Getting Into The Weeds On Marijuana Stocks (Podcast)

by: Eric Schleien

I had the opportunity to sit down with Brian Langis on the Intelligent Investing Podcast. Brian is a business appraiser and value investor in Canada.

I had Brian on the show just before the now infamous "funding secured" tweet from Elon Musk regarding Tesla. In this episode, we recap and discuss what's happened since.

We also dive into the most recent investor presentation and the quarterly letter from Brookfield Asset Management. Brookfield Asset Management is another business that Brian and I have discussed prior.

After doing a re-cap of Tesla and Brookfield Asset Management, we go into the marijuana industry and give a quite detailed primer on the industry as a whole.

Note: This podcast contains strong language and the transcript has been edited for clarity.

In this episode of The Intelligent Investing Podcast, Eric Schleien & Brian Langis do a re-cap on Brookfield Asset Management & Tesla. You can read the Seeking Alpha article associated with this episode here.

Then, the rest of the episode is dedicated to the marijuana industry and the publicly-traded companies poised to benefit. Neither Brian or I will touch the industry with a 10-foot pole... or bong.

What makes this episode unique is that we get very high up into the big picture as well as get right into the weeds with the nitty-gritty details of the industry.

You can always follow Brian's articles on Seeking Alpha here.


ERIC: Hi! This is Eric Schleien; you are listening to the Intelligent Investing Podcast. Today, we are going back up to my French-Canadian friend Brian Langis. You are French-Canadian, right?

BRIAN: I'm French-Canadian, that's right.

ERIC: I just felt like a [jerk] to just assume you were French because you're from Canada, but you sound French, so it'd be weird if you spoke French and sounded French, but you weren't French-Canadian. So, my French-Canadian friend, Brian Langis. I always want to say lingua when I talk to you, it just sounds more French than Langis. I met Brian in Los Angeles at the Daily Journal (DJCO) meeting on Valentine's day to hang out with our good friend Charlie Munger. You know, it's a conference for nerds when they have it on Valentine's Day, right?

BRIAN: Yeah. It's a very small group of people and you have to be a little bit of an insider and part of the value investment circle to make it there.

ERIC: Yes, and if you are not single, the person you're with has to be quite understanding that you want to go and hang out with a 90-year-old on Valentine's day.

BRIAN: 94.

ERIC: Exactly! So, I thought we should go over a few things, you had some interesting insights on the whole marijuana industry, I wanted to do a show today with you where we actually bring some substance and hopefully have one of the meatiest podcasts about the topic. Then, I'd also like to recap Tesla (NASDAQ:TSLA) and Brookfield Asset Management (NYSE:BAM) with you.

BRIAN: Well, Eric first thanks for having me on a third time. This is a lot of fun.

ERIC: Let's just do a brief recap on both of those companies before we get into the weeds on the marijuana industry, does that work?

BRIAN: Yeah, we can do that.

ERIC: You know, you are more than welcome to smoke pot on the show. You could even pretend and nobody will even know that you're pretending because there's no video.

BRIAN: Well, I'm not a director of a public company yet…

ERIC: No, you're not, and I am not the Joe Rogan Show, so you'll most likely have fewer listeners for this episode than the episode of Musk smoking pot on the Joe Rogan Show. However, you can inhale and no one will know if you're actually inhaling anything since there's no video. So have fun, go ahead.

BRIAN: Yeah. Well, I was thinking about these two companies. The first one, Brookfield Asset Management, is a very conservative company, very low key, and under the radar. Not a lot of people know about it and this company's been providing returns on average of fifteen percent for many years. Last week, they had their investor day in New York. When we talked about the company on the show a few months ago, the stock was trading at around $40 USD and now it's about $44.50 USD. In two months, your listeners are 10% richer if they bought shares then. Then, when you look at the other podcast about Tesla, we looked at that business from so many different angles. That was at the end of July and it's crazy how much has happened since. Right after we did the podcast, I think it's a couple of days later, he came out with his infamous tweet, the 4/20 tweet, where he said: "funding secured". He said he had a buyer and that the money was locked up. Then, a week later, he said no we're staying public. You've seen this stock go up and down, up and down, investigation and problems, and him tweeting crazy stuff.

ERIC: What speaks to the cult mentality of Tesla and Musk is that I actually had someone make a comment on my social media account regarding a post I made about how much I love arbitrage. The person making the comment was a Tesla shareholder and he said, I like arbitrage too and then made the comment that Tesla was a great arbitrage investment, and I'm thinking there's no way that this guy can possibly think this is what I mean by arbitrage.

BRIAN: I don't know why that you want to be a shareholder in such a volatile and crazy company when there are so many other things out there that you could look at that are cheaper.

ERIC: You are not going to sleep at night as a shareholder.

BRIAN: Right, one day, it's perfect and the next day it's hell and you would think the company will be bankrupt. Then, the next day, the Saudis are after the company. It's a good show, but it's not for me. I enjoy watching it.

ERIC: It's a wonderful show.

BRIAN: It makes great podcast material.

ERIC: Yes, it'll make a good movie someday.

BRIAN: Oh yeah that's for sure. Who do you think is going to play Elon Musk?

ERIC: Matt Damon.

BRIAN: I don't know why, but the first name that came to my mind was Tom Cruise.

ERIC: Yeah, I could see Tom Cruise too.

BRIAN: I can't tell you why that's the name that pops in my head.

ERIC: I'll tell you why it's that Tom Cruise has small eyes and so does Elon Musk.

BRIAN: Can Tom Cruise do a South African accent?

ERIC: Probably, he's Tom Cruise.

BRIAN: There's no such thing as a Mission Impossible, right?

ERIC: Exactly.

BRIAN: A little play on words there, right? Tom Cruise, okay. Your audience just tripled…

ERIC: Or they left. Anyway, back to Brookfield Asset Management and Tesla.

BRIAN: Right, well yeah, these companies could not be any more opposite from each other in their style and I still believe Brookfield Asset Management has shown that their business is still being undervalued by the market.

ERIC: Did you read Bruce Flatt's most recent letter?

BRIAN: Yeah, and he does good letters.

ERIC: Well, they had their investor day on September 26 and they showed that all the projections they had made the past five years were too conservative which is typically their deal.

BRIAN: Yeah, they were very prudent about that, I think they're doing on purpose. It's like a doctor telling you that you have a month left and then you live for six months, he looks like a hero right?

ERIC: Yeah. Also, August 9th is the date of the most recent letter from the second quarter. It was one of the better letters that Flatt has written.

BRIAN: No, I did not read it, I don't think I read that one.

ERIC: There was a lot of new stuff. Flatt breaks down numbers and talks about some of the stuff we have discussed here on the podcast. So, I'm going to read just one part of the letter where he actually goes into how he values his own company, he does it very specifically. So, it's better than just looking at a presentation. So, he says, "the continued growth of our asset management business and fee bearing capital provides us with cash flows that are diverse, covering our different fund strategies and publicly listed partnerships, sticky as the capital is invested across durations ranging from our private funds of ten plus years to our permanent capital vehicles and fast growing as we increase our fee bearing capital at a considerable rate. Over the last five years, fee-related earnings have grown at a compounded rate of 34 percent and we believe we can grow and achieve at a rate of more than 20% over the next five years"

And just for people listening to that and they're thinking how can a company that big grow that fast... you got to remember you're dealing with a multi-trillion-dollar industry here. A lot of people have a hard time putting their heads around that. So… "unrealized carried interest was two and a half billion dollars at the quarter end and we expect to recognize about a half of this in the next few years"… which is insane… "our current carry eligible capital of 47 billion means that our target carried interest net of cost is now eight hundred million dollars annually based on target returns. There will be a timing lag between when this carried interest is generated and when it is realized as we wait for clawback provisions to be met before recording and as income in our financial statements, we will continue to report our progress against this target and our supplemental information."

Now, here's where he goes into the valuation. "The total equity across Brookfield is approximately eighty billion dollars and the equity market capitalization for Brookfield Asset Management common shares is currently approximately $40 billion. So, the $40 billion can be broken into two components: our net tangible invested capital and our asset management business taking IFRS values for our non-listed assets and real estate businesses and using stock market prices for our other listed investments. The total tangible investment capital was 40 billion at the end of the second quarter and that's after deducting ten billion dollars of long-term debt and perpetual shares net investment capital was thirty billion. This scenario implies that $10 billion dollars is being attributed to our asset management business. In our view…" and this is the big kicker for the valuation…

BRIAN: $10 billion is being attributed to the asset management business?

ERIC: Yes.

BRIAN: That's very low.

ERIC: Right. And then, Flatt goes on to say… "in our view, this represents an extremely low value based on the underlying financial metrics and the way most investors value similar businesses, for example, this value represents ten times our current estimate of annualized fee-related net earnings, approximately a billion with no value attributed to the gross carried interest of eight billion dollars that we stand to earn over the next ten years if we achieve target returns. This is also based only on funds raised to date with nothing attributed to our ability to grow our franchise. Stated differently, if our shares reflected a twenty times multiple for fee-related earnings and a ten times multiple for net annualized carry on existing funds this would add 18 billion dollars of value or eighteen dollars a share.

This is close to a fifty percent increase over current stock market prices and this still has no value attributed to the growth and our future franchise including larger and new funds."

BRIAN: I have to read this.

ERIC: Yeah, and then he breaks down the returns since 1999 with book value, market price, FFO, market price plus dividends, and goes into shares outstanding growth, book value growth, and AUM growth.

BRIAN: Well, like we talked about part of the discount is trying to figure out this company.

ERIC: Yeah, so, I want to point you to one more thing from the BAM Investor Day Presentation. I'm just scrolling through over the pages right now. So, give me 30 seconds, why don't you just sing or something Brian to some music.

BRIAN: I don't want to scare the listeners. If the people remember, we went from a million listeners to five… yeah, I don't want to lose these five nerds. While talking about Bruce Flatt, I think you're the one who sent me that… it was the Google presentation. You know, how Google has these talks and they have these guests that go to Google… and they do like an hour-long presentation, it was Bruce Flatt which, you know, does not make a lot of public efforts, does not do a lot of media… he does but not a lot… and he went to… he was invited at Google to do a talk on his company Brookfield and I think it was something on how to value or invest in real assets. So, he talked about real estate infrastructure and all that stuff... and this is one of the best investors in the world, right? An investor with one of the best track records and I think there was like ten people there.

ERIC: Yeah, it is unbelievable.

BRIAN: People don't know what Brookfield is. If he was properly promoted, he could fill a stadium.

ERIC: Well, he doesn't want to do that. I just want to turn to page 108, it says plan value results $118/share over the next five years and it's the same valuation he's been using for years. So, you assume a 20x multiple on fee-related earnings, a 10x multiple on generated carried interest, and these are to be clear multiples that are not conservative but fair. Flatt is giving a five-year intrinsic value estimate of $118/share based and that includes dividends and right now the price, the price at this point was $42/share. What's also interesting if you go to page 112 on the slides… he looks out at ten years and Flatt says that total fee-related earnings will be twenty billion, net invested capital 25 billion, realized carried interest fifteen billion. That's sixty billion dollars.

BRIAN: I love these round numbers.

ERIC: Yeah. So, here's what's interesting, cash investment into listed partnerships is negative ten billion, return of capital for dividends is negative ten billion. That means over the next ten years he's estimating there will be an additional forty billion dollars of excess capital for share repurchases.

BRIAN: Hey… that's buying back the whole company.

ERIC: Right, which is the entire current market cap. He's just laying it out for shareholders.

BRIAN: Well, he's a capital allocator. I've been investing in Brookfield since 2012 and I mean the returns have been great and a company I had been following for a long time and I'm not cashing out, let them do their thing... you know it's a buy and hold… and you know it's not an easy company to value, you can trust his valuation or you can adjust it. But even a conservative downward adjustment valuation leads you to not paying through the roof here.

ERIC: No, I think you could say, and this is just my personal view, it's not a recommendation, but I see it as even if you're wrong you're probably getting a very fair valuation of the company which over 20 years, you're going to do quite well.

BRIAN: For sure, yeah

ERIC: I'd be careful. I would not say for sure. There's nothing for sure in this world.

BRIAN: No, exactly but you can make a good judgment right? You can make analysis and have good judgment, I mean between Tesla and marijuana, I will put my money on Brookfield.

ERIC: Ha-ha-ha, Between Tesla and marijuana, I will take Brookfield, ha-ha.

BRIAN: Wow, yeah, the money you make with Brookfield maybe you can buy a Tesla.

ERIC: Yeah, exactly. Why don't we move on to marijuana?

BRIAN: Sure, all right.

ERIC: This is going to be the investor's guide to marijuana right now. Let's start that segment…

BRIAN: All right. I'm in Canada and I have a front-row seat to the legalization of marijuana for recreational purposes.

ERIC: How did you say it?

BRIAN: Recreational, big word for me. So the landscape for marijuana is very different in Canada than the US. Canada always had a lax attitude towards it and it's been legal for medicinal purposes since 2011. Law enforcement agencies were never hard on you. They would go after sellers and growers. If they caught you with it or if you're smoking it and all that said, they wouldn't bug people about it as they have better things to do with their time. Also, the previous government under Prime Minister Harper made it so you could get a license to grow it by filling out a two-page form and unless you have a sketchy story or you had a criminal record or something, you will get a license to grow. The idea at the time was to stamp out the black market. What happened is that the policy made it worse because it wasn't really regulated so I could apply, I may have friends who have the license, you get the license and you grew marijuana but nobody's watching how many plants and you could only sell it to people with prescriptions... but who's watching, right? So, thousands of people had the licenses, how many people actually follow the guidelines... you know, who knows? And this stuff like it wasn't like you needed a different like a business or a warehouse know you could grow it at home. So, you have all these nice homes, suburbs whatever and the cost from your raid and be like hey what are you doing, I have a license they'll be like oh sorry. So, the whole thing was out of whack, so they decided in 2014 or 2015 to upgrade the license to what we have now. So, basically they were changing the game if you wanted to be a marijuana player, you must have a real place of business, a real facility, security guards, the whole nine yard. So, right now, we have licensed growers in Canada which are for both medicinal and recreational purposes and that number is growing. Right now, everybody with a prescription can order it on the internet and that's not going to change. So, that's the game and that's not going to change. But now you won't need a license and so the federal government is controlling production. So, how it's going to be sold, how you're going to buy it and how are they going to sell it. So, every province it's going to have their own rules about just like the United States right now every state have some kind of law against their different system and you know the United States federally, it's still a Schedule one drug it's illegal but at the state level, you get a different story. I think you have States that they have some form of medicinal or recreational legalization but not up-to-date with what's going on in the United States, but the attitude is changing. So, what's going on in Canada? It's not that we're talking about taking the market away from the black market. Are they going to drop the ball to do that? Not the first year. It's going to take a while… the black market especially for marijuana is well supplied and their prices are very competitive… and from what I know, I talk to people… and they said the quality of the product is great, it's not…

ERIC: For the legal or the black market?

BRIAN: The black market. The black market stuff. These guys been growing weed forever and you know the today weed is not your parents weed, that's the joke right? And so that market is highly competitive and the problem with the government coming in trying to sell it themselves because let's say Quebec... Quebec is going to have government-controlled stores and so you're going to have to go to the government store and buy it. And you know their prices per gram might be in the ballpark… once you add the taxes and all that stuff…

So, they might be able to get your casual smoker… but for the guy that smokes every day, those people are not going to quit their dealer. For one, it's their dealer. And two, prices the government charges are not in the game yet. So, it might be a couple of years before you really take the black market away. Also, you also see dry cannabis, what you call the commodity. This is going to be a hard game because what the black market is producing is the same thing. So, even if you come up with a brand and all the fancy labeling and packaging in marketing, you're still buying a commodity. So, what a lot of these producers are doing is getting into a big market, the derived products. The derived products consist of: edibles, drinkables, medicine, this is where the money is going to be made. Why? Because in the dry stuff, you're competing with a lot of people, it's going to be a lot of supply and maybe the market can be flooded, I don't know… nobody really knows what's going to happen and how the markets are going to react… You can look at what happened in Washington and Colorado. So, what happened in those States is that there was a lack of supply like at the very beginning, prices exploded and then there was a flood of supply… and since 2015 prices have been dropping for over 10% a year. What people are focusing on are products like oils and you know products that are derived from the oil that have one of value at it and you probably can set a higher margin and you can really differentiate yourself. So my point was, yes Canada is trying to attack the black market but it's much bigger than that. It's more so about having the first mover advantage. Canada is the second country in the world to legalize marijuana, Uruguay did it in 2013, I believe. So what Canada is trying to be is the leader of supply, the leader in production, and the leader in research. Research is important, especially medical research due to all the advancements going on right now and they want to have a head start. It's not just about getting a head start over other Countries but about getting a lot a lot of investments in Canada from the United States and you're getting companies to develop network and partnerships. For example, the largest company in this space is Canopy Growth (CGC). I saw a very interesting presentation from the company where the CEO takes a bottle of vodka out and there are no labels on it. It's just a bottle. He explains that right now this is marijuana in Canada. There are no brands, there's no brand loyalty. He shows that what he wants to do is take this bottle of vodka which is a commodity and put a label on it and all of a sudden instead of your accountant sipping on wine on a Friday night he's smoking weed instead. His aim is to make it totally socially acceptable to be smoking weed from highly regarded brands as opposed to weed being attached to losers and stoners.

That's the play here. What makes Canada an interesting place to invest in right now for marijuana is that currently in the United States due to federal regulation, a US company or US-listed stock cannot have any operations in the US without losing their listing. So, do you follow me? A US-based company can't be listed in the US because it is illegal. So, what these companies do is that they get themselves listed in Canada and if you're listed in Canada, you can have operations in the United States. So, Canada is like a back door, it's kind of bypassing the system. So, that's why there's a bit of a grey zone in the United States. If you follow the rule of the law, you can't but you follow the rule of law of Canada, you can. So, it is what is it right? So, in Canada, we have the TSX, Toronto Stock Exchange, which is the big boy exchange like the New York Stock Exchange of Canada. So, that's where all the big companies are listed and then you have the TSX Venture Exchange a which is where junior companies, companies raising capital get listed.

ERIC: This is the exchange with the small mining companies, right?

BRIAN: That's right and the hope of these companies is to graduate to the TSX. And then we have an exchange that's even smaller even more junior. This exchange is called the CSC which is short for the Canadian Stock Exchange and this is where a lot of companies can get their start. If you go on the website of the exchange it's not a good website. The website talks about two things: marijuana stocks and cryptocurrency stocks. There are less than four hundred stocks and none of them have a billion in market valuation. Cannabis stocks are like 20-25% of all listings and half the trading is done in weed based businesses. So, the idea is to get up-listed to the TSX Venture and once you're on the venture and you become credible and legit then you can be up-listed to the TSX. One of the advantage from being on the CSC is that the listing is cheaper and there are less regulatory requirements. So, it's easier to get started but there's a lot of crap on there so you have to do your homework. The bigger opportunities in marijuana like I said before is the medical opportunity. We know that millions of people are already using medical cannabis to treat different conditions and there's a lot of people that report it helps with pain and a whole variety of other conditions, but the research has been limited so far. There's a lot of research especially you know the campaign to allow marijuana products for medicinal purposes is gathering pace and is it's one the biggest upsides in the industry. So if I was looking at it from an investor point of view, I would be doing my research in that field where there will be new products that that will help people. Right now, most of the research is focusing on CBD.

ERIC: Like when you get CBD oil or something like that.

BRIAN: Right, THC is the ingredient that gets you high. Right, so when you when you're looking for weed, you're looking at the THC content which you know the higher it is, the higher you get. CBD is the compound without the high and this where the opportunities are right now on the medicinal side of the industry. For example, in the United States, the FDA has recently approved a drug called epidiolex. This drug got the green light from the government and it helps with epilepsy. Really, it helps people with epilepsy symptoms and now that the FDA has approved that drug, you can buy it in the United States and it has opened the door to an avalanche of research, money, and companies trying to develop products. A lot of research right now is refocusing on developing intellectual property around the CBD compound which can be turned into a drug or treatment.

I think this is where the multi-billion dollar opportunity could be. It's not so much the dry cannabis, the commodity, and I think if they're able to create a patent or pill or treatment, it's really hard to take that away from that. When that happens, you have insurance companies getting involved and the game gets interesting.

ERIC: Regarding actual publicly traded marijuana stocks, are there any of them that you see as viable investments or is it all equivalent to gambling in your view?

BRIAN: Just to make sure that the listeners understand, I'm not endorsing any of these companies, investors beware, they are at sky-high levels and I wouldn't even touch them.

ERIC: can you really can you really do a proper valuation on these things or do you really have to approach it more like a venture capitalist?

BRIAN: Oh, totally like a VC, we barely know anything honestly. I called Canopy Growth last week to prepare for the podcast… I'm like… hey, what's going to happen when Canada legalizes marijuana… and they don't know. Canopy Growth is the most legit company here, let's talk about them. Canopy Growth had a head start over everybody else. They used to be North Street. It's a nice little story. Just an hour south of Ottawa is a town called Smiths Falls. Smith Falls is an old school industrial town where they used to do manufacturing. A lot of these jobs are gone and about 10 years ago there was a Hershey chocolate factory that closed down and that was a major part of the town and it hurt the town a lot. The company which is now renamed Canopy Growth bought it. They bought the chocolate factory and it into the biggest marijuana company in the world. So, good for them, Canopy Growth is first class. These guys are ahead of the game, they are in a lot of fields, they're the biggest, they have access to capital, there produce weed, they have a lot of it, they're in the medical sector, they are all over the world. I think they're very well managed. This company is the real deal. I'm telling you all these things that are all positive, but the thing is the market valuation of the business. The key question is how much are you willing to pay for it? So, let's work some numbers here. The company has exposure to what they believe to be a $9 billion dollar market and they say it's going to take a couple years for the legal space to crush the black market space. If you take all the big marijuana companies in Canada we have a total market cap of $60 billion with a potential of a $9 billion industry. So, you just see how out of whack it is right? So Canopy Growth will just have a portion of that maybe you know a good size of it but how so where is the opportunity so they're looking at international, they're not just looking at Canada because obviously Canada it's just a drop in the bucket. We're such a small country. Yes, we consume weed but as a percentage of international consumption, we're nothing. So, they're really looking at the international opportunities and they're really looking at the United States when it becomes legal. There's also Aurora Cannabis (ACB) which is the second biggest in Canada with a market cap of 11 billion. These guys are using their overvalued, inflated, sky-high shares to make acquisitions. Their stock is currency. So, they're buying everybody and everything in fields such as: medical research, distribution, and dry cannabis retail. They're trying to have a hand in everything and Aurora Cannabis is more flashy and aggressive than Canopy Growth. Another producer that's interesting is Aphria (APHA). The company is smaller, and these guys play a different game. They don't want to be like the Canopy or Aurora. Instead, these guys are only focusing on one thing and that's being the low-cost producer. So, they're focusing a lot on costs. They are doing that by focusing on the greenhouse which currently costs them $55/sqft. They keep their costs lower by being outside where they have natural light which lowers electricity bills compared to the people growing inside. Also by being and also by being outside, you're using a lot less fertilizer. So, less electricity, more light, and less fertilizer, which equates to cheaper costs. So, that's their game. I think they know that's going to be important especially for the dry cannabis so they're sticking with that approach. Another small company is Hexo (OTCPK:HYYDF) which is based in Quebec. What makes them different is that they're the exclusive weed seller for the government of Quebec. When the government of Quebec opens their stores, they're going to be the exclusive provider. So, that's really good and their market valuations are high but not as crazy as the other guys. And they just graduated from the venture to the big TSX. There's also Tilray (TLRY). Have you heard of them?

ERIC: Of course

BRIAN: Yeah, that's the company backed by Peter Thiel. This company in September was worth about 30 billion for a brief amount of time while having only 20 million in revenues for the first half of the year. So what happened was that Tilray got to grow marijuana in Canada. It's one the few pot company listed in the US and the stock exploded when it was DEA approved that they were allowed to export a small amount of cannabis to California for medicinal study and the market went absolutely crazy. In addition, the company has a small float. So, good for them and good for Peter Thiel. The stock has gone from 100 bucks to 300 and then it went back to 125. What you're buying is hope and potential and there are lots of people that want to make money quickly, get rich quickly, and they're all jumping on the bandwagon. I'd like to know how many people actually open the 10K and read it. I don't think a lot of people do. So, these are a couple of companies that you can keep an eye on. I also want to bring up alternative suggestions. This is what I would actually look at. The people that make money during boom periods are the people that provide the pick and shovels, right? It's not the people going to the mountain and digging for gold. Most of them come out broke. And you see this pattern repeating over its itself over and over again, you look at it with the ".com" stocks, the internet stocks, real estate before the crash, and we saw it last year with the Bitcoin and cryptocurrency mania. Look at it, look where it is now. It was a great story. The blockchain, you couldn't go a day without hearing how the blockchain was going to change everything.

ERIC: I think, it's such an interesting story though.

BRIAN: It is, it's a great story… but the people who make money are the pick and shovel guys, the guys who provide the pick and shovels. Who made money. It was Nvidia (NVDA). They provided the cards, they did the video cards for the miners. Nvidia is one of these stocks that just went through the roof. I think it's hard to just pick the right stock but maybe there are other ways to look at it. For example, one that made the news that recently was Constellation Brands (STZ). So, who are these guys? They are the Corona guys. Corona beer, they're in beer, they are in hard liquor and now they're in weed. It's a great company. These guys, they had a stake in Canopy Growth that they bought a couple years ago and now back in August they just raised that to a 38% investment which equals four billion dollars and now they own 38% of Canopy and I think they have a warrant to buy more.

ERIC: And just something too, I don't know if any of these companies have publicly traded warrants, but, as a warning to American investors, if any of them did want to do something like this, Americans cannot exercise Canadian warrants.

BRIAN: Thank you. That's good to know. So, the Corona people… they own ~40% of Canopy group and now if Canopy Grow is worth 14 billion or 15 billion well now you can own that indirectly at a much more reasonable valuation because there's no marijuana premium in the current market multiple. So, it's kind of like a backdoor to buy Canopy Growth, right? Especially if they buy the whole company. There's also Molson Coors (TAP), they're another one following the move made by Constellation Brands. They have made a JV investment with HEXO to develop cannabis related drinks for the marijuana industry. There's also Coca-Cola (KO) which has said they are exploring something with Aurora. Coca-Cola, they're looking for growth. Coca-Cola disclosed they're considering adding CBD to sports drinks. So, who knows. But again, they haven't said anything they're just exploring the space. The investment bank Cowen (COWN) which is a small investment bank in United States with a market cap or about 500 million. Actually, I got the idea from Barron's, it was Barron's pick of the week last week and I'm like in the podcast and I should bring it up.

ERIC: Big shout out to Barron's by the way, it is such a high-quality magazine.

BRIAN: So, there is Cowen, the guys who took Tilray public and they own a part of it. It's a small stake. Cowen is a low profile investment bank and they are in the marijuana industry, but they don't have the marijuana premium attached to them. So, that's kind of interesting so that's maybe one way to play it and Barrons broke down the numbers but it's pretty cheap as it is trading at five times projected 2018 earnings and they are trading at 80% of tangible book value.

ERIC: I want to ask you to obviously with any of these new industries, there's always a bunch of weird sketchy stuff that ends up going on. Just look at ICO's with Bitcoin. What kind of red flags do you look at in the marijuana industry? Do you see any weird behavior going on?

BRIAN: First, well you look at the financial statements a lot of these companies are using IFRS.

ERIC: There's nothing inherently evil or scammy about that per se.

BRIAN: That's true, you're right

ERIC: Because Brookfield has gotten a ton of pushback for that from a few journalists. I thought it was really bad reporting.

BRIAN: Yeah, actually it was from Barron's right?

ERIC: I believe so. I actually remember reading that article and thinking that if this is a scam, then it's a really dumb scam due to the fact that they under promise and over-deliver and it turns out that they tend to understate their assets on the books.

BRIAN: For people who don't know what we're talking about... Brookfield Asset Management uses the IFRS reporting standards. What happened is that Brookfield got knocked on for how much they are reporting their assets on their books for and some assets were shared with other companies. So, company X will have it at this price on their financial statements and Brookfield will have it at a price much higher. The journalists were accusing Brookfield of inflating numbers because these numbers were IFRS instead of GAAP. GAAP uses a cost-based approach while IFRS is more fair value, which Bruce Flatt thinks is more relevant.

ERIC: And GAAP you could say would be more conservative in that respect, but it also has its issues. Just look at companies whose assets are clearly worth more than they are on the books for.

BRIAN: Yeah, exactly. There are rules you have to follow so Brookfield is simply following the rules and you have to use a certain amount of judgment. The knock on Brookfield was that their numbers were out of whack with that another company's numbers. Brookfield made the case that they are simply following their reporting standard rules and that if you look at their history, they have recycled capital which means they have sold assets that they had on the books at X amount at a higher price than we have reported and they do this all the time. They sell assets every year and they're selling those assets at a much higher price than what's been reported on their financial statements.

ERIC: I wouldn't say always much higher, I would say higher and it's usually on the higher side.

BRIAN: Yeah, exactly. And anyway, you have to go case by case but the message it is sending is that the assets are real and the money Brookfield gets for these assets is real. Cash is cash.

ERIC: I've seen Chinese companies fake their cash but that's a different story.

BRIAN: Yes, it is a different story and that would be a good podcast. You were talking about red flags. The accounting is not a red flag, but you have to know how the numbers are reported by each cannabis producer. Many of these companies use a model that's favored by the agricultural industry in which companies place value on plants while they're still in the ground.

So, it's like it's like putting a value on eggs that haven't been laid yet. So what happens if things don't work out like they are supposed to? Then you have to take a big write-off. One impact of this is that there's no financial clarity. So, that's one thing I will look at. There's no standardization across the cannabis industry. So, you're not comparing apples to apples. So, every company makes different assumptions and they break down their numbers differently than their competitors. I hope they're going to fix that. So, here's a couple things. You really can't look at valuations in a traditional sense with these businesses and they are hard to figure out. If you want to invest, and this is probably the part where people don't like to hear me say this, I'm telling you not to touch the space. I have friends who invested in Canopy Growth at like ten bucks okay? It's sixty-something right now and they bought it at ten, at twenty, at thirty, at forty and you know I'm like, oh I'm the investment guy, I am a valuation guy and I have a friend that just doubled his investment. So why listen to me, right? If you made money in that space then good for you. You put your money on red and red came up. I always just say take your money and cash out. It's not going to end well unless you have a multi-year horizon, but investors don't have that, especially in the marijuana space. So, figure out what you're buying, figure out what it's worth and tried to buy it for less, that's what smart investing is. And it's no different in the marijuana industry even though it doesn't seem like it. Approach it from a business point of view. Right now in the marijuana industry the game is buying an asset that you aren't sure what it's worth and hoping the next buyer buys it at a higher price than you bought it for. That is the game right now and it's not a game that's interesting to me. So, do the boring thing. Focus on assets that produce cash. Just look at Berkshire Hathaway (BRK.A). Warren Buffett isn't buying weed stocks and I think he knows something about investing, I don't see him talking about buying weed companies. It's not like he doesn't like money, so you should be careful with how you navigate the space and obviously, it's not a space we can pull out a financial map and try to make sense out of it. Just do the boring stuff.

ERIC: My only comment is if you are going to invest in the space you want to treat it with a VC mindset and if you put something into a financial model your model will be mostly wrong.

BRIAN: Well, maybe take five percent if you want to play this space. Take five percent of your cash or your net worth and go have fun.

ERIC: I don't have about five percent. If you're willing to lose five percent of your entire net worth then fine. For me, this industry is a zero percent position. The point is if you're willing to potentially lose all of your money on this, then fine. If you're not, then don't invest in marijuana stocks.

BRIAN: Right, just do your homework.

ERIC: Or just buy Brookfield and call it a day.

BRIAN: Hey, if you are a listener, you could have made money on that call on the prior podcast.

ERIC: I don't like that way of thinking though because it's only a few months. You know it could be down 20% this quarter. I don't want to give any credit to that. Let's come back in five years and see what the stock price is.

BRIAN: I'm trying to make you look good.

ERIC: I know, I just don't want to take credit where I shouldn't. So, let's come back in five years and then if the stock had a good rate of return then I can I say okay, there's probably something smart about that. And for full disclosure, it's a pretty big position for me and about the same allocation for most of my investment clients too. So, I have a lot of skin in the game.

BRIAN: This was a lot of fun.

ERIC: Yes it was.

BRIAN: All right, thanks a lot.

ERIC: Thanks. Talk to you later. Bye!


OUTRO: Thank you for listening to the Intelligent Investing Podcast, with Eric Schleien. If you'd like to connect with Eric for questions, comments, feedback, ideas or to inquire about being on the show, please contact Eric... So, in the words of Charlie Munger, I have nothing to add.

Disclosure: I am/we are long BAM, BRK.B. 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.