The cannabis industry was under immense pressure in July, as Black Swan events rocked the markets.
July was without a doubt one of the toughest months for the cannabis sector this year, with all of the major indexes significantly down for the month. The markets were significantly impacted by two very surprising, one very damaging, events.
First there was the sudden departure of Bruce Linton – Canopy Growth's dynamic CEO, and then CannTrust rocked the industry even further with the revelation that fraudulent growing of illegal cannabis had been taking place in unlicensed grow rooms.
On the 3rd of July, Canopy Growth issued a press release announcing the departure of Bruce Linton as CEO, which came into effect immediately. The release noted that the decision was mutual, and that the company had decided that a new leader was required to take CGC on to their next phase of growth.
Just hours later in a televised CNBC interview, Linton was pretty frank in his side of the story. "Left," he said, "no, I was fired. Plain and simple."
The origins of this could be traced back to the fact that in its last quarterly earnings report, Canopy burned almost $350 million as it pursued an aggressive global expansion.
"I was of the view this is a rocket ride that will measure earnings per share sometime, but not in an immediately required time and I have $4 billion in the bank so the point of that is to spend it."
– Former CEO of Canopy Growth, Bruce Linton
A few weeks earlier, at the Constellation Brand's earnings call, the CEO announced his "disappointment" in Canopy's results, which is what really got tongues wagging. Constellation's $5b investment in Canopy late in 2018 was game-changing for the industry—and Canopy as a company—as it gave Constellation 4 of the 7 board seats, and with it, ultimate control of the company.
This control was flexed when they immediately fired Linton, and with it, issued a clear message to the industry. The time for burn, burn, burn was over. The time for profitability has come.
Constellation did not intend to preside over mounting quarterly losses as their war chest continued to diminish. This really scared investors and broad market selling took place in the days following the news. And then came CannTrust.
If you can't trust CannTrust, who can you trust?
On the 9th of July, the Canadian Globe & Mail broke the news of alleged illegal cultivation activities at the CannTrust facility in Pelham. Apparently, a disgruntled staff member blew the whistle on the entire operation.
"I'm not into criminal stuff. We were literally hanging up poly walls to hide thousands of plants from Health Canada so we could snap a picture and then send that to them."
ex-CannTrust employee, Ryan Lalonde
This rocked the market, causing CannTrust to lose 20% of its value in one day. Then Health Canada stepped in and delivered a notice of non-compliance over cannabis grown in five unlicensed rooms between October 2018 and March 2019. Due to this noncompliance, Health Canada went on to place a freeze on 5,200 kg of cannabis—with the company announcing a voluntary holding of another 7,500 kg of cannabis—for a total of 12,700 kg estimated to be worth around $50m in potentially lost revenue.
Finally, the company came out and announced that it was creating a Special Committee to investigate the company's non-compliance, "comprised of independent members of the Board of Directors".
The stock continued to lose value and was downgraded by most of the leading analysts with price targets dropping from the CAD$14 to $18 to a measly CAD$2.50 (essentially the NAV of the company).
Then, on July 25th, a major shakeup in CannTrust's senior leadership occurred as the Board of Directors terminated with cause CEO Peter Aceto, and demanded the resignation of chair Eric Paul, who complied with immediate effect. They also announced that Robert Marcovitch would be the interim CEO, stepping down from his role as chairman of the special committee.
In other words, the man who was leading the special committee that was supposed to be independently investigating CannTrust's illegal growing scandal will now be taking over as interim CEO. Mind-boggling really.
The newly-christened interim CEO Robert Marcovitch stated in a press release that "our first priority is to complete the remaining items of our investigation and bring the Company's operations into full regulatory compliance. Implementing the necessary changes is essential to the interests of our medical patients, customers, shareholders, and employees."
It is simply incomprehensible how the market's leading medicinal Licensed Producer, the darling of nearly every global cannabis analyst, could fall so hard and so quick, as a result of such fraudulent behavior. Mails were leaked showing that both Aceto and Paul knew of the illegal growing and sanctioned it, even coaching staff on what to say to Health Canada officials. This occurred over the time frame that CannTrust completed a $230m capital raise. News of class-action lawsuits quickly came to light, with potential jail time for the CEO and Chair being suggested.
The Bottom Line
These events really weighed heavily on the sector and dragged almost everything down with it, as retail investors fled for the hills. It is a timely reminder that this is still a very nascent industry, and as a result, there is still cowboy behavior when decisions are being made, and investors should take this into account when diversifying their portfolio.
As we close out one of the toughest months in recent history, we take this opportunity to reiterate our belief that the second half of 2019 holds great promise for the industry. Canadian retail is starting to grow, and with edibles and extracts to be legalised in late October, the future is bright for Canada. Look to the US DOJ to finally approve the mega-consolidation deals that took place earlier in the year, and with it, better US investor sentiment.
The darkest hour is the one just before the dawn.
This is the cannabis green rush, and although we maintain a 5 to 10-year bull market thesis, that doesn't mean it's a straight line up. We continue to recommend that investors take a diversified approach when investing in the sector, as it is still far too early to pick the winners, and even the biggest are still not beyond failing.
Until next month.
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