Pharmacan Capital Corp, recently renamed The Cronos Group (OTCPK:PRMCF), is a merchant bank that invests in the Canadian marijuana space. They hold equity interests in five of thirty-five licensed producers in Canada: Peace Naturals Project Corp (100%), Whistler Mountain Marijuana Company (21.5%), ABCann Medicinal (6%), In the Zone Produce (100%), and Hydropothecary (1.9%). The former three companies are also licensed to sell medicinal marijuana under Health Canada's Access to Cannabis for Medical Purposes Regulations (ACMPR).
Cronos is regarded as merely being a holding company that was seeking a liquidation exit strategy for its portfolio of minority ownership in licensed marijuana producers. The market typically frowns on such a passive business model and it is quite common for a holding company discount to be applied to the valuation of its stock price. Very much has changed since late spring of 2016, with its recent corporate rebranding also coinciding with the shift in their approach to the medicinal and recreational sectors of the marijuana market. Cronos intends to position Peace Naturals to focus exclusively on medicinal supply and to set up In The Zone Produce to supply the recreational market if/when it becomes legalized.
A Troubled Past
Confusion and turmoil existed prior to 2016 with regards to company strategy. At one point Cronos had a potential deal in place to sell their 80% stake of In The Zone Produce for up to $4.5 million but the deal fell through in early Oct 2015. Then the majority shareholder who owned 48.5% of Peace Naturals, Barnes Family Trust, received an offer to sell their ownership stake to a third party in mid-Oct 2015. Cronos had right of first refusal to purchase this stake but elected not to exercise its right and instead exercised its tag along rights to participate in also selling its 27.3% stake of Peace Naturals to this third party too under the same terms.
In a convoluted series of press release updates from Oct to Dec 2015 the dance concluded with the inability to close a deal, and thus Cronos retained its right of first refusal on any future ownership stake sale. Management came to the conclusion at the end of fiscal 2015 that the company was unable to exercise significant influence and thus had reclassified Peace Naturals from equity method of accounting in their financial statements to one of available for sale financial assets status.
Their minority ownership stake in three other companies that applied for potential Health Canada marijuana production licenses, (Vert/Green Medical Inc, Evergreen Medicinal Supply Inc, and CannMart Inc), were deemed in fiscal 2015 to be unlikely to ever receive licenses. Thus equity investments and associated loans were written off to zero. There still exists the (remote) commitment of a further $2 million investment to increase ownership stakes in these companies upon receiving a production license from Health Canada.
Management Change, Fortunes Rebound
On May 16, 2016, CEO Paul Rosen had resigned and was replaced by company consultant and vice-chairman Michael Gorenstein, who has a background in investment banking. It was around this time that the fortunes for this company began to turn around. A $6 million equity financing was completed by the end of May. In mid-June it was announced that a deal had been agreed upon with Barnes Family Trust to purchase their majority stake of Peace Naturals and they also agreed to exercise its right to compel the other minority shareholders to sell their shares under the Peace unanimous shareholders agreement. Another equity raise of $15 million coincided with this news in order to fund the $9.5 million cash component requirement of this potential acquisition. Not too surprisingly the market had a muted reaction to this news in the summer because the company had attempted unsuccessfully in the past to acquire a majority interest in Peace Naturals.
Peace Naturals has a storied history as being the first non-incumbent licensee by Health Canada for medicinal marijuana production. It started from humble beginnings when the co-founder, Mark Gobuty, decided to grow marijuana in Ontario for his parents suffering from ailments and it evolved into the Project as it now stands many years later. Peace Naturals has a credible and solid reputation in the medicinal marijuana community. Most investors are unaware of its potential scale due to it being a private company for so many years. However, with the Sep 6, 2016 acquisition that allowed Cronos to increase its stake from 27.3% to 100% ownership, the financial and operating results of Peace Naturals will now get reported as a wholly owned subsidiary moving forward.
Peace Naturals has a 38,000 sq. ft. production facility after a two phase expansion in 2015. It is located on a massive 95 acres of land assembly in Southern Ontario that dwarfs even top tier competitor Aphria's (OTCQB:APHQF) recent land purchases that totaled 48 acres. They are currently licensed to produce 2,500 Kg and existing facilities can support 3,000 Kg of production.
In The Zone Produce located in the Okanagan Valley of British Columbia is their other wholly owned subsidiary with a production facility located on 14 acres of land. The company has recently entered into a tentative purchase agreement for adjacent land that more than doubles its size and is scheduled to close by the end of Oct. I anticipate more details for this operation to emerge after the legal framework for recreational marijuana is announced.
The other two licensed production subsidiaries worth noting are its 21.5% ownership in Whistler Medical Marijuana Company (WMMC) and its 6% ownership in ABcann Medicinal.
WMMC, located in Whistler, British Columbia, can produce as much as 500 Kg of cannabis each year. It is a certified organic cannabis grower by the Fraser Valley Organic Producers Association and one of only two in Canada. They sell a higher priced premium product ($8 to $13 per gram range) that receives favourable reviews. Of interesting note is this subsidiary actually paid a $10,000 dividend in the fiscal quarter ending Jun 30, 2016 to all of its private shareholders, with Cronos receiving $2,150 for its stake. This might very well be the first dividend issued by a (private or public) Canadian licensed medicinal marijuana producer in history.
ABcann, located in Napanee, Ontario, uses a chemical free, scientific computer-based production method to ensure the consistency of the chemical compound in each cannabis plant. They have a research partnership with the University of Guelph. Near term expansion plans are in the works with a focus solely on providing medicinal marijuana.
Catalyst For Revaluation
I believe as operational details of Peace Naturals unfold in the upcoming quarterly reports, investors will become more aware and revalue Cronos accordingly. With 100% ownership the company can now implement decisive, strategic actions, and as a consequence, it will likely shed itself of the holding company discount and be valued more as an active management company.
The acquisition of 100% Peace Naturals instantly propels Cronos into the top six licensed producers in Canada. With current relative valuations of its peers, the Peace Naturals subsidiary alone is likely worth more than the entire market capitalization of Cronos (roughly 150 million shares outstanding at C$1.15 or U$0.86). Having stated that fact be aware that the entire marijuana sector is extremely heated and has risen substantially, especially during the past three months.
Sources: Company press releases, financial statements.
Disclosure: I am/we are long PRMCF.
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.
Additional disclosure: I am long the Canadian equivalent ticker MJN trading on TSX-Venture exchange.