The Cannabis Company For The Fundamental And Value Investor

Summary

Third largest Canadian cannabis LP by production footprint and design capacity (3.5m sq ft, 479,283kgs). Fully funded to a capacity of 131,283kgs with 8 provincial supply agreements.

Deeply undervalued relative to peers and under-the-radar; covered by just one street analyst.

Zenabis has the requisite horticulture expertise for quality and cost/gram leadership; its Chief Growing Officer, Leo Benne, ran North America's largest greenhouse propagation business for nearly 30 years.

Talented, well-aligned management with uncompromising ethics. ~71% owned by management/founders. CEO forgoing short-term salary and bonus for compensation based on EBITDA/share and share price hurdles.

We estimate an intrinsic value of ~$21.00/share.

Investment Thesis

As the third largest Canadian cannabis licensed producer ("LP") with a market capitalization of < $750m, Zenabis Global Ltd. ( ZBISF) (TSXV-ZENA) is deeply undervalued, and remains well under-the-radar of Bay/Wall Street and cannabis investors more broadly, offering substantial share price upside. As we will explore, Zenabis has:

• the management talent and strict ethical standards to build a well-respected, global, profitable cannabis company; and
• the horticulture talent and distribution relationships to produce and sell large volumes of high-quality cannabis at the industry’s lowest marginal cost/gram.

Zenabis is a ‘different’ cannabis company with at least an equal chance at becoming an industry leader versus any mid/large tier cannabis LP, and as such, we encourage both cannabis sector investors and fundamental/value investors to consider it.

Note: an original PDF formatted version of this report is available here.

Business Description

Zenabis Global Ltd. (“Zenabis” or the “Company”) is a Canadian licensed producer and marketer of medical and recreational cannabis and related products. It has six facilities for cultivation and production, four in British Columbia, and one in both Nova Scotia and New Brunswick, with 3.5m square feet of available production space and design capacity for growing up to 479,300kg of cannabis . The Company has supply agreements with eight provinces (all except Ontario and Newfoundland) and one territory (Yukon), and with two major Canadian pharmacy chains ( Shoppers Drug Mart and Pharmasave). It is run by a talented and ethical management team experienced in horticulture, finance, medicine, regulated businesses and even the military. Zenabis aims to be one of the leading Canadian cannabis LPs, and well-positioned globally.

Zenabis is the product of a Reverse Take-Over (“RTO”) of an established public operating company, Bevo Agro Inc. (“Bevo”), by a private Canadian LP, SunPharm Investments Inc (“SunPharm”) (the “Merger”).

Investment Thesis Detail

The following illustrates that that Zenabis has at least an equal chance of becoming an industry leader versus and of its mid/large tier sector peers.

• Among the Largest Available Production Footprints in Canada: With 3.5m square feet (660,000 of which is fully indoor), and a design capacity of 479,283kgs, Zenabis has the 3rd largest available production footprint and design capacity in Canada, ranking behind Canopy Growth ( OTC:CGC) and Aurora Cannabis (OTC:ACB). Early in the third quarter of 2019, its operational footprint will have grown to ~934,000 square feet, producing at a run-rate of 131,283kgs annually—more than all other mid-tier Canadian LPs, and behind only Canopy, Aurora and Aphria. Early in the second quarter of 2020, the Company expects to produce at a total run-rate of 461,183kgs annually.
• Requisite Horticulture Expertise for Cost/gram and Quality Leadership: To date, the Company has produced at $1.10/gram in its NB facility, and at full scale forecasts a production cost of $0.75/gram at its Langley, BC facility ("Zenabis Langley"). The Company has at least an equal chance at achieving these targets versus any competitor as a result of its BC climate exposure, facility design, automation, economies of scale and experienced growers at Bevo (discussed later). We posit that Chief Growing Officer, Leo Benne (from Bevo), a second-generation Dutch trained horticulturalist, with nearly 30 years of experience in plant propagation, could emerge as the industry’s most respected grower leading the industry’s best growing team.
• Talented and Well-Aligned Management and Founders: Across all required disciplines, Zenabis has competent and experienced management. Additionally, management and founders own ~71% of the basic shares outstanding and are subject to a minority shareholder-friendly pooling/lock-up agreement. This level of insider ownership resulting from founders personally funding the business from inception is rare in the cannabis industry. Other identifiable shareholder cohorts, who we estimate are long-term supportive, own an additional ~24%.
• Governance Gold Standard: Zenabis is a model for good corporate governance, and management’s ethics and shareholder alignment are rare and remarkable. For example, its CEO, Andrew Grieve, a paid-in shareholder, will forgo a salary and short-term bonus, and earn based only on forecast EBITDA per share and share price hurdles. Additionally, Bevo, the Zenabis predecessor company was an exceptional value creator that treated its minority shareholders fairly. We think a [true] shareholder friendly orientation is/will be a meaningful differentiator in the cannabis industry.
• Undervalued and Under-the-Radar: Despite at least an equal likelihood of success in the industry, Zenabis is undervalued relative to its peers and to estimates of intrinsic value. Zenabis was opportunistically formed via an RTO of a well-established public operating company with valuable production assets and management talent, rather than through an RTO of a shell company or traditional IPO. Moreover, the Company has yet to raise capital in the public markets having already raised material founder and private capital, Schedule I bank debt, and more recently, a small debenture. This has left Zenabis reasonably well-capitalized, but uncovered and under-followed. It remains under-the-radar, with research coverage by just one analyst (versus up to 15 analysts for the typical mid/large-tier LP), but we think the Canadian banks and brokerage houses could find the Company’s progress and prospects increasingly difficult to ignore. We believe management understands the importance of building awareness among the analytical and investment communities and will approach that endeavour in many ways.

Investment Risks

Although Zenabis is well-positioned for industry leadership, investors should consider the following risks to our thesis.

• Nascent Industry: the legalization of medical and recreational cannabis in Canada ended almost 100 years of prohibition, creating extraordinary opportunity and a valuable industry through the single stroke of a pen. However, there are still many unknowns: consumer behavior, degree of black-market conversion, production levels, pricing at all levels of the value chain including retail, wholesale and producer, market share, regulatory considerations, size of the global opportunity and fundamental valuation approaches are all still uncertain. To ensure success, a company needs to have management talent across several disciplines to execute, survive and create value in the long-run.
• Competition and Potential Over-Supply: the dawning of the medical and legal recreational cannabis industries in Canada resulted in large scale capital formation with incredible velocity that enabled rapid industry capacity build-out. Announced capacity by the peer group of the largest Canadian LPs used in this report is in excess of 2.6m kgs annually; Scotiabank and Veritas Investment Research make similar estimates. This is relative to forecast demand estimates widely estimated to be anywhere between 0.5m to 1.0m kgs annually for the Canadian adult-use recreational market. [1] This potential over-supply will result in pricing headwinds over time and force LPs to achieve a low marginal cost of production or exit the industry. As we argue herein, we believe Zenabis has as good of a shot as anyone in the industry at being a high-quality, low-cost scale producer.
• Execution Risk: As detailed in the “Facilities, Production Space and Build Timelines” section (below), Zenabis plans to grow its production capacity from its current operational footprint of ~214,000 square feet to up to 3.5m square feet over the next few years. It also plans to increase its work force from 600 employees currently, to over 2,500 during this period. The execution risk inherent in these rapid growth plans should be considered and watched closely, but we believe the Zenabis management is capable of the task and will approach it in a disciplined and measured way, which they have so far demonstrated in their execution to date.
• Capital Markets Risk: Zenabis is fully-funded to complete the current phase of its operational plan to grow to ~934,000 square feet of production space and 131,283kgs of run-rate capacity, and has filed a Shelf Prospectus for $100m of additional financing to use for opportunistic M&A and expansion. However, a capital markets disruption or a major negative sentiment shift in cannabis equities could impair the Company’s ability to raise capital in the future.

Merger Background

Zenabis is the business combination of publicly traded company Bevo Agro Inc. (previously TSXV:BVO), an established agriculture company, and private company SunPharm Investments Inc., a Canadian cannabis LP, announced on October 4th, 2018 and closed on January 8th, 2019. The Merger brought together SunPharm’s established presence in the medical cannabis market and its partially licensed, indoor facilities with Bevo’s large greenhouse assets and 30+ years of horticulture experience, positioning newly formed Zenabis for industry leadership. The Merger was completed via a Reverse Take-Over, with Bevo and SunPharm shareholders receiving/owning 14% and 86% respectively of Zenabis, the resulting issuer. [2]

Predecessor Company Business Descriptions

Investors will find the history of the two companies that formed the Merger rather interesting and instructive.

Bevo Agro Inc. (previously TSXV:BVO) was a value creator

Greenhouse Propagation:

Based in Langley, BC, Bevo is North America’s largest plant propagator. Bevo was founded in 1987 by Jack Benne and son Leo who are lifelong, expert Dutch horticulturalists that immigrated to Canada from Holland. Bevo grew from 109,000 square feet of greenhouse on 26 acres of land in 1987 to 2.3m square feet of greenhouses on 110 acres of land today. Plant propagation is a niche agricultural business supplying greenhouse growers with young, well rooted, healthy and pest free plants grown under stringent, controlled conditions. It propagates vegetable plants such as tomatoes, peppers, cucumbers, as well as bedding plants, flowers and poinsettias sold to established greenhouse growers, nurseries and retailers throughout North America. A useful video, produced by Bevo, explaining the business of propagation in more detail can be found here: goo.gl/xiz5Au.

Value Creation:

Bevo was a value creator and its operating metrics during its history as a public company were impressive for a mature agricultural business. From FY2000 to FY2018, revenue grew organically from $10.1m to $32.8m (6.8% CAGR) and Adjusted EBIT from $2.1m to $6.4m (6.3% CAGR). It was Adjusted EBIT positive during this entire period, and although capital intensive, the business consistently achieved an acceptable ROIC in excess of its WACC (which was low due to its land and asset backing). Its 5- and 10-year annualized total shareholder returns to October 4th, 2018 (last close prior to Merger announcement) were 38.3% and 75.0%, respectively. Shares outstanding increased just 1.0% annually. Here are some recent historical financial metrics:

Fair governance:

The Benne family owned 60% or 15.6m of the 26.2m shares outstanding, leaving a small public float of just 10.6m shares ($24.4m value @ $2.30/share) that remained under the radar of the investment and analytical communities for many years. Although family controlled, the Benne’s treated minority shareholders fairly, receiving modest salaries of $252,000 for Jack and Leo each, and $140,000 for the CFO, with fair performance bonuses based on EBITDA performance, and minimal share option issues (just 1.55m options issued to management during its public history). The Benne’s were net buyers of Bevo shares since 2001, and on a few occasions gifted shares totalling 2.5m (on which they even obtained third-party synthetic repurchase options on the number of gifted shares to retain ownership/upside!). No dividends were issued, with management preferring to reinvest excess cash flow for growth.

CubicFarm Systems Corp., a value creating spin out:

Lastly, concurrent with the RTO, Bevo spun out to existing shareholders its ~41% interest CubicFarm Systems Corp. (“Cubic”), a BC-based producer and developer of a proprietary and patented indoor vertical farming system contained within a forty-foot shipping container designed for commercial scale food production anywhere in the world. The patented technology was pioneered and developed over almost a decade by Jack and Leo and commercialization is now underway by Cubic. Cubic has recently raised $10m of capital at a $100m valuation, which values the prior Bevo shareholder interest in Cubic at ~$25m. It is anticipated that Cubic will be listed for trading on the TSX Venture Exchange in Q2 of 2019. Cubic and its spin out is an excellent example of Bevo and the Benne family’s ability to create value and their willingness to unlock it in a fair way, and was a material windfall for patient Bevo shareholders.

SunPharm Investments Inc.

Founded in 2014 and operating under the Zenabis brand, SunPharm is a Canadian LP serving the medical and recreational cannabis markets. It owns and operates three indoor production facilities in Atholville, NB, Delta, BC and Stellarton, NS, with a combined total of 660,000 square feet of available production space. At the time of the Merger announcement, SunPharm had provincial supply agreements with BC, NB and the Yukon, and had fulfilled orders in NS, a supply agreement with a major pharmacy chain, and international partnerships and distribution relationships. SunPharm was founded by three successful entrepreneurs, Rick Brar, Monty Sikka, and Mark Catroppa (bios below), who invested a total of $17m of their own capital in the business. In addition, SunPharm received start-up and follow-on capital from the NB government and various nearby First Nations communities.

Shareholder Dynamics

Insiders and management own shares totaling 70.6% of the basic shares outstanding, and are subject to a minority shareholder-friendly lock-up agreement (terms below). Certain other identifiable shareholder cohorts (listed below) own an additional ~23.7% of the basic shares. As these groups together account for ~94.3% of the basic shares outstanding, there is a very limited float resulting in potential share supply dynamics with favorable price implications as awareness of the Company increases (some caveats related to potential dilution below in the “Capitalization” section).

Certain other shareholder cohorts identifiable from Company disclosures and publicly available sources are as follows. Note: except as noted for the Seed Shareholders, none of these shares are subject to lock-up provisions and may have been traded since the Merger was effective on January 8 th, 2019.

Interestingly, Zenabis is the only Canadian LP that we are aware of that has received an investment from a government entity (Government of the Province of New Brunswick in this case), and from various First Nations communities. We think this speaks to the Company’s credibility and its capacity to create meaningful partnerships with a broad range of stakeholders (related press release).

Capitalization

The Company’s capital structure is a basic mix of common shares, warrants, convertible debt., Schedule I bank debt, and some additional recently obtained convertible debt financing with a flexible issuance schedule (described below).

The Company’s debt components are summarized here:

Although as noted above there is currently a relatively tight float for the Company’s shares, the Secured and Unsecured Notes are in-the-money and represent a source of additional dilution and potential share supply, as does the Recent Financing described below. While there is also some degree of refinancing risk in October 2019, we think management understands this risk and will prudently manage its capital structure.

Recent Financing: Not included in the above capitalization tables is a recent $75m, 6% interest convertible debenture financing announced on March 4th ( detailed press release ). The debentures will be issued in stages at the Company’s sole discretion; an initial $15m was already issued via bought deal, and the balance of the $60m is issueable in tranches. Although dilutive, this financing is creative and advantageous to the Company as it provides (i) enough capital to fully fund to a 131,283kgs production capacity, and (ii) the option to finance by other means or to wait to trigger the future debentures if/when the stock price is higher.

Industry Backdrop and Comparable Analysis

Operational and other comparative metrics for some of the largest Canadian LPs are summarized here relative to enterprise values. It should be clear on only brief inspection that Zenabis is undervalued relative to its peers on these metrics, but is just as well positioned as any other Canadian LP to achieve at least the operational success currently priced into the peer group.

Production Footprint and Capacity vs. Enterprise Value:

The following table summarizes each company’s EV and the (i) currently active, (ii) near-term (loosely defined as space and capacity expected to be online in CY2019) and (iii) total announced/available production space and capacity:

Among the comparables in the above table, Zenabis has the lowest EV, but the third largest production footprint. The total EV-to-total square feet of the peer group is $1.9b ($30.7b / 16.1m sq. ft.), implying an EV of $6.5b (or ~$29/share) for Zenabis. The total EV-to-total kgs of production capacity of the peer group is $16.2m ($30.7b / 1.896m kgs), implying an EV of $7.8b (or ~$35/share) for Zenabis.

Other Comparative Metrics vs. Enterprise Value:

Zenabis has secured supply agreements in eight provinces and belongs to a cohort of just six Canadian LP’s with eight or more provincial supply agreements . Ontario is the last remaining major provincial supply agreement for Zenabis to obtain and doing so could be a meaningful positive catalyst for its share price.

The final two columns are further evidence of the Company’s ‘under-the-radar’ status: Zenabis’ trading volume remains very low relative to its peers and is only covered by one analyst (recent coverage by Eight Capital, who led the Recent Debenture financing). This will particularly delight value investors looking for under-followed companies in an emerging and popular sector. The the “Valuation” section below provides additional comparable analysis and industry metrics used in our determination of intrinsic value for Zenabis.

Facilities, Production Space and Build Timelines

The Company has four world-class facilities on both coasts that will be used for the cultivation and processing of cannabis. Together, they are situated to provide high-grade cannabis across Canada and represent one of the largest available production footprints in the industry, with a total design capacity of 479,283 kgs. It has two additional facilities, Zenabis Topgro and Zenabis Pitt Meadows, that will continue serving Bevo’s propagation customers and remain available for cannabis production in the future.

Zenabis Langley’s cannabis conversion is based on a closed greenhouse design, in which standard greenhouse venting does not occur. Instead, mechanical cooling and humidification will be utilized to control the greenhouse environment. The Company believes this design will (i) produce a higher quality, more consistent crop on a larger scale than other greenhouse producers, (ii) mitigate the impact on its surrounding community by reducing unwanted odour, and (iii) better control pests and other contaminants from entering the greenhouse.

The following is a table produced by the Company and contained in its recently filed Shelf Prospectus summarizing its build out and production capacity timelines:

Management

Zenabis has talented, well-aligned management with experience in large agriculture operations, the cannabis industry, regulated businesses, medicine, and corporate finance roles. Also, two executives have high-ranking military experience; its CEO is a Major in the Canadian Armed Forces, and the CAO was a Senior Commanding Officer in the British Army and served overseas in Afghanistan and Iraq (he also remains an active member in the Canadian Armed Forces). As discussed above, the Company’s Chief Growing Officer has a lifetime of experience running a complex and niche agriculture business.

Regarding shareholder alignment, in addition to the SunPharm founders owning ~47.8% of the basic shares outstanding of Zenabis, management controls or exercises discretion over another ~23.0%, as outlined in the “Shareholder Dynamics” section above. One of the three SunPharm founders, Monty Sikka, remains as Director and Chairman, while the other two, Rick Brar and Mark Catroppa remain as Special Advisors to the Company (see bios in the “Board of Directors” Section).

Regarding CEO compensation, Andrew Grieve will forego short-term annual salary and bonus compensation and instead receive long-term compensation consisting of

• (1) 750,000 options granted in connection with his appointment, exercisable at $4.25/share and vesting over three years, and
• (2) a performance incentive payment (the “PIP”) comprised of two components:
  • a share of EBITDA generated in 2020 above $0.42/share (subject to certain adjustments or debt outstanding);
  • a share of EPS generated in 2020 above $0.16 per share. The PIP is payable in four equal installments on a quarterly basis from June 2021 through March 2022, and at each payment date is only payable if the share price exceeds certain predetermined thresholds ($4.90/share for the first potential payment in June 2021 and increasing at each payment date thereafter).

To our knowledge, this type of compensation structure is unprecedented for a CEO (or any executive) in the cannabis industry. Moreover, management’s conviction in its ability to execute implied therein is compelling. Assuming the current basic shares outstanding, the CEO’s compensation package implies an EBITDA threshold of ~$80m for 2020. Additionally, given that the EBITDA and earnings thresholds are both on a per share basis, management is incented to be judicious with its equity. Lastly, the CEO foregoing short-term salary and bonus sets a constructive internal cultural tone with employees and other stakeholders.

In total Mr. Grieve or entities in which he has an ownership interest invested nearly $5m in securities of Zenabis including common shares and convertible securities. He is aligned with the Zenabis shareholders in that these securities were purchased rather than granted.

Senior Management biographies can be found on the Company's site here. Investors are also encouraged to visit the links provided in the “Helpful Links” section below, which include candid interviews with the Company’s CEO.

Partnerships and Distribution Channels

Zenabis has a well-established medical and retail distribution platform in Canada that rivals any of its mid/large tier industry competitors, and is selectively considering international markets, primarily in Europe and Latin America with partnerships and new licences.

Medical Distribution: Zenabis is become a preferred supplier of medical cannabis to Pharmasave, and has a supply agreement with Shoppers Drug Mart (one of only about a half-dozen Canadian LPs) and its products will be available on its website cannabis.shoppersdrugmart.ca . Zenabis is among only about a half-dozen Canadian LPs that have agreements to supply Shoppers Drug Martwith medical cannabis products.

Lastly, Zenabis has a unique and exclusive partnership with GroupHEALTH Benefit Solutions, one of Canada’s largest benefits providers, to create and offer benefits program that includes a medical cannabis component to GroupHEALTH’s 4,000 employer clients covering over 426,000 Canadians. This type of partnership was the first of its kind in Canada.

Recreational/Retail Distribution: The Company distributes to the recreational market through three main channels: (i) provincial supply agreements, (ii) direct sales through Zenabis dispensaries and online through Zenabis.com, and (iii) distributor and retail partnerships. The Company has secured supply agreements with 8 provinces (all but Ontario and Newfoundland) and one territory (Yukon). Zenabis also has distributor relationships with various domestic and international wholesalers of cannabis products and a direct investment in and supplies its cannabis products to National Access Cannabis (TSXV:META), the largest private cannabis retailer in Canada with 23 locations in Alberta and Manitoba.

International Distribution: The Company has also been active in growing its international footprint, and we believe it will opportunistically evaluate prospects to ship, build or buy abroad, as the pace of change toward legalization in many countries accelerates. Here is a table produced by the Company in its recent Shelf Prospectus filing summarizing its current international arrangements:

Brands and Products

Zenabis’ sells full lines of dry cannabis and, in early Q2 of 2019, pre-rolled and oil products such as sprays and gel caps all with varying THC and CDB levels under two brands, “Zenabis” and “Namaste”. The Company is also developing a line of food products that will include conventional and organic hemp grain, and subject to regulatory restrictions, will be sold or provided as promotional items with “Zenabis” branded products. Future products subject to legalization and legislation include full lines of products for the Food and Beverage, Health and Beauty, Pet Food and Health, and Vapes and Concentrates industries. Lastly, three additional brands, “Dope Tribe”, “Blazery” and “HighGenics” are being developed to address various other consumer segments in the recreational cannabis market.

More broadly, Zenabis is employing a strategy of acquiring or partnering with consumer product companies that have existing, compelling products with the intent of providing complimentary cannabis products upon expected legalization of infused beverages and edible products in late 2019. For example, it recently acquired 51% (with an option to purchase the remaining 49%) of Hillsboro Corp Inc., a Canadian cultured tea beverage company known for its True Buch Kombucha, adding a new product line. Based in Calgary, AB and founded in 2014, and True Buch produces cultured tea beverages in 11 distinct flavours available in 257 retailer partners in AB. Moving forward, we believe Zenabis intends to continue to partner with leading organizations to develop, license and sell products to new markets and further develop new and innovative technologies.

Medical Strategy

Under the leadership of its Chief Medical Officer, Dr. Zeid Mohamedali, an accomplished physician and surgeon (bio in “Management” section, LinkedIn profile), the Zenabis medical division appears to have a strong team working on various clinical, educational, and research goals related to medical cannabis. In reviewing Dr. Mohamedali’s background and those of his peers at other leading cannabis companies, we observe him to be among the industry’s most accomplished and respected medical professionals. Interestingly, Dr. Mohamedali was previously an Advisory Board Member at Tilray, leaving that board to join Zenabis.

We think management understands the importance of and the R&D opportunity presented by the legalization of cannabis and will strive to be an industry leader in this regard. Its medical strategy is focused on progressing the science-proven benefit of cannabis, and will consist of three main components: (i) a “Centre of Excellence” and a to be formed medical advisory board consisting of key medical experts in the cannabis industry, (ii) medical platforms that support new product formulation, including in areas such as delivery systems and plant chemistry to deliver high-quality consultation to patients, and (iii) clinical trials and research in both clinical and basic science to further the understanding of cannabis medicine.

Board of Directors

The Board of Directors appears to be reasonably well-disciplined and well-aligned, the Chairman and CEO roles are separated, and four of the seven directors are independent. While we give the Company and its officials top marks for governance, management ethics and previous shareholder value creation, we do have some caveats related to the Company’s board that management may address in time:

• Although the board is well-rounded, there is a notable absence of consumer-packaged goods experience, which will be critical for success in the cannabis industry. We would like to see the board’s skill set rounded out, perhaps with a candidate with relevant Fortune 500 experience; we think management understands this and is endeavouring to make it happen.
• Regarding alignment, as of the date of this report, according to SEDI, of the four independent directors, only one, Daniel Fairholm, owns shares directly (633,000), while a second independent director, Larry Van Wieren, who joined the Bevo board in 2018, controls 189,141 Zenabis options. We would like to see and would consider it a positive development if the remaining two independent directors Daniel Burns and Adam Spears (each new) purchase shares (we acknowledge it is possible that Company insiders may be blacked-out with an inability to purchase shares).
• A minor note: although Mr. Fairholm is considered an independent director, he has had a relationship with Bevo since its inception, so his level of independence (in essence) could be weakened (but this could also be a strength).
• Lastly, two of the SunPharm founders, Mark Catroppa and Rick Brar, who hold a combined 30.6% of the basic shares outstanding, have only advisory roles at Zenabis going forward. While these two individuals have impressive backgrounds and are assets to the Company, we would like management to provide additional detail regarding their involvement at Zenabis going forward.

Director bios can be found on slides 37 and 38 of the Company's latest Investor Relations Presentation .

Valuation

Here we present our estimates of intrinsic value per share for the Company. We use a simple forecast and valuation methodology whereby we (i) apply a simple industry average forecast EBITDA/gram sold estimate to our forecast/run-rate production estimates for Zenabis in 2019 and 2020 [3] to arrive at EBITDA estimates for these periods, and then we (ii) apply a multiple that is conservative relative to average EV/EBITDA multiples for the peer group. Lastly, we (iii) build down to value per share estimates, subtracting the current net debt and the estimated incremental capital required to build the production capacity assumed in our forecasts, and (iv) then take a simple average of all our estimates.

Some valuation caveats and assumptions:

• While we think EBIT is a better metric as a basis for applying valuation multiples, it is too early in the industry’s development to ascertain meaningful estimates for normalized maintenance capex or long-run “DA”. To account for this, the EBITDA multiples applied to Zenabis herein this section are conservative relative to the peer group.
• We prefer to incorporate a company’s normalized Return on Invested Capital (defined as [EBIT / (Net Working Capital + Fixed Assets)]) into our valuation methodologies, but similar to the first caveat, it is too early to ascertain meaningful invested capital estimates. Further, ‘on an envelope’, our estimates of EBITDA relative to our estimates of cumulative capital build costs for Zenabis appear to suggest acceptable ROICs. Given the large-scale capacity build out in Canada, how industry ROICs develop over the medium- to long-run will be fascinating to watch.
• We use 2020 and 2021 estimates for the applicable operating metrics and comparable trading multiples analysis used herein and applied to Zenabis, as they are reflective of the industry having reached some level of normalization/maturity.
• We acknowledge the weakness inherent in applying a comparable trading multiples-based approach in that it is done at a point in time and average multiples can fluctuate, and not every company is created the same (again, we use a conservative multiple relative to the peer group).

The following table is a rudimentary consensus forecast for revenue, EBITDA and kilograms sold for 2020 and 2021, compiled from select analyst estimates where available (as footnoted); although only the latest estimates from CIBC, GMP, and Canaccord for the following peer companies were readily available, we think this cross section provides enough data points to provide meaningful averages. From this table, we arrive at a forecast industry average EBITDA/gram sold of $1.44 and $2.10 in 2020 and 2021, respectively. For conservatism, in our valuation table below we will apply an EBITDA/gram of $1.25 to our Zenabis production forecasts.

The next table is a simple EV/EBITDA comparable valuation table, using the same rudimentary EBITDA consensus forecasts as above. The average EV/EBITDA multiple for 2021 after removing certain outlier companies as indicated below is 13.0x. For conservatism, we will apply a 10.0x multiple to our EBITDA forecasts for Zenabis.

Our production estimates for Zenabis in the first row of the below table are based on the target facility completion dates disclosed by the Company (as noted in this report and as clearly illustrated in slide 10 of the Company’s IR presentation). For conservatism, we added a six-month lag to account for potential delays and for the time between planting a first crop and ultimate harvest/sale. The table then builds down to our per share intrinsic value estimates based on the valuation assumptions outlined above.

The intrinsic value estimates in the above table along with the share price estimates based on production footprint and design capacity comparables derived in the Industry section above are summarized here:

We use the simple average of these estimates as our estimate of intrinsic value: $21.00/share.

Catalysts

There are several potential catalysts that could close the valuation gap between Zenabis’ and its peers and between today’s share price and our estimate of intrinsic value per share:

• Additional Supply Agreements: Obtaining a supply agreement with the province of Ontario, and if it also obtains a supply agreement with the province of Newfoundland, the Company would join a group of just three Canadian LPs with supply agreements with all 10 provinces.
• Financing and/or Research Coverage from a Canadian Chartered Bank: We believe it is only a matter of time before the Company attracts the attention of the Canadian Schedule I banks and major independent brokerages that cover the industry, who will find it increasingly difficult to ignore the Company’s prospects.
• Initial Conversion of Langley Facility and Licencing: Successful conversion of Zenabis Langley and completion Zenabis Atholville with the requisite licensing as expected in early Q3 of 2019 would be a great indicator of the Company’s progress and an indication of its ability to execute on its published targets.
• ETF Share Demand: There are a few cannabis funds in Canada that invest in cannabis companies with varying degrees of active/passive strategies. The largest is the Horizons ETFs Marijuana Life Sciences Index ETF, with ~$1 billion in AUM. Zenabis was just added to its holdings, and as of March 15th, 2019, the ETF held a 0.26% weight in shares of Zenabis (implying ~700,000 shares). The ETF weights its holdings by market capitalization and based on certain of its holdings with market capitalizations similar to Zenabis’, we estimate potential demand from the Horizon ETF of up to ~8.5m shares , versus the current average daily trading volume of ~374,000 shares.
• Production Volume, Sales and Cost/gram Updates from Producing Facilities: Additional updates on the Company’s production volume, sales and cost/gram achievements will further educate investors on the Company’s progress towards achieving scale
• TSX Up-listing or US Listing: We believe the Company is actively pursing an up-listing to the TSX and may also be seeking to obtain a listing on a US stock exchange. Achieving either of these would help to increase liquidity and interest in the Company.
• Partnership with a Large Pharmaceutical or Consumer Packaged Goods Company: Given our argument that Zenabis is just as well-positioned for industry leadership versus any of its peers, we think there is potential for the Company to secure a partnership with a large publicly traded company in the pharmaceutical or consumer packaged goods industries, similar to the partnerships secured by Canopy Growth, Hexo, Cronos and Tilray. Although only anecdotal, we find it of note that two of the SunPharm founders, Mr. Catroppa and Mr. Sikka, have extensive experience with a pharmaceutical distribution business they had previously founded, and the Company’s Chief Medical Officer in his Linkedin bio notes relationships with large pharma companies.

Helpful Links

• Interview with CEO Andrew Grieve on the Midas Letter on March 8th, 2018
• Interview with CEO Andrew Grieve on the Midas Letter on January 29th, 2018
• The 4:19 Episode 58 Andrew Grieve, CEO, Zenabis
• Latest Zenabis Investor Relations Presentation
• Various videos and presentations created by Bevo Agro explaining the business of propagation and the operational history of Bevo
• Management Information Circular for the Merger

Appendix

Facilities Descriptions

Zenabis Langley: an existing 2.1m square foot high-tech propagation greenhouse located in Langley, BC, (that will be converted to cannabis production) with a design capacity of 426,000kgs upon full conversion. An initial 450,000 square feet, with an expected production run-rate of 96,100kgs annually (the “Initial Conversion”), will be converted at a cost of ~$30.0m. Approximately half of the Initial Conversion will be ready for Health Canada inspection by June 2019, with the second half of the Initial Conversion ready for final inspection in early Q3 of 2019. The full conversion of the remaining 1.65m square feet is intended to be complete in early Q2 of 2020, at an additional cost of ~$120.0m, at which time the facility is expected to produce at a cost of $0.75/gram. The portion of the facility not included in the Initial Conversion will continue to be used for Bevo’s propagation business.

Zenabis Atholville: a 380,000 square foot indoor cannabis production facility located in Atholville, NB. It has a design capacity of 34,300kgs and is currently producing at a rate of 9,300kgs. Its operational area will grow from the current 136,800 square feet (including 61,500 square feet of cultivation space) to 380,000 square feet, at a remaining cost of ~$47.6m, becoming operational and licenced by Health Canada in stages, with final licencing expected in June 2019. Additional rooms are being completed monthly, and the next anticipated licensing and operational milestone is expected to occur in May 2019, with production growing to a rate of 22,400kgs. The facility has produced at cost of $1.10/gram to date and has an extraction design capacity of 18,000kgs of input material.

Zenabis Delta: located in Delta, BC, Zenabis Delta is an indoor facility currently in operation with a cultivation and sales license. The facility is being revised for EU GMP certification. It has a design capacity of 500kgs and is currently producing at a rate of 100kg. The facility will act as a cultivation, extraction, distribution, R&D and call center facility. It has an extraction design capacity of 165,600kgs of input material, which is expected to be operational by early in Q3/2019, coinciding with the expected completion of the Initial Conversion at Zenabis Langley.

Zenabis Stellarton: a 255,000 square foot indoor cannabis production facility located in Stellarton, NS. It has a design capacity of 18,500kgs and is currently producing at a rate of 800kgs. Its operational area is currently 78,933 square feet (including 12,747 square feet of cultivation space) and is operating with a cultivation license. Timing and cost for the full build out of Zenabis Stellarton will be determined at a later date.

Footnotes

[1] Various industry supply and demand estimates in the reports, “Initiating Coverage: Growing for the Future” by Scotiabank, and “Canadian Cannabis-End of the Rainbow” published by Veritas Investment Research, both in October 2018.

[2] Some anecdotal trading history: Shares of Bevo were halted (pending the Merger announcement) on October 4th, at ~$2.30/share ($60m market capitalization and $77m enterprise value). Assuming no premium assigned to the Bevo equity, this implied a value of ~$370m for the SunPharm equity, and valuation of ~$430m for the combined entity. On October 25th, Bevo reopened for trading at $4.24/share, giving Zenabis a ‘notional’ pro-forma market capitalization of ~$800m.

[3] Based on the Company’s expected operational/licensing timelines plus a six-month lag to account for potential delays and for the time between planting a first crop and ultimate harvest/sale.

Disclosure: I am/we are long ZBISF.

Additional disclosure: THE ANALYSES AND CONCLUSIONS DEVELOPED BY THE AUTHOR CONTAINED IN THIS PRESENTATION ARE BASED ON PUBLICLY AVAILABLE INFORMATION.

THE VIEWS AND CONCLUSIONS IN THIS REPORT ARE THOSE AND ONLY THOSE OF THE AUTHOR. THE WORDS ‘US’, ‘OUR’ OR ‘WE’ REFERS SIMPLY TO THE AUTHOR.

THIS PRESENTATION AND THE INFORMATION CONTAINED HEREIN IS NOT A RECOMMENDATION OR SOLICITATION TO BUY OR SELL ANY SECURITIES.
THE AUTHOR DISCLAIMS LIABILITY ON ACCOUNT OF ANY PARTY’S RELIANCE ON THE INFORMATION CONTAINED HEREIN OR WITH RESPECT TO ANY PURCHASE OR SALE OF SECURITIES.

FULL DISCLOSURE: Zenabis Global Ltd. is a client of Stockhouse Publishing.