Cannabis sector focus shifts from legalisation to legitimacy

After a wild year for the cannabis sector, it’s appropriate that 2019 kicks off with a focus on Aphria Incorporated, the Canadian pot producer that was attacked by short sellers and is now the target of a hostile takeover bid.

Aphria reports results for the fiscal second quarter on January 11, and there will undoubtedly be plenty of questions on the conference call about the allegations from short sellers that it overpaid for "worthless" assets in Latin America.

Aphria called the claims by Quintessential Capital Management and Hindenburg Research "malicious and self-serving."

The saga took a new twist in the quiet days between Christmas and New Years, when Green Growth Brands proposed a hostile bid for Aphria, whose stock lost a quarter of its value in December.

The potential offer, which has yet to be finalised, raised further questions about Aphria’s links to the much smaller Green Growth, with short-seller Hindenburg Research saying it’s "likely an attempt to generate the appearance of demand in the hopes of spurring credible offers."

Aphria said the offer, valued at about $2.1bn (about R29bn) at the time, "significantly undervalues the company."

The fallout will affect the sector as a whole, resulting in "greater emphasis on corporate governance, deal due diligence, and M&A valuations," Andrew Kessner, analyst at William O’Neil & Co, wrote in a recent note.

Aphria played just one part in a hectic year for the burgeoning cannabis sector. At the beginning of 2018, former US Attorney General Jeff Sessions had just thrown a wrench into states’ legalisation plans, Canada’s recreational market was still just a campaign pledge by Prime Minister Justin Trudeau and pot stocks were trading well above current levels.

We can sum up the year with three 'L' words: legalisation, legitimisation and listings.

Legalisation of medical marijuana has spread well beyond Canada to places like Thailand and the UK that few people saw coming.

Legitimisation of the drug has gathered pace at an astonishing speed, with traditional consumer and pharmaceutical companies ranging from Constellation Brands and Anheuser-Busch InBev SA, to Altria Group and Novartis investing in or partnering with pot firms.

The number of cannabis listings has soared, with at least 149 companies worth a combined C$54.7bn (about R570bn) trading on Canadian stock exchanges as of January 2. A growing number of those are US firms with market values above C$1bn (about R10.4bn).

In terms of stock performance, the BI Global Cannabis Competitive Peers index sank 54% in 2018. It was a wildly volatile year for many pot stocks, but none could match Tilray, the only cannabis stock to be listed solely on a US exchange.

It closed the year up 315% from its July initial public offering, but that represents a major come-down for investors – at its highest point in September, it was up 1 665%. The stock peaked at $300 (about R4 170), and now trades close to $70 (about R 970). It still has a market value of $6.6bn (about R92), surpassed only by Canopy Growth among pot firms.

It’s going to be hard to top the action-packed year that was, though 2019 will have almost as many catalysts for cannabis investors as 2018.

What to watch this year

The US will dominate the news flow and stock listings: with the recently passed farm bill legalising hemp, some say it’s only a matter of time before legislators follow suit and legalise cannabis nationwide.

Others argue a divided congress will stymie any real progress. Either way, 2019 will be America’s time in the marijuana spotlight as investor interest rapidly shifts from Canada to the much larger US market, where consumer spending on legal cannabis is expected to reach $20.9bn (about R290bn) by 2021 from $11bn (about R153bn) last year, according to Arcview Market Research and BDS Analytics.

As the US weighs proposed legislation that could open up banking and stock exchanges to cannabis companies, institutional investors will feel increasingly comfortable investing in the space. To date, cannabis investments have largely been the purview of retail investors, family offices and specialty hedge funds.

Legalisation of both medical and recreational cannabis will continue to spread around the world, with France, Italy, Peru, New Zealand and even Lebanon on the list of countries thought to be the next movers.

Clear winners and losers will begin to emerge in Canada as pot producers report their first earnings that include recreational sales. Expect plenty of consolidation and a few outright failures.

Upcoming events this week

AltaCorp Capital and ATB Financial host their 7th Annual Institutional Investor Conference in Toronto with a full day of sessions dedicated to the cannabis industry on January 8.

Companies presenting include Hexo, MedMen Enterprises, Aurora Cannabis, Curaleaf Holdings, Cronos Group and Organigram Holdings.

Vivien Azer, one of the leading analysts in the space, hosts Cowen’s Cannabis Outlook on January 8 at the firm’s New York headquarters.

KushCo Holdings, the California-based cannabis packaging company, reports its fiscal first quarter results on January 8 after markets close.

Aphria reports results January 11 for its fiscal second quarter. Expect plenty of questions about short-seller attacks and the hostile takeover bid from Green Growth on the conference call, scheduled for 09:00 New York time.

Ontario holds a lottery on January 11 to determine who will be able to open the first 25 retail cannabis stores in Canada’s most populous province. Results of the lottery will be posted online within 24 hours.

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