Cannabis industry activism took a new twist this morning, when the second largest shareholder of Hydropothecary Corp (TSE:HEXO) (OTCMKTS:HYYDF) stock pleaded its valuation case to the public. The clearly-defined press release struck an obvious chord with investors, which have sent shares surging by $0.51 to $6.40/share (↑8.66%) on volume which could best that seen following the August 1st Molson Coors deal.

Foremost, the dissemination by Riposte Capital LLC focuses on the compelling valuation case in comparison to HEXO’s peers on a EV/EBITDA multiple basis. In the opening op-ed style investment letter, Riposte Capital emphatically states several key reasons why this is so, insisting that management must take specific steps to remedy shareholder value.

In particular, the organization cites HEXO’s potential $1 billion supply deal with SAQ, poor research coverage and investor awareness, and unsatisfactory uptake on the Molson Coors junior venture are key soft points in the valuation equation. The op-ed portion finishes off with a salient point on one valuation metric, which stands out like a sore thumb:

Yet HEXO trades at an EV/EBITDA multiple of just 8.1x 2020 consensus EBITDA – a mere fraction when compared to Tilray at 93.8x, Canopy 89.2x, Aurora at 27.2x, Cronos at 23.7x and Aphria at 19.5x.

On a current peer valuation basis, HEXO’s case appears less sanguine.

Interestingly, Riposte’s lack of management endorsement is quite notable throughout the op-ed part of the press release. While acknowledging the company’s many milestones on the operational side, nowhere is actual tacit Board affirmation delivered. The closest such expressions are that “we [Riposte Caiptal] have appreciated and look forward to continuing our dialogue”—but the overall piece reads more as a colloquial warning for management to get its act in gear more than anything else.

Certainly, there is no lack of de facto demands given which appear to emphasize this sentiment.

Riposte Capital ‘Suggests’ Measures To Enhance Shareholder Value

Perhaps the most interesting aspect of the release was not the re-iteration of facts already known on the street, it was Riposte’s suggestions on how to go about fixing the valuation gap. While acknowledging management’s “operational acumen” as instrumental in cementing the Molson Coors deal, ultimately, their conclusion is that “HEXO still suffers from a low multiple and share price, which is critically important, as it significantly hampers the company in the race for global growth and expansion.”

As such, Riposte provided four remedial courses of action management should enact at the next scheduled Board meeting. The tone is brusque, direct, and anything but leisurely.

1) Engaging with any interested buyers of the company at a significant premium to the current share price.

2) Taking the company private, now that the financing markets are open to the sector and banks are providing leverage, and doing so in a manner that would permit us to maintain our existing ownership percentage in the company.

3) A meaningful direct investment from Molson Coors to fund growth and further strengthen the company’s relationship with a major alcohol player.

4) A no-premium, accretive merger with a comparably-sized LP that can add further geographic diversification, scale, international opportunities, and medical expertise.

The first suggestion is rather self-apparent, as the majority of Canadian LPs are interested in being acquired for the right premium. The sector has multiple precedents of such action in 2018, including the CanniMed Therapeutics deal with Aurora Cannabis (Newstrike Brands was previously courted), MedReleaf Corp. in May, and recently with Hiku Brands (which closed yesterday). Even Constellation Brands recent direct-equity investment in Canopy Growth was, in essence, a de facto takeover, as Constellation could garner over 50% ownership and majority Board of Directors control. There’s ample anecdotal evidence other Canadian cannabis LP’s are willing acquisition candidates at the right price to avoid the cannabis cash crop compression and competition which lies in waiting in the second half of 2019 and beyond.

The second suggestion is an very interesting one, and could make sense on a number of levels. If HEXO is indeed as undervalued as Riposte suggests, and can obtain a credit facility and/or will generate the free cash flow necessary to avoid tapping the public markets for additional capital, then why not make a run at going private? This might be a legitimate forward-looking way of unlocking shareholder value the market is refusing to deploy (irrespective of today’s price action). It also comes with a number of benefits, including lower operational costs, less pressure to make short-sighted decisions to make quarterly numbers, possible tax and re-branding applications.

The Midas Letter argued that Go-Private Intentions Could Make Sense For Select Cannabis LPs just last month. Some institutions may very well look at HEXO’s forward enterprise value/future cash flow and decide taking HEXO private via leveraged buyout at $12 or $14 or $18/share makes sense.

In my opinion, the third suggestion is a complete non-starter. Asking Molson Coors for a 20% direct-investment mere weeks after signing a sweetheart deal is just poor optics. Not only would it threaten the integrity of the agreed-upon deal and damage mutual trust, it would be tacit acknowledgement that HEXO made a poor deal to begin with. As we argued at the time, the deal was a one-sided affair, which is why the stock reacted poorly in the days after it was announced.

But what’s done is done. Going back to Molson Coors cap-in-hand and demanding better terms would undermine HEXO’s operational reputation and integrity—in my opinion. The better option: Molson Coors recognizes the deal’s asymmetrical gravitas, and voluntarily agrees to additional concessions in an uncoerced and mutual reinforcing manner—before the partnership kicks off.

Final Thoughts

Riposte Capital’s intervention today was a brilliant display of shareholder activism at work. The firm clearly achieved its end goal by explicitly stating HEXO’s valuation case, which investors have clearly taken to heart. Simultaneously, the firm implanted upcoming catalysts for investors to anticipate, while using firm language implying that Riposte’s “suggestions” aren’t really up for negotiation. One gets the sense that if these measures are ignored, heads are going to roll. As HEXO’s second largest shareholder, they presumably have the power to make that happen.

Given the effectiveness of today’s campaign, it’s a safe assumption we’ll see similar maneuvers with other large cannabis shareholders going forward.