Marijuana stocks have recently taken an odd trip. They were led by U.S.-listed grower, Tilray, which went public in July 2018. Stocks of the Canadian cannabis producers skyrocketed on Sept. 19, and then gave most of their gains back. That week, Tilray opened at $117, hit $300 on Wednesday, and closed Friday at $123.

Licensed marijuana producers in Canada will begin recreational sales on Oct. 17, and there are acres of greenhouses in bloom for opening day. However, stock prices have been weakly tied to business fundamentals for months. Last week proved that trading has become irrational. At the height of stock prices Monday, Tilray was valued at $30 billion, which was more than CBS, Twitter, and American Airlines.

In December 2017, Bitcoin peaked at more than $19,000 and has fallen to $6,700. Barron’s says to expect Tilray to do the same.

It is difficult to understand why Tilray is valued above more established, larger rivals like Canopy Growth and Aurora Cannabis. On Wednesday, the value of Tilray “surpassed 85 times bullish estimates for its 2020-year sales and 340 times that year’s estimated cash flows.”

Stocks in Canadian marijuana was overvalued in March according to Barron’s cover story. However, prices started to skyrocket in August after Constellation Brands, the liquor store giant, agreed to add $4 billion to its investment in Canopy Growth.

Shares for Aurora Cannabis were bolstered to 17 percent on Monday. This occurred after Bloomberg reported that Aurora Cannabis was talking with Coca-Cola about putting cannabidiol in sports drinks. Cannabidiol is a non-psychoactive ingredient in marijuana. Aurora stated that there was “no agreement, understanding or arrangement” with any beverage company at this time.

Tuesday evening, Jim Cramer with CNBC hosted Tilray’s chief executive Brendan Kennedy, who said the cannabis industry would spawn several $100 billion companies. According to Barron’s, “hysteria ensued Wednesday as 31 million shares changed hands and the stock doubled from the prior day close – only to plummet again.”

Kennedy would not speak to Barron’s, but he heads Privateer Holdings, a Seattle venture fund. The firm is backed by billionaire investor Peter Thiel, who spent $40 million for 82 percent of Tilray’s shares. On Wednesday, at 2:45 p.m., that stock was worth more than $20 billion – a 500-fold increase in value.

Industry leader Canopy Growth was unable to keep pace with Tilray, which baffled chief executive Bruce Linton. He told Barron’s that is seems like every time Canopy Growth does something, it is good for the stocks of the industry.

Along with the backing of Constellation Brands, Canopy Growth has more than a third of outstanding purchase orders in Canada and a substantial market share abroad. “Our objective is to dominate the sector and to do the best globally. That will not be food for all the other companies. When I see the valuations being attributed to places that have virtually no production, virtually no off-take agreements, which don’t operate in multiple countries and have a very limited scientific research team…”

As American investors rush to become part of the marijuana craze, Tilray shares skyrocketed because of the scarcity. Only 10 percent of their shares became free-trading in July’s IPO. Because that is such a small niche, Tilray stock is difficult to buy, borrow, or sell short. Over 100 percent of the Tilray stock changes hands every day, since Canopy Growth’s August deal with Constellation Brands and it is clear that U.S. retail investors are responsible.

There are several marijuana companies that are dual-listed in Canada and the U.S. including Canopy Growth, Green Thumb Industries, Cronos Group, and MedMen Enterprises. The majority of their daily trading volume shifted to the U.S. last month. This could be why Canada’s other big producers are rushing to American exchanges.

Aurora and Aphria got rid of their U.S. subsidiaries in 2018, because operating in a country where cannabis is still illegal under federal law was an impediment to listing on the NYSE of Nasdaq. Soon, U.S. investors will have other marijuana stocks to sample.

Tilray will likely take advantage of its valuation by doing a follow-on offering. Barron’s asked if Tilray had such plans, they declined to comment. In the meantime, Kennedy and his Privateer partners are sitting on a several thousand percent unrealized gain. There are 66 insider shares locked up until mid-January 2019, unless they are released by underwriter Cowen & Co.

Cowen locked up its own gain on 170,000 shares it purchased in a financing round before Tilray’s IPO. This gain is worth more than $30 million to Cowen & Co.

Canopy Rivers to Go Public

Canopy Growth will be turning its new financial investment into a publicly traded firm, which will pursue investment opportunities in the cannabis industry.

If it can successfully leverage its business model, Canopy Rivers has the potential to become larger than Canopy Growth in the future.

Canopy Rivers with begin trading on Thursday, Sept. 20, 2018, as (TSXV:(RIV)). Two to three weeks after the company goes public, it is anticipated that shares will start trading over the counter.

After raising $104 million in July 2018, Canopy River announced it was close to going public. Here is the description of the business:

The Company is a unique investment and operating platform structured to pursue investment opportunities in the emerging global cannabis sector. The Company works collaboratively with Canopy Growth to identify strategic counterparties seeking financial and /or operating support. The Company has developed an investment ecosystem of complementary cannabis operating companies that represent various segments of the value chain across the emerging cannabis sector. As the portfolio continues to develop, constituents will be provided with opportunities to work with Canopy Growth and collaborate among themselves, which the Company believes will maximize value for its shareholders and foster an environment of innovation, synergy and value creation for the entire ecosystem.

Canopy Rivers will make an offer for a desirable company competing in the marijuana market, taking a partial stake in the business. Canopy Rivers will provide capital and offer its management expertise.

Presumably, if the investment pays off, it is probable it could acquire entire companies. This is not definite, but it is part of the strategy for the companies that respond well to Canopy Rivers’ investment and improved execution.

Some pundits are gushing about the potential of Canopy Rivers, however, there is a headwind that will determine the long-term performance of the company.

Constellation Software has successfully targeted and acquired software companies by supplying them with capital and expertise. The difference is, Constellation Software identifies companies that compete in niche markets or verticals that larger companies are not interested in acquiring because they are small businesses.

The point is capital investment and management expertise are not as important as identifying companies that have little competition, which means they can be acquired cheaply with few to no peers. These companies perform well when they are a big fish in a small pond.

Business Model and Strategy for Canopy Rivers

Canopy Rivers can make acquisitions that will build its production base, diversify products, and allow them to expand into different geographical areas. Any company that has enough capital and talent in the cannabis industry can do the same thing. Companies do not even have to compete in the marijuana sector. If companies have enough money, like tobacco, soft drink, and beer companies, this is a reproducible strategy.

Canopy Rivers will do well if it is making investments in smaller, quality marijuana companies that need a cash infusion. There is an ongoing consolidation happening within the industry. The companies that have a lot of capital to offer are not going to look at little companies that do little to add-on to their larger business.

The business model used by Constellation Software had a built-in moat. This meant it acquired smaller software companies that compete in a narrow niche market like local real estate, waste disposal, medical, and a variety of other markets.

Even if Canopy Rivers purchases a position in a significant number of marijuana firms, it will not have done much to differentiate, which is the key to long-term success. If the acquisitions do not create a defensible moat, then Canopy Rivers is doing nothing to keep from becoming a commodity business.

How Can Canopy Rivers Expand?

The biggest question is whether or not there is a large enough base of verticals within the marijuana industry to generate significant numbers. It Canopy Rivers takes a position in a targeted company, will it have a number of peers that will be able to compete against the acquired company? Are there marijuana verticals that exist which provide services or products that are in demand, but small enough to be profitable, but not so large to attract bigger buyers?

There is also the fact that a number of its peers can employ the same strategy. That has happened in the production and distribution side of the marijuana industry already. That is why it is the verticals of the industry that matter. It is not clear if there is enough to make the long-term growth of Canopy Rivers sustainable.

Beyond marijuana sales and production, medical cannabis, and hemp, there are not a lot of other verticals for Canopy Rivers to choose from. However, it could take a position in a company that helps others build infrastructure and greenhouses. That is not something that can be easily done by competitors.

If Canopy Rivers and Canopy Growth can execute well and has the opportunity to make money from investments on the picks and shovel side of the business or make money from management fees, it will do well.  There is, however, the potential for companies it invests into to grow also, providing more growth.

If Canopy Rivers was to build it moat, it would have to do it in relation to the types of companies it will invest in. First, the size of the investments, which as stated by Canopy Rivers, with be no more than $10 million. This would mean that few or none of the larger competitors would be interested in competing for them, due to their smaller size, which would drive up the price. As long as Canopy Rivers does not change its strategy, this will not be an issue. Only its peers would be considered competition for taking a position in the smaller marijuana firms, according to Seeking Alpha.

When developing a moat, it is important to consider the type of companies Canopy Rivers plans to acquire. Seeking Alpha recommends looking for companies that do things that are not easy to replicate, such as improve distribution systems and gain approval for medical usage. Production is too easy to reproduce.

Lastly, another area that would help the company take a lead in the industry and make it difficult for competitors to copy would be for Canopy Rivers to take positions in companies with high-quality leadership that locks in through agreements. If Canopy Rivers reaches them before their competitors, it could dry up the talent pool as the market expands. This will take some time.

It is likely Canopy Rivers will receive the benefit of parent company Canopy Growth and ride it coattails for as long as necessary. However, there are growing concerns about the rapid increase in share price and market cap, but there is a strong probability that it will correct big in the near future.

By Jeanette Smith


Seeking Alpha: Will Canopy Growth’s Spin-Off Canopy Rivers Be A Powerful Growth Engine?
Barron’s: Marijuana Stocks Are the New Bitcoin