Cannabis Wheaton Income Corp (CVE:CBW) (OTCMKTS:KWFLF) (FRA:3KF) CEO Chuck Rifici, who has a co-founder of Canopy Growth Corp (TSE:WEED)’s Tweed Marijuana – the first and largest ACMPR-licensed grower in Canada to become publicly traded – knows a thing or two about cannabis economics. He joins us to explain the business model of his most recent venture.

James West: Chuck, thanks for joining us today!

Chuck Rifici: A pleasure to be here, James.

James West: Chuck, give us the overview – what is the value proposition for investors in Cannabis Wheaton?

Chuck Rifici: Well, Cannabis Wheaton really came from three gaps identified in the market for developing the Canadian cannabis industry. Really, a lack of a diversified, risk mitigated platform for investors; a really inefficient distribution between licensed producers today and going into the adult rec market; and most importantly, just the difficulty in finding accretive capital to finance the obviously significant expansion

So that’s – enter Cannabis Wheaton, the world’s first cannabis treatment company. What we do is, we’re fundamentally trying to change the investment model for how the industry works together, to really broaden the opportunities for both our investors and our streaming partners. And we do that by providing CapEx financing, CapEx through equity, for our regulated licensed producers and late-stage applicants to either build out their initial facility or to expand their capacity.

And then in exchange for that, we take a minority equity interest at an agreed-upon valuation up front, as well as a portion of that partner’s cannabis cultivation yield, at an agreed-upon price. And then so, aside from those two primary economic components of our agreements, then we also provide our management and advisory team, which I think are arguably top experts in their field in Canadian cannabis. You know, we help our partners to basically build on their strengths and help with their weaknesses as they execute their own business plans to further their growth.

James West: Okay. So on May 1st, Bruce Linton at Canopy announced the rollout of Canopy Rivers, which sounds to me like pretty much exactly the same thing. Are you familiar with that offering, and if so, how similar is that to what you’re doing?

Chuck Rifici: Well certainly I’ve heard of it; they haven’t disclosed very much, but I think they – well, they first announced, Cannabis Wheaton, when it was trading under its, before its name change, announced the acquisition of 13 of our 14 streaming agreements on Wednesday, April 26th, and then the following morning Canopy announced intents to create Canopy Rivers. So I think it’s a great validation, and seeing someone who, they’re the largest market cap company in the space, kind of taking their eye off their primary business model to emulate something that we’re doing, I think that sends a very strong signal to the market that we’re on to something. And we’re very pleased that we have been working on this for some time, since last year, so I think the fact that we’ve been able to enter into 16 agreements with 14 partners speaks to the quality of our model, and what we’ve put together.

At the same time, I’m not exactly sure, you know, not much has been said on the Canopy Rivers side. So they’re calling it a streaming company, but I guess until we see the details of when they sign their first agreements, then I’d be happy to give you a more fulsome answer on what I think of their model.

James West: Sure. Okay, so then, in terms of the 14 streaming agreements that you’ve got, what kind of risks are associated with that to the company in the event of a sort of downward price direction in marijuana products itself as a result of commoditization as a result of excessive supply?

Chuck Rifici: So I mean there’s a few things. I guess I’ll start off by saying I don’t foresee in the short or medium-term being in that kind of scenario. You know, we have between 150,000, probably close to 200,000 medical patients today, and that, just the demand from that small patient group is outstripping supply incredibly and growing with 10 percent a month growth. Then you layer on the adult rec market, which will be at least a 10X – there will be 70 times more people accessing cannabis, but obviously recreational use is not the same kind of unit per person use.

We’re going to see, again, massive, exponential increase in demand, and it takes about 18 to 36 months for a facility to truly come online, and to break that down, from the time you decide to break ground on an ounce of expansion or from the time that we decide to fund a stream, usually let’s say roughly a year to build out a facility, six months to get the facility going, and you know, it’s an agricultural product, so that first crop takes, let’s say, six months.

So in your 18 months before you start seeing your first product, but then maybe another year and a half before the facility really starts running well; we see yields per square foot kind of increasing over time, and there’s efficiencies that are particular to each building and the associated genetics. It’s a weed, it grows by itself, but to grow it well takes time.

So with an 18 to 36 month lag, and with legalization coming in before, roughly in between 18 months, today we’re already seeing that there’s going to be tremendous demand on the existing and announced capacity supply. So I think it’ll be many years before in that scenario.

However, that scenario will surely come at some point. So I think the way Cannabis Wheaton would mitigate that risk is really twofold: One, by being essentially a portfolio having many different streaming partners, and with the team that we have, our stream cost is, in almost all instances, it’s a floating cost on our partners’ cost. So whatever our partners’ direct cultivation cost is, with a small adjustment, that’s our cost for the stream. So we’re incentivized to drive our partners’ costs down, to basically improve the value of our stream.

As the market gets eventually saturated, whether it’s three, five, 20 years, I think we’ll be in a position to see which of our partners are the best cultivators; who’s cultivating at the lowest cost. And over time, as we ramp up the size and scale of our own streams by funding further expansion with our streaming partners, we’re going to be betting on the partners that are meeting the market demand, that have the lowest cost production for inputs to oil. But at the same time, partners that have top-shelf buds, that people will pay a premium for. We’ll be able to, eventually, with foresight, look at which partners are developing skus of products that are meeting where we see demand on the rec side.

So that’s ultimately I think we’re very nimble. The diversification of having many streaming partners, I think, helps us better adapt to when that situation would come.

And then the last thing I would add is that we’re already seeing Canadian exports to other jurisdictions in limited quantities, let’s say, with Germany. So over a three to give year period, I think it’s reasonable to expect that some other avenues for export may open up, and I think Canada as an industry are the world leader in large-scale, regulated, safe cannabis production. I think we’ll be first in line to take excess domestic supply and put it into other jurisdictions.

James West: Interesting. So does this make Cannabis Wheaton – do you actually have to sell the product that you realize in your streams, or do you just more or less participate in the ACMPR growers’ retail stream to an equivalent of their obligation to you?

Chuck Rifici: Yeah, so I guess if we look at the actual agreements, you know, the core covenant of the agreement, in exchange for taking our very accretive capital that we can direct our streaming partner to on kind of a wholesale-type basis, like not individually packaged but on a wholesale basis, to direct that product to another lawful holder. Obviously, we’re dealing with a controlled substance; we don’t take delivery of it, we can direct them to another licensed producer in our platform, a licensed producer outside of our platform, or, eventually, to an institutional buyer like an LCBO, if they’re doing that, or a regional pharmacy in some province.

So the model is that that is fundamentally what we can do. However, our aspirations are for every one of our partners is that they sell our stream within their retail channel. And because we have a minority equity interest, we’re very much incentivized to drive their top line, drive their overall value, and make sure they have enough demand to sell that retail. And then essentially it would be, we just would take a fee to basically monetize this stream. So it’s flexible, and I think one of the biggest issues, especially the newer applicants coming on with expansions is, we see wholesale costs today, people paying up to $7 a gram.

Now, why would a licensed producer pay $7 a gram, when the average retail price is $7 and change? Because it’s, if you register a patient, and whether it’s through crop issues or too much demand, if you lose that customer because you cannot fulfil their demand, it’s going to cost you three or four times more to bring that customer back in. so with our platform, I think the balancing that we can provide between just recently licensed cultivators, people with a cultivation license – you can’t start your sales process when you don’t know when your sales license will be. So they’re starting to build inventory in their vaults so as soon as they get their sales license, we can help them drive revenue and then ship it over to, what I would call the demand generation machines of the licensed producers who are just great at their branding and demand creation. We need that wholesale supply.

So inherently our platform, everybody’s incentivized to balance that out. I don’t think anybody can offer that. But I think, going back to your question, are they going to sell it themselves, I think that’s actually a key differentiator and why I think our model is very much a partnership, versus a wholesale agreement. I think the worst thing a licensed producer could do is take capital to be forced into a wholesale agreement where they get intermediate from their customers. That’s absolutely not what Cannabis Wheaton wants to do; we want our partners to be selling that product.

James West: Mm-hmm. Interesting. In terms of the accounting and the structure of an income fund, then, do you recognize the value of the cannabis as income on the balance sheet when you take delivery of the product, or when the obligation to transfer the product to you occurs contractually? Or do you not recognize the revenue until you’ve actually received the money for the sale of it?

Chuck Rifici: That’s a very good question, and not one I would have a great answer to; I would refer that to our CFO. But I think that’s something that we will certainly disclose in the future as the model rolls out.

James West: Sure, okay. So I guess from an investor perspective, that’s the crux of the biscuit, as it were, in terms of trying to value the company based on its assets and its cash flow.

Chuck Rifici: Well, I think I can say that if we look at licensed producers for the most part, they’re valued on 20/21 cash flows, and I think if we’re looking on an annual basis, I don’t think the timing of recognizing those streams is really going to impact that. At the end of the day, we’ve announced that if we were to proceed with every one of our and fund the agreements are have in place, our effective 2019 production would be effectively the equivalent of 1.3 million square feet of your typical licensed producer size. So that would produce a very significant amount of output, and for the model, what we can say is, our model in a typical transaction, and this is just for example purposes: for every $30 million that we would deploy in CapEx, once that stream comes online in what we expect to be a scale up between 18 and 36 months, we would typically expect to monetize about $20 million a year in cash flows from that $30 million one-time investment.

So most of our streaming deals are 10 years from delivery of the first stream, so the IRR on this model is incredibly accretive. But at the same time, the reason we’ve been able to attract partners is, it’s incredibly accretive for our partners, because we’re typically putting in that, say as an example case, we put in $30 million for CapEx to build out a facility, we’re putting that in at let’s say three times the valuation. So if you break that $30 million down, that company is effectively providing us with $10 million worth of equity relative if they went to the Street and got $10 million. And there’s an extra $20 million there because of our multiple on the valuation. And so they’re getting 2/3 of their facility being built with capital that they wouldn’t otherwise have.

Our stream would typically be a third of the output of that facility, so there’s 10 million of that going to our benefit, effectively. But there’s one third that is an extra $10 million there on a $30 million deal that they wouldn’t otherwise have. And then throw in the bonus of the team and the platform, it’s a very compelling offer.

James West: It is. It’s intriguing, and I’m looking forward to see how you make out. Chuck, we’re going to leave it there for now because there’s so much more to cover, but let’s let it get a little mature and we’ll come back to you in a quarter’s time or so and see how it’s progressing. Thank you for your time today.

Chuck Rifici: Thank you very much.