Growlife - It's All Smoke And Mirrors: Research Uncovers Why Shares Are Overhyped And Overvalued

| About: Growlife Inc. (PHOT)

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I've been investing for many years and thought I've seen it all, but Growlife Inc. (OTCPK:PHOT) is one of the most unbelievable situations I've come across in my career. I've spent the past few weeks digging into their corporate structure and public filings and my findings definitely aren't pretty. Growlife management has worked hard over the past few months to complicate their corporate structure via new entities, partnerships, and joint ventures that dramatically take advantage of Growlife's shareholders. I'll explain how management is transferring huge amounts of shareholder value (via massive stock and warrant grants) from Growlife shareholders to newly formed partnerships with CANX, CEN (OTC:FITX) and RXNB. After the hype subsides and value transfer/dilution is complete, Growlife shareholders will be left with a stock worth around $0.03 per share, 92% below the current share price.

Before Growlife started striking deals in late 2013, their shares were trading around $0.04 per share. Their fully diluted share count (common shares, warrants and convertible debt) was around 859m with very little cash or debt on the balance sheet. Therefore, Growlife was being valued at approximately $34m and had a stagnant business which generated about $4m of sales. Even then one could argue the company was way overvalued. They were losing money every quarter, burning the little cash they had, and still valued at almost 8.5x revenues - a multiple similar to hyper-growth industry leading technology and social media companies. Today, the market cap of Growlife is $335m, and that's before huge amounts of upcoming dilution (discussed below).

On November 17th, management inked a Joint Venture Agreement [JV] with CANX. The structure of the deal is mind blowing:

  1. What is CANX? - good question. No one seems to know much, including the investor relations consultant for Growlife who we talked to twice. He didn't know the ownership structure of the entity. His only comment was that "the structure is complicated". What we do know is that CANX is a newly formed entity in Nevada with no assets and no revenues.
  2. What is the deal structure? - the entity will house their OGI joint-venture which will be 45% owned by Growlife and 55% owned by other CANX partners who remain undisclosed. CANX will provide an initial $1.3m of growth capital and has agreed to provide additional funding under a 7% Convertible Note.
  3. There are 4 warrant traunches associated with the CANX transaction:
  • Traunch I: In return for closing the $1.3m convertible note, Growlife gave CANX 140m warrants at a maximum price of $0.033. Now, why would it make any sense to issue freely tradable warrants at $0.033 when your stock was trading at $0.09? Essentially, CANX loaned Growlife $1.3m and in return gets 7% interest on their loan and received $13m in warrants that can be exercised immediately. Now, one has to wonder why they'd price the warrants so far under the current stock market price and why on earth they'd give someone $13m in stock in return for a $1.3m loan. At today's share price of $0.39, those warrants are worth $55m. CANX loaned Growlife $1.3m and in return will be selling $55m of warrants. You can bet that this is all coming at the expense of Growlife shareholders and whoever the undisclosed CANX partners are will reap all the profits. What makes it even better is the disclosure in the 8k filed on November 19th, 2013, stating how CANX can sell shares immediately and short Growlife's stock at any time: "Acknowledgement Regarding CANX's Trading Activity. Anything in this Agreement or elsewhere herein to the contrary notwithstanding, it is understood and acknowledged by GrowLife that: (NYSE:I) none of CANX has been asked by GrowLife to agree, nor has CANX agreed, to desist from purchasing or selling, long and/or short, securities of GrowLife, or "derivative" securities based on securities issued by GrowLife or to hold the Securities for any specified term; (ii) past or future open market or other transactions by CANX, specifically including, without limitation, short sales or "derivative" transactions, before or after the effective date of this Agreement of this or future private placement transactions, may negatively impact the market price of GrowLife's publicly- traded securities; (NASDAQ:III) CANX, and counter- parties in "derivative" transactions to which CANX is a party, directly or indirectly, presently may have a "short" position in the Common Stock, and (iv) CANX shall not be deemed to have any affiliation with or control over any arm's length counter- party in any "derivative" transaction. GrowLife further understands and acknowledges that (NYSE:Y) CANX may engage in hedging activities at various times during the period that the Securities are outstanding, including, without limitation, during the periods that the value of the Warrant Shares deliverable with respect to Securities are being determined, and (NASDAQ:Z) such hedging activities (if any) could reduce the value of the existing stockholders' equity interests in GrowLife at and after the time that the hedging activities are being conducted. GrowLife acknowledges that such aforementioned hedging activities do not constitute a breach of any of the Transaction Documents."
  • Traunch II: Upon completion of Growlife's authorized share count increase (shareholders will vote this Friday at the annual meeting to increase authorized shares from 1 billion to 3 billion), CANX will be given another 100m warrants at the same $0.033 strike price. At $0.39/sh, Growlife will be giving CANX $39m of stock for absolutely nothing in return. You have to admit that's a pretty neat trick. So, now between Traunches I and II, Growlife has essentially given away $52m of stock ($94m of stock at the current share price) in return for a $1.3m loan. Do you now understand why it would make sense for Growlife and CANX members to do everything possible to artificially inflate their share price? Only based on Traunches I & II, every $0.01/sh increase in Growlife's share price = $2.5m of additional profit for CANX.
  • Traunch III: Every $1m of additional capital loaned to Growlife (up to $20m) will each trigger another 10m warrant grant to CANX (at the same $0.033 strike price). At $0.39/sh, Growlife will be giving $3.9m in stock to CANX in return for a $1m loan. Obviously that math doesn't work. It's the Growlife shareholders that are once again being taken advantage of through excessive dilution, while the CANX entity cashes in.
  • Traunch IV: If the OGI joint venture achieves $80m in revenues or completes $40m in acquisitions, then Growlife has to give CANX warrants equal to 49% of their entire company. Assuming the FITX and RXNB deals move forward, that would mean that Growlife would have to give CANX around an additional 790 million warrants at a cost of $0.033/sh. When all is said and done, Growlife will have issued CANX 1.23 billion warrants at $0.033/sh and if all those warrants are exercised it would provide Growlife with only $40.6m of warrant income. Essentially, Growlife will be giving away half their company for only $40.6m. Growlife's management themselves are valuing their company at approximately $83 million based on their CANX contract. With a fully diluted share count of 2.58 billion shares after their CANX, FITX, and RXNB deals are fully executed, that leaves an equity value of $0.03 per share (92% below the current share price).

Now let's review Growlife's joint venture with RXNB:

  1. RXNB deal: Growlife owns 45% of OGI, while OGI owns 40% of RXNB. Therefore Growlife owns 18% of RXNB. In return for the 18% stake, Growlife will issue RXNB 265m shares at a cost of $0.17 per share. OGI guarantees that the Sellers will receive in the aggregate not less than $18m within nine months from January 24, 2014 or upon the Sellers' liquidation of the RXNB Payment Shares, whichever is sooner.
  2. Why is Growlife issuing $45m of stock ($103m of stock at today's share price) for an 18% stake in a company that supposedly generates $27m of sales? That would value RXNB at $250m, or about 10x my estimate of the company's actual worth. Yet another example of Growlife destroying shareholder value in order to grow revenues, and also another example of why Growlife needs to keep their share price propped up as long as possible before its ultimate collapse.
  3. Try searching for RXNB on the internet. It's nowhere to be found - hard to believe for a company that supposedly generates $27m in sales.

Now, let's review their joint venture with CEN Biotech:

  1. CEN Biotech deal: Growlife owns 45% of OGI, while OGI owns 25% of CEN (owned by FITX). Therefore Growlife owns 11.25% of CEN. In return for the 11% stake, Growlife will issue CEN 235m shares at a cost of $0.17 per share.
  2. Once again, why is Growlife issuing $40m of stock ($92m of stock at today's share price) for an 11% stake in a company that generates $2m of sales? That would value CEN at $356m, or about 100x my estimate of the company's actual worth. CEN's 85,000 square foot grow facility may or may not get approval and be constructed. Either way, its value is a small fraction of the valuation Growlife is placing on the company via their share issuance.

Now, let's value the company using a sum-of-parts approach, not even including the upcoming share and warrant dilution. It assumes a 20% return on their $40m financing package:

Finally, let's also look at the fund raising the company has done in the past, before the industry hype. There were 10 equity raises at an average cost of $0.03/sh:

Do you see the trend here? Growlife will increase revenues if their joint ventures move forward, but absolutely no equity value will be generated for the Growlife shareholders. Instead, their partners will reap all the profits of selling low cost Growlife shares and warrants, while Growlife shareholders face a near endless cycle of dilution. When the music stops, I expect the majority of Growlife's stock value to vaporize.

Disclosure: I am short PHOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.