Vivo (ABcann): Acquiring Canna Farms For The Easy Way Out

Summary

• Vivo (previously ABcann) decided to acquire an established producer after repeated failure in completing its own constructions.
• We like the deal because Vivo management is clearly unable to meet its own deadlines and it needs capacity badly to participate in legalization.
• Going into 2019, we expect Vivo to face tough competition along with other small/mid-cap producers including a looming oversupply.
• We would suggest investors consider large-cap Canadian names which are better equipped to cope with a fundamentally challenging market in Canada as a result of the glitchy rollout of legalization.

We first wrote about Vivo (VVCIF) (then still called ABcann) back in April 2018 in the article "The Cannabis Player That Moves Like A Snail." From the article title, you can tell that we were clearly frustrated by the slow path of execution at the company and we urged management to pick up its speed. In this article, we will discuss what has transpired since our last article and where we see the company going into 2019.

What Happened Since April 2018?

Since our last article, the company changed its name from ABcann to Vivo Cannabis and made a large acquisition of Canna Farms. In short, we think Vivo is seeking the easy way out by acquiring Canna Farms which gave it instant access to an established cannabis producer with ample capacity potential. Vivo has failed very hard on its own capacity buildout plan, as we will illustrate later, and the company has chosen to acquire instead of build.

Perhaps given the repeated delay and revisions, Vivo could finally use this deal to get back on track. We think the Canna Farms deal was a great transaction, and actually a necessary one, to help Vivo stay in the game. Without this deal, we think Vivo will struggle a lot.

(Source: TSX)

Canna Farms Acquisition

On July 30, 2018, Vivo announced that it is acquiring Canna Farms, a private Licensed Producer in British Columbia. Canna Farms claims to be the first producer to be licensed for cannabis cultivation in British Columbia. Vivo paid $133 million including $22 million in cash and 92.5 million of Vivo shares at a deemed price of $1.20 (Vivo's share price has since dropped ~25%).

We think the main reason why Vivo acquired Canna Farms is that it needs to increase its capacity very badly. The company now expects its 2019 Q1 capacity to hit 11,000 kg, largely due to the contribution of Canna Farms. Without the acquisition, Vivo would only have 4,100 kg of capacity by early 2019 which equals to around $20 million of annual revenue potential assuming all cannabis can be sold at $5.0 average price.

(Investor Presentation)

It might be worth noting that Vivo had sold 50% of its Kimmett expansion capacity to Auxly (OTCQB:CBWTF) and the two sides are still finalizing the construction plan. Another case where execution has been extremely slow and management has been overly naive upfront.

Constant Construction Delays

Historically, Vivo has been one of the worst executors in terms of its capacity expansions. In July 2017, Vivo announced that it will commence its first cultivation at Kimmett in Q4 2018 and Kimmett will reach its full capacity by Q1 2019. In March 2018, Vivo declared its plan to expand its capacity to 75,000 kg per year through a combination of 32 tons of internal expansions and 43 tons of other and third-party sources. In September 2018, Vivo again announced that it expects its capacity will exceed 12,000 kg by the end of 2018. However, the latest timeline as discussed above includes a 4,100 kg expected capacity by 2019 Q1, with total expected capacity decreasing dramatically to only 11,000 kg excluding contributions from Canna Farms.

(2018 March Investor Deck)

For some reason, it just seems like the Vivo management is utterly incapable of meeting its own timelines and it finally decided to give up and acquire an established grower rather than racking up further delays. The company now expects its Kimmett facility to be completed by 2019 Q4, which is a full year later than the original timeline announced back in 2017. The company could not wait that long given the recreational market was opened on October 17, 2018. Vivo would have had little capacity to meet consumer demand in 2019 given its current capacity of 1,500 kg is a rounding error compared to some of the largest producers in the industry.

(Company Filings)

Outlook for 2019

Vivo has supply agreements with Alberta and Ontario, and Canna Farms has entered into deals with B.C., Saskatchewan, Ontario, Manitoba, and Yukon. Both companies have Ontario and both missed Quebec. With the help of Canna Farms, Vivo will be able to become a meaningful supplier to the various provinces. However, Vivo remains one of the dozens of small producers in Canada that lack competitive advantage, scale, and capital.

Due to our unfavorable view of the small/mid-cap space in the Canadian cannabis market, we remain Neutral on Vivo. We would suggest investors consider large-cap Canadian names which are better equipped to cope with a fundamentally challenging market in Canada as a result of the glitchy rollout of legalization and expected oversupply in 2019/2020. Vivo remains a show-me story in a tough industry that will face intensifying competition.

Analyst’s Disclosure: I/we 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.