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We have been discussing the cannabis industry capital crunch since late September, when the vaping crisis escalated. After this “black swan” event for the industry, we issued a stark warning:
“Very few public companies are generating positive cash flow based on the adjusted operating income column in the Public Cannabis Company Revenue & Income Tracker, and the reduction in capital available is weighing on the entire sector. Companies that have high cash burns and weak balance sheets have seen their stocks fall 80% or more, and investors are realizing that many companies may struggle ahead without raising additional capital on what could be egregious terms… While demand for cannabis stocks is muted, the supply isn’t. We continue to see insiders and early investors selling stock, and we expect that companies may become aggressive in trying to raise capital.”
Of course, even before this week’s stock market crash related to the COVID-19 pandemic, this had been playing out, with several capital raises from those able to do so. Through February, the Global Cannabis Stock Index had declined by more than 25% to begin the year, and it is now down almost 50%. Unfortunately, COVID-19, the second black swan event in six months, could prove to be more fatal to cannabis companies than the vaping crisis. Quite simply, capital has become more scarce overall.
As the broad markets were melting down, Harvest Health and Recreation priced a deal that was 60% below the price at which it was trading in late September. Tilray followed it up with an offering that also included warrants that was priced 82% lower than it was trading in late September. The stocks of both companies, which generate large quarterly operating losses, fell substantially below the deal prices, leaving each of them down in excess of 70% year-to-date.
So, what is an investor to do in this environment? We will repeat what we said in late September:
“While fundamentally sound companies with strong balance sheets and minimal cash burns (or even positive cash flow) are seeing their stocks pressured nonetheless, those that can pursue their plans, even if scaled back due to market conditions, will likely provide big returns to their investors once the storm has passed. We think investors should focus on the companies that are on the path to profitability while they are on sale.”
In the panic, most stocks declined in similar magnitude. This could be a great time to book the tax-loss as one upgrades away from riskier names, where the outlook has just dimmed. The deeply-discounted equity offerings from Harvest and Tilray are likely a harbinger of more stock sales ahead as companies with inadequate capital struggle for survival. At 420 Investor, we have begun to reposition model portfolios further to reflect this dynamic, as we expect the weakest stocks will struggle to rally substantially.
It’s always difficult to tell what’s priced into a stock. 2020 has proven already that oversold stocks can keep dropping substantially. For long-term investors, there are likely to be some great opportunities, but the volatility we are seeing is likely to persist. We think the most important thing now is to understand that many companies aren’t likely to survive without substantial dilution to existing shareholders.
This week, we are surveying our readers to learn what you expect to happen with stocks as measured by the Global Cannabis Stock Index over the balance of the month. We plan to offer more surveys to our subscribers in the future, so stay tuned. Additionally, we would like to sincerely wish our readers well during these turbulent times.
New Cannabis Ventures publishes curated articles as well as exclusive news. Here is some of the most interesting business content from this week:
- Cannabis REIT to Invest up to $50 Million in GTI Illinois Cultivation Facility
- Canopy Growth Extends $80.5 Million Loan to Strategic Partner TerrAscend
- Columbia Care Reports $23 Million Revenue in Q4 and Sees 2020 Exceeding $155 Million
- Harvest Launches $100 Million Equity Offering at Steeply Discounted Price as Founder Departs
- Guest Post: January Cannabis Sales Advance Despite Weakness in Pre-Rolls
- KushCo Holdings Expects Fiscal Q2 Revenue to Decline to $30 Million and Retracts Prior Outlook
- Exclusive: Medicine Man Technologies On Track to Roll Up Leading Colorado Cannabis Companies
- Tilray Prices $90.4 Million Equity Offering at $4.76
- Exclusive: Vanguard Scientific Systems Helps Cannabis Extraction Clients Prepare for Sweeping Regulatory Reforms Ahead
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Alan & Joel