Where There's Smoke, There's Fire: The Citron-Fueled Fall Of Namaste Technologies

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About: Namaste Technologies Inc. (NXTTF)
by: Jonathan Cooper
Summary

Citron wrote two short theses on Namaste in Fall 2018.

Where there's smoke, there's fire: Citron's findings have led to the termination of former CEO Sean Dollinger.

Since Citron's initial report, shareholders have lost nearly 80% of their investment.

Troubles continue: Namaste's auditors resigned on March 5th and the market is assuming the worst.

Citron Weighs In On Namaste

Source: Citron Research.

The first salvo: Back on Sep 13, 2018, noted short-seller Andrew Left's Citron Research published a short report on Namaste Technologies (OTCQB:NXTTF). That report suggested that Namaste shares would never trade on the Nasdaq and set a target price of $0.25/share.

Among other statements, Citron suggested that Namaste was engaged in stock promotion by promoting a party for shareholders that did not sell shares within a 90-day "pledge" period. Meanwhile, four insiders were said to have sold shares between the announcement of the pledge and the end of the 90-day period. Without opining on the legality of this scheme under Canadian securities law, those allegation were a bad look for the company.

Source: Citron Research.

Once more unto the breach: Citron upped the ante less than a month later with a second short report on Namaste Technologies on Oct 4, 2018. Rather than merely suggesting that Namaste shares would not reach the Nasdaq, Citron suggested that Namaste was engaging in fraud and shares could be halted by the Canadian TSX-Venture exchange.

In its second report, Citron suggested that then-CEO of Namaste, Sean Dollinger, lied about Namaste being accepted to the Nasdaq.

Citron also suggested Namaste had undisclosed related-party sales. Namaste wanted a stock listing on the Nasdaq. As with other Canadian cannabis companies, a listing on a U.S. stock exchange requires that companies divest all U.S.-facing assets. Namaste then sold its U.S. assets for $400,000 to ESC Hughes Holding Limited, which Sean Dollinger claimed were arm's length buyers.

Source: Citron.

However, Citron produced a document purporting to show that ESC Hughes Holdings was a related-party entity, with leadership including Namaste Chief Marketing Officer David Hughes and long-time Namaste employee Paul Burns.

Early in October, Namaste responded to Citron's reports, denying Citron's claims and questioning Citron's credibility:

Namaste Technologies Inc. is aware of several misleading and false 'research reports' published by Citron Research Inc. and press releases and advertisements distributed by several US-based law firms seeking plaintiffs for potential securities litigation against the Company.

...

Citron is engaged in the practice of short-selling securities for its own financial gain. Citron has previously published false and misleading information in respect to the Company as a means to manipulate the Company’s share price. Citron has also targeted other Canadian companies in the cannabis sector. The Company is prepared to pursue any legal remedies it deems necessary to protect its rights and its reputation and shall continue to respond strongly to false and defamatory statements such as those mentioned in these publications.

Namaste Press Release, Oct 9th, 2018

Newton's Third Law

Citron's two short theses caused immediate reaction in both cases. Citron's first article caused a 12% decline in Namaste shares on Sep 14th and Citron's second article caused a 5% decline on Oct 4th. In both cases, comments on Seeking Alpha and other platforms were largely anti-Citron and pro-Namaste.

Unfortunately for shareholders, it looks like Citron Research may have been onto something. Loyal Namaste shareholders are yet to be rewarded for their faith.

Prior to Citron's original report, Namaste shares closed at $2.68 / C$3.50 on Sep 12th. Since then, shares have dropped nearly 80% to $0.55 / C$0.73. Over this period, Namaste has performed much worse than the cannabis sector's (OTC:HMLSF) 8% decline and much worse than the performance of leading names like Canopy Growth (OTC:CGC) at -12% and Aurora Cannabis (OTC:ACB) at +9%, much less the runaway success of Cronos (OTC:CRON) at +100%.

What happened?

Trouble in Paradise

It has been a rough few months for Namaste.

On Sep 21st, Namaste announced the receipt of Canada's first no-cultivation ACMPR sales-only license, allowing the company to sell medical cannabis on its Cannmart site. Shares closed at an all-time high of C$3.74 on Sep 24th and have fallen since then.

Since then, Namaste's shares have fallen due to several problems including auditor troubles, dilution, and serious management issues.

Auditor changes: On Sep 25th, Namaste announced that they were switching auditors from MNP to PricewaterhouseCoopers ("PwC"). MNP agreed to resign as auditor at Namaste's request. As it later turned out, the deal with PwC wasn't long for this world.

Unfortunately, after-hours on March 5th, PwC resigned as auditor for Namaste. This will likely lead to delays in Namaste's filing of their annual report:

Namaste Technologies Inc. confirmed today that PricewaterhouseCoopers, LLP will no longer be acting as the Company’s auditor. The Company’s audit committee and board have accepted PwC’s resignation and are in advanced discussions with potential successor auditors, one of whom is in the final stages of its client acceptance process. The filings required under Section 4.11(5) of National Instrument 51-102- Continuous Disclosure Obligations will be made publicly available at www.sedar.com. The Company’s annual financial statements are due to be filed by March 31, 2019. The Company currently believes that it is unlikely that it will be able to meet such filing deadline. The Company will continue to assess this and will update the market in due course.

Namaste Press Release, March 5th

While there is no smoking gun in this announcement, the optics look bad for Namaste. PwC is an enormous accounting firm and they're unlikely to resign - and potentially cause annual statement to be late - without reason.

Without speculating on what might have caused PwC to step down at such an inconvenient time, the market's reaction here was very negative. Namaste shares lost 14% on March 6th on heavy volume.

Dilution: Namaste's shares have also been negatively affected by dilution. On Sep 25th, Namaste announced a $45 million bought deal raise at a price of C$3/unit, with each unit including both a share and half of a C$3.50 share purchase warrant with a four-year exercise period. Shares fell 8% after this announcement.

Because of falling share prices, on Oct 19th Namaste amended the bought deal by including 3/4ths of a warrant in each unit, decreasing the warrant strike price for C$3.15/share, and increasing the exercise period of the warrant from four to five years. The deal, underwritten by Eight Capital and Canaccord Genuity, closed on Oct 25th including a full exercise of the over-allotment option, generating nearly $52 million in gross proceeds for Namaste. Shares fell on news of the amended bought deal, but largely recovered when the deal closed, with ~25% swings in both directions over the course of a week.

Trouble At The Top: CEO Dollinger Fired

But even more than either of those issues, leadership trouble at Namaste is alarming.

In Citron's short reports, they suggested that Namaste engaged in stock promotion, Sean Dollinger had prior fraud charges, and that Namaste was paying very high consulting fees:

Source: Citron.

In a manner very similar to what occurred at Aphria (OTC:APHA), suggestions on insider dealings led to an investigation and led to the removal of former Namaste CEO Sean Dollinger:

The Special Committee's thorough investigation examined all material allegations against the Company. The only one that was substantiated and required action, as recommended by the Special Committee, related to the sale of Namaste's US subsidiary, Dollinger Enterprises US Inc., in 2017, and subsequent transactions involving its assets and companies in which Sean Dollinger and Namaste's head of marketing David Hughes have a beneficial interest, as well as breaches of fiduciary duty by Sean Dollinger and evidence of self-dealing. In light of these findings and the Special Committee recommendations, the Board concluded that it is in the best interest of Namaste that Sean Dollinger be terminated from his role as CEO for cause and removed as Director of the Company. In connection with the findings of the investigation, the Company is commencing legal action against Sean Dollinger for damages and disgorgement.

Namaste Press Release, Feb 4th

According to Namaste's internal investigation, Citron was correct that the buyers of Namaste's U.S. holdings were not a third-party, as alleged by Sean Dollinger. Instead, those assets were purchased by companies in which Sean Dollinger and David Hughes had a beneficial interest. This is a clear breach of the duty of loyalty owed by a director or officer of a corporation.

Sean Dollinger did not take this lying down. Dollinger believed he had been wronged and filed suit against Namaste in Ontario. Dollinger also discussed his grievances on Midas Letter Live, above. Among other issues, Dollinger suggested that the board members who allegedly found his misconduct were absentee and inexperienced.

As I have discussed regarding the former CFO of MedMen suing the company (OTCQB:MMNFF), these types of cases can get quite nasty and could lead to unpleasant disclosures for the company. Thankfully, Dollinger and Namaste agreed to a settlement about two weeks later. Under the settlement, Dollinger withdrew his suit and entered into an advisory role at Namaste to provide transition support to the company.

Shareholders lost 15% on Feb 4th when Dollinger was fired and have not recovered since then.

Thoughts

Unfortunately for Namaste shareholders, Namaste looks like a mess and it appears that Citron was correct. Citron's report directly led to CEO turnover at Namaste and shareholders have suffered. While Aphria shareholders have recovered from their early December losses, Namaste shareholders have not been so lucky.

The March 5th resignation of PwC is also alarming. Perhaps there is a good explanation for why PwC has decided not to represent Namaste. If there is, Namaste should come forward with that explanation as quickly as possible, since shares have already fallen 18% since PwC stepped down. Until shown otherwise, the market looks to be assuming the worst.

I will continue to stay on the sidelines here. Perhaps Namaste will recover, but even in the high-volatility world of cannabis, there are much safer places to look for good returns than Namaste. As always, investors should do their own diligence, especially when considering investments in small companies like Namaste and other fast-rising cannabis (and non-cannabis) stocks.

Happy investing!

Disclosure: I am/we are long CGC. 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 short Cronos via puts.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.