Is CannaVest's Sky-High Valuation Justified?

| About: CV Sciences, (CVSI)

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On February 12, 2013, when CannaVest, Inc (CANV) closed at $4.60 on nine hundred (900) shares traded, its market capitalization was $32.2 million. Less than one year later, on January 24, 2014, the stock closed at $85.55 on 24,455 shares. Its market cap at the close was an estimated $1.2 billion. Is this 37-fold increase in CANV's market cap justified? In this writer's opinion, it is not.

CannaVest filed an 8-K on February 12, 2013, announcing that it had acquired from Medical Marijuana, Inc (OTCPK:MJNA) the license rights to the name Phytosphere, along with certain assets. The $35 million cost of the acquisition was to be made in five installments that were payable in cash, shares, or any combination thereof. Any payment made with shares would be "collared" at a price no more than $6.00 per share, nor less than $4.50 per share.

With this acquisition, CannaVest described itself as being in "... the business of developing, producing, marketing and selling end-consumer products containing industrial hemp-based compounds with a focus on cannabidiol [CBD]." Note that CANV is not involved with marijuana or products that contain THC.

Cannabidiol is the non-psychoactive chemical found in both marijuana and industrial hemp, and appears to have several wellness benefits, and is being studied by the pharmaceutical industry for a variety of therapeutic uses, including treatment of pediatric epilepsy.

If the industrial hemp, which contains little of the federally-illegal THC found in marijuana, is grown overseas and the CBD is extracted outside the United States, then that CBD may be imported into the U.S. and legally sold in nearly every state (there is a gray area in a few states involving extracted oils from any type of Cannabis plant).

CannaVest's Phytosphere company arranges to grow and process the industrial hemp overseas and imports the raw hemp paste, which is then refined to a CBD-rich oil that is used by CannaVest's other portfolio companies to make retail-ready products, such as Cibdex tinctures, Real Scientific Hemp Oil, and Cibaderm personal care products. It also sells refined hemp oil directly to other manufacturers.

In July, 2013, CannaVest and HempMedsPX, a portfolio company of Medical Marijuana, Inc., signed a distribution agreement that gave HempMedsPX exclusive license to sell CANV's products on the web, and non-exclusive license to distribute products in the brick-and-mortar world. Since then, CannaVest has not announced any new distributors or direct sales to any retailers, large or small.

On Wednesday, January 22, 2014, Medical Marijuana, Inc. announced preliminary results for the fourth quarter of 2013. In its press release, MJNA declared product sales through its HempMedsPX portfolio company of $1.31 million, an increase of $1.06 million from the third quarter's $249 thousand in revenue.

If HempMedsPX generated $1.31M of sales in 4Q/13, then how much product did CANV ship to its distributor, and potentially how much refined oil did it ship to third-party manufacturers? In 3Q/13, HempMedsPX achieved revenues of approximately $249 thousand, as reported on page 10 of MJNA's quarterly filing. For that same quarter, CANV reported revenues of roughly $164 thousand, which for now, we'll assume were products shipped to HempMedsPX. Running the numbers gives us about a 50% markup at the distributor, so the $1.31M of product that HempMedsPX shipped probably cost them about $900 thousand.

Let's be generous, and call that $1M of finished goods shipped by CannaVest to HempMedsPX. Furthermore, we'll give them another $200 thousand of refined oil that could have been shipped to third-party companies, for a total of $1.2 million. Since their gross margin in the third quarter was about 70%, we'll do the same for the fourth, leaving gross profits of $840 thousand.

CannaVest's General and Administrative expenses in 3Q/13 were $1.1 million, and interest expenses added another $134 thousand. The fourth quarter expenses are likely similar, so odds are, CANV will show a small loss in Q4.

In the 10-Q for 3Q/13, CannaVest declared it had 11.7 million issued and outstanding shares. Since then, it has sold an additional 1.2M restricted common shares out of a planned 10 million, for $1 per share. On December 31, 2013, MJNA was due to receive up to an additional 1.08 million shares as the final payment for the Phytosphere assets, which is also described in the 3Q/13 10-Q, on page 13. Therefore, there should now be approximately 14M outstanding shares.

Using the $85.55 closing price from January 24, 2014, along with the estimated 14M outstanding shares, CANV's market cap is now approximately $1.2 billion, on estimated fourth quarter revenue of $1.2 million. This appears to be an extreme valuation for the stock.

One possible reason for the lofty share price, beyond enthusiasm for the potential of cannabidiol, is that there may be very few available shares to trade.

In November, 2012, a buyers group consisting of Mai Dun Limited, LLC, Mercia Holdings, LLC, General Hemp, LLC and Bamburgh Holdings, LLC acquired 6,979,900 shares of Foreclosure Solutions, Inc, a development stage company which had no revenue in 2011 or 2012 and very little assets. Within a few months, the name was changed to CannaVest, and the present business model adopted.

At the time, there were 7 million outstanding shares, and with 97.7% of the shares in the hands of the buyers group, that left approximately 20 thousand shares in the open market. According to the DEF 14A filing of June 24, 2013, as of May 31, 2013, the beneficial ownership of directors, officers and 5% shareholders totaled 5,723,518 shares. As none of those beneficial owners have filed forms indicating that they have sold shares, and since all of the shares issued since January 1, 2013 have been restricted shares, there is likely less than 1.3 million trading shares on the open market.

It could even be less than that, because since February 12, 2013, the total number of CANV shares traded as of January 24, 2014 is less than 240 thousand, and 82% of those have traded since December 1, 2013.

It's possible that a Herculean effort by HempMedsPX, along with some direct sales opportunities in 2014, could result in CannaVest achieving several tens of millions of sales this fiscal year, but at the current stock price and number of outstanding shares, CANV would have to see net profits in 2014 of $30M to bring the forward price-earnings ratio below 40.

A further complication is that in addition to the 8.8 million restricted shares still being offered to accredited investors for $1 per share, the third quarter 10-Q also discussed the probable conversion of a $6M loan from Roen Ventures at a conversion price of $0.60, which will add another 10M shares, for a possible total of 33 million shares.

In my opinion, CANV is extremely overvalued, barring some fantastic guidance from management when CannaVest files its 10-K, which is due in late March.

CANV could be a good shorting opportunity, if one has the stomach for it, but the (currently) small number of trading shares leaves the potential for a serious short squeeze.

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.