Alan Brochstein, CFA on Aphria Inc (TSE:APHA) Short-Seller Report

420Invester and New Cannabis Ventures founder Alan Brochstein, CFA shares his thoughts on the Hindenburg Research report on Aphria Inc (TSE:APHA) (NYSE:APHA) (FRA:10E). Brochstein cautions viewers that the full picture has yet to emerge and it’s still unclear what this means for Aphria long-term. He notes that Aphria got behind its peers, companies like Canopy Growth Corp (TSE:WEED) (NYSE:CGC) (FRA:11L1) and Aurora Cannabis Inc (TSE:ACB) (NYSE:ACB) (FRA:21P) domestically and internationally and may have felt external pressure to complete the deals mentioned in the report. Brochstein suggests that while US cannabis stocks have been outperforming their Canadian counterparts recently, the Aphria report will impact the entire space. Brochstein adds his thoughts on the Cronos (TSE:CRON) (NASDAQ:CRON) (FRA:7CI) partnership rumours with Altria (NYSE:MO) but suggests that a pharmaceutical company entering the cannabis space would really shake-up the industry.

Transcript:

Ben Smith:         Nice to meet you, Alan. I’m a big fan of your work, I do follow your New Cannabis Ventures property, and it’s nice to meet you finally.

Alan Brochstein:   Yeah, likewise, and thanks for all that Twitter love. I wish I was as giving as you are.

Ed Milewski: So, what do you think of this, what do you think of this Aphria story that’s developing?

Alan Brochstein:   What Aphria story, I haven’t heard? [laughter]

Ed Milewski: You know what? I was afraid you were going to say that…

Alan Brochstein:   Yeah, you know, I’m still processing it. I’m kind of upset for the industry, for company. I don’t want to – let me be the first to say that these short sellers, I don’t have any problem with generally the work they do, and I think they serve a very valuable purpose, and I’ve been known to publicly criticize companies, so I have no problem with that. My big-picture takeaway is that they’re focusing on some very specific details, and these details may be accurate; I’m trying to figure out how they relate exactly to Aphria, and it’s not clear. So you know, to me, it was always obvious exactly what was going on: that you had insiders in Scythian, which is now SOL, they put together this deal, they ran it through Scythian for whatever reason, and then Scythian sold it to Aphria.

So the question becomes, if there is some sort of fraudulent activity, which I’m not sure there is, but you know, there’s some funny details, obviously; people who don’t exist, addresses that aren’t there – but what does this mean for Aphria? And I’d like to just be certain that there’s no fraud at the Aphria level. I obviously don’t know that, but I don’t believe that to be the case. I think the alternative, though, is it looks like maybe their due diligence process wasn’t so great.

And you know, my intake on Aphria, they were one of the early frontrunners, and the company was always mentioned in the same breath as Aurora and Canopy; in fact, it was probably mentioned Canopy, Aphria and then Aurora. At this point, they got behind these other companies on multiple fronts. They got behind in the domestic assets, and so they brought Broken Coast very early this year because their mantra was always ‘we’re going to do everything out of Leamington, out of the greenhouse’, and I don’t think that proved to be the right strategy, at least in the short term, because of all the provincial contracts and branding and a lot of different reasons.

But on the international front, I think they got way behind. So think if you step back and you say, you know, what’s really going on here? This is the second time they’ve done this deal like this, where they go out and they buy a package of assets that they didn’t specifically put together, although they were very involved in the due diligence process to some degree, right? They were pole, one of their directors went down to Latin America. So it’s not like they were just buying this package with no due diligence.

So I think it kind of tells you that maybe they were under pressure to keep up with the other leading LPs to establish their international footprint, and they kind of had to do these deals this way. And I think the one thing that I’m most critical of is that they gave SOL free-trading stock, free-trading stock to – and I think if you look at other deals that are done in the sector, they’re often tied to performance and future payouts. So this was 100 percent stock, free to trade.

Ed Milewski: So the fact that they, the fact that they just got listed on the New York Stock Exchange relatively recently, I mean, I think it’s pretty well known that the scrutiny by the New York Stock Exchange is much more than it is in, you know, in Canada – at least that’s, you know, the feeling, that you got to pass a lot of, go through a lot more hoops, you know, etcetera, etcetera. They’re New York listed. So now, there’s got to be a response from the New York Stock Exchange, no? Or is there? I’m just wondering, I’m just talking.

Alan Brochstein:   I don’t know why there has to be a response.

Ed Milewski: Okay, okay.

Alan Brochstein:   I play the devil’s advocate: why does there have to be a response from the New York Stock Exchange?

Ed Milewski: I don’t – I mean, especially if there’s, look, if the stock drops from, you know, $20 to $5 now, this has all happened in a month and a half…yeah, maybe not. I just, you know, the scrutiny going forward for this industry is going to be a lot more, you know, the magnifying glass is going to be a lot bigger. There’s going to be a lot more due diligence, you know?

Alan Brochstein:   So at this point, I don’t know why the New York Stock Exchange would be looking at anything right now. Prices fall all the time, or they go up, and I don’t think the Exchanges micro-manage. If there was some information that came out that tied, you know, the principals, you know, the key people at Aphria to fraudulent activity, then I think that would be an issue. But they’re relying on, you know, the work of their legal counsel and in the outside fairness opinion. There’s a whole bunch of things that are in place here that I would think would protect them unless there’s some sort of new evidence that comes out.

Ben Smith:    Now, Alan, I know you’ve been a big proponent of the US sector, of the valuation disparity between the US sector versus the Canadian side; of course, the Canadian side is a lot more expensive, and you have been writing and talking about that since earlier this year, in the Spring, I believe. And I agree with you; I’ve said the same thing post-legalization, that there could be a chasm where US stocks to fill in the valuation gap, because there’s a lot more catalysts ahead of it. And that’s exactly what has happened. You know, US stocks have been outperforming Canadian ones quite markedly, 13, 14 percent.

Now, do you think the Aphria situation has finally sort of hit US stocks insofar that there’s suspicion sort of going with some of the things going on most commonly seen in US stocks, such as a super-voting rights and all that? Do you think there’s sort of a pall between industry practices on both sides of the border now, or is it something was just going to fill the gap anyway?

Alan Brochstein:   Yeah, this whole super-voting stuff, I don’t even fully understand it, to be perfectly frank. It’s become very common. Some of the older deals were not done this way. There was an article in the Globe & Mail a couple of weeks ago about corporate governance, and I think there were 250 TSX-listed companies, and right at the bottom was, I think Aurora, and Canopy right above them, and Aphria a few notches up. So it’s pretty clear, and I don’t think it has anything to do with the cannabis industry; I think it has more to do with new companies, and new companies have to evolve and get their standards up in terms of corporate governance.

In the United States, I don’t know that there’s going to be spillover. This voting share issue – I think it’s troubling to some people, but I don’t know that there’s more bad governance, besides that. That’s obviously not the American way; in America it’s democracy, everybody should get to vote. But you know, it’s not like this is a big secret; all these deals come forward and it’s all clearly explained. And I’m not exactly sure why they structure it this way. I’ve tried to understand it. I’ve listened to some people talking about these new classes of shares that are created, and I think the answer, from what I understand, is, it’s to avoid having to register with the SEC. So they’re registering in Canada, and it’s complicated, apparently, to also register with the SEC – I think. So on a new issue, because it’s a new issue.

I don’t know, it’s a little bit beyond me, but to your other point about the valuation gap, I didn’t necessarily think Canadian valuations would go down, and I like to remind everybody, you know, Canada has the whole world, and the United States is limited. But the point I’ve been making is, while there’s a lot more legal risk and there should be a valuation haircut in the United States, all you have to do is go to New Cannabis Ventures and look at, you know, the revenues that are being generated in the United States among the MSOs right now, and they’re just getting started.

And I get it: there’s going to be a hockey stick in Canada as well, for a few companies, not that many. But you know, we’re going to see sales really ramp up for the larger companies that have large-scale production facilities and all these contracts in hand, and that are focused on the legal market. Well, in the United States, the product set’s better, and there’s all these new markets opening, and there’s the M&A activity and all that; we’re starting to see some really big numbers. It won’t get that hockey stick, necessarily, just like Canopy Growth and Aurora and Aphria are going to have in the next few quarters, but the numbers are higher in the United States.

Ben Smith:    So relatively speaking, do you feel the US market has a little bit more potential than, say, the Canadian LPs who have the international side as well as the domestic market here, which is approximately 10 times smaller? Would you say the US side probably has a little bit higher potential for growth, you know, a few quarters out, say, six to eight quarters out?

Alan Brochstein:   I think, yeah. Yes. What I would say is, there’s more potential, and more risk, and I think that’s the right way to frame it. People forget it was less than a year ago where the whole industry was thrown into chaos because the Cole Memo was rescinded, and there was a lot of uncertainty about what was going to happen. And there were people that had raised a lot of money, or were on the verge of raising money, and the elections – I mean, this happened even before; when Donald Trump got elected through uncertainty, and when the Republicans did the sweep, basically, and there were people that were ready to invest in the US cannabis industry, but after that election, they pulled back. I heard this from a lot of people, and just said, you know, give me my money back, I’m not investing.

So it’s definitely more risky in the United States. I think we’re heading in the right direction; that doesn’t mean we’re legalizing, by the way. So everybody needs to understand, so I tell my subscribers at 420 Investor, while I think the opportunity is greater in the United States, you should be prudent. I said this even yesterday; pick the best Canadian LPs. Maybe have more exposure to the American market, but it might be imprudent to have all your eggs in the American basket.

Ed Milewski: Hey, Alan, I see that Cronos said again today that they’re in talks with Marlborough, which is part of Altria. Any comments?

Alan Brochstein:   Right.

Ed Milewski: Cronos stock’s acting –

Alan Brochstein:   You know, at this –

Ed Milewski: Acting much better. Like, it’s, you know, it’s up from about, I guess $10, $11, I think it hit $15, currently around $13…might be sort of a key point, right?

Alan Brochstein:   Yeah, I was kind of confused about why it did so well in November. It was an outlier, it was the best performer and not even close. Canada is not known for being tight-lipped; most of these deals leak out. It was pretty amazing that the Constellation/Canopy deal went against that observation, but almost every other deal, it’s amazing how leaky things are in Canada. I have not heard anything about this, and to the point, I don’t even quite understand why Cronos Group necessarily over other companies. Like, it would not be my first pick; nothing against the management team or anything like that, but there’s other companies that seem to be more advanced thus far, anyway, but more importantly, just better values.

So I’ve struggled with the Cronos valuation for the last couple years, so I might not be the right person to ask. But in general, this would be the kind of thing the industry needs to see. There’s been a lot of talk that this company in particular was rumoured to be talking with Aphria; nothing happened. Coca-Cola was speaking with Aurora, and nothing happened. Diageo was supposedly going after Aphria, and nothing happened. So it would be nice to actually see one of these deals hit.

My prediction is that we’re going to see more of these deals, maybe a pharmaceutical company. I think it makes a lot of sense. So, a pharmaceutical company that wants to get into cannabis really, in my view, has only two, three options. One is to just start up, and I don’t think that’s a great option. Two is to buy GW Pharma; I think that’s a pretty darn good option. But three would be to buy a Canadian LP. It allows them to do a lot of research without all the rigamarole of being a US operator. Of course, if you’re a multinational company, that might not be an issue anyway, but the Canadian LPs, it’s totally legal in Canada. It’s as safe a haven as one could ever find to do that type of research, and we’re already seeing companies in Canada like CannTrust, like Canopy Growth, I’m trying to think, there’s some others, too, that are doing these clinical trials right now already.

And so that to me is going to be exciting. I think we’ll see that next year, finally where we see a pharmaceutical company enter the space.

Ed Milewski: Okay.

Ben Smith:    Sounds good, Alan. I guess we have to wrap it up, this segment is over, but I was going to ask you, what stock you liked? What’s your favourite name? If you can do that in 20 seconds, before we wrap up, that’d be great. Client, no client.

Alan Brochstein:   Oh boy. You know, I really don’t like to do that. I will say that if you read what I wrote in my newsletter on Sunday, I mentioned a whole bunch of companies and their operating cash flows that really are radically different. And I’m kind of interested in some of those companies that are not burning cash as fast. And I’m not saying that you should avoid the ones that are, but I’m thinking that maybe some of these other companies that are better capital-allocators, that may be something that people pick up on next year. So go to my newsletter at newcannabisventures.com on Sunday and you’ll see at the top of the list and at the bottom of the list and you’ll figure out what I’m talking about.

Ed Milewski: Thank you very much, Alan. Always great to hear from you from Texas, and we’ll talk to you soon.

Alan Brochstein:   All right.

Ed Milewski: Thank you very much, Alan.

Ben Smith:    Thank you, Alan.

Original article: Alan Brochstein, CFA on Aphria Inc (TSE:APHA) Short-Seller Report

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