Investors in industries deemed popular or in vogue by the general public have a propensity to engage in folly often resulting in the manifestation of valuation bubbles for the pioneering companies. As the great Charles Mackay wrote in 1841: "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." Nearly 200 years later, these words are still relevant as even nowadays men find it difficult to act against the herd while the herd goes mad.
Infitialis is a research collective that exposes fraud and folly in an effort to identify bubbles before they implode. In this report, we will be exposing folly on the scale of our prior exposés on NASDAQ listed firms such as The Tile Shop and Mellanox and prior fraud report on Medical Marijuana Inc. (OTCPK:MJNA). Purportedly operating in the same sector as MJNA, GW Pharmaceuticals, Inc. (NASDAQ:GWPH) appears massively over-valued and presents a clear and present risk to long investors.
- Marijuana Hype Overplayed: GW Pharmaceuticals will derive no benefit from the nascent retail marijuana market opportunity in Colorado, Washington, and other legalizing states.
- Corrupted Research: The purported "research literature" regarding marijuana plant-derived cannabidiol (CBD) use in pediatric treatment-resistant epilepsy seems especially dubious because GW Pharmaceuticals has corrupted the objectivity of the authors by being their financial backers; it has failed to disclose this critical fact in SEC filings or investor materials.
- Limited Intellectual Property & Pricing Power: Because GW Pharmaceuticals' main products are natural plant-derived extracts, they cannot be patented and there are basically no barriers to other firms extracting and selling the same biologicals. For example, just because orange juice is demonstrated to provide a health benefit doesn't mean that a company can earn outsized returns by selling concentrated Vitamin C.
- Ridiculous Market Valuation: As of yesterday's close of $57.44/ADS, GW Pharmaceuticals is currently trading at a market capitalization of $1,098.5m, for a shocking valuation of 19.6x LTM revenue and 18.5x P/B despite barely being break-even on an operating cash flow basis since its reverse-merger formation in 2001.
- Backdoor Listing onto NASDAQ: After completing a reverse-merger listing in 2001 to the London AIM exchange (equivalent to U.S. OTC market listing), GW Pharmaceuticals listed its American Depository Shares (ADS) on the NASDAQ on 05/01/13 as an "emerging growth company" under the relaxed regulatory requirements of the JOBS Act at only $8.90/ADS.
- Massive Shareholder Dilution: GW Pharmaceuticals has been a serial issuer of equity, massively diluting its common shareholders since its listing without significant technological advancement or technology monetization. For example, GW Pharmaceuticals sold a 5.8% stake in the Company for $11.2mm in 2009 ($193mm implied enterprise valuation) to a private equity firm with a history of backing some rather dubious biotech offerings.
- Egregious Insider Compensation: Annual management compensation has generally exceeded annual operating income since the reverse-merger formation in 2001. Moreover, while public shareholders have been significantly diluted over GW Pharmaceuticals' history as a public company, management and insider compensation has increased 205.9%.
- Preposterous Sell-Side Analyst Cheerleading: Underwriters of GW Pharmaceuticals' numerous equity market issuances have been relentless cheerleaders of the "story" since the single digit listing of the ADS last summer. As the ADS price has rocketed up 545% over the last 9 months since listing on the NASDAQ, the sell-side analysts have continually raised their price targets as prior estimates were blown through and utilized "goal-seek" financial models to justify their current estimates. Utilizing more realistic valuation assumptions, GW Pharmaceuticals' intrinsic value appears to be in the teens per ADS even in the unlikely upside case the proposed Epidiolex epilepsy treatment is a blockbusters success.
Long investors in GW Pharmaceuticals should immediately consider reducing the position as public dissemination of these significant concerns will likely lead to a massive correction in the Company's share price. Speculative investors should consider a short position in GW Pharmaceuticals as it appears massively overvalued on a fundamental basis at 19.6x LTM revenue and 18.5x P/B and the additional issues uncovered in this report will likely accelerate a significant pricing correction.
GW Pharmaceuticals Introduction
Founded in 1998 by current Chairman Dr. Geoffrey Guy to monetize a product portfolio of cannabinoid prescription medicines to meet patient needs under medical supervision, GW Pharmaceuticals has purportedly assembled a large in-house team with extensive experience in developing cannabinoids, medicines containing controlled substances, as well as plant-based prescription pharmaceutical products.
GW's lead product, Sativex is now approved or recommended for approval in 24 minor countries, such as Norway, Israel, and Austria. It is indicated as a treatment for symptom improvement in patients with moderate to severe spasticity due to multiple sclerosis (MS) that have not responded adequately to other anti-spasticity medication. GW has now entered into five separate licensing agreements for Sativex with Bayer HealthCare in the UK and Canada; Almirall in Europe and Mexico; Otsuka Pharmaceutical Co. Ltd. in the United States; Novartis in the Middle East, Africa, and Asia; and Neopharm in Israel. Over the ~10-year history of Sativex production, GW has generally been operating at a cash flow loss due to limited sales of the product and expensive ongoing operating costs for the corporate entity.
GW's other products, Epidiolex and the GWP4200x derivatives are seen by many long investors as providing upside opportunities and are currently beginning Phase III and II programs, respectively, for the potential treatment of Dravet Syndrome, a form of epilepsy particularly resistant to traditional pharmaceutical treatment regimes, and other ailments.
Marijuana Hype Overplayed
GW Pharmaceuticals' sole business model is the monetization of a product portfolio of cannabinoid prescription medicines to meet patient needs under direct medical supervision. The Company will derive no benefit from the nascent retail marijuana market opportunity in Colorado, Washington, and other legalizing states. As an analogy, after the repeal of Prohibition in 1933, the businesses that prospered were the ex-bootlegger brewers such as Anheuser-Busch, not a pharmaceutical firm that was attempting to study the medical benefits of a daily glass of wine in the prevention of cardiac disease.
Next, it is important to understand that medical research into potential uses of marijuana-derived cannabidiols has been ongoing for hundreds of years and has yet to be successfully monetized on a pharmaceutical scale. This makes it even harder to believe that a UK reverse-merger pharmaceutical company with a limited scientific track record will be able to successfully develop and monetize novel uses of marijuana. Simply put, GW Pharmaceuticals' research efforts show nothing new or special to warrant such a premium market valuation. For example, in 1842, Dr. William Brooke O'Shaughnessy, a Professor of Chemistry in the Medical College of Calcutta, published a paper describing the uses of marijuana to reduce infantile convulsions, hydrophobia, masseter spasm, and other afflictions. More recently, there have been four limited control independent trials to study the use of marijuana plant-derived cannabidiol for the treatment of drug-resistant epilepsy.
Notably, the two most recent controlled independent trials to study the use of marijuana plant-derived cannabidiol for the treatment of drug-resistant epilepsy showed NO difference in treatment efficacy between the CBD and placebo (sugar-pill) patients. Moreover, in the Ames trial, several of the CBD-treated patients suffered from adverse drowsiness (being stoned) that would prevent them from functioning normally on a daily basis, which further calls into question the viability of this purported potential treatment option. Finally, Dr. Orrin Devinksy, Chairman of the NYU Epilepsy Center and leader in the study of cannabidiols, recently wrote an Op-ed in the NY Times that cautioned about the risk of serious psychiatric disorders and long-term cognitive problems associated with marijuana treatments in children.
Corrupted Research and Pseudo-Science
The purported "research literature" regarding marijuana plant-derived cannabidiol use in pediatric treatment-resistant epilepsy touted by the Company seems especially dubious because GW Pharmaceuticals funded the researcher, yet failed to disclose its financial interest in the study in its SEC filings or investor materials. Unlike previous placebo-controlled trials, the recent December 2013 article in The Journal of Epilepsy and Behavior was solely a 19-patient survey of parents belonging to a Facebook group dedicated to sharing information about the cannabidiol-enriched cannabis artisanal treatments for their child's seizures. Simply put, it is hard to imagine a purported research project constructing a more biased self-selected sample set (with a complete lack of placebo control group). Even worse, buried in the Acknowledgements section on the last page of the journal, it is disclosed that Dr. Catherine Jacobson, the corresponding author for the article, is actually funded by GW Pharmaceuticals, which presents a massive conflict of interest, and the disclosure fails to mention GW's sole business is the production of marijuana plant-derived cannabidiols. It is shocking investors have been hoodwinked by such flimsy pseudo-science regarding Epidiolex's potential.
Limited Intellectual Property Results in No Pricing Power
Because GW Pharmaceuticals' main products are derived from a natural plant extract, it cannot patent its products and there are basically no barriers to other firms extracting and selling the same biologicals. For example, just because orange juice is demonstrated to provide health a benefit doesn't mean that a company can earn outsized returns by selling concentrated Vitamin C. For a CBD-based treatment regimen such as Epidiolex, all which is required for production is low-THC variety marijuana, developed via traditional horticultural crossbreeding, and some simple drying, crushing, and centrifugal separation equipment.
Setting aside the current lack of robust scientific evidence that marijuana plant-derived cannabidiols are actually an effective alternative cure for pediatric treatment-resistant epilepsy (or better than a placebo treatment), if the products are ever developed for commercial treatments (no earlier than 2018 as per most sell-side analysts), it appears GW Pharmaceuticals will have limited pricing power because of the complete lack of barriers to entry in the sector. In the unlikely event that Epidiolex successfully completes a Phase III trial by 2018 and launches for prescription usage, numerous other generic producers could promptly start selling the same biologicals and undercutting GW's pricing. In addition, a variety of other biotechnology firms, such as Cara Therapeutics, Inc. (NASDAQ: CARA) have filed for intellectual property protection of their purported cannabinoid breakthroughs, so GW Pharmaceuticals' may be accused of infringing on other firms' intellectual property as it attempts to distribute Sativex and Epidiolex in the United States.
As Dr. Sanjay Gupta discussed in the recent "Weed" special report on CNN, some parents are utilizing a variety of non-approved and non-standardized "artisanal" CBD preparations to purportedly control their children's drug resistant seizures, despite a lack of robust scientific evidence these treatments are more efficient than a placebo and without fully understanding the risks of serious psychiatric disorders and long-term cognitive problems associated with marijuana treatments in children. For example, Ms. Paige Figi, a housewife with no prior scientific background, currently artisanally produces marijuana-derived CBD extract for her daughter Charlotte at a cost of less than $800/month. Shockingly, the current product production competition for a $1bn market capitalization pharmaceutical company is a hippy housewife working out of her kitchen in Colorado.
With cost control and corresponding changes in treatment reimbursements as the mantra of the healthcare industry after the passage of the Affordable Care Act, it seems exceedingly difficult to believe GW Pharmaceuticals will ever be able to charge >$70k per patient for CBD-derived Epidiolex and capture prescriptions for >9k patients in the United States and a similar number abroad as currently estimated by sell-side equity analysts.
This financial model by an underwriter of GW Pharmaceutical's prolific equity market issuances seems to be a prime example of "goal-seek" financial modeling where a sell-side financial analyst is forced to enter more and more ridiculous assumptions into excel in an attempt to justify the current market price of the Company's ADS. For example, Infitialis challenges this sell-side analyst to rationalize their forecast for a massive increase in the Epidiolex retail price from $40/k per patient per year in 2018 to $76k just four years later in 2022. In the unlikely event Epidiolex completes a successful Phase III trial, it seems likely United Health, CIGNA, and WellPoint would do everything in their oligopolistic power to avoid paying for marijuana prescriptions at this price point.
Ridiculous Market Valuation
Even accepting the preposterous sell-side financial model assumptions presented on the previous page at face value, GW Pharmaceuticals currently trades at a rich 2.2x FY2020 revenue potential and is expected to be EBITDA negative through at least 2017, and this excludes significant continued shareholder dilution that would occur between now and 2020 and the substantial risk that the Epidiolex Phase III trial will not produce statistically significant proof of the efficacy of the treatment, especially relative to placebo treatments, which have an effective cost of $0.00/patient. As of yesterday's close of $57.44/ADS, GW Pharmaceuticals is currently trading at a market capitalization of $1,098.5mm, for a shocking valuation of 19.6x LTM revenue and 18.5x P/B despite barely being break-even on an operating cash flow basis since its reverse-merger formation in 2001. Moreover, the Company's market valuation has increased 545% since listing of the ADS on the NASDAQ just 9 months ago.
Additionally, even summing up all the potential milestone payments from commercial partnership agreements for Sativex, it is only ~$330mm in cumulative total, before further research and development costs, corporate costs, taxes, and with significant time delay and execution risk. It is shocking that GW's current market capitalization is more than 3x these potential milestone payments.
Backdoor Listing onto NASDAQ
Because it would have never passed the due-diligence process of a traditional IPO process underwritten by a respectable underwriter, GW Pharmaceuticals listed on the Alternative Investment Market ("AIM") in London in 2001 via a reverse-merger with an existing shell company. The AIM market is analogous to the OTC market in the United States because it allows smaller companies to float shares with a "more flexible" regulatory system than the main London Stock Exchange market. Specifically, the AIM has reduced disclosure requirements relative to main LSE market, has no requirements for capitalization or shares issued, and an option for issuers to exempt out of regulatory requirements by simply notifying the exchange why it has declined to comply. In March 2007, U.S. SEC regulator Mr. Roel Campos expressed concerns regarding AIM's rules for share trading and stated "I'm concerned that 30% of issuers that list on AIM are gone in a year. That feels like a casino to me and I believe that investors will treat it as such." In addition, AIM has been critiqued for allowing the listing of abject frauds on its exchange, such as the USD$750mm collapse of Langbar International, which was subsequently found to possess none of the assets declared at original listing.
After completing its 2001 reverse-merger AIM listing, GW Pharmaceuticals listed its American Depository Shares on the NASDAQ exchange on 05/01/13 as an "emerging growth company" under the relaxed regulatory requirements of the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act") at only $8.90/ADS. The irony of a UK weed company selling equity to its former colonists under a regulatory framework designed to increase domestic employment would be a humorous anecdote if it did not present such a clear and present danger to investors. Since completing its ADS listing, GW benefited as investors bid up its limited float and then the Company raised an additional $101.1mm on 01/14/14 at $36.00/ADS, despite already having $58.5m in cash as of 12/31/13.
Massive Shareholder Dilution
GW Pharmaceuticals has been a serial issuer of equity, massively diluting its common shareholders without significant technological advancement since its reverse-merger listing on the London AIM exchange in 2001. In addition to secondary offerings, GW Pharmaceuticals has generously distributed stock options, warrants, and other equity-linked compensation to insiders since going public to the dilutive determinant of public investors.
As a result of these multiple equity issuances since GW Pharmaceuticals' reverse-merger listing on the London AIM exchange in 2001, common shares outstanding have increased 139.8% despite limited scientific advancement and de minimis monetization of the existing product portfolio. This poor capital planning has been highly dilutive to existing shareholders and illustrates the management team's history of poor capital allocation decisions.
In 2009, after several years of Sativex sales and with basically the same product portfolio as currently under development, GW Pharmaceuticals sold a 5.8% stake in the Company for $11.2mm for an implied enterprise valuation of $193mm to Great Point Partners, LLC, a U.S. private equity firm, in an equity and warrants transaction structured by the infamous underwriters at Rodman & Renshaw, LLC. First, Great Point Partners, LLC appears to have a history of backing some rather dubious biotech offerings, such as Biodel, Inc. (NASDAQ:BIOD), which went from near triple digits to single digits in less than 18 months from its IPO in 2007. Great Point Partners had Board of Directors representation in Biodel and owned 13.7% of the shares outstanding prior to the firm's public offering. Next, Rodman & Renshaw, LLC, the underwriter of the transaction, filed for liquidation on 09/12/12 following the collapse of a disturbing number of its issuer clients under allegations of accounting irregularities, embezzlement, and fraud. It appears quite curious that Rodman & Renshaw's only AIM underwritten offering was for GW Pharmaceuticals.
More recently, on 01/16/14, Great Point elected to exercise 50% of the warrants issued to the firm in August 2009 for a strike of 0.1p each. The exercise of these warrants further diluted common shareholders by 1,888,480 new ordinary shares and came at a significantly higher valuation than that which Great Point Partners had originally bought in. Finally, Great Point Partners, LLC now has August of this year to exercise its remaining outstanding warrants for the issuance of an additional 1,888,480 new ordinary shares for a strike of 0.1p each. Based on Great Point Partners' prior presciently timed moves of selling out at the top, this seems to be further indication that GW Pharmaceuticals' market valuation has reached its apex.
Egregious Executive Compensation
GW Pharmaceuticals' annual management compensation has generally exceeded annual operating income since its reverse-merger formation in 2001. Despite producing Sativex for ~10 years, GW Pharmaceuticals has consistently been free cash flow negative and continued to accrue operating income losses. Finally, while public shareholders have been diluted 139.8% over GW Pharmaceuticals' history as a public company, management and insider compensation has increased 205.9% during the same period.
Preposterous Sell-Side Analyst Cheerleading
Underwriters of GW Pharmaceuticals' numerous equity market issuances have been relentless cheerleaders of the "story" since the single digit listing of the ADS last summer. As the ADS price has rocketed up 545% over the last 9 months, the sell-side analysts have continually raised their price targets as prior estimates were blown through and utilized "goal-seek" financial models to justify their current estimates.
For any pharmaceutical company at this stage of its development and with such a limited product portfolio and revenue potential, it is difficult to imagine it having a market cap of greater than $100mm. However, "reefer madness" and a lack of understanding regarding the business model seems to have compelled the equity markets to bid up GW Pharmaceuticals to a significant multiple of its intrinsic value.
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Unlike the preposterous sell-side estimates presented above, utilizing more realistic valuation assumptions for GW Pharmaceuticals implies an intrinsic value in the teens even in the unlikely upside case the proposed Epidiolex epilepsy treatment is a blockbusters success. For example, a base case scenario at a 12% discount rate and utilizing the 19.1mm ADS currently outstanding under the treasury stock method for options/warrants/etc, GW Pharmaceuticals' intrinsic value is $14.75/ADS with a 50% probability of Epidiolex successfully being monetized by 2018.
In a bullish upside scenario with full credit for the Epidiolex revenue potential in 2018, the Company's intrinsic value is only $19.75/ADS. Conversely, under a bearish scenario where Epidiolex is not successfully monetized, GW Pharmaceuticals' other potential products in the development pipeline only represent $9.74/ADS of intrinsic value and only a slight premium to the recent May listing on NASDAQ at $8.90/ADS. Because of GW Pharmaceuticals' history of cash burn and poor allocation of capital funded by continued shareholder dilution, there seems to be significant downside between the current ADS market price and their fundamental intrinsic value.