Medical Marijuana, Inc. (OTCPK:MJNA) has been very quiet since I last shared an update in June. Since then, the stock shot up 45% to as high as $0.145 but has pulled back to the $0.12 area on rapidly thinning summer volume. It's not only the trading that has died down, as the company hasn't posted a press release in over a month. Despite the appearance that nothing is going on, the reality is that investors should be preparing themselves for several near-term drivers that could either help reaccelerate interest in the stock or lead to more of its shareholders throwing in the towel.
I start with the most obvious of the near-term events. A quarter ago, MJNA had already shared two press releases about the recently completed Q1 by April 11th. It's unclear why the company has changed its recent habit of sharing information in advance of the official disclosure, which is due for Q2 by August 15th. Hopefully the company won't wait until midnight PST again!
The key issues for the quarter in my view revolve around the recently launched CanChew CBD Gum product, which was delayed but did ship during Q2, its line of nutraceuticals (Dixie Botanicals) and a new product launch, Real Scientific Hemp Oil. Of course, the financials will also command a lot of attention. Q1 showed very poor cash flow generation on a sequential decline in sales and net income. The company has token cash balances (but no debt), no access to credit as of 3/31, very few remaining shares authorized but not issued (936mm out of 950mm authorized) and illiquid assets while at the same time disclosing that it needs capital to proceed on its growth initiatives.
Late in the quarter, the company used very heavy discounting on the gum, and it isn't clear that this was successful, as the discounts of 40% have persisted into Q3 (code = sm40). This is a unique, proprietary product, so recent results and expectations are important. The discounted price per stick of gum on the 32-stick package works out to about $2.62, including $8.95 shipping. For 96 sticks, the price per stick drops to $1.98, including delivery. At approximately 10mg per dose, this product, at the discounted price, is priced more attractively than its other products, including the new RSHO described below. Of course, bulls are looking forward to the day when it is selling the chewing gum to deliver THC.
Dixie Botanicals, which includes CBD delivered through capsules, topical balm or sublingual drops, has now been on the market long enough that the products need to be showing traction. The company has taken the approach of selling directly over the internet and hasn't added a substantial number of retail outlets, which I think would be a smarter strategy, especially if it could enlist a well-known retailer. According to its own website, only 25 of the more than 500 Colorado dispensaries that stock Dixie Elixirs & Edibles products, which is very low penetration. MJNA signed an agreement with a distributor earlier this year for Michigan and Kentucky, but its website doesn't reflect the addition yet of any retailers. My guess is that the cost is a major barrier.
After the quarter ended, MJNA began marketing RSHO, which is manufactured by CannaVest. This product is very different - a mega-dose of CBD. Sold in 1-gram syringes that contain 180mg per dose of CBD (so about 18X the amount in a stick of CanChew Gum), the product is very expensive. The website supporting the product suggests a 60-day regimen,which would cost $3600 at its current 40% discount. HempMedsRX, a subsidiary of MJNA, is also offering a smaller quantity that would represent a 10-day supply for $699. Hopefully the company can explain how it intends to develop the market for a product that costs $60 per day at a discounted price. Per mg of CBD, each dose costs $0.33 (if one spends $3600), but the gum, even without the 40% discount, would cost $0.32 per mg (for 96 sticks delivered). One difference may be that the RSHO comes with a certificate of analysis, while the gum doesn't and may be short of the 10mg promised (the company uses "approximately" to market it). Already there have been accusations of product quality deficiencies for Dixie Botanicals products, and I haven't seen any test yet of the gum's potency.
CannaVest Annual Meeting (and results)
In some ways, CannaVest (CANV.OB) may be the most important near-term driver for MJNA. Recall that CANV and MJNA entered into a deal announced in January and effective 12/31 where CANV acquired assets and intellectual property related to PhytoSPHERE, a subsidiary of MJNA (80% owned, with the balance owned by CannaBANK (or Hemp Deposit & Distribution Corp), the company that acquired MJNA in 2011 through reverse merger). CANV was formed through reverse-merger into Foreclosure Solutions last year and capitalized at just $350K (7mm shares purchased for $0.05 each). The company had no operations and no substantial assets or liabilities prior to entering into the deal with MJNA. Its sole executive at the start was Michael Mona, Jr., who was disclosed to own 37.4mm shares of MJNA as of 2/11/13, a day before the 8-K announcing the deal. CANV trades on the OTCBB and is an SEC filer.
The CANV/MJNA deal was characterized as $35mm to be paid in installments over 2013 in cash or stock (at the discretion of CANV) and subject to a collar between $4.50 and $6 per share. While there hasn't been an official disclosure by either company, it seems reasonable to assume that CANV issued shares for its June installment of $8mm, which leaves two more payments of $10mm (9/30) and $6.5mm (12/31).
CANV has traded very thinly over the past several months, often going for days without a trade. This isn't surprising, as almost all of the stock is held by insiders or affiliated companies. The company, which will be holding its annual meeting on 7/25 in Las Vegas, filed its proxy last month, which indicated 8.9mm shares outstanding. Page 14 indicates that executive officers and directors (four persons) own 5.723mm shares. MJNA is listed as owner of 720K shares, but its subsidiary, PhytoSPHERE, owns 1mm. This totals 7.44mm. There was another 180K distributed by PhytoSPHERE to Hemp Deposit & Distribution Corp (when MJNA got its shares), which increases the total to 7.62mm. Nicholas Filardo, through Bamburgh Holdings, is listed as owning 628K shares, increasing the total to 8.25mm. Finally, another 628K shares are owned by Stuart Titus, through General Hemp, which gets the total known ownership to 8.88mm (99.8% of the shares outstanding).
When it's all said and done, contrary to what MJNA said apparently, MJNA will be a minority investor in CANV. Here is the math:
- 12/31 $4.5mm at $5 price resulted in 900K shares to PhytoSPHERE (180K, or 20%, distributed to HDDC)
- 03/30 $6mm $6 cap resulted in 1mm shares to PhytoSPHERE
- 06/30 $8mm at presumed $6 cap will result in 1.333mm shares to PhtyoSPHERE
- 09/30 $10mm at floor of $4.5 is max 2.222mm shares to PhytoSPHERE(could be less at $6 cap)
- 12/31 $6.5mm at floor of $4.5 is max 1.444mm shares to PhytoSPHERE (could be less at $6 cap)
The most shares PhytoSPHERE could end up owning would be 6.899mm, which will lead to a total of 13.899 outstanding. MJNA is entitled to 80% of this number, which could be lower should the price of CANV stay above $6. At the cap (for the last two payments), PhytoSPHERE would receive 5.983mm shares in total.
Theoretically, MJNA could end up with fewer than 80% of 6.9mm shares (below the floor) or 5.983mm shares (above the cap) if CANV pays cash, but that appears highly unlikely at this point. The 8-K filed in mid-June to announce Q-1 results didn't really provide much of an update to the amended 10-Q that had been filed on May 30th to correct the initial one that had been filed a few days late (due to auditor change). As of 3/31, the balance sheet was pretty thin, with just $200K in cash. While the company booked sales of $1.275mm during Q1, it received no payment. I am not sure how this is possible, but its account receivables grew from 0 to $1.67mm (i.e. more than sales) during the quarter. Total current assets were listed as $2.79mm, so it seems unlikely that any cash will be paid to PhytoSPHERE unless business really accelerates dramatically. Further, the June press release pointed to necessary capital expenditures to expand production.
From the MJNA perspective, based on current prices and the likelihood that it will end up receiving stock and not cash, MJNA could end up with about 4.79mm shares of CANV. At the current last price of $14 (which I believe is highly overstated, but that's not the point of this article), the implied value would be about $67mm. Based on 936mm shares and $0.12 per share for MJNA (market cap of $112mm), CANV theoretically accounts for 60% of the value of the entire value for MJNA.
MJNA shareholders should be aware that CANV has a very large authorized share-count (190mm shares), which could allow the company to potentially dilute the stake. It has already made a small outside investment in KannaLife (as did MJNA). Further, CANV has borrowed a little over $1mm from a related party, Roen Ventures, which is providing a $2mm LOC. This creates another potential avenue in certain circumstances for potential dilution. While CANV and MJNA certainly appeared initially to be "friends" and not "foes", the dueling press releases that I detailed in my last article certainly create some concern that this appearance could be suspect. They are jointly marketing RSHO described above, with CANV making it and MJNA selling it. Given the financial condition of both companies, I think that there could be a wide range of potential outcomes in the quarters ahead.
So, the annual meeting could provide news regarding CANV's recently completed quarter. From the MJNA perspective, establishing true third-party customers for its CBD oil is extremely important for CANV. Further, the June 8-K indicated that the companies still haven't negotiated pricing for sales to MJNA, and clarity on this point could help investors better understand the benefits to MJNA's cost structure.
Authorized Share-count Clarity
The third near-term driver is the authorized share-count, which officially stands at 950mm as of Q1. I had discussed this issue in my last article, noting that it was unclear what the company had done with several "articles of correction" it had filed with the State of Oregon. Several days later, these documents were made available to the public and can be accessed here. The bottom-line is that the company's previous increases to its authorized share-counts were rescinded, apparently due to the failure to have them approved by shareholders. Recall that MJNA instituted an internal review with outside legal counsel earlier this year, and its Q1 disclosure alludes to this issue on page 31. The good news is that the company is moving towards cleaning up past mistakes, which, ultimately, could lead to a move from the pink-sheets to a better listing. The bad news, at least for now, is that the company has failed to clarify this issue with a public disclosure regarding these rescissions to its previous amendments to its articles of incorporation. While my best guess is that this isn't the case, investors could reasonably conclude that the authorized share-count may revert to 5 billion shares. Given the massive dilution in the two years following the CannaBANK deal in 2011 to take control of MJNA, this would be very negative regarding the prospects for further dilution. I would expect that this will be explained by 8/15 (when the company files its Q2 disclosure, presumably), but perhaps the company will do the right thing and clarify this important issue more quickly.
I think that one of the biggest challenges for MJNA and its opportunity to create a market for CBD products is the lack of awareness as well as the very high price points at present. On the latter, the prices will likely decline significantly over time as CBD-rich strains of hemp are grown more abundantly and as the legal landscape for hemp production improves. On the education, though, there aren't too many sources. A great one, by the way, is ProjectCBD. Well, the company has recently made a move to grow awareness, enlisting fellow Seeking Alpha contributor Perry Coleman to write a series of articles sponsored by MJNA on the examiner.com. Here is a link to his most recent article, and you can find the other five that he has written from there.
MJNA has historically shared a lot of information through press releases, but it has recently augmented this process by sharing "news releases". In fact, there have been 21 of these in the past five weeks, which can be accessed here. Many had been critical of the numerous press releases by the company which were tangential at best, failing to address MJNA-specific issues but rather discussing broader topics, such as the MMJ laws in France or U.S. Hemp legislation (this was one of the points I raised in my last article). I think that this is a smart idea to share the information as "related news" and to confine company updates to press releases.
I want to be clear that I still expect MJNA could trade down to the $0.05-.06 area as I detailed in my last article. In addition to my fundamental concerns regarding near-term results, weak cash flow and limited access to growth capital as well as the issues over authorized share-count and unfilled positions in management and on the board of directors, the chart, in my view, suggests caution. While it's true that the stock is in a longer-term uptrend and is up about 20% in 2013, it is mired in a nasty correction from $0.50 with many trapped longs who got in on the run-up or decline and could be forced out if the stock gets back down to $0.10 again. Finally, I want to say that MJNA isn't an automatic buy should it get to my $0.05-.06 near-term target. Similarly, should the circumstances warrant it, I might become more positive at the current price or even a higher price.
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.