The global cannabis market is no doubt an exciting one, and there are many companies auditioning for your investment dollars. Cannabis stocks range from penny stocks to multi-billion-dollar global companies, so there's quite a lot to choose from when thinking about how to play the space.
Two companies on opposite ends of the cannabis spectrum are Canopy Growth Company (NYSE:CGC) and Medical Marijuana, Inc. (OTC:MJNA). Canopy, based in Canada, is the largest cannabis company in the world by market capitalization, and has Constellation Brands (NYSE:STZ), the owner of beer brands such as Corona and Modelo, as its largest strategic investor. Constellation invested $4 billion in Canopy last August for a 38% stake, along with warrants that give it the option to potentially purchase a controlling stake in the company.
Meanwhile, Medical Marijuana is a very small stock that trades over-the-counter in the United States at a market capitalization of just $200 million. Unlike Canopy, which focuses on medical and recreational marijuana sales in non-U.S. countries where cannabis has been legalized, Medical Marijuana decided to focus on the cannabidiol (CBD) market in the U.S. Though THC products, which contain the psychoactive agent in cannabis, remain federally illegal, the 2018 Farm Bill, passed in December, legalized the cultivation of hemp in order to produce CBD without THC, the psychoactive agent in cannabis. Medical Marijuana did have about $20 million in sales last quarter, which means there is a real potential business there.
Comparing operating results
Canopy currently generates much more revenue than Medical Marijuana, but it's not as much as you might think. Last quarter Canopy made just over CA$106 million in revenue, more than 400% growth over the prior-year quarter, while Medical Marijuana made just over $20 million in revenue, nearly double the amount in the prior-year quarter.
Canopy is certainly larger and growing faster than Medical Marijuana, but considering Canopy's stock is valued at roughly 68 times that of Medical Marijuana's it's not a stretch to think the scrappy upstart could be the better bet.
In fact, when one looks at profitability, Medical Marijuana looks much better. Last quarter Medical Marijuana actually posted positive net income of $9.5 million according to generally accepted accounting principles (GAAP). Of course, that's largely attributed to an unrealized gain on minority investments in subsidiaries. But even without that extraordinary gain, net income would still have been about $1.5 million.
Compare that with Canopy, which posted a staggering CA$335 million net loss just last quarter, and a loss of CA$670 million for the year. The losses were due to Canopy's heavy spending on expansion in Canada and 15 countries around the world. Even after the end of the last quarter Canopy continued its spending spree, buying Germany's C3 Cannabinoid Compound Company, the UK's This Works Products, a CBD company, then paying $300 million for the right to purchase Acreage Holdings (OTC:ACRGF) for $3.4 billion should the U.S. legalize cannabis at the federal level.
Canopy has been flush with cash from its Constellation investment last year, which may explain why the company has been spending so aggressively recently.
Problems with management
Both companies, however, have some potentially large red flags regarding their respective management teams. Canopy co-CEO Bruce Linton stepped down following the company's recent earnings report, but in an interview with CNBC, Linton conveyed that he was essentially fired by the board of directors, which now contains four directors from (or selected by) Constellation. My colleague Sean Williams thinks Linton's firing is due to the escalating losses at Canopy (and thus Constellation), and I think there's merit to that. In any case, co-CEO Mark Zekulin will stay in his role for the time being, but Zekulin is just an interim solution as the company searches for new leadership. With escalating losses and turnover at the top, things look precarious for Canopy.
However, there's also reason to be worried about Medical Marijuana, which has made its own slew of questionable acquisitions, including investing a 38% stake in Axim Biotechnologies (OTC:AXIM), a cannabinoid drug developer. That investment had to be written down substantially in 2018, leading to over $130 million in paper losses.
More problematic in my mind, however, is that Medical Marijuana has some unusual loans on its books. First, the company has funded itself with a mix of stock issuances and convertible debt. Its $15 million in convertible debt has a coupon of 8%, but the real concern is the conversion option. Noteholders have the option to convert their shares, and may do so at a price equal to 70% of the average of the three lowest closing bid prices in the 20 days prior to conversion. Those are pretty lenient terms, and looks as though they may provide convertible noteholders with an opportunity to massively dilute existing shareholders at a time of low stock prices.
Combing through the financials further, the company also appears to have made loans to several executives within the company or its subsidiaries. These include a $107,000 loan to CEO Stuart Titus, a $77,000 loan to the CEO of MJNA's subsidiary Kannalife Sciences, Inc., and a $435,000 loan to a company partially owned by Axim's CEO John W. Huemoeller II. It also appears that one of Medical Marijuana's noteholders has also taken out loans from the company against that convertible note, making related-party transactions even more of a jumbled mess.
There may not be anything wrong with such a tangled web of loans between the company, its subsidiaries, and its executives, but this kind of complex situation opens the door to all kinds of insider self-dealing that investors should fear.
Titus also recently had to write a letter to shareholders in which he outlined hopes for getting the company's financials audited and GAAP-compliant so that the company could become listed on the Nasdaq by 2020. Basically, Medical Marijuana is so small and closely held that it doesn't have all of the necessary financial reporting procedures in place for prime-time as of yet.
If it sounds like I think you should steer clear of both companies at the moment, you're right. However, if either of these two stories strikes your fancy, the silver linings are that Canopy will likely soon get a new CEO under the guidance of Constellation Brands' proven leadership, while Medical Marijuana is actually, you know, profitable -- albeit just barely.
Still, the lack of accounting compliance and potential governance issues makes Medical Marijuana a no-go for me, leaving Canopy (under Constellation's guidance) the better alternative for now.