Canaccord Genuity Research Analyst Matt Bottomley discusses what the passing of bill C-45 means for the investment environment inside the Canadian recreational cannabis industry. He outlines how the historic event effects large market-cap Canadian cannabis organization valuations and the consequential future direction of all North American cannabis competitors. Organigram Holdings Inc (CVE:OGI) (OTCMKTS:OGRMF) (FRA:0OG) management team and facilities are highlighted as well as MedMen Enterprises Inc (CNSX:MMEN) (OTCMKTS:MMNFF) large retail brand presence.

TRANSCRIPT:

James West: Hey, there. Welcome back to Midas Letter Live. My guest this segment is Matt Bottomley. He’s an equities analyst at Canaccord Genuity. Matt, welcome back.

Matt Bottomley: Nice to see you again, James.

James West: Matt, let’s dive right into the cannabis sector. We’re now in a recreational legal environment in Canada, though the Senate passed the third reading with 40 amendments. Do those 40 amendments mean that we are actually not quite into the legal cannabis or the recreational cannabis era, yet?

Matt Bottomley: Yeah, technically we’re not, but I think this is more procedural or logistical. So basically what’s going to happen – and I believe part of this has already occurred – those 40 amendments go back down to the House, the House has their say on them, I believe they okayed 26 of them. It then goes back to the Senate for royal assent. If the Senate wishes to, you know, kick dirt up on any of the 14 or so that they didn’t pass, it could go a bit back and forth between the Senate and the House. But my understanding is it’s going to be a matter of weeks before this is officially legal.

That doesn’t mean we’re going to see legalized sales; I still think there’s a lot of other logistical hurdles to go over when it comes to provincial implementation.

James West: Sure.

Matt Bottomley: But we’re at the goal line, we’re 99 percent there with respect to this being a legal rec market.

James West: You bet. So then, assuming that that timeline unfolds, when do we expect to see recreational marijuana available generally?

Matt Bottomley: Yeah, I think there’s a bit of a window here. You know, we’re hearing, first we heard July 1, now we’re hearing summer, then late summer. I think most licensed producers that I’m familiar with, that I’ve talked to and that I cover, are expecting to facilitate delivery of a lot of product in September, so I would expect by October we should see a lot of the product rolling out in stores all over the country. I think each province is going to obviously have their own challenges in ramping it out; some will be faster than others. But I think the first legal sale could happen maybe in August, if it’s an online platform somewhere, because there are a lot of online platforms rolling out in Canada. But I think that, when we’re talking about the legal market being fully ramped up, it’s years away; in terms of it being generally available, I would say October.

James West: Okay. Do you think that the valuations currently in the marketplace among the large caps, are they being negatively or positively impacted? It looks like the index is more or less in sort of a drift pattern.

Matt Bottomley: Well, I think what we saw leading up to the legislation or the vote on June 7th was a lot of the valuations running up to that date. I don’t have the specifics here with me, but I think it was something like four or five sessions in a row we saw, you know, maybe 4 or 5 percent day-over-day for a lot of the names, and then we saw maybe a trade-off a little bit the day after, and now, you’re right, it’s been a little bit in flux, but generally at the current levels. I think over the next little while there’s going to be some positive catalysts. We’re still waiting on British Columbia, Alberta and Ontario to announce the winners of the tender process and, potentially, pricing; I personally think Shoppers Drug Mart is going to announce something soon. I know their gearing up to be an online distributor of the medical cannabis. So I think there’s a lot of positive catalysts to come.

I think the larger players are fairly valued in many cases; some cases I think it’s a bit lofty, but it’s really hard, as we’ve talked before in the past, of where to apply the fundamentals. Because I think if you’re just trying to take the domestic fundamentals that come out of Canada, it’s very hard to support a lot of valuations, but when you look at some of the larger companies in the space, the Canopy’s, etcetera, a lot of the larger cap names, they have a lot of fish hooks in the water and international markets. And it’s very difficult to guess which markets are going to roll out and when, and what the pricing might be, and what competition will be internationally.

So I don’t think the larger cap names are necessarily, you know, overvalued right now, but I think you have to keep a discerning eye, and I do think that there’s going to be challenges in rolling out this market province by province. I don’t think we’re going to have – you know, a lot of estimates, mine included, say the regulated market closer to maturity is 10 billion; that’s not happening anytime soon. You need enough storefronts, you need online platforms, you need capacity expansion. So it’s going to take a while before that happens, and I would be cautious about valuations sort of in the back end of this year, early 2019.

James West: Okay. So we’re going to avoid a conversation about most of the large-cap companies that you cover at this point, because there’s too much going on for you to be able to talk about them comfortably.

Matt Bottomley: That’s true. We’re research-restricted on a number of them; it wouldn’t be a fair conversation, but…

James West: Okay. Well, let’s talk about some of the more recent ones that have gone public. The one that you just told me about that I hadn’t actually heard of before was Green Thumb Industries. What’s the story with them?

Matt Bottomley: Well, Green Thumb Industries is a very interesting story. My favourite company in the space historically that I cover, and currently, is IAnthus Capital Holding, and that’s a company that has exposure to a lot of blue-chip states. So Green Thumb is very similar. They just recently got some exposure in Florida, they’re in a lot of states in the northeast. So really what that is, is a lot of bigger players are coming to market now that are able to raise capital in Canada and potentially become consolidators in the US space, and that’s something that historically has been a huge challenge.

Most states, particularly California, which is the largest market in the US, are incredibly dis-aggregated. So we’re seeing a lot of companies come to market now; Green Thumb is another example of one, MPX is another one I’ve mentioned, that really are going to have strong balance sheets, ability to raise capital, and they’re going to be picking up what I think are blue-chip licenses in states where they’re risk-mitigated because there’s, you know, maybe not license caps, but certainly there’s visibility on how much licensing is going to happen – as opposed to Canada, which only has 35 million people, is not as vertically integrated as the US because the governments are getting involved on the retail side, and there’s not as much competition in terms of the number of publicly listed companies on the US.

That’s changing; I think we’re going to see a lot of interesting stories come to market in the second half of this year, and Green Thumb is just the most recent one.

James West: Okay, so who is behind Green Thumb? Is it anybody from the industry we’d recognize?

Matt Bottomley: I don’t know, there’s so many different people in this space. They definitely are experienced; over the years, a lot of these companies stayed private for some time, but yeah, I’m not sure if you’d know them directly, but it is a good operating team that has exposure in many different states.

James West: Okay. Well, let’s talk about another US consolidator that’s come to market recently: MedMen, trading on the Canadian Securities Exchange under the symbol MMN. What can you tell me about MedMen?

Matt Bottomley: So, MedMen is an interesting story. It probably has some of the most exposure right now with respect to all of these names that are in the pipeline that are US operators, but Canadian listed. So a lot of the companies I just mentioned are companies that have vertically integrated licenses, and MedMen has that as well, but they probably have the biggest retail presence right now in the US, particularly in Los Angeles and other areas of California. So they’ve probably done the best job, from what I’ve seen, in terms of operators that are able to get, you know, I say blue-chip licenses; these would be double-blue-chip real estate in terms of, you know, having sites in West Hollywood, having sites in Manhattan. Right now in New York State, for example, there’s only, I think, two licenses in terms of dispensaries that are on Manhattan, and MedMen has one of them. They recently entered Florida; they’re planning on getting a South Beach location there. So they really are, I think, a leader right now in terms of the pull positioning as to who has the best brand.

When it comes to the retail dispensary model in the US, the question is, you know, where’s the best part of the value chain to be? Is it to have the cultivation, production and retail like MedMen has? Is it to be, maybe, a distributor in California, like a company like CannaRoyalty is? So I think MedMen is a company that has a lot of execution to do in order to get to where they’re planning to be, but they certainly are the leader right now when it comes to the retail brand for publicly available investments.

James West: Okay. Now let’s touch on one that’s actually been sort of really amping up in market cap and valuation and increased interest, and that’s one where we were both present for their sort of show and tell day – Organigram Holdings.

Matt Bottomley: So Organigram is, I think, a great company. It’s got a great management team. I’ve been doing some facility tours more recently; I went to Aphria as well, and I looked at a lot of these companies when I was first initiating coverage on them early in 2017, and what I saw at Aphria, what I saw at Organigram, it’s night and day. I mean, just the level of capacity that’s been expanded, the level of automation that we’ve seen, the number of grow rooms, which I know you saw as well…so Organigram is definitely one of the leaders in the Canadian industry, when we’re talking about, you know, 107 licenses, maybe 30 or 40 operating companies, they’re certainly a Top 10 name when it comes to all the metrics of infrastructure, geographic reach, cost of production. And I think that relatively speaking, it’s a very cheap stock compared to some of the larger cap names that have much higher relative multiples. So, very impressed with their – I don’t know if this is, you know, I’ve got to be careful there because I’m sort of speaking off the hip here, but I do think Organigram might have a top five facility in terms of how large it is today. There’s a lot of competition in the space, don’t get me wrong, but Organigram is certainly, since Greg Engles came on, has been executing very, very, very well, and it’s a name I’m very favourable on.

James West: Hmm, great. I was impressed as well. One of the big questions that a lot of people are asking about is the idea that there’s going to be this huge shortage of legal cannabis in the face of the onset of recreational use by pretty much everybody. And I’m curious as to, you know, if we look at this map that I’m putting up now on the screen, these are all the illegal dispensaries in Toronto that are currently servicing the recreational market.

Matt Bottomley: I wouldn’t know anything about that.

James West: Okay [laughter]. That’s reassuring! But I mean, I just look at this map, and most of these companies, you can either walk in and buy recreational cannabis today without fear of being arrested because of the Constitutional quagmire that implies in the face of a newly legalized environment. But are all these guys just going to disappear, and is the new recreational rules sort of the framework under which the government will shut these guys down? What’s sort of your position on that?

Matt Bottomley: Yeah, well, because this is a map of the GTA and therefore Ontario, I do think that. I mean, these dispensaries, for the most part, do not have the – now, the Canadian market to start is going to be a little bit shy when it comes to how much product breadth they have, but these dispensaries do not have the product breadth that we’re going to see in a regulated market, particularly if you compare it to what we’ve seen in a lot of US states. I’ve been to dispensaries all over the US, probably five or six states now, and when you look at a fully ramped up recreational dispensary, it’s nothing compared to what’s in here. These stores will sell little jars of dried bud, maybe one or two cartridges with oil in it; maybe someone in the back room makes the edibles, I don’t really know.

But the provincial and Federal government have basically said – now, they haven’t acted on it – that once, I think it was the first or second reading of the Bill went through in Congress, that these dispensaries are effectively on notice. And I don’t think you’re going to ramp up a large infrastructure, LCBO-type models in Ontario, and let those dispensaries that are illegal compete for tax dollars with you. So I fully expect there to be enforcement; I’m actually a little surprised it hasn’t happened yet.

James West: Really? Okay, so then, you don’t think that there’s a risk that these guys try to stay in business, the Feds try to shut them down, there’s Constitutional challenges from that quarter saying, well, if these guys can do it, why can’t we do it if it’s generally legal?

Matt Bottomley: I think it’s certainly a risk, but I think the provinces, at least I would hope, are aware of this risk, and they should be pricing the product accordingly in the retail stores to ensure that they’re not competing on price with these illicit organizations. I think that if price is not a consideration, and if – this is a big if – Ontario is able to get their 40 stores to start, and then up to their 150, and they have brick and mortar access, where it’s not inconvenient to find a legalized store, I would think, you know, price being the same, people are going to want to buy something that’s regulated. You know there’s no fentanyl or pesticides or any other garbage in your product, and again, it’s in a regulated environment you can be comfortable with. So I absolutely think the illicit market’s going to be here for a very, very long time. I don’t think it’s going away in the next handful of years, let alone next year. But certainly, the regulated market should start chipping away at it almost immediately, assuming that the provinces roll this out in an effective and responsible way.

James West: All right, Matt. That’s fascinating and enlightening as usual. Thank you very much for joining me today. We’ll come back to you again in due course.

Matt Bottomley: Thank you.

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