fyi, I'm long on HIP with 573k A warrants.
Tilray: Sell Before The Lock-Up On ~80M Shares Expires |
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| All weed stocks have been crashing since legalization day, but Tilray has a lot further to fall. |
| Tilray still has one of the highest valuations in the sector despite having no deal for (potentially) high-margin cannabis drinks, lower production capacity, higher costs, and less cash than competitors. |
| Investors should know that, on January 15, 2019, the lock-up on ~80M shares will expire, giving insiders a chance to become billionaires at the expense of retail investors. |
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| Not only is the stock participating in the euphoria surrounding Canadian weed stocks, but it's also being propped up for two other reasons: |
| 1) The company's IPO provided just 9M shares, while 75M shares were retained by Privateer Holdings Inc. There's also a group of undisclosed institutional investors who own about 8M preferred shares that converted to Class 1 shares after the IPO. This left stock market players competing to buy or borrow a very limited number of shares. |
| 2) As a result, it's almost impossible to short the stock due to insanely high borrowing rates. |
| Just to see how fast TLRY has risen, look at the (log-scaled) chart below comparing the price of Bitcoin to the price of TLRY. Notice how far and fast the price has risen. Both prices show convex growth, even on a log chart, which is often a sign of unsustainable price levels. |
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| TLRY data by YCharts |
| Why did the stock shoot up so fast? |
| TLRY announced that the U.S. Drug Enforcement Administration granted them approval to import cannabinoid into the U.S. for a clinical trial to test its efficacy for treating Essential Tremor. Basically, the company is providing capsules that researchers can use to test the effect of CBD and THC. |
| Yes, that's the supposed catalyst. A trial. |
| There's also the fact that TLRY is the only weed stock on the NASDAQ, which gives the stock better access to investors who may be under the mistaken impression that Tilray is a technology company. |
| It seems as though the price of this stock, more than any other weed stock, is driven by sentiment. |
| Let's look at some concrete reasons why this stock is wildly mispriced. At the end of the article, I'll talk about catalysts that could cause the price to fall even further. |
| 1) The international market story is really weak |
| TLRY was the first company to win approval to market both cannabis flower and oil products in Germany. Canopy Growth (CGC) and Cronos Group (CRON) already supply flower products to Germany, but not oils. |
| Is this a big deal? |
| Not really. Sure, Germany is the largest cannabis market outside of North America, but total cannabis sales in Germany are projected to reach just $1.6 billion by 2022. There's not as much potential there as people seem to believe. |
| So far, only 5% of TLRY's Q2 revenue of $9.7M came from international sales. Meanwhile, CGC is way ahead, generating 14% of its revenues from international markets. |
| 2) TLRY is burning cash |
| The company lost $7.5M in 2017 on $20.5M in revenue. |
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| They did manage to boost revenues by 62% YoY while improving their gross margin from 22% to 55%. However, increases in operating expenses offset these gains: TLRY increased spending by 179% on R&D, 99% on sales and marketing, and 71% on general and admin expenses. |
| This paints a picture of an inefficient company. |
| You might say R&D spending is a good thing, but look how much they spend compared to medical cannabis leader GW Pharmaceuticals (GWPH). Looking at the chart below, I have a hard time believing TLRY will become a leader in the medicinal market. And even if they did, the medical market is much smaller than the recreational market. In Canada, it accounts for just 10% of sales. |
| TLRY Research and Development Expense (Annual) data by YCharts |
| In their August 2018 investor presentation, the company said they expect to achieve an operating margin of 20%, but they provide no timeline or plan to get there. |
| But don't worry, the CEO says their high cannabis costs (some of highest in the industry) are decreasing rapidly. |
| The main plan to reduce costs is to do more growing outdoors. So regular farming, basically. This is just more evidence that barriers to entry into the cannabis market will be very low, causing intense competition and even more pressure on margins. |
| 3) Margins will shrink as competition grows |
| When this happens, companies that can differentiate themselves through branding will be the ones that win the high-margin sales. CGC seems to be heading down this path. |
| But companies might also survive through achieving operational excellence and healthy margins. So far, TLRY is not part of this group. But what about branding? |
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| All we know so far is that they have a graphic designer who created lots of cool logos to cater to every possible mood, time of day, or social setting. I must say, it's comforting to know that my wife now has a brand of weed just for her unique sensibilities. |
| Of course, there's also Leafly.ca, the Amazon of weed, which is: |
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| That was a real problem before Leafly came along, right? |
| 4) Price action is determined by overly optimistic retail investors |
| Citron Research noted that (on Fidelity and Ameritrade trading platforms) TLRY and CRON are some of the most actively traded stocks, behind Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB). |
| It's no wonder when investors see analysts make statements like this: |
| Bocskor said that from a "fundamental perspective" - as in, the financials and basic business of the company - there is "no justification" for Tilray's current valuation. But, he said, the stock's naysayers and short-sellers could have it wrong, and this may be the Amazon of the cannabis industry. "From a valuation perspective, from the investment perspective, from trying to create context. …Amazon is a very valid reference point," he said. "Only time will tell." |
| "Amazon is a very valid reference point?" |
| The CEO of CGC has said this before as well. But you can forgive a CEO for being optimistic. It's probably a good thing for the company. But how can an analyst say a weed stock could be the next Amazon? Do they not realize Amazon is a technology company that has entered into and dominated many different markets, starting with books then moving on to pretty much everything else? |
| Are we supposed to envision a future wherein everyone is baked 24/7 and no longer feels the need to buy regular things on Amazon, but instead choose to get by on weed-branded food and merchandise alone? |
| What catalysts will take the price down? |
| The stock is crashing toward $100 as I write this. But there's also a market-wide selloff going on. And all weed stocks have been falling for the past few days. But for TLRY, this is just the beginning of what's to come. |
| There are two major catalysts in the near future that could cause the price to sink toward IPO levels. |
| 1. Earnings at the end of November (they're likely to report around Nov. 27th), and |
| 2. The end of the share lock-up (January 15, 2019). |
| Number two is the major catalyst to watch. |
| I've noticed that articles published at the time of the IPO mentioned this lock-up period expiration, but more recent articles have failed to do so. This makes me wonder whether TLRY investors even know that, in a few months, there will be about 80M more shares on the open market. That's going to create some action, for obvious reasons. |
| Insider selling galore |
| Privateer Holdings Inc. owns 76% of TLRY. They're a Seattle-based fund that opened for business seven years ago to focus solely on cannabis. It was founded by Tilray CEO Brendan Kennedy, Michael Blue, and Christian Groh. Kennedy and Blue both got MBAs at Yale. Kennedy and Groh worked together at SVB Analytics. |
| When Kennedy was recently asked whether he's sold any stock since the IPO, he said no, but he failed to mention the fact that his shares are locked up. |
| Why did he fail to mention this important caveat? |
| He and his partners can't wait to unload shares and become billionaires at the expense of retail investors. He knows he's sitting on a winning lottery ticket, and if he can just keep investors blind until the lock-up expiration on January 15, he'll be filthy rich. |
| Even if he doesn't cash out in an effort to maintain investor confidence, his partners likely will. |
| What's the play? |
| You can't really short TLRY unless you're trading intraday. Last time I checked, borrowing costs were 370%. That means holding a short for three months would cost you 100% your position. |
| Instead, buy puts that expire after the lock-up period ends. Even if you're die-hard cannabis investor, consider hedging your bets with a bet against TLRY. |
| Don't hold shares into the lock-up expiration on January 15 and make these guys rich at your expense. |
| Disclosure: I am/we are short TLRY. |
| I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. |
| Additional disclosure: I'm shorting via options. |