Momentum in the marijuana industry proved almost unstoppable in 2018, with the cannabis movement notching more than a dozen history-making advances. Of course, none of these was as impressive as the legalization of recreational marijuana in Canada this past October. Becoming only the second country overall to green light adult-use weed, and the first industrialized country, Canada put the pot industry on the map as a legitimate business model.
Marijuana companies rush to go public
This push to validity is a big reason we've witnessed so many North American marijuana stocks rushing to go public. Given the growth potential surrounding marijuana, publicly traded pot stocks have the ability to quickly raise a lot of capital via an initial public offering (IPO) or gain access to bought-deal offerings or common stock issuances via a reverse takeover. That's money these businesses could use to execute their strategy, whether that entails capacity expansion, brand building, an international push, or acquisitions.
Arguably no newly public pot stock stood out more last year than Tilray (NASDAQ:TLRY). Tilray became the first marijuana stock to go the IPO route on a major U.S. exchange -- in this case, the Nasdaq. After the company initially listed 9 million shares at $17 in July, Tilray's stock would go on to hit $300 on an intraday basis less than two months later, valuing the company at a peak of $28 billion. Even with its stock having come back to earth, Tilray's share price has more than quintupled since its IPO.
Of course, going public isn't as cut and dried as you might think with pot stocks. That's because the New York Stock Exchange and Nasdaq won't allow companies to list their shares if they do business in the United States, since marijuana is still a Schedule I drug. If Canadian weed companies have any operations in the U.S., listing on a reputable exchange isn't an option.
There are also rigorous hoops that companies wanting to go public have to jump through. It can be costly and take a lot of time to go public via an IPO. That's why quite a few previously private companies have chosen the reverse merger route, whereby a larger private company acquires a publicly traded company (often a shell company).
While things may seem great now, this go-public trend has a downside, too.
Beware lock-up expirations
When Tilray began trading publicly on July 19, the clock started ticking on the company's 180-day lock-up period. A lock-up period describes the length of time that the insiders and pre-IPO investors in a recently public company are unable to sell their shares. In a simpler context, it's to prevent the insiders of a company from going public just to dump their shares on an initial pop, leaving retail investors holding the bag.
On Tuesday, Jan. 15, Tilray's lock-up expiration hit, freeing up more than 80 million shares to be sold should the investors behind these shares choose to do so. Privateer Holdings, a private-equity fund backed by legendary investor Peter Thiel, owns close to 80% of all Tilray shares and noted last week that it wouldn't be selling any of its stake during the first half of 2019. Privateer cited a strong belief in Tilray's long-term growth model and has chosen to hang onto its massive stake in the interim.
Removing Privateer's stake from the equation, only around 10% of Tilray's outstanding share count was subject to the lock-up expiration this past Tuesday -- and yet the stock still lost more than $17 per share, or 17% of its market value. Some of this could be short-term traders anticipating the lock-up expiration and heading for the exit. Then again, it could be non-Privateer insiders locking in gains. If Tilray plunged 17% with only 10% of its outstanding shares potentially hitting the market, imagine what's going to happen if and when Privateer begins to sell off some of its position.
Although Privateer has agreed to hold onto its investment into the second half of 2019 without selling a share, Tilray could certainly challenge that resolve. Tilray's push into foreign markets, its need to expand capacity, and its desire to conduct medical research are all reasons it's expected to lose money in 2019. With an added focus on fundamentals, Tilray's operating performance could force Privateer's hand, further pressuring its share price.
Check out the latest Tilray earnings call transcript.
This isn't just a Tilray problem
But investors have to understand that this isn't just a Tilray problem -- huge lock-up expirations are an industrywide problem.
For instance, this coming March 4 will see approximately 90% of the total outstanding shares of MedMen Enterprises (OTC:MMNFF) released from lock-up. Unlike Tilray, MedMen's stock hasn't performed nearly as well since going public. Part of the reason could be the high degree of competition in the vertically integrated dispensary space, as well as the need to spend liberally in order to open new locations and develop cultivation farms and processing facilities. Like Tilray, MedMen Enterprises has little chance of being profitable this year, which makes its lock-up expiration a potentially worrisome event.
Along those same lines, vertically integrated dispensary operator Curaleaf Holdings (OTC:CURLF), which raised $400 million after going public in late October, is set to have approximately 85% of its total outstanding shares unlock on April 27. Curaleaf is a bit further along than MedMen in terms of its physical store presence in the United States (MedMen has 14 open locations right now), but there's still no guarantee of profitability. Curaleaf aims to boost its store count from more than 40 stores now to 67 by the end of calendar 2019, and that's going to take quite a bit of capital.
Though not a huge name like Curaleaf or MedMen, the next lock-up expiration on the docket is Trulieve Cannabis (OTC:TCNNF), which is a fixture in Florida's dispensary market. Trulieve will have roughly 89% of its total outstanding shares unlocked one week from today, on Friday, Jan. 25, 2019. Although Trulieve has been profitable on an operating basis, which could help to mitigate its potential downside, Tilray's performance on lock-up expiration day is nevertheless a warning to all investors in newly public pot stocks.