Capitalizing On Cannabis: A Volatile Month Caps A Wild Year In The Sector

by: Alan Brochstein, CFA

(Editors' Note: This article discusses micro-cap stocks. Please be aware of the risks associated with these stocks.)

This will be my last monthly review of the cannabis sector this year. As I pointed out three months ago, the stocks no longer move in tandem as investors are beginning to differentiate between the business models and reporting practices of the companies in the space. Before I jump into the monthly review, let me offer some perspective by sharing here for the first time my "420 Stock Index":

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I will be rebalancing this index at year-end, but the 2013 members, equally weighted, include: Cannabis Science (OTCPK:CBIS), Greengro Technologies (OTCPK:GRNH), GW Pharma (OTCPK:GWPRF), Hemp, Inc. (OTCPK:HEMP), Medbox (MDBX), Medical Marijuana, Inc. (OTCPK:MJNA), GrowLife (OTCPK:PHOT) and Terra Tech (OTCQX:TRTC). The index has been a lot more volatile than the S&P 500 but has ended up with about the same year-to-date change. Remarkably, only 2 of the names are up this year, but the powerful moves in GWPRF (+189%) and PHOT (+277%) have carried the index. MDBX has been the worst performer, losing almost 82%.

For those new to the whole idea of investing in cannabis-related stocks, 2013 has been quite the year. Following the 2012 elections in Colorado and Washington which set the stage for legal marijuana in those states in 2014, investors poured into the sector, fueling an explosive rally that peaked in February. The bubble deflated over the next six months, but a remarkable reversal of opinion by CNN's Sanjay Gupta regarding the potential benefits of medical marijuana followed by clarification regarding state implementations from the Department of Justice in August helped resurrect interest in the sector. I have written extensively since February on the sector, and you can access a complete list of what I have written.

As I indicated, the last month has been very volatile. The following table highlights the dramatic price changes in both directions since late November:

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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. 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. I color-coded all of the stocks that moved by more than 10% over the past four weeks.

A Look at the Winners

While the winners are fewer than the losers, the gains have been impressive. FusionPharm (OTC:FSPM) is very thinly traded, and the move is just a recovery of the prior month's decline. I haven't written much about this company, which has a very interesting product, the PharmPod. The share structure is rather extreme, with the CEO owning a convertible preferred that represents the vast majority of the value of the company. I have reached out to Mr. Dittman on several occasions over the past few months because I have concerns about their accounting, but he has yet to address my questions. The company is late filing its disclosure for Q3 with OTC Markets, even though it had indicated that it would do so by 11/19.

I shared an interview with Paul Rosenberg, the CEO of mCig (OTCQB:MCIG), a few months ago. The stock fell sharply as shareholders of the company it acquired, LifeTech, appeared to have been selling, but the company also had a very limited launch of its product on 10/31 (selling out in just days). The company recently indicated that it will be shipping its 2nd-generation product beginning 12/30. MCIG has a $10 vape pen that handles both raw plant material as well as wax. The company has 270mm shares outstanding, and the CEO holds 23mm preferred shares that are convertible in about a year into 230mm common shares. This is one of the more interesting stories in the cannabis sector, and they have an additional product that they are calling "Vita" that extends beyond the marijuana market.

PHOT has enjoyed a remarkable run as the company has announced some truly extraordinary moves that will hopefully allow it to play a major role in helping supply medical and legal cannabis. The company participated with me in a live interview on iCannabisRadio on 11/18, and 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 on 11/21. The details were released in an 8-K exhibit. More recently, it announced a new President, Marco Hegyi, who worked at Microsoft and Yahoo previously and highlights how mainstream business people are embracing the cannabis opportunity. 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). Rob Hunt, who is the President of GrowLife Hydroponics, was a guest of mine in a webinar on 12/16. You can access the full 90-minute presentation & Q&A or this brief synopsis.

Peoplestring (OTCQB:PLPE), new to my focus list, will be changing its name to Vape Holdings and will soon trade under the symbol "VAPE". There isn't a lot of information quite yet, but the interest has been quite high. The company expects to name Kyle Tracey, formerly the President of PHOT, as its CEO, and it will be focused on vaporizers and concentrates as well as e-cigs. The website has been updated recently and gives a broad description of the business despite the lack of details.

TRTC has had a rough 2013 but is ending the year with a nice bounce, almost doubling off of recent lows. The company announced another hydroponics produce distribution agreement and also named Fairway Market as a new customer. TRTC was initially focused on being an equipment provider, but, as CEO Derek Peterson explained in a webinar last week (slides here), it is positioning itself to grow marijuana and hemp legally as the laws permit. I continue to view this company as a relatively inexpensive call option given that the produce business should keep it cash flow positive in 2014 while it awaits regulatory change.

A Look at the Losers

Advanced Cannabis Solutions (OTCQB:CANN) fell during the past month, but from a lofty price. The liquidity in the stock is quite poor given the very small public float of about 1mm shares. I like the story, and those interested will enjoy the interview with CEO Robert Frichtel that I published earlier this month.

CannaVest (CANV) fell sharply, but one has to wonder if the price is anywhere close to reflecting reality. Most of the stock of the company, which was essentially spun out of MJNA, now a minority investor, earlier this year, is closely held, and trading has been sporadic. The company is currently selling stock at just $1 to accredited investors. Assuming the 10mm shares are sold, I calculate a potential share-count (assuming conversion of all securities) of about 34mm. This would suggest a market cap of $544mm, making it the largest company by that metric in the sector.

CBIS has been drifting to 52-week lows. The company, which has been public since 2009 after a reverse merger, remains undercapitalized, seemingly unable to fund its research initiatives, which are still in pre-clinical development.

Endexx (OTCPK:EDXC) recently filed with OTC Markets, ending a long period where it had not shared information. The company was named by Creative Edge Nutrition (OTC:FITX) as a technology provider in its bid to receive a growing license in Canada, and it has reported traction in a leasing program for its Autospense, a dispensing kiosk that controls inventory.

HEMP finally broke the .01 level, a prediction I had shared in July. The company still doesn't appear to have a viable business. HEMP heralded the long-awaited production of hemp seeds and fiber through its JV in China, but a review of the numbers suggests that the effort is unlikely to produce a significant financial impact.

MDBX has done something for which I struggle to find precedent, announcing a 2-for-1 stock split that ties up its shareholders for up to a year on half their holdings. Shareholders benefit, on the one hand, as management diluted itself. In round numbers, common stock holders will now own 2/3 of the company compared to a little less than half previously. This happens because the 3mm preferred shares are still convertible into 15mm common shares (the split doesn't apply to the preferred). On the other hand, and this is the part that blows me away, the split is in the form of a special stock dividend that is payable in restricted stock. Holders will be forced to maintain half their shares for up to a year. The press release also detailed that the company has withdrawn its S-1 filing with the SEC. MDBX had intended to sell 3mm shares and to allow holders of restricted stock as well as insiders to sell stock between $16 and $20.

Nuvilex (NVLX) and Plandai Biotechnology (OTCPK:PLPL), both of which are promoted by the same paid research companies, shared lots of vague press releases over the past month. Additionally, the NVLX 10-Q detailed significant dilution after a preferred stock conversion. Puget Technologies (OTCPK:PUGE) and Medical Cannabis Payment Solutions (OTCPK:REFG), two recent reverse mergers that appear to lack substance, continue to get pounded. REFG is behind in its OTC Markets disclosure.

Bottom Line

2013 was a year of challenges for those who like the cannabis theme. 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. For the companies committed to investor transparency and equipped with a solid business model, 2014 should prove to be a great year.

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. 420 Investor offers trade-alerts and may maintain positions from prior buy recommendations

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