Over the past year, there's probably not been a more disappointing industry to invest in than cannabis. After more than a dozen pot stocks rocketed higher during the first quarter of 2019, they've spent the better portion of the past 12-plus months screaming lower at a jaw-dropping pace.
To our north, the Canadian marijuana industry has primarily been undermined by regulatory issues. The slow approval process for cultivation and sales licenses, along with a delayed launch of derivatives and an insufficient dispensary presence in Ontario (the country's largest province by population), has created everything from product shortages to bottlenecks, depending on the region.
Meanwhile, in the U.S., high tax rates have made it almost impossible for licensed producers to compete with black-market growers.
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The world's most popular pot stock just announced a massive reverse stock split
If there's a marijuana stock that stands out as the face of this disappointment, it's Alberta's Aurora Cannabis (ACB -0.15%). Since naming billionaire activist investor Nelson Peltz as a strategic advisor back in mid-March 2019, Aurora's share price has lost nearly 93% of its value. The sad thing is that it's still not an attractive investment. In fact, history suggests that it's on track to lose another 50% of its value.
For those of you who haven't kept tabs on the most popular marijuana stock, it announced last week that it would enact a 1-for-12 reverse stock split on or about May 11, 2020. In effect, this would take the 1,313,494,990 common shares that were currently outstanding at the time of its press release and consolidate them into 109,457,915 shares. At the same time, its $0.69 share price would increase by a factor of 12 to $8.28. You'll note that stock splits, including reverse splits, don't have any bearing on a publicly traded company's market cap.
The reason Aurora Cannabis is being coerced into this move is simple: it wants to keep its shares listed on the New York Stock Exchange (NYSE). Being listed on the NYSE comes with a level of prestige that I'm certain Aurora's management team doesn't want to lose. It also helps that being listed on a major U.S. exchange can improve volume-based liquidity and Wall Street coverage. But in order to remain listed, a publicly traded company must maintain a minimum listing price of $1 a share, which Aurora has not done for over a month. A reverse split is a quick and easy way to rectify the company's current deficiency in the eyes of the NYSE.
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History suggests an additional 50% downside may await Aurora Cannabis' stock
However, a reverse stock split isn't as benign as it sounds. Even though it doesn't alter a publicly traded company's market cap, it does come with a history of negative connotations that typically results in additional downside. After all, the reason a company chooses a reverse split is almost always because of the poor performance of its share price and/or underlying business. In essence, it's viewed as a necessary act of weakness by a company.
While a reverse split doesn't guarantee that a stock will head lower once the split is administered, history has shown far more often than not that a move lower is likely.
For instance, just last week we witnessed Chesapeake Energy (CHKA.Q), which was once an oil and natural gas powerhouse, enact a 1-for-200 reverse split. Though comparing Chesapeake Energy and Aurora Cannabis is like trying to compare apples to oranges, the point is that Chesapeake nosedived more than 50% over a four-day stretch. I'm sure weaker crude prices played a role, but it was likely also due to the fact that, with Chesapeake's share price jumping from about $0.13 to $26, there was no longer the perceived and psychological downside buffer of being near $0. Now quite a ways away from $0, pessimistic investors see room for additional downside.
And Chesapeake isn't alone. TransEnterix has shed 80% since a 1-for-20 reverse split in December 2019, Pier 1 Imports lost 98% following its 1-for-20 reverse split last June, and Camber Energy has plummeted 99% since a 1-for-25 split last July, and 60% since a subsequent 1-for-50 reverse split three months later in October. The track record isn't pretty for companies that do a substantive reverse split to buoy their share price.
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Here's why things could get even worse for Aurora Cannabis and its shareholders
What makes things potentially worse for Aurora Cannabis is that the company doesn't look to have sufficient cash to cover its projected liabilities over the coming 12 months. When publishing its management discussion and analysis in mid-February for the quarter ended Dec. 31, 2019, Aurora forecast $373.6 million Canadian in expenses for the next 12 months. Yet, according to the recent press release announcing its upcoming reverse split, Aurora has only CA$205 million in cash on its balance sheet.
How will the most popular pot stock raise additional funds, you ask? Why, of course... issue more common stock. Over the past 5.5 years, Aurora's share count has ballooned from about 16 million outstanding shares to 1.31 billion. With the company approving $350 million (that's in U.S. dollars) in at-the-market (ATM) offerings last week, Aurora now has the capacity to issue more than 500 million additional shares to raise capital. It should be noted that this $350 million is tied to a $750 million shelf offering filed last year, of which $400 million in ATM offerings are already used up.
Aurora Cannabis is a habitual diluter of shareholder value. With its balance sheet in shambles and the company likely staring down another sizable writedown in the future with CA$2.41 billion in goodwill, no bank of sound mind is going to give the company a loan. It's only means to raise money is going to be to sell its stock, which in turn is going to put even more pressure on its share price.
In short, if you think Aurora's share price is low now, give it a few more months.
