Article by Mark Rendell and Tim Kiladz, Globe and Mail
The warning signs were there all summer, but it wasn’t until the first business day of September that the reckoning arrived for Canadian cannabis companies in need of money..After markets closed on Sept. 3, Aurora Cannabis Inc., one of Canada’s largest legal marijuana producers, tried to sell its 10.5-per-cent stake in a rival company, The Green Organic Dutchman Holdings Ltd. – better known as TGOD – to public investors..After two days of marketing, roughly half of the $86.5-million in TGOD shares remained unsold, according to sources familiar with the sale. TGOD had been an investor favourite and the deal was priced at a 14.5-per-cent discount to the market, but investors still balked..At the time, there were already clear signs that the days of easy money for cannabis companies were over. The total amount of money raised by the sector had plunged over the summer. But the TGOD deal sent a message to the entire industry: The taps were almost fully closed..With little access to fresh cash, Canada’s licensed producers now face a new reality. They have spent years focused on financings to fund their expansions, paying little mind to positive cash flow. Without new capital, they will have to scrap construction projects and scale back growth plans..“The vast majority of the companies are going to go bankrupt,” said Igor Gimelshtein, the former chief financial officer of MedReleaf Corp., which was sold to Aurora Cannabis Inc. in 2018 for $3.2-billion. He is a partner at Toronto-based Zola Global Investments, which invests globally in the cannabis industry..In September, independent investment bank Mackie Research Capital Corp. calculated that nine companies had less than six months worth of cash available to fund operations. The figure jumps to 21 companies after adding capital expenditures. A few weeks later, TGOD shelved plans to finish a 1.3-million-square-foot greenhouse facility in Quebec, and it is seeking bridge financing just to keep the lights on at a smaller operation in Ontario..In this environment the share prices of many cannabis stocks have been eviscerated, and executives face painful options: fire sales, shotgun mergers, radical downsizing or bankruptcies. Even the largest producers are selling off assets and taking on expensive financing to ride out the bear market..In the past two weeks, Canopy Growth Corp. and Aphria Inc. have both sold stakes in Australian cannabis companies. Late last month, Hexo Corp., Quebec’s largest cannabis grower, announced it is shuttering one of its greenhouses and laying off 200 staff..Amid the rout, cannabis executives are taking it on the chin, and some, including ex-Canopy chief executive Bruce Linton, have been ousted..Bay Street, however, has largely evaded blame – even though the industry was built on the terms it set. The cannabis bubble was fuelled by stock promoters, hedge fund managers, investment banks and law firms that have helped raise close to $8-billion from public investors since 2017, and have clipped hundreds of millions of dollars in fees in the process..With the money pouring in, cannabis executives made outlandish predictions and inked expensive deals with few repercussions. Of the industry’s many problems, “the biggest one is the lack of intellectual integrity,” Mr. Gimelshtein said..For all the money they made, the industry’s original financial backers have now largely moved on to more promising U.S.-based companies, or are out of the sector altogether. Retail investors, meanwhile, are still heavily invested, holding 80 per cent or more of many cannabis companies’ shares..It is all too familiar a tale. As with so many bubbles, much of the smart money got out early, leaving behind retail investors who clutch shares with dwindling values – with little hope of recouping big losses.
LAYING THE FOUNDATIONWhen the federal Liberals came to power in 2015 with the promise of legalizing and regulating recreational cannabis, they touched off a stock market frenzy. To many investors, it was a once-in-a-lifetime opportunity to become the new-age alcohol barons, and licensed producers soon began trading on the TSX Venture Exchange and the Canadian Securities Exchange..Amid the hype, no one seemed to care how realistic business plans were; actual legalization was still some distant event. It was the perfect environment for stock promoters, many of whom had been starved of oxygen after the junior miners and junior energy companies they touted in the early 2000s, and again after the Great Recession, collapsed after commodity price downturns..These promoters prowled the country looking for early-stage cannabis companies to take public, typically by merging them with a dormant mining shell company still trading on the TSX-V or CSE..It was a tried-and-true formula. Much like in mining booms, promoters would sell a publicly traded shell to a private cannabis company, then take cheap shares in the new public entity. As a condition of the merger, the cannabis company would also pay for stock promotion, using third-party “investor relations” firms to produce online posts and videos directed at unsophisticated retail investors..Cannabis companies would routinely pay tens, even hundreds, of thousands of dollars for a few months of promotion. One company, Wayland Group Corp., formerly called MariCann Group Inc., paid investor relations firms more than $4.5-million in 2018 – half in cash, half in shares..One investor relations specialist, who spoke on the condition of anonymity, estimated that at least half the cannabis companies that went public on the CSE were never intended to survive long-term as real businesses. They were vehicles that promoters could use to make quick money, and then bail..Compared with prior booms, promoters didn’t have to work all that hard, either. Many baby boomers and millennials are passionate about cannabis. Millennials were also often new to investing, so they had never experienced a downturn. All they saw was upside potential..In other words, they were fresh meat..“It’s been really distressing to watch, because I’ve seen a lot of bad corporate behaviours [and] gross disrespect for shareholder money,” said Jeannette VanderMarel, who co-founded TGOD but sold a controlling stake in the company to a group of investors in 2017, when it was still a small, private greenhouse operation. “A lot of it has been shameless self-promotion without any viable products to sell.”.Yet, as cannabis stocks soared, detractors found themselves screaming into the wind. To the surprise of everyone, U.S. beverage giant Constellation Brands Inc. bought a 10-per-cent stake in Canopy in October, 2017, for $245-million, and pot stock prices soared after. Here was real money from an established company justifying all the hype.
BUILDING THE BUBBLE – ON BAY STREET’S TERMSThe cannabis boom was an investment banker’s dream. With so much retail investor demand, it was easy to underwrite share sales – and to dictate the terms of the game.Because licensed producers weren’t generating much revenue or cash flow, the mantra when selling deals was “funded capacity.” The formula: Take the value of cash on a producer’s balance sheet and multiply it by the amount of land it owned and the amount of cannabis per square foot it hoped to grow. Little attention was paid to the quality of marijuana or the challenges of building a viable business..“Companies were just rushing for scale,” said Aaron Salz, principal with Stoic Advisory Inc., a cannabis capital markets advisory firm. “That wasn’t optimized for success with consumers. It was more optimized for success in the capital markets.”.It became a speculative circle. The more money a producer raised, the more it was worth – which helped it raise even more money. Aphria Inc., one of the first out of the gate, raised $305-million from four share sales in 2017.