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Is Aphria a Marijuana House of Cards or a Bad-News Buy?

By Todd Campbell - Dec 7, 2018 at 8:01AM

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Shares in the third-largest Canadian marijuana company have crashed because of short-sellers. Here's what you ought to know.

After short-sellers questioned the company's recent acquisitions, shares in marijuana stock Aphria Inc. (APHA) have crashed over 50% this week, and as a result they're trading 72% below their peak in September. Short-sellers are smiling, but are they right to bet against Aphria long term? Management's response, including a decision to buy more shares and launch an independent investigation, suggests Aphria's shares could be on sale, but there are still questions that investors need answered.

Bought the rumor, selling the news

Marijuana stocks, including Aphria, rallied sharply higher in the first nine months of 2018, ahead of Canada's recreational marketplace opening for business on Oct. 17. Since then, it's been tough sledding for every stock in this emerging market. 

A house built out of playing cards crumbles.


Canada's recreational sales could eclipse 4 billion Canadian dollars in 2019, according to Deloitte, but reaching that number will require a big increase in supply to meet demand and the regulatory OK of value-added consumer products, including marijuana vapes, edibles, and beverages.

So far, supply has been inconsistent and there's little indication when Health Canada may green-light additional high-margin products. The ongoing prohibition of marijuana in the U.S., uncertainty over how quickly sales will ramp up in Canada, and sky-high valuations across the industry have led investors to rein in enthusiasm until a new major catalyst emerges or future quarterly financials prove that recreational sales justify a rally.

A fast-growing business

Aphria isn't the biggest Canadian marijuana company, but it's one of the top three marijuana producers there and its revenue is growing gangbusters. In the third quarter, revenue more than doubled to CA$13.3 million year over year, and investments to expand its Aphria One greenhouse and construct a greenhouse with Double Diamond have it on track to increase its marijuana capacity from about 35,000 kilograms to 255,000 kilograms per year.

The revenue growth last quarter is entirely due to Canadian medical marijuana sales growth, so recreational sales should result in Aphria reporting even more significant increases in the coming quarters. Aphria's opportunity isn't limited to Canada, though. Marijuana spending eclipses $150 billion per year worldwide, according to the United Nations, so Aphria and its peers are racing to acquire and build out infrastructure in emerging marijuana markets, including Europe and Latin America.

To that end, Aphria's been on a spending spree this year. Previously, Aphria's focus was on low-cost, organic growth, but it acquired Nuuvera for $425 million in March to bolster access to Europe, and it exchanged about CA$194 million in shares for a 90% stake in Colombia-based Colcanna, 100% of the Argentina-based pharmacy player ABP, and a 49% stake in Jamaica-based marijuana grower Marigold in September.

What short-sellers are saying

Aphria's spending has drawn the attention of short-sellers Quintessential Capital Management and Hindenburg Research. The two companies released a scathing report this week questioning if Aphria overpaid for these assets.

It's not the first time that Hindenburg has taken aim at Aphria. In March, it also issued a report suggesting Aphria overpaid for Nuuvera, a company with a short operating history with ties to Aphria CEO Vic Neufeld. Hindenburg asserted that Nuuvera's virtually nonexistent revenue didn't justify a nine-figure purchase price, but it also disclosed it was short shares in Nuuvera. Since Aphria's purchase price represented a 30% premium to Nuuvera's 10-day volume weighted average price at the time it was announced in January, Hindenburg had an incentive to talk the deal down. 

In the latest short report, Quintessential and Hindenburg assert Aphria grossly overpaid for Colcanna, ABP, and Marigold when it acquired them from Scythian Biosciences (since renamed SOL Global Investments Corp.), a company with ties to Neufeld and longtime Aphria investor and advisor Andy DeFrancesco. Neufeld is Scythian's former chairman of the board and DeFrancesco is the current chairman of SOL Global.

To back up its thesis, Quintessential claims it went to Jamaica to investigate Marigold's properties and that the properties were either in disrepair, inactive, or unable to be verified. The report goes on to question if Marigold's cannabis license is worth Aphria's purchase price because, according to Quintessential, a marijuana license in Jamaica can be obtained in less than six months for about $500.

The short-sellers also question the $84 million price Aphria paid for Colcanna's assets in Colombia, which includes a plot of land and a marijuana license that hadn't been fully approved when the acquisition was announced. The report further questions if Colcanna has obtained all the licenses necessary it needs to operate in Colombia, including a "characterization" license.

Furthermore, the short report suggests the Argentinian pharmacy operator, ABP, isn't worth its CA$50 million price tag, either. ABP operates one retail pharmacy location and, according to the report, its annual revenue is less than $500,000. 

A marijuana leaf resting on a green background.


What Aphria's saying

Since shares have fallen significantly following the short report's release, it's not shocking that Aphria's management has taken notice and responded to the allegations.

On Dec. 3, Aphria called the short report "a malicious and self-serving attempt to profit by manipulating Aphria's stock price at the expense of Aphria's shareholders." It also said, "[the] Board of Directors of Aphria confirmed that it received financial advice and a fairness opinion from a reputable firm that the consideration to be offered by Aphria in respect of the transaction was fair, from a financial point of view, to Aphria and its shareholders."

Aphria followed up those comments on Dec. 4, saying, "Since closing this important strategic acquisition in September, we have made considerable progress supporting and building out our operations on the ground in Latin America and the Caribbean. We have nearly 100 employees across the region dedicated to advancing the Company's business interests..."

It also reiterated that Aphria and Scythian engaged professional financial advisors to negotiate the Latin America transactions and that the two companies weren't sister companies "at the time the transaction was agreed to between the parties." The company hired by Aphria, Cormark Securities, has worked on similar deals with other companies, including Aurora Cannabis' $1.1 billion acquisition of CanniMed Therapeutics, in which it represented CanniMed.

Furthermore, Aphria says "that certain insiders of Aphria owned a de minimis amount of shares and warrants of SOL [Scythian] and that such insiders had disclosed such interests to the Board of Directors and recused themselves from the deliberations during which the Transaction was discussed and from voting on the resolution approving the Transaction."

Then, it went on to explain progress it's making integrating and advancing operations at all three companies:

  • In Colombia, Colcanna has secured a characterization license and greenhouses are planned for up to 20 acres with peak production of over 30,000 kilograms.
  • In Jamaica, Marigold's harvested 2,500 kilograms of marijuana and two herb houses will open for business in January.
  • In Argentina, ABP is facilitating a donation of Aphria CBD oil to an Argentinian hospital for use in a 2.5-year epilepsy study and its warehouse facility is being retrofitted.

It also disclosed, as an additional vote of confidence, that members of management, including Neufeld, personally invested "more than $3.1 million in Aphria's common shares" during the Dec. 3 sell-off caused by the short report.

On Dec. 6, Aphria announced its board had created a new committee comprising of independent board members who have all joined Aphria's board following the announcement of these deals "to review the Company's previously completed acquisition of LATAM Holdings Inc. (the 'Acquisition'), which closed on September 27, 2018, and confirm the Company's belief that it conformed with all Company policies and generally accepted corporate governance practices." 

That committee is being led by John M. Herhalt, who was appointed to the board in September. Herhalt's a retired partner from KPMG with 39 years of advisory and audit services experience.

What's next

Valuation in an emerging industry like this is tricky, and since marijuana stocks were rallying significantly at the time these deals were announced, it's certainly possible that Aphria overpaid for them, at least short term. Ultimately, though, their value could justify their purchase price if Latin American markets pan out.

Therefore, the real question might not be if Aphria overpaid, but if everything that happened as part of the price negotiations were on the up and up. If so, then this story will fade into the background as regulated, legal marijuana markets mature and sales roll in. If something more nefarious was happening, then it would be a different story.

Overall, most investors should wait for the independent committee's findings and see if any regulators come knocking. However, risk-tolerant investors might want to pick up some shares, especially if they believe Aphria's already established itself enough in Canada's marketplace to remain a top player there.

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