When it comes to the hottest and fastest-growing industries on the planet right now, marijuana is either at or near the top of the list. Having produced "only" $5.4 billion in legal sales in 2015, per Arcview Market Research and BDS Analytics, Wall Street foresees $50 billion to $75 billion in worldwide annual sales by 2030. That could mean a compound annual growth rate of more than 19% over a 15-year period.
Knowing the opportunity at hand, investors have bid a number of pot stocks considerably higher since the beginning of 2016. But what many investors may not realize, or could be purposefully ignoring, is the fact that share-based dilution has been seriously distorting their returns.
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Raising money is the marijuana industry's necessary evil
Prior to the legalization of recreational marijuana in Canada, access to non-dilutive forms of financing, such as secured loans and lines of credit, were extremely few and far between for marijuana companies. Instead, if pot stocks wanted to raise money, they often needed to turn to the secondary market by selling their common stock or issuing convertible debentures (debt notes that can be converted to common stock at a later date, if the noteholder chooses to do so).
If there's a positive here to having limited capital-raising options, it's that raising money in the secondary market has always done the trick for marijuana stocks. Unfortunately, it's also led to pretty persistent share-based dilution.
Here's the issue: Regardless of whether a company sells its own stock, offers convertible notes, or sells options and/or warrants, the end result is that a company's outstanding share count rises immediately, or over time. This has the effect of weighing on the value of existing shareholders, and it can make it considerably tougher for a publicly traded company to generate a meaningful per-share profit.
Making matters worse, with consolidation picking up in the cannabis industry, and pot stocks demonstrating time and again their unwillingness to make deals that involve large cash components, common stock issuances have become the typical "currency" to finance these deals.
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Share-based dilution has crushed pot stock investors since the beginning of 2018
Just how bad has share-based dilution been for investors? First, let's take a closer look at how market caps have increased since Dec. 31, 2017, for a handful of popular pot stocks, then examine how this compares to the actual share-price movement in these companies over the same time frame.
Since the end of 2017, and through this past weekend (May 26), here's a glimpse at how much the market caps of some of the most popular marijuana stocks have increased:
- Aurora Cannabis (ACB 12.87%): Up 173%
- Cronos Group (CRON -0.41%): Up 346%
- Auxly Cannabis Group (CBWTF 8.76%): Up 39%
- Canopy Growth (CGC 20.65%): Up 249%
Based on these figures, the assumption would be that investors who've held onto these names for 17 months should be rolling in the green. But there's a pretty big gap between market-cap increases and the actual share-price performance of these same stocks since Dec. 31, 2017.
- Aurora Cannabis: Up 9%
- Cronos Group: Up 99%
- Auxly Cannabis Group: Down 55%
- Canopy Growth: Up 88%
As you'll note, most investors would have made money, but the return on their investment is substantially lower than the aggregate value that's been added in terms of market cap.
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What gives?
Aurora Cannabis, the most popular marijuana stock of all, has been notorious for using its common stock as collateral to make acquisitions, as well as to fund a handful of organic construction projects. In 19 quarters (less than five years), Aurora Cannabis has issued roughly 1 billion shares of stock. Thus, while its market cap continues to climb as the result of acquisitions, its share price goes virtually nowhere for its existing investors.
The same can be said for Auxly Cannabis Group, which was primarily a cannabis royalty company until somewhat recently. In order to provide up-front capital to its licensed partners, as well as fund its own push into wholly owned grow farms, Auxly has regularly sold shares of its common stock. These share issuances are what's primarily responsible for its share price falling 55% in 17 months.
Meanwhile, Cronos Group and Canopy Growth have delivered more impressive returns, with major equity investments accounting for the improved shareholder returns. Canopy Growth secured a $4 billion equity investment from Modelo and Corona beer maker Constellation Brands in November 2018, while Cronos Group closed on a $1.8 billion equity investment from tobacco company Altria in mid-March. With both deals leading to share issuances, Canopy and Cronos saw their market caps soar overnight. But getting back $4 billion and $1.8 billion, respectively, in cash helped buoy their share prices.
Mind you, this isn't to say Canopy and Cronos aren't guilty of traditional share offerings to bolster their cash on hand. However, they've been far less guilty than Aurora Cannabis and Auxly Cannabis Group in terms of persistent share-based dilution, and this is reflected in the difference in overall share performance.
As much as pot stock investors would like to dismiss share-based dilution as no big deal, the data shows otherwise.
