The Story Behind The Marijuana Investment Story No One's Telling

| About: Great Elm (GECC)
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BDC Full Circle Capital is tied to a marijuana-related company.

A recent email solicitation by an investment newsletter suggested that the stock is undervalued.

The pitch fails to take into account recent negative news about the marijuana-related company.

FULL now trades at a substantial premium to its NAV.

On January 22, a day after Advanced Cannabis Solutions (OTCQB:CANN) announced a funding deal with Full Circle Capital (FULL), 420 Investor recommended that subscribers consider buying FULL as a backdoor marijuana play. CANN was added to the "Flying High" model portfolio at $7.13 initially and held until March 27th, when CANN was unexpectedly suspended by the SEC for reasons related to a third-party. The appeal of FULL was the fact that it had purchased warrants to buy 1mm CANN at $5.50 and also had the potential to acquire another 1.5mm shares at $5 (contingent upon funding a loan). While CANN has dropped about 40% since the initial buy recommendation of FULL in January, FULL has rallied about 14%, closing most recently at 8.13:

Since the initial announcement, not only has the price of CANN declined, but FULL has seen some deterioration in its Net Asset Value, which was reported in its most recent quarter (Q3, as of 3/31/14) at $7.20. While this was up from Q1 ($7.09), it included the value of the warrants, as detailed in the 10-Q:

This is a complicated calculation, but simply put, it shows CANN's value at 12.37. The point is that the NAV, had FULL not included the $6.3mm paper gain, would have likely declined to about $6.58. The NAV is important, as Business Development Corporations like FULL tend to closely track this metric.

So, the excitement over FULL must be tempered, as the price of CANN has declined and the likelihood of FULL funding a deal (and getting its sweetheart convertible notes) seems to be diminishing. During the conference call in May, the company responded to a question about the potential with a very lukewarm response:

"As it relates to the funding of the notes, I think that is still, again, a -- something that we continue to evaluate. As you know, during the quarter, there was a new piece of information as it relates to the suspension of the stock, which is unfortunate. And that's something, of course, that we continue to work through with the company to see how to move forward. And we're evaluating that on a case-by-case basis."

Another month has passed, and there is no funding. Perhaps FULL is concerned that CANN won't be able to escape the Grey Sheets status. While FULL has filed a Form 211 after having found a market-maker to sponsor them, it has been awaiting approval from FINRA. The process, which is described here, doesn't seem to require FINRA to make a timely response unfortunately.

After a Form 211 is filed, how long until the security can begin quotation on the OTCBB?

There is no standard time to process a 211 and clear the market maker to begin quoting a security on the OTCBB. The time it takes to review a 211 may vary significantly depending on many factors including whether or not FINRA has to request additional information from the market maker that submitted the form and upon how long it takes the market maker to respond to requests for additional information."

Of course, if CANN resumes trading with quotation, there is no guarantee that FULL will fund it, but it would be a positive sign. So, with everything seeming less positive, why has FULL been acting so well lately?

The Pitch

In mid-May, several 420 Investor subscribers wanted to know the identity of the secret stock described in this email solicitation. The video runs about 30 minutes, narrated by Frank Curzio, who is trying to entice listeners to subscribe to his "Phase 1" research service:

Phase 1, which was being offered for $3500 (normally $5000 per year) is one of several letters published by Stansberry & Associates Investment Research, which based in Baltimore and majority-owned by publisher Agora Inc. The company boasts of a daily readership that exceeds one million.

The pitch is very persuasive, but it became factually incorrect after CANN's suspension. Curzio suggests that a 50% rise in the marijuana stock would yield a 100% rise in the backdoor play. Their disclosure indicates that this analysis was based upon work provided by analyst Andrew Kerai that was published on March 20th (see note 30).

At the time the pitch was sent, CANN had dropped significantly, while FULL much less so. As detailed below, the potential returns described by Curzio are likely substantially less than promised.

In addition to the email promotion for Phase 1 that teased FULL, Stansberry & Associates offers a free daily email called 'Growth Stock Wire'. Editor Jeff Clark also teased FULL in March, just days before CANN was halted:

Another recommendation is in the fastest-growing natural-resource business in the world right now - marijuana. Ever since Colorado and Washington legalized the use of marijuana, the "pot" stocks have been going nuts. Most of the stocks are trading at ridiculous valuations - similar to the dot-com bubble of 2000.

But I found one stock that has been largely overlooked by the investment community. It's an indirect play on the marijuana boom that trades at about 45% of book value and pays a 10% dividend.

The final stock is going to remain a secret until the conference. Its upside potential is even better than the other two recommendations. But you'll have to join me in Dallas to hear about it…"

The Dallas conference was held on May 31st, but it's not clear if FULL was mentioned.

FULL Appears "Full"

As it stands now, FULL owns 1mm warrants to buy CANN at $5.50. There are many factors that impact the value of those warrants, as the stock that FULL would receive would be restricted. Presently, it's not clear if FULL would be able to actually sell the stock while CANN remains unlisted. Assuming that it can, and looking at potential returns to the company based on successful disposition of FULL, the following table highlights the possible outcomes for just the warrants:

Price of CANN

Value to FULL











FULL is carrying the warrants at $6.87mm currently and has about 10.1mm shares outstanding. To calculate the impact of changes in the price of CANN on the price of FULL, the excess value is determined by subtracting the current carrying cost included in the $7.20 NAV ($6.87mm) and then dividing by the number of shares. For instance, if CANN were to double (from 11 currently to 22), then FULL's NAV would increase by $16.5mm less $6.87mm, or $9.63mm. This would boost the NAV by $0.95.

This math suggests that FULL, trading at $8.13, is potentially incorporating a sharp rise in CANN, as it trades at $0.93 above the most recently published NAV. This analysis, though, excludes any potential windfall from funding a loan to FULL.

While the odds of doing so appear to have declined, this convertible note, which would give them the ability to buy 1.5mm shares at $5, could be even more lucrative. In the same scenario of CANN doubling to 22, the 1.5mm shares, if converted and sold successfully, would yield $25.5mm additional gains for FULL. This would work out to $2.52 per share. In other words, if CANN goes up 100%, combining the value of the warrants and the not-yet-issued notes, the NAV of FULL (excluding any other changes within their portfolio), would increase to $10.67. If FULL were to trade at NAV, the stock would rally by 31%.

This is a very bullish case: CANN doubles, FULL funds the loan, and FULL is able successfully sell all of the stock it acquires through conversions and exercises. It also depends most likely on CANN successfully relisting.

On the other hand, if CANN turns out to be a dud, investors could remove the current premium to the NAV that FULL commands. A decline to 7.20 would represent a loss of over 11% (more than a year of income). Investors should be aware that the NAV has been declining over time and that many BDCs trade at a discount to the NAV. In other words, the risk isn't limited to an 11% loss.

The bottom-line is that FULL was a great story, exactly the way Frank Curzio describes it, but the story changed dramatically in late March, when CANN was suspended by the SEC. It is very likely that the recent performance of FULL has been boosted by the Stansberry & Associates teaser promotion of its Phase 1 service. At this point, FULL is priced at a premium to NAV that appears to be unwarranted. Until CANN's Form 211 application is approved by FINRA, FULL is unlikely to proceed with funding any potential deals. The "Marijuana Investment Story No One's Telling" was told by 420 Investor and others months ago, and now it has been told loudly and incorrectly.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: A similar article was published behind the paywall at 420 Investor on 6/14/14.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.