(Editors' Note: This article discusses micro-cap stocks. Please be aware of the risks associated with these stocks.)
When I reviewed the entire cannabis sector two months ago, I pointed to a big change: Not all of the stocks were moving in the same direction. My thesis was and remains the same: Investors are beginning to differentiate on both transparency as well as leverage to the big themes of recreational legalization and a more enthusiastic embracing of the medical benefits of marijuana. Again, the DOJ "hands-off" policy that gave the green light to Colorado and Washington to proceed with their implementations as well as Sanjay Gupta's reversal of his previously negative view on the medical aspects, both August events, paved the way for investors to sharpen their focus on these themes.
As I suggested then (note: here is a link to all of my previous articles on the sector) and reiterated last month, two of the better stocks to take advantage of these themes are GW Pharma (GWPH) for medical and GrowLife (OTCQB:PHOT) for recreational (but also medical). While they have held up, most of the sector hasn't fared as well. Here is how the cannabis stocks I track have performed over the past month:
Again, the requirement to make this list is to have a market cap, including assumed conversion of any convertible securities, of at least $10mm. There are some assumptions that I make, so please let me know if there is any question about how I calculate it. Note that of the four companies with market caps in excess of $100mm, two are non-reporting to the SEC. How much longer will investors pay such high valuations while accepting such limited disclosure? I have included the number of Seeking Alpha "Followers" as an indication of investor interest (all increased since last month). Finally, note that the fiduciary assessment is my own and should be considered a relative rather than absolute judgment.
The only big winner was Endexx (OTC:EDXC), which finally updated its OTC disclosure filings after a long delay. It also acknowledged that it is partnering with a Creative Edge Nutrition (OTC:FITX) in it client's bid to become a licensed grower in Canada. EDXC has several different opportunities in the cannabis arena, including a medication dispenser (Autospense), a dispensary location service (THCfinder.com) and its M3Hub software to help with regulatory compliance.
The list of losers is quite long, with 10 of the 18 names declining double-digit percentages. I will discuss a few of these below, but, as far as some of the rest, Advanced Cannabis Solutions (OTC:CANN) began trading only recently. Its recent 10-Q indicated that it had spent $150K on an option that it ended up not acting upon. CannaVest (OTC:CANV), Medical Marijuana Inc's (OTCPK:MJNA) partner, reported a terrible quarter and awarded its insiders stock at just $0.60. Additionally, the company is selling restricted stock at $1 (obviously the buyers of late didn't get this message!). Note that for the market cap, I am including outstanding shares plus recently sold shares, dilutive convertible notes and projected issuance to MJNA. mCig (OTC:MCIG) had its initial launch but apparently didn't have sufficient inventory. It is launching an improved version in the next couple of weeks. MediSwipe (OTC:MWIP) is doing a 10:1 reverse split.
Why Medical Marijuana, Inc., Hemp Inc. and Medbox Lost the Lead
As 2013 began, the three stocks that were capturing the most attention were Hemp, Inc. (OTCPK:HEMP), Medbox (OTCPK:MDBX) and MJNA. All three of these companies do not file with the SEC (though MDBX is trying to uplist) - they are "pink sheet" stocks. MJNA and HEMP have names that easily attract novice investors, while the appeal of MDBX is a bit different. In any event, investors have had it with all three of these companies, which are trading at small fractions of their peak value earlier this year.
As far as I can tell, HEMP's sole purpose appears to be to enrich its CEO, Bruce Perlowin, the "King of Pot". I have discussed previously how he lends the company cash and then takes back preferred stock that converts into 10 shares of common per share (Series K). During Q3, he converted 16.5mm Preferred K into 165mm shares, helping to boost the share-count by 14% sequentially from Q2. More disturbing is the spin-off the company has suggested that it is doing. It intends to award 2mm shares of a new company, BioAdaptives, to common holders (he knows how worthless it is and opted not to award it to preferred holders). This is a joke and a bad one at that. The company recognized the majority of its revenue in H1 through the receipt of stock as part of a license agreement with CleanPath Resources (OTC:CLNP), and it is dumping these essentially worthless shares into BioAdaptives. In doing so, it appears that the company is attempting to preserve this income it already recognized. The Q3 OTC disclosure statement lists the 200mm shares as being carried at $240K, down from where it valued it previously (and now worth just $120K), but there was no adjustment to its sales or earnings. Most investors have already figured out that HEMP is not what they thought, and the stock has declined by more than 50%. I expect that the stock will trade below $0.01 and believe it to be worth no more than $0.003, which is based on the value of its domain name.
I haven't written that much about MDBX, which captured attention with its brief catapult to $215 per share a year ago before returning to Earth. Investors need to be aware that the limited float at the time led to that spike, with very little volume actually traded (1400 shares total on 11/15/12). In fact, even today, almost 90% of the company is held by insiders. MDBX has filed an S-1 and is attempting to become an SEC-filer and offer 3mm shares between $16 and $20 (and 576K on behalf of selling shareholders). On page 45, the filing details that the CEO and the founder are each trying to sell 50K shares (and reveals the previous buyers of its restricted stock at $5). MDBX filed its Q3 OTC disclosure on 11/19, and anyone investing in the company should be concerned with the poor fundamentals, which include 1.4mm in negative operating cash flow year-to-date. There are also disclosures that 2 of the 3 recent acquisitions failed to close and are in litigation. The deal that closed (Vaporfection) strikes me as odd, as it got MDBX into a business that seems inconsistent with the core strategy of working with dispensaries (Vaporfection makes hand-held vaporizer devices). Litigation is a big issue for MDBX, and I am aware of a suit that it filed prior to its Q3 disclosure document that isn't mentioned. I also understand that it is involved in litigation with Autospense, which dates back to 2012 but isn't updated in its disclosures. The company has been selling restricted stock at $5 (331K shares from 1/1/13 to 7/11/13), but the pace increased recently. In Q3, the company sold 770,050 shares for $3.748mm. This seems like a larger-than-normal discount to the market price and is a red flag. I leave readers with one final consideration: Southern Investigative Research Foundation shared a very unflattering look at the founder of Medbox, Vincent Mehdizadeh, who currently serves as COO and pocketed $231K or almost 5% of sales through Q3 for providing consulting services.
MJNA, which had not yet released its press release when I wrote about some serious additional challenges that have arisen, finally posted it on 11/21, and it did little to alleviate my concerns. In fact, as I describe here, I am now expecting the stock to trade to $0.05. I also posted a video that describes a chart that is breaking down. Note that CANV has already sold 1.2mm shares (of up to 10mm) at $1, the dilution of MJNA's stake is happening. For the past two months, I have been trying to weigh what I perceive as improving fundamentals against continued transparency issues. It appears that MJNA has been benefiting from increasing demand for the products it distributes for CANV, but there are some concerns that there may be a quality issue. MJNA can ill afford any question about its products, yet Tamar Wise, the former Head of Science at Dixie Botanicals (part of its subsidiary Red Dice Holdings), is in the process of sharing her concerns about the safety of its hemp oil. As states legalize hemp and the supply becomes both more abundant and easier to obtain, I expect that its supplier, CANV (and, consequently, MJNA), will face competition, as there are no patents on the processes used to create the high-CBD hemp oil. MJNA, with its maxed-out share-count, poor cash flow, illiquid assets and now questions about the quality of its products, is not worth the risk, especially considering the SEC inquiry that it continues to disclose.
Why Growlife and GW Pharma are Attracting Investors
Two months ago, I discussed a divergence in the sector, pointing to:
As you will see, the sector doesn't move in lock-step. I think that we should expect more divergences. Many of the early investors bet on concepts or perhaps just names. There wasn't much research, and there certainly hasn't been much from the publicly-traded universe in terms of revenues or especially cash flow generation. I believe that we are moving from the "rising tide" mentality, which crushed traders and investors who didn't exit during the post-election bubble that popped in February, to a more thoughtful approach.
In that review of the sector, I called out GWPH and PHOT as poised to best capitalize on the favorable industry trends. Since then, both companies have performed very well, with GWPH more than doubling while PHOT has advanced by about 60%. PHOT is an SEC filer, while UK-based GWPH trades on the NASDAQ (please see my recent write-up for a deeper discussion of the risks and opportunities). As I described, the company is a pure-play on medical cannabis, with two different Phase 3 programs in the U.S. for Sativex and an exciting childhood epilepsy trial.
PHOT continues to impress me. The company participated with me in a live interview on iCannabisRadio on 11/18. They answered my questions as well as many from the public. It was refreshing to see a penny stock company make this kind of effort. The 100-minute event gave investors and potential investors a great look at the leadership of the company, which not only spoke about the potential but also addressed some challenges and recent short-comings. Unfortunately, PHOT was unable to share details on what I believe may be the most exciting announcement in the industry thus far. On 11/21, the company announced that it had entered a joint venture that will allow it to access at least $40mm of capital to fund its new "GIFT" program. The details were released in an 8-K exhibit. One that I think the market hasn't yet figured out is that the JV has the right to appoint directors to the board. My understanding is that these will be successful business people with Fortune 1000 experience, a considerable accomplishment if this comes to fruition. PHOT is a "picks and shovels" play that is poised to benefit from both medical and legal cannabis, and it is evolving from an equipment supplier to a partner to growers and even dispensaries (through the recently announced GrowLife Financial).
Of course, these two companies are quite risky, but they stand out from the rest of the group. At 420 Investor, I include them with just a few others that should be considered for investment. I have shared one-year targets with my subscribers, both of which exceed the current quoted price.
One of the key points that I have been trying to convey is that the few public companies today are just a small part of what will be a large and growing industry. This is fortunate for investors, as I would suspect that many if not most of the stocks in the sector will not ever succeed. My expectation is that investors won't have such a bad list from which to select if they want to invest in the sector.
In the last few months, there have several new entrants that I have shared previously, including MCIG, which I like, CANN, which I am trying to understand better (they intend to buy real estate and lease to cannabis growers in Colorado), Puget Technologies (OTC:PUGE) and Medical Cannabis Payment Solutions (OTC:REFG), which advertises its stock on the radio and has apparently set up a fake research site to promote it stock. Recently, Plandai Biotechnology (OTC:PLPL) announced that it is pursuing cannabis extraction. Note that this is just one more red flag in my opinion for this company which I described in detail in September.
So, not every new entrant merits attention, but I am optimistic that 2014 could be a great year for new opportunities. I base this not only on the information I am receiving from those considering entering the public markets but also information in the public domain. California-based analytical lab Steep Hill Halent suggested that they might become traded publicly within the next three months. This is an easy-to-understand business and one that could proliferate as legal marijuana hits the market.
The opportunities available to individual investors in the stock market continue to lag the promise of the proliferation of medical marijuana and the expansion of legal cannabis. Investors have been burned by the hype earlier this year as well as a lack of rigorous focus on some of the companies in the sector. The current group of stocks includes just a few that are worth considering, but the likelihood is that better options will exist in the near future.
Additional disclosure: I currently include PHOT and TRTC in my "Flying High" trade alert service at 420 Investor.