by Travis Johnson, Stock Gumshoe | November 5, 2019 4:58 pm
What have we learned about teaser ads over the past decade or so? A lot, I hope, but two lessons stand out:
First, dates in teaser ads are often made up and don’t really represent meaningful “catalyst” events, they’re just a way to make you feel rushed and get you to pull out your credit card before you think it over too much… so in that vein, let’s recall that Matt McCall sent out a very similar ad about the “Royal Gold of Marijuana” in the summer of 2018, with the urgent promise that “if you act before July 18th you could watch a small stake grow into a massive fortune.” And with this latest ad, it appears the main thing that has changed in 16 months, aside from the stock he was teasing at the time falling dramatically, is that the date has now been replaced by “November 21.”
Second, once an ad works well to recruit subscribers, they keep using it. It doesn’t matter if the central argument of the pitch no longer really holds true… if it works, it mails. In this case, the company McCall was teasing in the summer of 2018 had already by that time, at least in my judgement, really given up on the notion of being a “royalty” company, but, well, investors love royalties, so the ad stuck.
Anyone want to hazard a guess as to what’s going on this time, with the “Royal Gold of Marijuana” pitch that Investorplace is circulating this week? Do you think it’s a new stock idea from McCall, or do you think maybe they’re just re-using the same ad from last year because it worked well?
Come on, now don’t be cynical! Maybe it’s all new and exciting! Really!
OK, no, not really… but we can dream, right? I will, at least, go through the motions and check our clues here to see what stock is being touted. And, of course, I’ll let you know if we’ve seen any meaningful changes to the ad since last time.
Here’s the beginning of the spiel that caught our readers’ eyes:
“And it involves NONE of the usual risk of buying ordinary pot stocks—and NONE of the typical work or capital needed to start your own business. Yet it could realistically multiply your money several times over in the coming years… if you take part soon… before November 21st (I’ll tell you exactly why in just a moment.)”
Sound familiar? Yes, it’s ALMOST the same as the spiel from July of 2018… but in addition to updating the date, they also replaced “weeks and months” with “years” — so that’s at least a small nod to the fact that marijuana stocks have gotten clobbered this year and are no longer being looked at by many folks as instant 1,000% gainers.
The comparison to the gold royalty companies, particularly Royal Gold, is still the same, talking up the incredible win that those stocks represented if you got in before anyone appreciate them. Here’s a little extract of him talking about Stanley Dempsey’s founding of Royal Gold (RGLD):
“Back in the 1980s, a lawyer and geologist named Stanley Dempsey decided to start his own gold mining company.
“But after a few long months, instead of finding gold, all they really discovered was just how grueling the mining industry can be…
“First, the costs alone to explore for gold were astronomical. His company burned through tremendous amounts of capital just trying to identify a target gold deposit — and then you add in land, labor, insurance, permits, and not to mention, the super-expensive gold mining equipment.
“And this is BEFORE he even discovered a single ounce of metal!
“For months, he and his men hit nothing but dirt…
“But Dempsey was a clever geologist… and a lawyer…
“So he took what little money he had left… and rather than spend it to have his own company explore for more gold… he offered it to other, more knowledgeable and experienced folks in the gold mining industry…so they could explore. And in return… Dempsey’s company would receive a percentage of gold the mining companies found and sold… in the form of huge royalty payouts.
“In short, he figured out a way to earn huge royalties over and over again from the world’s richest gold mines—without any of the risks or costs that usually go with the mining industry.”
And then that jumps right in to marijuana…
“You see, the key to making a fortune in royalty companies is to get in at the very beginning… you want to be there first.
“As you’ve probably guessed, a brand-new royalty opportunity has just opened up… only this time, it’s in one of the newest and fastest-growing industries in the world today…
“I’m talking, of course, about the red-hot marijuana industry.”
Those are identical to the words McCall used almost year and a half ago, so, again, be careful about trusting the urgency of ads like these. More from Matt:
“… right now, you have the rare opportunity to get in at the early-stages of this brand-new royalty opportunity… what I’m calling the “Royal Gold of Marijuana.”
“This is a tiny company — like Royal Gold was at the very beginning. Very few people even know it exists — and practically no one on Wall Street is following it… at least, not yet.
“As you’re about to see, this is the most exciting opportunity I’ve come across in several years. I think you’d be crazy not to take advantage of it…”
And there are some examples given of the royalties that this firm already has on the books — again, with no change from the way these deals were described in the Summer of 2018… here’s one example:
“For example, this company has a royalty stake in what will soon become the single largest marijuana indoor grow facility on the planet.
“It’s a former Kraft food manufacturing plant. Currently under renovation, this state-of-the-art facility will be the size of more than TEN football fields.
“With more than 600,000 square feet of grow space, it’s going to be the Madison Square Garden of the pot industry.
“When completed, this gargantuan facility will churn out more than 40,000 pounds of marijuana per year.
“And the best part? The “Royal Gold of Marijuana” gets a cut of the revenue. And I’m not talking table scraps, either. They’ve negotiated a massive 50% royalty deal on all the pot produced at this facility — for — get this — possibly up to the next 99 years!
“Yes, you heard that right.
“That means, when completed and at full production, this tiny royalty firm could rake in as much as $220 million per year for multiple decades… all from a one-time $120 million initial investment.”
They took out the part about marijuana soon being legal in Canada, since that’s now in the rear view mirror… and they also took out the “you can buy this for under $2 a share” bit that was a useful clue at the time — is that because it’s a different company now? Or did the stock price just change?
Well, it’s the latter, I’m afraid — that unbeatable marijuana royalty company that was trading for less than $2 a share in early 2018 is now trading for about 65 cents a share… and that’s Canadian, so for us folks on the US side of the border think “50 cents a share” and almost a new all-time low for the company.
McCall is also (still) saying that the company’s revenue is about to skyrocket as the royalty deals begin to pay off, with the graphics in the ad indicating that they’re just at the leading edge of booking $94 million in revenue in 2019 and $286 million in 2020.
And that’s about it by way of meaningful changes that I saw in the ad… except for one thing. McCall in 2018 was pitching this idea for his $2,999 newsletter Early Stage Investor… but today, he’s using essentially the same ad as bait while he fishes for subscribers to Matt McCall’s Investment Opportunities, which is an “entry level” letter that starts at $49/yr.
Which isn’t unprecedented — we’ve seen newsletters do that before, pitch an idea with a premium-priced letter ($1,000 and up) and then, after they’ve exhausted that cohort, using the same tease to recruit entry-level subscribers. The cynic among you might say either that they just don’t want to waste good copy, and the real cynic would say that they’re using their low-cost subscribers to try to boost the share price of the teased stock and benefit the folks who paid $3,000 for the idea a year and a half ago and are sitting on 50% losses on their investment. I’m not that cynical, so I’ll just guess that they’re re-using tried and true ideas just because they worked.
And yes, this is, once again, a veiled pitch for Auxly Cannabis (XLY.V in Canada, CBWTF OTC in the US).
I’ve written about Auxly Cannabis a few times, including back in 2017 when it was brand new and being touted by some of the pot newsletters (like Jimmy Mengel in May of 2017, and, as you can gather from my comments above, I also wrote about it when Matt McCall first teased it as the “Royal Gold of Marijuana” in the summer of 2018), and I’ve been tempted before, mostly because of the notion of “cannabis royalties.” Most of the comments I’ve shared about this stock in that first year or so of its life as a public company were along the lines of, “I love the idea of this business model, but boy, I wish it was a better company and traded at a lower price.” Much of what I’ll share below is not new, I wrote some very similar things when James Altucher pitched the same stock in September (though the story has changed a little since then… and the stock has come down by another 20-30% or so).
And that “former Kraft facility” that was going to be the biggest marijuana cultivation building in the world? Well, that was a deal made in late 2017 that had some initial promise, with FV Pharma in Ontario… and by the time this ad ran the first time in July, 2018 that was being finalized in phase one as a 220,000 square foot facility with a first harvest hoped for in January of 2019… but now, though that part of McCall’s ad remains unchanged, that deal is over — terminated way back in February. Whether that was Auxly’s fault or FV Pharma’s depends on which of them you believe (Auxly said they had concerns about staffing and infrastructure and asked for changes, FV Pharma says they couldn’t wait around with Auxly behind schedule and dragging its feet on development), but the fact remains that Auxly is no longer affiliated with this “biggest grow project” and won’t be getting 50% of anything (or spending $50 million to build the project for FV Pharma, though I suppose some of this could end up in court).
How would you feel if you were primarily excited about that aspect of the teased company, got excited about this massive grow project, and subscribed to a newsletter just to learn what it was? I wonder if McCall’s “special report” on the Royal Gold of Marijuana has been updated any more carefully than this ad was.
Here’s what I wrote about them on June 9, 2017 in a Friday File, just FYI — I’ve been going back through the older articles to see what I was thinking at the time (the stock price was just under a dollar then)…
“The streaming deals they have so far look terrible, honestly — the ones I’ve looked at where they’ve provided some specifics are based not on current economics, but on some hypothetical world where prices rise dramatically for legal marijuana in Canada. That might come, but this is going to be a regulated market that might even have strong price controls, and I suspect a bank wouldn’t lend based on those estimates… a streaming company trying to expand quickly apparently will, and perhaps that’s why the streaming company hasn’t raised the $500 million they need to fulfill their end of the streaming deals they’ve made… and, it seems, is having some trouble raising even a tenth of that amount. Which, in turn, could mean that some of their streaming deals won’t close, because the deals that I saw described in detail were contingent on Cannabis Wheaton raising money.
“I do kind of hope that this one hits a rational price as disenchantment continues, and they did bring in a new executive this week, presumably with some hope of righting the ship and restoring some credibility, but we’ll see — it’s quite possible that they missed their chance now. If you intend to build a long-term successful business, it’s short-sighted to be raising this money with junky convertible debt and warrants when there’s a lot of interest in marijuana equities, they could perhaps have set themselves up for a much healthier business if they had just sold a big slug of equity right away and kept expectations a little more in check… but, of course, that would have driven the price down a bit more, at least in the short term, and it seems to me that many of the marijuana market participants who are starting or listing companies in the public markets seem to be quite enthusiastic about getting their windfall profits quick before the story or sentiment changes. That’s probably a word to the wise for us all: Investors can obsess over share prices and have wild mood swings, but when companies themselves are focused on the short term stock price movement instead of on building a sustainable business, things can get ugly quickly.”
So what has happened since the stock got a flurry of attention in 2017 and 2018 for trying to become the first big “marijuana streaming” company?
Well, they got a lot of flack for borrowing the Wheaton name (they started out calling themselves Cannabis Wheaton Income, then just Cannabis Wheaton), which led to changing the name to Auxly Cannabis in the Summer of 2018… and it wasn’t just a name change, it was a strategy change — they don’t really throw that “streaming” or “royalty” idea around anymore.
And, of course, the stock soared to about C$2.50 at the peak when everyone was excited in early January of 2018, but has been mostly quite disappointing for investors since then.
As I noted when I wrote about this stock in solving a James Altucher teaser pitch back in September, I think it’s probably good that they abandoned the “royalty” model and decided to try to become a “vertically integrated” cannabis company, regardless of how much I prefer the royalty business — it just wasn’t working, and the royalty deals I saw all made really aggressive assumptions about how much their partners had to grow production to get Auxly a return… and, at least from my earlier looks at the first deals in 2017, the deals also only really worked out if marijuana prices surged dramatically higher. Which they haven’t, as far as I can tell, and quite possibly they won’t. Agriculture-based streaming deals are difficult in general, and tend not to provide any windfall opportunities like mining or energy royalties sometimes can, and in a market as volatile as marijuana they might just not make any sense at all.
The biggest news out of Auxly lately is their deal with the British tobacco company Imperial Brands (Auxly press release here), owner of the Blu vaping brand (probably the second-biggest US vaping brand behind Juul, bought from RJ Reynolds about five years ago) as well as some legacy cigarette brands (like Winston). Imperial is investing $123 million in Auxly in a deal that just closed about a month ago, and will get a convertible debenture that gets them 20% of Auxly at an effective 81 cents/share (and a way to back out and be repaid if they decide not to convert after three years). This gives Auxly a licensing deal for any global marijuana products Imperial wants to launch, as well as the license to Imperial’s vaping technology for when vaping products are legalized in Canada… which was expected to be late this year (with the latest vaping health problems, that could presumably change).
Legal market sales have been growing considerably less quickly than inventories in Canada, according to Stats Canada, so that’s a general concern for all of the growers — for the month of August, the latest one reported, sales of dried cannabis were about 12,000 kilograms and inventory was over 325,000 kilograms (up from 7,000 and 99,000 back in November, right when legal sales started, with inventories roughly tripling as sales doubled). Growth in production capacity has been remarkable, and big grow houses are mostly in constant harvest mode (if they planted their pot all at once, they could get three harvests a year… but they stagger plantings for constant production). Cannabis oils are growing sales and inventory at a similar pace, though inventories actually dropped in August for the first time, and that market certainly might change later this year when marijuana edibles get legalized and create a new source of demand, but at this point it’s pretty clear that the massive production increases that were made by the first wave of Canadian pot companies have met the legal demand just fine, and arguably exceeded it so far. That might not be the case next year if edibles or vaping take off, I don’t know, but there’s at least a big backlog of flower inventory and harvests are not stopping.
The official statistics don’t yet cover 2018 or 2019 for marijuana prices, but as of 2017 the market for legal medical marijuana had had pretty steady pricing — with prices per gram moving down a few percent from 2010-2017 to $8-10, on average… and the reports in Canada’s first year of recreational legalization are that most legal sellers are selling at pretty close to that price as well. Which means legal pot is not undercutting the black market, which generally offers per-gram pricing about half that of legal sellers. The hope seems to be that the next wave of products (edibles and beverages) and some sort of gradual marketing build and brand-building (if that’s ever allowed) will increase demand… and provide more earnings, since processed products would presumably offer higher profit margins than dried flower.
In the meantime, though, it’s not like all these giant marijuana grow-houses will stop growing, so supply keeps rising. That’s not necessarily a great sign for companies that appear to me to rely on rising wholesale prices and maybe on exports… like, say, Auxly Cannabis.
So now Auxly presents itself not as a royalty company, but as an emerging brand leader that’s trying to leverage their huge supply agreements with joint venture partners, many of which were initially described as more passive and “royalty” deals, into a competitive advantage in “high-margin, value-added, branded derivative products.” This is from their website:
“Auxly was founded in 2017. Recognizing the tremendous opportunity to become forward-looking leaders within an emerging Canadian and global industry, our team of experts leveraged their respective backgrounds in the space to form a business model with impact and longevity. Now, with operations based across Canada and Uruguay, we are poised to become a global cannabis leader focused on providing branded cannabis products backed by science and innovation.”
So it sounds like they at least hired some MBAs. What else do we learn about the current situation at Auxly, beyond this latest financing from Imperial Brands? Well, according to their investor presentation they should have a diluted market cap (roughly 850 million shares) of about C$550 million if you include the convertible debt from Imperial Brands (down from $800 million just a couple months ago). And they have an impressive sounding collection of partners and leaders.
But they don’t really have any revenue yet, and they don’t talk much about revenue… which really means there’s too much guessing for my taste. They do say that they expect to have 100,000 kilograms of “diversified cultivation supply,” which at $3/gram (just making up a wholesale number there) means the capacity might be there for $300 million in revenue. If they get wholesale prices of $6/gram, that’s $600 million in possible revenue.
That doesn’t mean they’re going to have that kind of revenue, of course — right now they’re on pace for about $10 million in sales per year, though it is ramping up quickly as supply comes on line, and they also hope to have sales of processed marijuana products that are far higher than any wholesale dried flower they produce through their partners (they just got permitting approval for some of their edible/processed brands, and that “Cannabis 2.0” wave of products is just now becoming legal across Canada, so it will be a while before we know what sales look like). They don’t really say anything about what margins they might get on any of that, or what their production capacity will be beyond dried flower… and to a large extent, that’s probably because they don’t really know, though I would expect the roll out to be slow.
They do have some flexibility now — the new convertible debentures from Imperial will add more debt to the balance sheet, but they have enough cash from all these financings to handle that for quite some time if they don’t make wasteful acquisitions (I’m making another assumption there, since I don’t know if they include their joint venture obligations on their books as liabilities), and they just redeemed almost all of their $100 million in convertible debt that was set to mature in January (they had to settle most of it in cash, but some folks did accept the 74 cent conversion price).
There are some analysts who have presumably tried to guess at those numbers with more rigor than I can muster, and they do think that Auxly will be profitable in the next two years — four cents a share in 2020 and 7.5 cents in 2021, thanks to the fact that next year is when their huge bolus of hoped-for revenue growth should come through, with C$244 million in revenue next year (up from $8 million this year). I have no idea whether or not those analysts will be correct — if they are, then Auxly is a pretty solid buy here.
I should note, in fairness, that it is hard to guess at the emergence of sales from a new producer… and that the analysts have not done so well at it so far, as of February they were still predicting that Auxly would post a profit of a couple cents a share in 2019, on revenue of $165 million, so their estimates for the current year apparently, at least going by Ycharts data, dropped by about 95% between March and May of this year (this is also a pretty small company and only has two analysts offering estimates… which often means the folks supplying analyst coverage are probably the same investment banks that are helping the company raise money).
I’m glad for Auxly that they got out of the royalty strategy that seemed to me to be based on unreasonable price assumptions… but to me this is a bet on brands that are untested in the market, and on production from facilities where we don’t know anything about the economics, which will go into a market in dried flower that is probably dropping in price, with hopes for a stronger emerging market in edibles and vaping products that is unknowable when it comes to either regulation or pricing so far (especially vaping, which is obviously far more challenged than it was even a couple months ago, when it was seen as the next great hope for Canadian producers before the massive health scare).
Maybe Auxly will end up being a dominant company in Canadian marijuana, but that’s too many uncertainties for me when it comes to a company with no real revenue yet. And no, though they did start out trying to leverage the idea of “royalties” it’s not really a passive royalty company at all at this point, despite the fact that there are still technically some “streaming” deals in their portfolio (bad ones, I’d guess, left over from 2017) — they will be spending plenty of money to try to build those brands and pushing for vertical integration even as they keep investing in new projects that amount to somewhat of an attempted “land grab” in Canadian cannabis, and they’ll be dealing with large production of cannabis from their joint ventures, they won’t just be sitting back and accepting checks like Royal Gold did 30 years ago.
It might work out OK, but I’m guessing that the financials will not make any sense for at least another year or two as the market settles down and their larger joint ventures begin to report meaningful revenue… and I continue to be pretty skeptical about the profitability of the oversupplied Canadian legal marijuana market.
Oh, and November 21 doesn’t really mean anything. Yes, there will be some changes in the market in the coming months because of new product releases, particularly edibles and oils that are being permitted now by the Canadian government, but that’s not going to result in a shock change to the business — it will probably be quite gradual as those products roll out, particularly with the newfound scrutiny of vaping products. It could be that Auxly will report its next quarterly update on November 21, they haven’t announced a date yet, but that would be unusual — more likely they’ll stay on the schedule they were on last year and report about a week before that (they technically have 60 days from the end of the quarter to file their earnings, so that could be anytime before the end of the month, but most companies stick to a pretty consistent schedule).
So my assessment still comes down to “I’m not particularly interested”… the valuation has gotten more compelling if you think the analyst forecasts should carry any weight, and it’s true that the big investment from Imperial Brands amounts to somewhat of a “vote of confidence” and a nice capital infusion that should help goose their growth (assuming, of course, that marijuana vaping remains a viable growth business once the scare passes), so there are some decent factors you can use if you want to try to build a case for Auxly. If you do have some faith in the forecasts or great confidence in Auxly’s business plan or unique capabilities, and particularly in their brands, you might find it worth a follow-up or an investment with your money… please do let us know what you think of Auxly by sharing your comments below.
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