We are in the midst of a true green rush. The legal cannabis market is already massive in the states where it is permitted. With more states expected to legalize in the coming years, the market for legal medical and recreational cannabis is poised to explode.
A host of cannabis startups and companies, serving every aspect of the industry, has popped up. Some even trade as public companies. This is truer of Canada, where national legalization makes public trading easier. But some cannabis stocks do trade in U.S. exchanges. One such company is the Cronos Group (CRON, Financial), a medical cannabis firm that has exploded into the news this week.
The news was not the good kind. On Aug. 30, Citron Research, a research group headed by noted short seller Andrew Left, published a scathing report in which it called out a range of shady business practices and questionable disclosures. As a result, shares have tumbled nearly 30% in one day to close at $9.12 per share.
In this research note, we take a look at Cronos. Let’s see what’s under the hood of this battered cannabis stock.
First mover with big ambitions
Cronos made history in 2013 when it became the first company to receive a license from Health Canada to do business in the medical cannabis sector. That won Cronos attention and investor support.
Here's how Cronos defines itself, in its own words:
"We are a geographically diversified and vertically integrated cannabis group that operates within Health Canada’s Access to Cannabis for Medical Purposes Regulations and distributes globally.
We don’t strive to follow best practices; we aspire to set them by building industry leading companies that transform the perception of cannabis and responsibly elevate the consumer experience."
Lofty ambitions indeed.
The Cronos Group’s core business
The Cronos Group itself owns and manages a number of cannabis ventures. Its “core assets” consist of three companies:
- Peace Naturals, “a company licensed to produce and sell medical marijuana as well as cultivate cannabis oil, acting under the authority of a license issued by Health Canada.”
- Original BC, “a company that is currently licensed to cultivate and sell medical marijuana, acting under the authority of a license issued by Health Canada.”
- Whistler Medical Marijuana Company (WMMC), “a company licensed to produce and sell medical marijuana as well as cultivate cannabis oil, acting under the authority of a license issued by Health Canada.”
Cronos has a 100% ownership interest in both Peace Naturals and Original BC, but owns just 21.5% of WMMC.
A highly questionable stock price
Before the plunge on Aug. 30, Cronos stock was soaring. Even with the current drop, shares are up about 40% from where they were a month ago. The upward spike was largely the result of speculation that Diageo (DEO, Financial) could buy Cronos to support its cannabis strategy. But this remains very speculative, and there are likely better candidates for the beverage giant to scoop up.
Financially and operationally, whatever first mover advantage Cronos might have claimed in 2013 is long since gone. Indeed, the company reported a measly C$3 million in revenue in the second quarter. Compared to the C$26 million in revenue booked by Canopy Growth (CGC, Financial), Cronos barely registers. Cronos may be growing revenues faster, but that hardly justifies a multi-billion-dollar valuation.
A problem of deceptive disclosure
Cronos may just look like an overvalued, hyped up pot stock. But there is more to it than that. Citron’s report has alleged that Cronos may be engaging in deceptive and misleading behavior:
"Cronos management appears to have been deceiving the investing public by purposely not disclosing the size of its distribution agreements with provinces – unlike every other major cannabis player.
Our sources have informed us that it’s because the agreements are so small they could never justify the premium investors are paying for the stock.
Some may argue that US listed cannabis stocks are subject to stricter regulation so companies are much more careful with what they disclose but both Canopy Growth (NYSE:CGC) and Tilray (NASDAQ:TLRY) are much more forthright."
If true, this could be a big problem. It also throws into doubt the notion of a tie-up with a heavy-hitter like Diageo.
Verdict
Citron’s conclusions may be a bit heavy-handed with regard to Cronos. But the questions its report raises are pertinent. There appear to be issues with disclosure, the European market opportunity has apparently stagnated and the absence of a U.S. presence continues to depress potential future opportunities.
Cronos has taken a nasty tumble. It probably has a good way further to fall before this is all over.
Disclosure: I/We own no stocks discussed in this article.
