Skip to main content
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 1
My notes are better read at this link, yet, I put in all but the tables and pictures below. https://rbcpa.com/aphria-rbs-investment-notes/

These are my Aphria investment notes. As all my posts, this post is nothing other than a sharing of research. Please read my disclaimer in the link below. I very well may never discuss this position again, even if we exit, or buy more. This post is not a solicitation, suggestion to buy or sell, nor an implication of such. Do your own DD!

These notes are in chronological order.


December 7, 2018 ($6.13) Quick Valuation look



The price has escalated in several days. The current valuation is $1.57B. This is 2.67X projected F2021 revenues. F2021 revenues could be incredibly aggressive.

Here is a table of potential valuations and Price to Sales metrics, using F2021 Projected revenues of $590M USD:

What if price? Shares O/S Valuation Price / Projected F2021 Revenues

$4.00 254M $1,016M 1.72X
$6.00 254M $1,524M 2.58X
$8.00 254M $2,032M 3.44X
$10.00 254M $2,540M 4.31X

To put this into perspective, Cronos (CRON $12.88) announced Altria would be a 45% investor. Cronos current market cap is ~$3.25B, and their F2021 revenues are not projected to be as high as Aphria. Hence one can see that on a relative basis, perhaps Aphria is underpriced, even at $10.00. Yet, relative valuation for a potentially over-valued sector is not necessarily relative to true valuation.

December 6, 2018 ($4.00) Increased our position to ~0.75% of a portfolio. Our average cost is now $4.36

There have been several rebuttals to the short selling report from Quintessential Capital Management and Hindenburg Research. The report could be accurate, yet as stated below, we think the risk reward of ownership at $4.36 is compelling. Aphria does have ~$300M CDN in cash and short-term securities.

December 5, 2018 ($4.55) Bought ~0.50% for certain accounts at $4.66 (12/4/18), and if cash was available
Market cap using 254M shares and $4.66 USD would be ~$1.2B. F2021 revenues could be $590M USD. Hence a Price to future revenues of 2X. This is not egregious if growth continues, and if fraud is not within the company.

The company has been defending itself since the short report from Quintessential Capital Management and Hindenburg Research, which was released on Monday. The short report claims that Aphria’s management has been deceiving its shareholders to line their own pockets. The report is well written, and there is a video linked below, that is also quite interesting and thorough. Aphria, in a statement issued Monday, called the allegations “malicious.”

Here is a link to the reports and videos of the allegations. http://www.qcmfunds.com/aa/

A cannabis analyst who I respect a great deal, doesn’t think they are criminals or liars. There are disturbing facts, like “Building 51”, “The lady who said she is not a director,” and “the missing scientist.” He doesn’t think Aphria are criminals and liars, but their due diligence failed. He thinks the wipe out of the potentially bad investments have been priced into the company. Of course, the potential for fraud exists, but again, he thinks fraud is not there, but you never know.

He does not expect a SEC investigation. Just his views, and perhaps he isn't correct. It is helpful to hear his views though. He certainly is disturbed by this but is expecting that the culprit is poor due diligence. Again, just his thoughts, we are early in this information stage, and we need to "stay tuned."

On another note, yet it rhymes, Nuuvera was purchased in July 2018. There were rumblings of disclosures of insider relationships not being disclosed. I am not familiar with how the investment community perceived this. The same analyst I referred to above mentioned, “Nuuvera was nasty. There were no legal requirements to disclose this, but it sure looked bad. I think companies need to do much better than "the bare minimum.”

Auditor is PWC.




Review of 1Q19 (August 31, 2018) financial reports:

Fully diluted shares on October 11, 2018 of 254,349,627. It is my understanding that option and warrant shares are not very material to the share count, and at this point I will not consider them in valuation work-ups.

$273M in cash. Excellent current ratio.

Shareholders’ equity of $1.5B. Tangible equity of $701M. There are “Capital assets” of $361M at 8/31/18, and based on some recent short discussions, these could be impaired. Hence, one could call Tangible equity to be $340M.

Nuuvera was purchased for ~$507M. I am concerned of faulty disclosures, and this could be part of the recent fraud accusations.

I have seen various potential revenue estimates for F2019 of an average of $279M, F2020 of $608M, and F2021 of $812M to $1,260M.

I have also seen shares outstanding projections of 248M for F2020 and F2021.

I have seen IFRS earnings per share of F2019 of an average of $0.14, F2020 of $0.35, and F2021 of $0.55. The “proforma earnings” are expected to be higher, with F2021 at $1.04, but I typically don’t put much credence in “proforma earnings.”

Could be a bargain, but a few caveats, which could make this a value trap:

1. Price multiple using F2021 revenues is 2.5 years out.

2. Entire sector might have crazy multiples, yet this is infant industry.

3. Hindenburg report could be correct, and this could be fraud ridden and truly go to zero.

April 2, 2018 ($8.62)

“I think the only thing is you may need to lengthen your time horizon to beyond FY19, which ends in May 2019, essentially the next year. Analysts project C$229mm for FY19 and C$651mm for FY20.

I like to look at price to tangible book. The tangible book value at 11/30 was about 386 million. If one were to assume all dilutive securities are exercised, this would bring in 30 million getting it to 416 million. Now, add 108 million net for the capital raise after the quarter. This gets to 524 million (Canadian). I am not sure of how Nuuvera will impact it (I think there will be some cash at a minimum), but let's just assume zero. If that's the case, then the stock trades at 4.6X (probably a little lower). This was all in Canadian dollars by the way. I think that is low compared to most peers in the Tier 1, but obviously not so low that it couldn't be lower.” AB 4/1/18

March 30, 2018 ($8.96)

Market Cap ~$2B

I will use the following assumptions, which are purely back of envelope and shooting from the hip, with no method, nor guidance, and just rough assumptions.

If we project Forward revenues of ~$100M in F2019 (11/30/19), I could see a potential market cap of $500M to $1B (almost ridiculous). Hence, we would need a share price of ~$2.27 CDN to ~$4.55.
CDN.

Hence in USD using conversion of 78%, I would consider buying for $1.78 to $3.55 USD.

I read investor deck (2/18), financials and MDA 11/30/17 and 2017 AR. Impressive company, yet no way in the world am I hitting this with current valuation of $2B. Perhaps I am missing something and will reconsider in future.
Print the post Back To Top
No. of Recommendations: 4
A cannabis analyst who I respect a great deal, doesn’t think they are criminals or liars. There are disturbing facts, like “Building 51”, “The lady who said she is not a director,” and “the missing scientist.” He doesn’t think Aphria are criminals and liars, but their due diligence failed. He thinks the wipe out of the potentially bad investments have been priced into the company. Of course, the potential for fraud exists, but again, he thinks fraud is not there, but you never know.

He does not expect a SEC investigation. Just his views, and perhaps he isn't correct. It is helpful to hear his views though. He certainly is disturbed by this but is expecting that the culprit is poor due diligence. Again, just his thoughts, we are early in this information stage, and we need to "stay tuned."


Due diligence?

You are being pretty generous. This is not a case of directors buying a company that is worth less than they thought. This is a case of company directors (de Francesco in particular) going out and buying some fairly banal assets (a house in Jamaica, a small warehouse, a permit application) for less than $1 million, then selling that for tens of millions to an intermediate company partially owned by Aphria (Scythian, recently renamed SOL*), and then getting Aphria to buy those assets for hundreds of millions, all within a few weeks. If the explanation is not transferring Aphria cash to directors’ pockets, I’d like to know what it could be. The story is not one of gullible Aphria directors buying some assets from a third party at an inflated price, it’s Aphria directors scheming to get gullible Aphria shareholders to buy these worthless assets for hundreds of millions.

One can perhaps make the argument that a loss of several hundred million does not in itself make Aphria worthless, given its other assets, but only if this was just a mistake, not a fraud. I can’t see how anyone who has read the QCM report carefully could come to any other conclusion than fraud.

*By the way, what is the meaning of SOL Global? Is this an abbreviation??



On another note, yet it rhymes, Nuuvera was purchased in July 2018. There were rumblings of disclosures of insider relationships not being disclosed. I am not familiar with how the investment community perceived this. The same analyst I referred to above mentioned, “Nuuvera was nasty. There were no legal requirements to disclose this, but it sure looked bad. I think companies need to do much better than "the bare minimum.”



I fear this story of insider dealing, and the fact that they seem to have gotten away with it, may have given them confidence that insider dealing is not punished. They may be right, and the company may survive, but I wouldn’t want to count on that, and this insider dealing seems much more brazen than in the previous case. I don’t think we should be applying Canopy/Aurora/Cronos multiples given what certainly appears to be egregious corporate malfeasance at Aphria.

DTB
Short Aphria, a small position given the uncertainty but I would say 50% chance of bankruptcy seems reasonable to me.
Print the post Back To Top
No. of Recommendations: 0
I answered this yesterday, and I wrote one word incorrectly, which I corrected here. I also added the last sentence at the end of the post.

Current price is $6.05.

I will wait to respond after their quarterly loss announcement. I think your assertions are vague and hypothetical. As you know Aphria has hired outside counsel, and will comment on it after their investigation is finished.

Keep in mind, Aphria has a 52 week high of $19.87, and a low of $3.75. Our average cost is < $4.50 per share. Of course it could go belly up, yet they do report MRQ of ~$300M in cash and equivalents.

What price did you short it at? are you still short?

I read the Hindenburg report carefully, and bought after that. I am not saying fraud did not exist, but I am writing that the potential for fraud not being committed does exist. I think the price and market cap, when it was at $4.36, very well could have reflected that.

If my conviction was greater, I certainly would have bought a greater position than 1/2 of 1%.


If it turns out there was no fraud, or any improprieties found could be remedied, I think you could have a multi-bagger here.
Print the post Back To Top
No. of Recommendations: 2
I am not saying fraud did not exist, but I am writing that the potential for fraud not being committed does exist.


OK, this corrected sentence is a little clearer now. In other words, fraud is possible but it is also conceivable, in your view, that there has been no fraud.

But I disagree. In the case of Nuuvera, they have basically already admitted to fraud. In the more recent Latam case, it is very hard to explain the facts revealed by QCM/Hindenburg without fraud being a part of it, unless QCM/Hindenburg are just out and out lying. I think the bull case is that there has been fraud, but it is not material, or has already been priced in, at $6 a share, and the value of the Canadian assets make it a reasonable take-over candidate with a premium from today's price.

And on the fraud front, the company has now added Act III: the Green Growth Brands takeover offer. Not only is the offer bizarre on several scores (the acquirer is a company with almost no assets, the offer involves no cash, the premium is based on a hypothetical increase in the acquirer's share price, and the present price of the acquirer's shares seems highly manipulated in the first place), but the multiple connections between the two companies makes it seem highly likely that the offer is designed primarily to reassure Aphria's investors that they have something worthwhile. I would admit that there is an alternative plausible explanation for this offer: an opportunistic bid taking advantage of Aphria's weakness and desperation.

As you know, I feel that share prices in the whole sector (Canadian cannabis companies) are highly inflated, and are based on extremely optimistic projections. Current Canadian cannabis consumption is around 1 million kilos a year, and current cannabis producer prices (about $3 a gram) are in the context of a legal industry that can only supply about half of this demand, so all the provincial dispensaries are out of product for most lines. BUT! all these companies (Canopy, Aphria, Tilray, Aurora, etc) are rapidly building out capacity, and cumulatively project production capacity of over 2 million kilos within a year (greenhouses are pretty quick to build, this is not like building a car factory). So current margins are likely to come under severe pressure very shortly, and may go to zero or lower. They like to talk about international expansion, but I suspect most countries will be like Canada in that they restrict business to domestic companies. Cannabis apparently is not part of our free trade agreement.

All these companies confidently project that they can quadruple their production and keep the same profit margins, but I suspect this will end in tears for most of them. I would not bet on any of them, but particularly not the one where there is also quite strong evidence of fraud. I have a small short on Aphria (much less than 1/2 of 1%, at an average price of about $6.25, very close to the current price, more for fun than for profit. I can't reasonably make it bigger because the borrow fee is outrageous (about 40% when I last checked). If you are long, although I think this is a poor investment choice, I suggest you at least look into holding your shares at a broker like Interactive Brokers, where you could be rebated half of this borrow fee. You might as well get paid 20% a year for the risk of losing all this capital!

DTB
Print the post Back To Top
No. of Recommendations: 1
I will wait for the reports to make judgements on the Aphria outcome.

One thing that has occurred since the Hindenburg report is the hiring of a new CEO, Irwin Simon CEO + Founder of Hain Celestial . This is a CNBC interview of Simon from last week. https://www.cnbc.com/video/2019/01/02/green-growth-could-bec...

I concur that margins will contract, yet so tough to judge with IFRS and Biological assets. Which for those who are not familiar with the industry, as is DTBoojum ( I am impressed with your level of knowledge in the cannabis industry), Biological assets are a form of inventory, and reported at fair value. I am not familiar with any company that has truly had any material operating profit, when adjusted to US GAAP.

I do think that the industry and world will go international, in the same fashion as the alcohol and tobacco industry. I think USA will remove Schedule 1 status within the next few months, to a few years. That will be a huge boom for the industry, as 280E tax law would disappear (280e is the non-allowability of G&A expenses in the cannabis industry), as well as banking will become much easier and cheaper. Of course this is not necessarily relevant to Canadian operators, but quite a few Canadian companies have U.S. operations, such as (MPXEF, GLDFF,ITHUF). Canopy is ready to operate in USA when the law changes. Of course you probably think the international operations of Aphria are primarily fraudulent. I do not. Yet, again, if my conviction was that of clean operations and future profitability, I would own up to 5% of a portfolio position.

My largest cannabis related investment is Scott's (SMG), which is a 3.5% position. Our entire cannabis position is currently about an ~8% allocation

I am investing in Aphria and more so, selected companies in the industry, for what I expect to be an industry that will be huge and legal worldwide.


I discussed cannabis quite a bit in my November 2018 presentation handout https://rbcpa.com/wp-content/uploads/2018/11/20181115-Presen...

I too think the industry is terribly over-valued. Yet, there could be pockets of opportunity such as Aphria, maybe a few others. I would buy Canopy again at much lower prices, same with Aurora, and any of the large companies. I might very well never get that opportunity.

I am a patient investor in this industry, and am willing to wait for many years.

Lastly, Value Line initiated coverage of 2 cannabis companies this week. Aurora and Canopy Growth. Interesting they label them the "Drug Industry."
Print the post Back To Top
No. of Recommendations: 2
April 1, 2019 ($9.66) Value Line initiates coverage – Their presentations are in USD

Price projection of $18 to $30 between 2022 – 2024.

Company financial strength of ‘B.” This is a relatively low grade, yet consistent with all other cannabis companies they follow.

Uses common stock of 249.3M shares, which equates to a market cap of $2.4B.

Projects F2019 (5/31/19) revenues of $150M, and F2020 of $555M.

Projects F2019 (5/31/19) eps of $0.10, and F2020 of $0.30. The forward P/E for F2020 projections is 32.2X.

Projects 310M shares outstanding at year end 5/31/20.

For F2020 they make the following projections:

Book Value $6.55
Operating Margin 23.0%
Income Tax Rate 15%
Long-Term Debt $60M
ROTC and ROE 4.5%

“According to a United Nations study, the global market is $150 billion annually, and almost 4% of the world’s population is cannabis users.”

They project annual revenues and earnings per share will reach $1B and $0.45 per share by 2022 – 2024. They expect management to remain active on the acquisition front, to fuel that level of growth. They also expect a few more share offerings during that time period.

VL projects quarterly revenues for period ending 2/28/19 of $45.0 USD.

My own quick mention

I have no real projections. I am merely hoping for lack of fraud.

I have some notes on Aprhia at this link: https://rbcpa.com/aphria-rbs-investment-notes/
Print the post Back To Top
No. of Recommendations: 4
Follow-up:

Stock was $8-$10 in early 2018, fell to about $5 when fraud allegations were first made by QCT/Hindenburg research groups, and we debated the pros and cons of holding this stock, I was short at about $6, BGM was long with an average cost of about $4.

We haven't had much in the way of news about what seemed pretty stinky to me, which tends to support the bullish view holding that the Latin American asset flip by previous management was a one-off and not significant to the business.

On the other hand, the rest of my short thesis seems to be playing out: the Canadian market for cannabis is still about 1 million kg of dry flower equivalent, and all the major Canadian brands have continued to rapidly build out capacity. Producer prices (https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=361005...) have continued to drop, down from $5.10 (CAD) in 2015 to $4.58 in 2018. I think they can go much lower. Aphria's revenues have rocketed up as one would expect, because of legalization, and were $13m, $22m, $74m and $129m in the last 4 quarters, but most of this comes from distribution partnerships in continental Europe; $29m came from selling 5574 kg of cannabis in Canada. Annualized, that would be about 22,000 kg, still tiny compared to their projected capacity of 255,000 kg which they expect to produce when current projects are complete, or about 1/4 Canadian demand (mostly recreational).

The 1 million kg estimate seems about right, with Stats Canada projecting about $5b in sales at consumer prices of about $8/g, suggesting just under 1 million kg. Another recent report from an American research firm, Brightfield, suggests the total market in Canada (medical + rec) will be about $8b in 2021, which is also close to 1 million kg. This is slightly less than the Colorado experience, where a state with a population of 4 million generates $1b in sales. (Canada has a population of 37m).

Ballparking the value of Aphria, (current market cap of $1.5b CAD), if they can maintain about 1/4 of the Canadian market under full capacity, and they get $5/g, that would mean $5k per kg, times 250,000 kg, so $1.25b in revenue. The whole question becomes, what kind of margins might they get? Current financial reports are not much help, since they are spending so much building out infrastructure and developing new products (comestibles become legal in Canada this Fall.) My bear thesis is that there will be fierce competition for market share, with capacity far exceeding demand, and margins will be close to zero for the basic product. Any hope for profit has to be on the basis of branding, but I still feel that all the Canadian marijuana brands are pretty much unknown to most people. Ask your Canadian friends if they can name one, for instance.

An additional piece of bad news for the whole industry is that vaping is taking a big hit, with the current crisis over 8 deaths in the USA and up to 500 cases of pulmonary illness. It is not clear whether this is a real problem, or something related to one of the vehicles for the active drug (vegetable glycerin, propylene glycol). Or perhaps the whole thing is being blown out of proportion (there are about 15 million vapers in the USA). On the other hand, maybe it is just the tip of the iceberg, since the product is fairly new and effects may build up over the years of use.

Anyways, it has been a bit of a roller coaster so far: $10/share in early 2018, down to $5 last Fall, back up to $10 this spring, and now back down to $5.70 as I type. I maintain a small short position, along with shorts in 3 other Canadian producers opened in the last 6 months. So far, I am comfortably in the black, and expect them all to drop by at least a half again, where I will probably close them. Aphria would be the last one I would close, as there is the additional possibility that further evidence of fraud eventually surfaces.

Regards, DTB
Print the post Back To Top