For the past year, the marijuana industry has been an absolute train wreck. Since the industry exploded higher during the first quarter of 2019, virtually every pure-play cannabis stock has lost between 50% and 95% of its value.
To our north, regulatory-based supply issues are predominantly to blame, with Health Canada slow to approve cultivation and sales licenses, and Ontario (Canada's most-populous province) struggling to assign dispensary licenses. Meanwhile, in the U.S., high tax rates on legal weed have made it difficult for licensed producers to complete with black-market growers. And, as the icing on the cake, obtaining financing for North American pot stocks has been hit and miss.
But there is one exception to the rule: Innovative Industrial Properties (IIPR +1.00%).
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Although real estate investment trust (REIT) Innovative Industrial Properties (also known as IIP) is down ever so slightly over the trailing 12 months, it's practically doubled in value over the past 18 months, and is up close to 200% since April 2018. Being the most profitable pure-play pot stock on a per-share basis makes these gains easy for investors to digest.
Yet, according to one short-side research group, IIP's gains may be the result of smoke-and-mirrors than actual operating prowess.
Innovative Industrial Properties is hit with a short-side report
Last week, Grizzly Research released a 36-page report highlighting the many ways it believes IIP is worse than WeWork.
The primary gist of Grizzly's report is that IIP has acquired a low-quality portfolio of assets in two respects. First, Grizzly's research appears to indicate that IIP grossly overpaid for the assets it's acquired, which in turn has inflated the company's book value. While book value isn't something investors pay close to attention to for most companies, it can have a lot more bearing with a REIT. In fact, Grizzly suggests these overinflated acquisitions are "bordering in our opinion on fraud."
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The second issue is that Grizzly foresees a number of IIP's tenants struggling to pay their rental income. The short-side group estimates that between 38% and 49% of IIP's 2020 rental income is in direct jeopardy, or has already been lost for the year.
It's worth noting that Grizzly also takes issue with IIP's hefty dividend payout of $1 per quarter, equating to a current yield of 5.8%. Grizzly's cash flow analysis suggests that the only way to maintain this payout will be for the company to issue additional stock to raise capital in order to pay its shareholders.
After dragging IIP through the coals, Grizzly Research believes the per-share value for the company is no higher than $22.29, which represents 68% downside to the closing price on the day prior to the release of the short-side report.
The biggest concern of this report isn't what you'd think
Innovative Industrial Properties was quick to respond to Grizzly's short-side report, noting that it contained "numerous false and misleading statements about IIP." However, the company chose not to respond too many of the allegations as the company claims Grizzly's research "is flawed and demonstrates a fundamental misunderstanding of IIP's business model."
The actual analysis of Grizzly's report, which I'll touch on a bit later, isn't necessarily what's worrisome here. Rather, it's that other short-side firms have had success in uncovering wrongdoings within the cannabis space, which makes pot stocks somewhat of an easy target.
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For example, in December 2018, the duo of Quintessential Capital Management and Hindenburg Research alleged that Canadian licensed producer Aphria (APHA +0.00%) was a fraud. In particular, the report suggested that Aphria had grossly overpaid for its Latin American assets, and that there were conflicts of interest associated with the purchase of these assets. Although an independent committee did validate the purchase price as reasonable, Aphria wound up writing down roughly a quarter of the purchase value ($50 million Canadian) a few months later, and its longtime CEO Vic Neufeld stepped down after conflicts of interest were uncovered.
Two months before Aphria was bludgeoned by a short-side report, it was Namaste Technologies' turn. A short-side report from Citron Research alleged the company was a "complete fraud" after uncovering a related party sale that wasn't disclosed. Once again, an independent committee debunked many of Citron's allegations, but it did find that now-former CEO Sean Dollinger sold company assets to a related party without disclosing it. He would be terminated a few months later.
Because short-side reports have had success in the cannabis space before, it gives Grizzly's report legs, whether it has merit or not.
Here's why Grizzly's research report is likely all wrong
However, after reading the rough analysis presented by Grizzly, I don't believe the report has any merit or should concern existing shareholders.
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The biggest issue I find with Grizzly's Research is it assumes that IIP grossly overpaid for its properties. Although overpaying has been commonplace when one company has acquired another in the cannabis space, and cultivation/processing assets are a difficult sell in Canada due to those aforementioned supply bottlenecks, the U.S. and Canadian marijuana markets are most definitely not alike. By this I mean we're not seeing much in the way of supply disruption, even in California, which has been slow to open up an adequate number of dispensaries for a state its size. With 2020 sales potential in the U.S of perhaps $8 billon to $9 billion, it should generate between eight and nine times as much pot revenue as Canada this year.
Grizzly's report also seems to overlook the quality of IIP's tenants. By leaning on IIP to bolster their balance sheets through sale-leaseback agreements, IIP has landed Cresco Labs, Green Thumb Industries, Grassroots (which is being acquired by Curaleaf), and Trulieve Cannabis as tenants. These are all well-funded businesses that have, in many cases, also gained access to traditional forms of financing.
While I don't doubt there'll be a continued shakeout in the marijuana space, pot stock Innovative Industrial Properties is not bordering on fraud, despite what Grizzly's analysis may suggest.
