Throughout the first half of 2018, marijuana stocks turned in a dismal performance. But over the past couple of weeks, they've been all the buzz, once again. The North American Marijuana Index, which is comprised of a few dozen of the largest and most influential cannabis names in the industry throughout North America, has risen by close to 50% in just three weeks.
What's causing all of this hoopla, you ask?
Part of it could be the expected launch of recreational cannabis in our neighbor to the north in just six weeks. On Oct. 17, Canada is set to become the first industrialized country in the world to open the floodgates to adult-use marijuana. There's an expected influx of up to $5 billion in annual sales once Canada's legal weed industry is fully ramped up, so there could be some obvious excitement among investors for this big event.
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Deal-making pushes pot stocks into the stratosphere
But perhaps even more than the actual legalization of recreational weed has been the amount of deal-making ongoing in the cannabis space.
Before the opening bell on Aug. 15, Constellation Brands (STZ 0.66%), the alcohol giant behind the popular Corona and Modelo beer brands, announced that it would be taking a $3.8 billion equity stake in Canopy Growth Corp. (CGC +10.80%) for what was a 51% premium at the time of the announcement. This actually turned out to be Constellation's third such equity investment in the largest marijuana stock in the world (by market cap), with Constellation gobbling up a 9.9% equity stake in Canopy last October, and a third of its 600 million Canadian dollar convertible note offering in June.
Prior to even the Constellation Brands megainvestment, Molson Coors Brewing (TAP +0.33%) announced its intent to form a 57.5%-42.5% joint venture with the Hydropothecary Corporation. Molson Coors has seen declining market share and sales of beer in Canada and is hoping that a partnership with Hydropothecary could yield new products, such as cannabis-infused beverages, that reignite its top line. It's worth pointing out that cannabis-infused beverages, along with edibles, and vaporized cartridges, won't be legal in Canada on Oct. 17, although Congress is expected to touch on and expand the legal forms of consumable cannabis in 2019. Thus, the Molson Coors-Hydropothecary tie-up is about staying ahead of the curve.
Then, just this Monday, Cronos Group (CRON +3.07%) announced a $122 million deal with Boston-based Ginkgo Bioworks to extract rare cannabinoids from the cannabis plant at commercial scale. Extracts have a generally high price point with little risk of commoditization, so it's generally viewed as a high-reward, low-risk venture for Cronos Group. Ginkgo will receive $22 million in cash from Cronos to fund research and development, with $100 million in common stock "being issued in tranches as it achieves certain production milestone," per Bloomberg.
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Marijuana stock Tilray has tripled in three weeks
And now, investors are all but convinced that newly public Tilray (TLRY +0.00%) is next in line to forge a major partnership with the alcohol, tobacco, or pharmaceutical industry. Shares of the Canadian medical cannabis producer are up more than 200% in roughly three weeks, and they've shot higher by more than 350% since its offering price of $17 in late July. No pot stock has outperformed Tilray since mid-August -- and that includes Canopy Growth, which is receiving the noted $3.8 billion equity investment.
But can this monumental move higher continue? To be blunt, no.
To preface my thoughts, I should be clear that I really don't what's going to happen in the very short term (i.e., the next few days to perhaps a few weeks). It's possible emotions and momentum trading could continue to push Tilray higher. After all, it was John Maynard Keynes who once said, "The market can stay irrational longer than you can stay solvent."
However, a few months down the road, I highly doubt we're going to be talking about Tilray maintaining or eclipsing a nearly $8 billion valuation.
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Tilray is far from a train wreck...
To lay things out, Tilray does have a number of positives on its side. Its recent initial public offering yielded $163.6 million in net proceeds after fees, which, along with $55 million in pre-IPO Series A funding, means it has more than enough capital to expand its capacity and build out its domestic and international infrastructure.
Tilray was also one of the first Canadian medical cannabis producers to receive a cultivation license from Health Canada. This suggests that it's one of the most experienced growers in the industry, and therefore has an above-average chance of nabbing supply deals and forging partnerships.
Lastly, the company is expected to finish 2018 with 912,000 square feet of developed space, spanning four total properties. A majority of this space (854,000 square feet) will be devoted to growing. Within the next year, it wouldn't be at all surprising if Tilray's expected annual production topped 100,000 kilograms.
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... but it's not a $7.8 billion company with these metrics
Yet, for all that Tilray brings to the table for a potential strategic partner, it's not even remotely worth $7.8 billion.
Speaking hypothetically, even if Tilray were to somehow double its growing capacity by the end of 2019, which would be an incredibly tough timetable to meet, it would only be generating between 150,000 kilograms and 175,000 kilograms annually, by my estimate. That would place it behind Aphria and The Green Organic Dutchman, which are expected to yield 255,000 kilograms and 195,000 kilograms, respectively, of cannabis-equivalent peak production each year. You could add the market caps of Aphria and The Green Organic Dutchman together and still be $3 billion short of Tilray's existing market cap, despite less annual production from Tilray. That makes little sense.
Though Tilray is focusing on medical cannabis patients, which should be a higher margin crowd than recreational users, the company will be aggressively expanding its capacity and its international presence (i.e., spending, spending, spending), which means profitability is not a given. There's a good chance Tilray loses money over the next few quarters, which makes its existing valuation even more absurd.
The bottom line is that Tilray is a top-tier name in Canada's pot industry, but its valuation right now makes virtually no sense.
