, it’s no guarantee of investment success but from the perspective of our own expectations, it sure helps convince me that the CGOC portfolios will continue to perform well.
A higher profile will help reduce the discount. I first became aware of CGOC a little less than a year ago when I was first told about the company by an Investment Advisor who I have known for many years and trust for his investment and cannabis expertise. That led to establishing contact with Bruce Campbell and Jamie Blundell. In his role as President, Jamie and I had discussions about CGOC and its position in the markets that recently led to an agreement in which I will advise the company on matters related to Capital Markets and Investment Banking for which I will be compensated. After discussion, Jamie already knew and accepted that more effort was needed to make investors aware of CGOC. We also agreed that the most urgent matter to address was reducing the discount to NAV. So I will have a direct and active, hands-on role in working to reduce the discount to NAV on CGOC’s shares.
Conclusion: As the stock price chart shows, the stock price rose only around 18% while the Net Asset Value was increasing by 55.9%. This combination of events created the opportunity that exists today. If CGOC’s stock price had only kept pace with the increase in NAV, the shares today would around $2.90 per share and there would still be a discount from NAV of around 20%.
I believe the combination of above average returns from the publicly traded cannabis stocks managed by Bruce Campbell, a professional portfolio manager, combined with higher returns from the less liquid private companies managed by Jamie Blundell added to the prospect of buying CGOC shares at a high discount and selling them at a much lower discount will result in very attractive returns to the investor. The ability to buy dollars at such a large discount is an opportunity to participate in.