In the final instalment of a three-part analysis of Australia’s legal cannabis landscape, Cannabiz chief correspondent Steve Jones examines the reasons behind the declining valuation of the industry’s listed enterprises.
In January 2018, buoyed by government clearance to export medicinal cannabis from Australia, Cann Group shares soared past $4.
Today they are valued at 42 cents.
Over at Auscann, meanwhile, the early days of 2018 saw shares hit $1.74. At the opening of business yesterday they were 14 cents.
Similarly Althea. In July it peaked at $1.20 per share. Since then the price has fallen 70%. Elixinol is another to see its value fall.
In fact, wherever you look in the ASX-listed medicinal cannabis sector, the pattern is the same. Stocks have suffered, almost without exception.
With local production slow to take off, little meaningful revenue generation, and profitability a distant ambition, that subdued picture is unlikely to change any time soon.
But few would contest the assertion that today’s valuations are a more accurate reflection of where the industry currently sits.
Which begs the question. How – when product was largely non-existent – did the Australian medicinal cannabis market rise so rapidly, only to fall away again?
The reasons are varied, the vagaries of the stock market being one.
But there is widespread and well-documented agreement that the rise and fall has its origins in Canada, a market built on hype and over-inflated expectations.
Several Canadian companies made cornerstone investments in local operations with Aurora throwing its hat in the ring with Cann Group, Aphria investing in Althea and Canopy Growth taking a stake in AusCann.
All either sold off or diluted their local interests as they faced growing scepticism and unrest in their home market. Fundamentally, the anticipated surge from recreational legalisation failed to materialise, supply outstripped demand – when the opposite had previously been true – and the market tanked, wiping billions off company valuations.
And Australia was caught in the maelstrom. As reality came knocking, local company valuations also crashed amid a growing realisation that the green-leafed pathway was not, after all, paved with gold.
According to Cann Group chief operating officer Shane Duncan, the initial surge in interest from cannabis start-ups and investors may partially have been triggered by a misplaced belief that recreational legalisation was on the horizon on the Australian side of the Pacific.
“I suspect there were a number who jumped in, hoping that recreational cannabis would come through reasonably soon, or that it would at least be on the agenda, but that has not been the case,” Duncan told Cannabiz. “If you look at Canada they had 15 years of experience with a medicinal program before going fully legal, and that wasn’t a medicinal program like we have here. In Canada you have a card and go to a dispensary. Australia is obviously far more restrictive, so it was never going to be straightforward, and people started to realise that.”
While acknowledging the 2019 implosion of the Canadian market drained confidence globally, Duncan said Australian valuations were already unravelling.
“There is no doubt the North American collapse, or bubble bursting, affected us all,” he said. “There was an incredible amount of pump and dump. Everyone built five glass houses and manufacturing facilities, demand was going to exceed supply for the next four or five years. And then it was ‘oh, actually, maybe that’s not true’.
“But there was already a decline in our value before that happened. I think everybody underestimated the time it takes to set up in such a highly regulated and restricted framework.
“The legislation was set up with the primary focus of preventing diversion. It was ‘how do we make sure this stuff doesn’t end up on the black market and in the wrong hands’.
“But there is some legislation which is just incredibly restrictive for no good reason. If I’ve got a licence, and you’ve got a licence, and we’ve both been through the same process then we should be able to do business. But it’s just not that easy. Two more applications have to go into a queue at the ODC so it’s taking everybody a lot longer to get going.”
Relaxing the regulatory framework under which the industry operates is among the ambitions of the Australian Medicinal Cannabis Association (AMCA). Such a restrictive environment and “serious delays” in obtaining licences has strangled local production and contributed to declining investor confidence, according to AMCA secretary Teresa Nicoletti.
With companies entangled in red tape, the sector has been unable to generate cashflow and capital is ebbing away, she said.
“There is no confidence in the sector because many companies have had to wait up to two years or more to obtain their licences,” Nicoletti said. “The general sentiment is that the medicinal cannabis industry in Australia is not viable. The burn rate is very high for no return on their investment.”
If anything, the valuations of listed firms are still too high, Nicoletti said, and propped up by ASX announcements which suggest the industry is making progress.
“The reality is that most businesses are struggling because the licences and permits that are being issued are unnecessarily restrictive in their scope and the amount of product that may be cultivated, produced and manufactured.”
The Canadian effect
The experience in Canada, where companies built and then closed or abandoned major construction projects at exorbitant cost, prompted counterparts in Australia to re-think their strategies, with several now favouring an asset-light approach.
Althea is one which shelved construction of a facility in Skye, Victoria.
Chief executive Josh Fegan said “horror stories” emerged from Canada of producers and cultivators spending hundreds of millions of dollars on greenhouse infrastructure and a “glut of supply with no-one to sell it to”.
“Share prices tanked right, left and centre and those facilities are probably never going to be able to pay themselves back,” he said. “That is why we put ours on hold. The board wanted to do a full feasibility review and really get down into the weeds of our own product forecasting.
“The Skye facility is still on hold for now although everything we have learned over the last few years means that if and when we decide to put it back on the table, we will have a very cost-effective and proficient operation in mind.”
He added that the “sluggish” results of a number of Canadian licenced producers, both domestically and abroad, combined with “questionable acquisitions” hasn’t sat well with investors.
“From missing guidance to massive write downs, investors in Canada have experienced highs and lows in just a few short years,” Fegan said. “I think that negative sentiment may have blown over to Australia.”
Nevertheless, Fegan insisted for a nascent industry, and a young business like Althea, success proves it’s an exciting sector.
For Rhys Cohen, director of Cannabis Consulting Australia and until recently principal consultant at FreshLeaf Analytics, the downturn in the Australian market can be directly attributed to the Canadian meltdown which reverberated through the medicinal cannabis landscape.
The chickens came home to roost, he said, following a period of hype, crazy valuations and unproductive assets.
“And they made no money,” he pointed out. “The Canadian listed market fell off a cliff and dragged everyone down with it. It made investors hesitant, and Australian companies were hurting as a result. Canada is a bloodbath.”
“We still have a lot of potential in Australia and there are some awesome, well-operated companies that are starting to generate meaningful revenues. But anyone who was relying on a new fundraising round is going to have a bloody hard time.”
The unflattering assessment of the Canadian industry is widely held, with reports the black market continues to thrive because of the ‘garbage‘ quality of the legal product.
Elisabetta Faenza, chief executive of unlisted LeafCann, said the capital markets were rocked by the failures of ‘irresponsible’ operators which undermined international markets.
“I’ll come straight out with it and say what they have done over the last few years by over promising and building bigger and bigger facilities has harmed everyone and set us back in a big way,” she told Cannabiz. “A lot of the investors who went through the Canadian experience either got out early and made a lot of money when these companies were ridiculously highly valued, or rode the rollercoaster. They are feeling bruised and don’t ever want to look at another cannabis company.”
Faenza claimed the industry was built on spurious growth projections drawn up by individuals and businesses driven only by self-interest.
“It’s a source of distress for me,” she said. “We said from the beginning that the hot money that went into Canada and in some cases came into Australia – although to nowhere near the same degree – was bad for our industry. It attracted all the wrong people. It attracted grandiosity and the creation of these ridiculous facilities that are just white elephants. Businesses were without any kind of principals and run by cowboys to enrich themselves. And that harmed our sector.”
Faenza partially blamed what she called the low level of compliance required by the Canadian Stock Exchange. Documentation was “shameful”, she said, which enabled business plans to go unfettered.
“The ASX is more active in chasing down misleading information and that is something Australia can be proud of,” she said. “Of course there’s always going to be scallywags but a lot of those have come and gone. The companies that are still around today are all working extremely hard to achieve the goal of providing patients with great product.”
Another to see its share price slide was Medlab. From a high of $1.12, its shares now sit at 16c. But chief executive and majority shareholder Sean Hall remained philosophical.
“I kept saying ‘guys, we’re not a pot stock’. I don’t grow it, I don’t manufacture it, I don’t put it in a bottle, I’m not interested in recreation,” he said. “We’re a drug, we are biotech. They said ‘right, we understand that’. Yet when the bubble burst, everyone panicked.
“But the market is going to do what the market is going to do and the ASX has a good mix of retail players and instos (institutional investors). There is no point going public and then whingeing about fairness of play later down the track. No-one complains about fairness when their stock is rallying.”
Nevertheless, Hall said the falling valuation “does make you stop and pause for a second”.
“It makes you think ‘are we speaking to the right people? Do we have the right people on our registry? Is my messaging making sense?’”
Morgan’s recently valued Medlab shares at 36c, more than double its current market cap valuation of $45m. But with the company pursuing registration with the Food and Drugs Administration (FDA) in the US – and poised for a phase 3 trial of its NanaBis medicine – Hall suggested a $1 valuation was nearer the mark.
“I’m not going to get that response from the ASX because we have a very small biotech community here,” he said. “But a play like that in New York or London that has savvy biotech instos is a whole different game.”
While Medlab successfully raised $7m in June and July, Hall admitted there had been nervousness over the market sentiment. And he predicted capital raising will become increasingly difficult particularly for “leaf touch products”.
“If you import it, or grow it and put it in a bottle, then you’ll quickly hit a brick wall because you’ve nothing that makes it new,” he said. “I don’t care how many smartphone apps you’ve got or how many people you’ve got out there. It means nothing. At the end of the day you’re still leaf touching, the product is undifferentiated and that will make it harder to raise money.”
Hall’s view was recently backed by Zelira Therapeutics CEO Dr Richard Hopkins who forecast the investment community would increasingly favour companies with clinical data rather than those with a high-cost cultivation and extraction model.
“It’s true the sector has seen a pullback but it’s transitioning from a focus on the cultivation/extraction side of the business which has really become a commodity,” he told investors.
Lower capex, higher-margin companies focused on patient outcomes “represent the future”, he said.
However, Althea’s Fegan argued that investor confidence remained high for the cannabis and hemp sectors based on capital raising over the past 12 months. Althea successfully went to the market last July to help support the acquisition of Canada-based Park Processing Solutions, he said.
For Cann Group, it too received a vote of confidence with an oversubscribed share purchase plan this month which raised close to $25m, $15m above target. Together with its placement offer, the company raised $40m to help fund its Mildura facility.
But Shane Duncan, Cann’s COO, stressed the company was anything but complacent and admitted the sector, including Cann, has been punished by the market.
Furthermore, while pleased with the response from shareholders, some institutional investors didn’t participate in the latest round of capital raising.
“As it’s got harder and you burn through what capital you’ve got, if you haven’t moved the rock far enough up the hill, you get whacked by your investors and the market, which is what we experienced,” he said.
“We’ve gone back, raised some more money and recapitalised the business to get on and deliver some of the commercial stuff. But we have been whacked because we’re back again asking for more cash.”
Duncan stressed Cann Group was under no illusions that it could not keep relying on investors to dig into their pockets. Quite the opposite, he said. Far better to treat the funding as a “last chance” than take further raising for granted.
“You go in thinking you’ve got a good story, and we’ve been given a vote of confidence. People have been positive and interested. But, you know, it doesn’t go on forever. It’s probably too strong to say ‘it’s your last chance’ but you’ve got to treat it like that. There’s not a bottomless pit.
“We’ve got a real gritty, start-up, smell of an oily rag kind of approach to it now. We’ve got capital projects but we’ll treat it like we’ve got $10m, not $40m, and see how we go.”
Despite the successful raising, Duncan said there is caution in the market concerning cannabis, a sentiment exacerbated by Covid-19.
“We get feedback that people are cautious of the sector now, and some of the instos (institutional investors) didn’t come in [on the capital raising],” he said. “Covid has also made it a little more difficult so everyone is a bit more cautious and probably a bit more opportunistic in trying to extract more of a discount and get a bit more value. People are also trying to work out the best time to tap the market.”
For the sector to gather momentum, it must demonstrate success, he said.
“What I think it needs is for a couple of us to get on and execute. The sector has been kind of bobbling along on the verge of greatness but it hasn’t quite got there yet.”
Cann chief executive Peter Crock added: “The focus now is on companies delivering on what they are promising rather than talking up the promise itself.”
“But the fundamentals have not changed. Cannabinoids in medicine are going to have a really important role to play. It’s going to be an important sector that, serviced correctly, will make a difference to a lot of people.
“A sustainable industry will grow up around it for sure.”
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