CB1 Capital Management CIO on US Cannabis Company Share Structures

CB1 Capital Management CIO Todd Harrison discusses the share structure of US multi-state cannabis operators that have recently listed on Canadian exchanges. Harrison admits there is “lots of hair” on these companies but reveals CB1 Capital is still investing in recently-listed US entities regardless of these issues. GW Pharmaceuticals plc (NASDAQ:GWPH) (OTCMKTS:GWPRF) (FRA:GWZA), makers of the epilepsy medication Epidiolex, is CB1 Capital’s favourite play and illustrates the fund’s preference for long-term investment in US cannabis biotech and life sciences companies. Harrison believes the market is beginning to understand the potential of the consumer side of the cannabis space but notes investors are still lagging behind in terms of recognizing the significance of efficacy-driven medical solutions. Harrison cautions against investing in pure cultivators, as they have the worst margins, and stand to lose the most as each new country and entire continents come online.

Transcript:

James West:   Hey, welcome back. Joining me again is Todd Harrison, the founder and – sorry, founding partner and CIO of CB1 Capital Management. Todd, thanks for joining me again today.

Todd Harrison: Thank you.

James West:   Todd, I wanted to run through a couple things with you and get your thoughts on, we’ll start with this idea that we have a lot of these companies in the US coming to the Canadian market with very large market caps – you know, we’ll use Acreage Holdings as an example – came to market with a $2.4 billion market cap, call it, after doing a $25 per share IPO, and the companies are demonstrating this propensity to come to market with a super-voting structure that precludes the ability of retail shareholders from participating meaningfully on a voting basis in the direction of the company. I’m curious as to how does that affect how you feel about these companies?

Todd Harrison: Well, I mean, listen, it’s not optimal, but it’s not also the first time we’ve seen this. Facebook, I believe, has a similar structure, and we’ve seen others. Certainly not the best case scenario if you’re looking at building a relationship with one of your investors and one of meritocracy that you’re going to get held accountable for, but I think what you’re seeing with a lot of these US multi-listed operators that are coming to Canada is, you’re seeing a lot of hair on these things, right? There’s a lot of wines, there’s a lot of fluff in there. Canadian elbow grease, we’ll call it, for lack of a better term.

And, you know, I think this is just sort of the cost of doing business, given that these names can list in more traditional Exchanges, and they are making deals with these shell companies for RTOs so they can get public. But as a whole, I think for any of these multi-state operators, we’re sort of throwing a dart from a valuation standpoint. We’re going to need a couple of quarters, a couple of years, even, for these companies to really grow into these multiples and start to demonstrate earnings power. I think, we think they will. We own all of these companies, and we continue to buy it under market, here.

James West:   Oh, so you’re buying these companies when they come to market?

Todd Harrison: Yep, we’re buying partial positions for sure, and you know, I’ve been on Wall Street for 30 years. When these stocks break issue price, traditionally that’s a pretty negative sign, but with RTOs, it’s very different than IPOs in that these bankers are not sitting there supporting the deal. So they are free trading, and I think we have a lot of, I think, fast money that was buying these things for initial pop.

We’re playing longball, here. We think that the best is in front of the US operators, both in terms of institutions, that demand, that institutional demand is still on the horizon. We think Canada turns buyer, and we think the US market by and large with the end products and a lot of the use-cases that we think will emerge are going to really drive these earnings going forward.

But literally first inning stuff right now, just coming to market and getting comfortable in some skin.

James West:   Sure. So you look at the biggest companies – GW Pharma, you were mentioning earlier, had a sort of revaluation at the downside. What do you think is driving that, and what do you think the prognosis is for the near term for GW?

Todd Harrison: Yeah, no, still our favourite position, star of our just holding; price doesn’t change that, facts aren’t insults, right? Stock was at 180, you know, on the back of getting approval for Epidiolex, which is their epilepsy drug, FDA approval. The DEA came out with a Schedule 5, which was the best case scenario, and then you saw just the entire buyer tech complex come for sale. I think the space is down 20, 25 percent since the beginning of October.

So GW is not immune corbus, another one of our top holdings also wasn’t immune, but we looked at GW, and I really, you know, I say this all the time, but I think it really encapsulates sort of the market’s misunderstanding with cannabis. You know, people still think this is a discretionary vice; not too many people are even contemplating cannabis as a biotech play, and certainly the efficacious agility. You know, we own this for brain cancer. We think they’re an oncology company dressed up as an epilepsy platform, but until that data comes out, and still they can’t release it as too many people are still surviving from February 2017 kept a lot of brain cancer, here. Pretty exciting stuff, but until the results come out, I think people are still going to look at this thing and look at it as an epilepsy platform. And certainly Epidiolex is awesome, but we think there’s a lot more to the story.

James West:   Interesting. So are you focused a lot on the idea of cannabinoids as pharmaceutical ingredients to treat indications in maladies like cancer, like, you know, Alzheimer’s, Parkinson’s, I mean, all of these things are demonstrating, at least at a preliminary basis, some efficacy as a result of cannabis treatment. So are there other –

Todd Harrison: No, yeah, certainly, you know, we want to follow the science. We were just telling the story before we came on air that the endocannabinoid system, which regulates your neurotransmissions, wasn’t discovered till 1990, so a lot of medical doctors aren’t even artware of what it does or what the role, how important a role this is for wellness and just in terms of unlocking a lot of these medical riddles that have stymied doctors for a long time. But certainly we think we’re scratching the surface of the science and understanding the sort of efficacious agility of the cannabis plant; remember, humanity has had a 30,000 year relationship with this plant, and it was medicine, it was prescribed by the American Medical Association for over 100 indications before it was weaponized as an immigration tool in the 20’s by the US government.

So you know, this is very much this last 90 years is very much a, you know, it’s the exception rather than the rule in terms of society’s relationship with cannabis, that when forward when we’re framing our wellness book is on the one side, we have these effications, these efficacious-driven solutions, right: medicine, clinical trials, more biotech pathway. That’s where we get really excited, because that’s where we think the baton is going to get handed during this next phase of the cannabis sector bull market.

But on the other side I think is what the market is really beginning to understand, and that’s really the consumer side of the equation, right? The beverages, and the nutraceuticals, the consumer packaged goods, the bath bombs, right? Like, that’s going to be a huge market, and that’s wellness as well. Even, you know, we sort of have taken the gloves off between recreational and medical because we figure a lot of people have been self-medicating for a long time; they don’t even realize that this is medicine, they thin it’s more of a discretionary vice.

James West:   Interesting. So are there any names you can with us of up-and-coming companies that you’re particularly excited about?

Todd Harrison: Well, on the biotech side, GW, I talked about Corbus, we’re big fans of. I mean, there’s a few others; on a biosythentic side, there’s a company called InMed Pharmaceuticals, which is early, right, pre-clinical, but it’s a biosythentic, and we think the trend is really going to move towards biosythentics, away from the more traditional farming side. So whenever we look at investments, with the exception of Village Farms, which we think is a unique situation given their US and Mexican optionality, we really try to steer clear of the pure cultivators, because we think the farming side is probably the least sexy side of the equation, right?

The margins are all on the back end. And as we reach this equilibrium from a pricing standpoint and cannabis comes online in entire continents, right, whether it’s South America, or whether it’s Australia, or you know, everywhere in the world is starting to come online, ultimately that’s going to drive prices down. Who is that going to hurt? It’s going to hurt the producers of the ingredient. Who is that going to help? Its going to help the consumers of the ingredient. So anybody who’s using cannabis or hemp as an ingredient, which is sort of how we’re looking at the world, we think they’re going to benefit from lower prices in time. Margins are going to expand , that’s why we look at the back end, that’s why we’re looking at end products, that’s why we’re looking at, you know, the consumer side as opposed to the farming side.

James West:   So we’ve seen some of the financials come out from the earliest LPs that got in the game in Canada, and without exception, they have been underwhelming in terms of anything approaching the idea of profitability. If anything they are, the bigger they are, the more money they’re losing, even though, potentially you have to look at it as, well, yes, on an accounting basis, it counts as a loss, but from an investment perspective, in the case of Canopy particularly, where they deployed 4330 million in capital, well, they’re sitting on 5 billion, and they’re investing this capital to grow markets in other places, and so, yes, on the one hand, on an accounting basis, it’s a loss; on the other hand, it’s an investment that hasn’t started to produce yet.

But what is your take on all of the earnings that we’ve seen so far this month, and the ones that are yet to come?

Todd Harrison: Yeah, no, I think first of all, we have about 9 percent of our portfolio in Canada right now, because it had big runs, because this is going to take some time, right? So our take is that yeah, it’s going to be sloppy. Anybody who’s buying, bought Canopy or any of these names for their first quarter’s earnings reports shouldn’t be buying these stocks, right? These are long-tail stories, they’ve got to grow into their multiples, they’ve got to use their paper to make accretive deals, right? They’ve got to use their paper’s currency, which we thin we’re going to see a lot of as soon as the US gets in shape here. So certainly bumpy; it’s going to take time, it’s going to take a few quarters, if not years, for these things to really start to demonstrate their value propositions. But we are, you know, we are skewed more heavily to US operators for reasons that I’m happy to talk about, but by and large, we think that that institutional demand is still in front of us, and that’s why we’re positioned as we are.

James West:   All right, Todd, we’re going to leave it there for now – very insightful as usual. Thank you so much. We’ll come back to you in another week and see what you’ve got to say for yourself. I appreciate your input.

Todd Harrison: Thank you, James.

Original article: CB1 Capital Management CIO on US Cannabis Company Share Structures

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