At seemingly every turn this year, the marijuana industry has made history. In Canada, nine decades of recreational marijuana prohibition was tossed aside in favor of legalization via the Cannabis Act. This should, once the industry is fully up to speed, generate billions of dollars in added annual sales for the industry.
In the United States, two more states approved medical cannabis (Utah and Missouri), bringing the total number of states with legalized medical weed to 32. Meanwhile, Vermont and Michigan gave the green light to adult-use pot, upping the number of recreationally legal states to 10.
Beyond simple legalizations, the U.S. Food and Drug Administration approved its very first cannabis-derived drug, multiple pot stocks graduated from the over-the-counter exchange to more reputable exchanges in the U.S., and pretty much every one of the largest marijuana deals and acquisition in history have been completed or announced since the year began.
A cannabis constant: Share-based dilution
And yet, there has been one negative constant throughout for marijuana stocks: dilution.
Before passage of the Cannabis Act in June, and even following it, pot stocks have had limited access to non-dilutive means of borrowing. In plainer English, banks haven't been willing to lend to cannabis-based companies, mainly for fear that they could face criminal and/or financial penalties for doing so. This has left marijuana stocks with one regular path to raise capital: bought-deal offerings.
A bought-deal offering involves the sale of common stock, convertible debentures, stock options, and/or warrants to an investor or group of investors in order to raise capital. Publicly traded pot stocks have had little issue raising capital this way, which is a positive for them. This money is being used to fuel capacity expansion, make complementary acquisitions, build up their brands, and develop alternative cannabis products.
The problem with bought-deal offerings is that they're potentially a double whammy for investors. First, by increasing the outstanding share count of a publicly traded company, it could weigh down its share price. And second, dividing net income into a ballooning outstanding-share count can reduce earnings per share, making an already pricey industry look that much more expensive to investors.
Major dilution offenders
Aurora Cannabis (NYSE:ACB) is the poster child for dilution within the marijuana industry. Given its aggressive acquisition strategy and desire to expand organic projects, Aurora's outstanding share count has ballooned from just 16 million at the end of fiscal 2014, to almost 962 million by the end of its fiscal first quarter for 2019. And, mind you, this doesn't take into account Aurora Cannabis' acquisition of ICC Labs in South America for roughly 290 million Canadian dollars ($216.3 million). Once this is factored in, along with share-based compensation and existing options and warrants, Aurora's share count should explode past 1 billion shares.
Another major culprit is Auxly Cannabis Group (NASDAQOTH:CBWTF), which has its roots in the cannabis streaming business. Although Auxly has used some of its capital to acquire wholly owned grow farms, this is a company that primarily funded grow projects in return for a percentage of annual yield at a below-market cost. Since most of Auxly's partners are still a few quarters away from meaningful production, the company isn't generating any positive cash flow, and has therefore been reliant on bought-deal offerings. Since the year began, Auxly's outstanding share count has soared from 263.5 million to 565 million.
Emerald Health Therapeutics (NASDAQOTH:EMHTF) has also gotten in on the act, with bought-deal offerings helping to fund the company's Delta-3 expansion, Metro Vancouver project, and CA$90 million purchase of Agro-Biotech, which should add more than 10,000 kilograms of annual output when at full capacity. Still many quarters away from having meaningful cash flow, Emerald Health has pushed its outstanding share count from 93.1 million to 136.2 million on a year-over-year basis, according to its most recent report. For Emerald Health and the companies listed above, bought-deal offerings are essentially a necessary evil.
Surprise! This pot stock just initiated a share buyback
However, one marijuana stock is attempting to show the world that not all marijuana companies will throw their shareholders under the bus during this rapid expansion process.
Last week, the newly public Curaleaf Holdings (NASDAQOTH:CURLF) announced that, between Dec. 12, 2018, and Dec. 12, 2019, it plans to commence share repurchases totaling as much as $50 million (those are U.S. dollars), albeit the timing and amount of shares to be repurchased will depend on market conditions and other variables. In terms of nominal value, $50 million in repurchases at today's market cap would reduce Curaleaf's share count by about 2%. This means it's unlikely to have a major impact on its earnings per share or share price. But it's the mere fact that Curaleaf isn't seeking to destroy shareholder value through a dilutive offering that's noteworthy.
Then again, Curaleaf had the advantage of waiting to go public. Rather than rushing to go public (or via a reverse takeover), Curaleaf waited until cannabis valuations had blossomed, so to speak. In the process, it was able to raise around $400 million. This should be more than enough capital in the meantime to fund its dispensary, cultivation, and processing expansion plans. That means, with the exception of share-based compensation, little worry about dilution.
And this is a good thing, because Curaleaf arguably has the largest retail presence in the United States. According to the company's buyback press release, it had 34 dispensaries, a dozen cultivation sites, and 10 processing facilities. It's angling to be a major presence in New Jersey, should the Garden State decide to legalize, and it'll continue to take advantage of state-level expansions throughout the U.S.
While there are plenty of things to worry about with marijuana dispensary stocks, dilution may not be one of them -- at least when it comes to Curaleaf. Though that may not be enough to make the company attractive to fundamentally focused investors, it's at least a step in the right direction.