“Cannabis IPO #1: The Unlimited Royalty Machine” teased by NICI

What's the stock being hinted at in ads for Cannabis IPO Insider?

By Travis Johnson, Stock Gumshoe, April 30, 2019

The “buy the next marijuana IPO” pitches are fast and furious these days, promising massive short-term gains as new companies go public (mostly in Canada) and try to capture the lightning in a bottle that generated bubblicious returns for speculators in past pot stock spikes (some of which have turned into hugely profitable — if volatile — investments like Canopy Growth, others of which have disappointed after an initial jolt).

And I don’t spend a lot of time writing about these stocks, because most of them are just wild stories cloaked in a ticker symbol, with no real financials on which I might base a decision, but I do get questions pretty much every day… so today we’re taking a look at one of those ads.

This one is from Money Map Press, in an ad for a service they’re calling Cannabis IPO Insider from their National Institute for Cannabis Investors, which was one of the higher-profile newsletter launches last year (they brought on several big names to sell memberships in their initial ad blitz, including retired Speaker of the House John Boehner). They charge $1,950/year for this IPO Insider, which basically provides “dossiers” on the new cannabis companies they recommend, along with regular updates, interviews and recommendations. As with most higher-cost newsletters, the refund policy is strict (it’s not as strict as the “no refund” policy that many have adopted, but they promise at least four of their 24 to-be-recommended IPOs will deliver 10X gains in the first year, and if that doesn’t happen you can call for a refund after the year is out.)

Their promise that you’ll see several marijuana IPOs generate massive returns over the next few weeks caught my eye, of course, partly because they dangle those tasty past returns that fortunate marijuana speculators could have gotten if they sold at the top of past price spikes, but what really grabbed my attention was their pitch about royalties.

I am, as I’ve probably made clear a few times, a fundamentally lazy dude. Royalties are my favorite investment, though it’s hard to find them at good prices — a royalty is basically a passive income stream that comes from intellectual property or a unique asset, and generates ongoing revenue without the need for additional investment. Like the royalty on a song, for example, that pays you a fraction of a cent each time that song is performed, or a royalty on a piece of land that gives you a portion of the gold or oil that is extracted from that land without obligating you to pay for finding and producing that resource.

This is a different kind of royalty we’re being teased with here, a royalty on some kind of extraction equipment that marijuana growers can use to make their own extracts (like CBD oil for use vape pens or edibles, for example).

Here’s a piece of the ad:

“They’ve created a proprietary extraction system for cannabis that’s unlike anything else in the world.

“But instead of spending tens of millions of dollars building grow houses and distribution channels… they license their technology to other cannabis companies.

“By doing that, they collect a sizeable royalty of 22 cents for every gram of product their equipment produces.

“Now here’s how the math works out if just a handful of companies are using their equipment:

“Aurora Cannabis is adding 128,000 kilograms of new capacity this year. That would be worth over $28 million.

“Tilray is adding 142,000 kilograms. That would be worth another $31 million.

“HEXO is adding 108,000 kilograms. That’d be an additional $23 million.

“Natura is adding 70,000 kilograms. That’s another $15 million.

“So you can see how easy it would be for this company to start raking in $97 million with just four clients. All with zero work.”

So who’s our “unlimited royalty machine” that’s about to go public? That’s very likely Xtraction Services, which is in the process of going public through a reverse merger with Caracara Silver (SILV.H on the venture in Canada as of last year, CARAF OTC in the US, currently in a trading halt pending the merger and movement to the CSE).

Xtraction and Caracara agreed to their merger last August and Caracara shares have been in a halt since then awaiting the consummation of the deal, with the most recent news being their “definitive agreement” signed last month. The terms of the agreement were filed on SEDAR on March 22 here if you’d like to see what limited info they make available.

Machines for extracting cannabis oils and other goodies from hemp and marijuana plants have been around for a while, and are not necessarily all that different from other extraction machines… though each company that makes or sells them, of course, believes it has a better product and an advantage (and marijuana is a tougher plant than, say, lavender or basil, so the hardware might be optimized a bit differently).

The interesting thing about Xtraction Services is not the machines themselves, though they’re probably just fine (I have no way of comparing them to the dozens of other extraction equipment packages that are being pushed now, and it seems like Xtraction is intending to work with multiple equipment manufacturers), but the financing plan — they’re essentially trying to place machines with customers and take a volume-based fee for offering up the machine and maintenance and trained operators, instead of a more standard leasing or purchasing agreement (though they will offer leases as well). Kind of like leasing a Xerox machine for your office, I suppose, with or without an operator who can man the machine and charge you per copy.

I don’t know if it’s precisely 22 cents per gram that will be paid for these licenses, that doesn’t appear to be in the filings, or in the private placement presentation materials back when they were making their pitch in December (they raised $5 million, the deal closed a while ago).

The main thing that keeps me away from most marijuana stocks, other than the crazy valuations, is the fact that it’s a commodity business, and I have no idea what the margins or competitive advantages might be among any of the substantial players once (if) things normalize. Xtraction is set up, it appears to me, to provide services to smaller growers who want to build an extracting/CBD business, it’s not likely to be the preferred option for massive players like Aurora or Tilray, those big guys don’t need a deferred-cost lease option unless the technology or output is dramatically better, and Xtraction isn’t really claiming that their equipment is better — their pitch is all about financing and services.

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I come in skeptical not because I’m an expert on the technology, but because breaking in to industries like this through some sort of technological advancement is rare and difficult. If the technology was markedly better, I assume, it wouldn’t be owned by a tiny company that’s trying to go public through a reverse merger with a failed silver miner, and it wouldn’t be raising money in preferred share offerings at $5 million a clip.

That’s a bias I have against tiny “better manufacturing tech” companies, but in my experience it’s been a profitable bias — little companies who develop better mousetraps do not take over markets from the established machine and equipment manufacturers and vendors. They might get bought out, if their technology is indeed better in some way, they might eventually grow little businesses on the periphery, but they don’t easily or quickly scale up and “own” these kinds of businesses. You can post extraordinary gains in sectors like software or retail, where some buzz and marketing can get you over the hump quickly to real revenue growth, but it’s not nearly so easy in capital-intensive processing industries like agriculture or food ingredient production. Not when there are also 40 other startup companies who are thinking they’ve also got a new and better system for CBD extraction.

So my biased outlook here is that there probably won’t be one “winner” in CBD production, but if there is one it will be either the low-cost volume lead