Gupta's Reversal: A Game-Changer For Medical Marijuana Stocks?

by: Alan Brochstein, CFA

(Editors' Note: This article covers micro-cap stocks. Please be aware of the risks associated with these stocks.)

Medical marijuana stocks jumped sharply on massive volume Friday, perhaps ending six months of steady decline. I had pointed out in February that the MMJ sector was in a bubble, and this was the best day for the group since then. Today, I want to examine the catalyst and to update my views on a few stocks.

Gupta Goes Gaga for Ganja

On Thursday, CNN Chief Medical Correspondent, Dr. Sanjay Gupta, shocked the world. A long-time opponent of MMJ, he totally reversed. The news came out during the day, but the stocks strangely didn't react until the next morning right after the open. Here is an excerpt:

Long before I began this project, I had steadily reviewed the scientific literature on medical marijuana from the United States and thought it was fairly unimpressive. Reading these papers five years ago, it was hard to make a case for medicinal marijuana. I even wrote about this in a TIME magazine article, back in 2009, titled "Why I would Vote No on Pot."

Well, I am here to apologize.

I apologize because I didn't look hard enough, until now. I didn't look far enough. I didn't review papers from smaller labs in other countries doing some remarkable research, and I was too dismissive of the loud chorus of legitimate patients whose symptoms improved on cannabis.

Gupta will be hosting the documentary "Weed" at 8 p.m. EST Sunday, August 11th that promises to help explain his reversal.

There was additional speculation that Attorney General Eric Holder will be suggesting on Monday that the U.S. relax sentencing guidelines, but I don't believe that this is relevant to the MMJ market. The real catalyst, in my view, was Gupta's reversal.

Why This is Important

Nothing against Snoop Lion (formerly Snoop Dogg), but his advocacy for changes in MJ laws isn't likely to lead to much for medical marijuana, though I am sure he can help catalyze the movement for recreational pot. MMJ has many, many advocates, but none that have the authority or reach of Gupta. There is a lot of emotion and too little focus on the science, but this appears to have instantly changed. Awareness can go a long way towards legitimacy and a potential landscape change at the federal level. While this was just a start, I think it's huge, and it will be interesting to see if more authorities embrace the potential of MMJ. In my view, this is precisely what MMJ has been missing.

Why The MMJ Stocks Overreact

Not surprisingly, there were some big moves in the MMJ sector on Friday. The best performer was Medical Marijuana Inc. (OTCPK:MJNA), which had been trading at $0.12 for a month with low volume. The price exploded, trading as high as just under $0.20 and closing near $0.17 (+40%). Volume was high too. I track several MMJ stocks, and here were the big gains from Friday:

Please keep in mind that all of these are highly speculative, and I am not recommending investment in any of them. One of the main points I want to make is that the supply of MMJ-related stocks is very limited. While the market caps on some are above $100mm, many are less than $5mm. In aggregate, there is less than $1.2 billion total market cap in the sector by my estimate, and much of it is not in the float (restricted stock, for instance).

Small changes in demand can lead to outsized moves in the stock. In my view, the bubble earlier this year was fueled by huge demand following legalization in Colorado and Washington in November. As I mentioned then, many of the investors are not particularly experienced in stock investing. The disclosures for these companies, which aren't listed, can be very minimal, even if the investors take the time to read them. MJNA suggested recently that 40K individuals held shares as of April -- this is truly amazing and suggests very strong demand for the stocks, perhaps without regard for the valuation in my view.

I want to share a quick example of why I think the stocks can move so much. Let's say that 1mm people take the time to read about Gupta's reversal or watch "Weed" and think about its implications, which are surely simple: MMJ is something that is likely to become a reality in all of our states eventually, with a clear federal regulatory landscape. Now, let's say that just 1% of those people decide that this is something to consider investing in (that's 10K people). Now, let's say that only 1000 of them actually invest and choose to invest $10K on average. That works out to be $10mm (which was about the aggregate volume I believe on Friday). I think these very small numbers show how quickly real money can materialize. If $1 billion wants to invest, the stocks will fly in the short-run. It's basic Econ 101.

Long-term Implications

As one might expect, rising prices for stocks leads to more supply. In the short-run, as long as investors are willing to pile into pink-sheet stocks with flimsy business models and a lack of solid financials and to capitalize them in the tens if not hundreds of millions of dollars, expect to see new entrants. For instance, just last month Refill Energy (OTCPK:REFG) merged and will become "Medical Cannabis Financial Group." Here is a link to the filing that describes the transaction. With about 80mm shares and a price near $0.50, REFG is capitalized at about $40mm! (Please note that I am neither recommending nor not recommending this company, but using it only as an example of how interest in the MMJ sector can lead to an increase in companies pursuing the market). Right now, there is a very limited supply, but it's not that difficult to create supply.

The real issue is the longer-term. Many investors seem to believe that there is some sort of "first mover advantage" or that the potential exists for a winner-take-all scenario. This is far from the reality, as it's a highly fragmented market. I hear from a lot of people, and it's clear to me that many companies are working on extraction, strains, etc., but these aren't public companies. Rather, they are entrepreneurs looking to build a real business and not just get rich quick. Further, as the regulatory and legal landscape changes, even more legitimate companies will surely enter the market. So, those who rush in to MMJ penny stocks because that's all that exists presently without regard for valuation are risking increased supply of stock competitors in the near term and real competitors in the long term.

Update on Stocks

Medical Marijuana Inc.

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I continue to focus my MMJ research most intensively on MJNA, as I believe it is one of the few companies in the sector that has potential. The stock had huge volume on Friday, but the total dollar value was only about $6mm. The stock failed at what is obvious resistance at $0.20. I highlighted the big move at the end of April (following company press release to address many issues). We still don't know exactly what was going on in mid-June, when the stock took out the $0.10 level briefly on heavy volume but no news. My theory is that a lock-up expired, permitting some sales by the principals of CanChew, but this is just a hunch. It might also have been the sale of the 47mm shares issued earlier this year to its subsidiary to fund research.

I have written extensively about the company, sharing substantial criticism regarding transparency and other issues, but the company appears to be intent upon addressing a lot of my concerns. Since my last article, the company still hasn't cleared up the confusion about its authorized share count, which conceivably increased to 5 billion shares. While I expect that the company may actually retain the 950mm share limit, it's not clear how based on the rescinded filings, as I discussed.

The company has beefed up its marketing efforts with the re-named HempMedsPx, bringing in new leadership, and the changes are already evident. I want to commend the company for posting "certificates of analysis" on its website, offering consumers proof of its products containing advertised levels of CBD. I continue to think that the company's CBD-based products are unique and offer potential, but the challenges of very high cost and lack of public awareness will likely hamper sales in the near term. Gupta's reversal begins to address the awareness issue, and the potential to grow domestic hemp legally would likely bring down raw material costs, which the company could then pass through.

The real issue I see for MJNA besides the legacy accounting issues is that its strategy is hampered by its finances. The company has 936mm out of 950mm authorized shares outstanding, so, without raising the A/S, it can't fund its growth. Cash flow has been minimal, the company has little cash and, at least as of its last filing, it had no access to credit. Additionally, the company has guidance from February that hasn't been updated and is overly aggressive.

Finally, a quick update on the relationship with CannaVest (CANV.OB). I have some concern that its investment there could be diluted. By the end of the year, MJNA will own approximately 6.9mm shares (a little less perhaps), a slight minority. In a recent 8-K filing, CANV detailed 500K options that will be issued to its CEO, Michael Mona, Jr. Additionally, Mona and a partner, through Roen Ventures, have loaned the company now over $4mm (with the potential to go to $6mm). The loans are convertible into stock. Here's the issue: The option and notes will convert at a price to be determined by an appraisal process. MJNA investors should be very concerned if the price is set below the $4.50-6 area where it did the inventory transfer and IP sale in exchange for stock in CANV, as there could be a potential take-under. Recall that the first 7mm shares of CANV were bought for just $0.05 in November (and are very closely held). CANV has 190mm authorized shares but only a projected 14.9mm outstanding at year-end. While CANV's quoted price is $14, the stock is so illiquid that I would project that any sort of analysis would lead to a very low valuation. Based on the $0.05 transaction, the lack of cash flow, the fact that it has going concern issues and the lack of assets all suggest to me that the exercise price for the options and the conversion price for the notes will be quite low.

MJNA should report results by Wednesday (8/14) in order to be timely with its disclosures, but it hasn't yet announced that it will. I continue to monitor it closely and look forward to the next update.

Hemp, Inc.

HEMP bounced on relatively large volume but remains mired in a downtrend:

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53mm shares sounds like a lot, but we are talking about dollar volume of just $800K. Since I last looked at HEMP and discussed how the CEO has used convertible preferred stock to massively dilute other shareholders (buying 2 billion shares for 1/10 of a penny effectively), I have become even more concerned that it is not a real business at all. 2012 sales were less than $20K! I would avoid this stock, currently trading near $0.015, as I expect that it could be worth well below $0.01. Currently there is a 3 billion share limit on shares outstanding, but, with control of the company, CEO Bruce Perlowin could likely get around this. With effectively about 5 billion shares, the company is capitalized at about $75mm. I think that it is worth no more than $10mm (domain name).

Nuvilex (NVLX.PK)

NVLX is a stock that I am beginning to investigate more thoroughly. It has been around a while as a nutraceutical company with biotech ambitions, but it announced in February that it had entered the medical marijuana market with its "Medical Marijuana Sciences, Inc." The best I can tell, MMS has no operations whatsoever. The person in charge, Director Matula, works full-time for LiveDeal (NASDAQ:LIVE) and has served on the Board since 2004, and he appears to have no background in MMJ. The company intends to use its "live cell encapsulation" technology in conjunction with cannabis compounds in order to target potential cures for brain cancer and pancreatic cancer. The company has limited financial resources, so it's unclear how it will fund its ambitious plans. With almost 1.5 billion shares authorized and only 510mm outstanding, it's not hard to imagine. Clearly, NVLX excels in press releases. Here is a link to 51 pages of just headlines over the past three years. Its website and filings don't share any helpful information about the MMS subsidiary. I consider NVLX to be a pretender in the MMJ market at this point.


The reversal by CNN correspondent Dr. Sanjay Gupta is quite meaningful in my view, as he lends significant legitimacy to the MMJ movement. Unfortunately, the quality of MMJ stocks is extremely poor. With so few choices and such limited supply relative to the potential demand, prices can outpace the fundamentals. I continue to watch MJNA as a company that could emerge from the pink sheets to be a real contender, but it is one of the few in the sector that warrants consideration. One that also has captured my attention is GW Pharma (NASDAQ:GWPH), which is based in the UK and recently listed ADS shares in the U.S. GWPH has a real MMJ product on the market (not in the U.S.) and a management team with strong backgrounds. The field of potential choices drops off dramatically after these two, in my view. I need to research GWPH further, and I currently do not recommend buying MJNA, but I plan to revisit my thesis following its Q2 report.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.