The Cronos Group (TSXV: MJN) (OTC: PRMCF), which owns Canadian licensed producers Peace Naturals and In the Zone and has several other investments among LPs, had a management change in mid-2016, with Mike Gorenstein named CEO. Given the company’s broad exposure to the industry, we checked in with Gorenstein to learn how he is positioning the company and to hear his outlook as Canada prepares for full legalization.

Alan: Mike, thanks for taking the time to share your perspective. I have a lot I would like to discuss, but, first, congratulations on your first year as CEO. It’s hard to believe it has been just 15 months since you assumed your current position of what was then PharmaCan Capital. You have raised a lot of capital, obviously, but what are some of your other key accomplishments to date?

Mike: Thanks, Alan. When I took over, the industry was in its infancy. There were unlimited opportunities and the landscape was rapidly changing, making it crucial to be flexible, aggressive, and strategic. My goal was to build a company that wouldn’t simply follow the existing industry standards, but instead would focus on innovation and establishing best practices. I think my biggest accomplishment has been assembling the Cronos Team we have in place today. Every key milestone we’ve achieved is a reflection of this team’s hard work and collective ingenuity. But we’re not celebrating yet…we have very big plans and expectations for the future of Cronos.

Alan: You own fully two LPs. How about an update on your core holdings, Peace Naturals and In the Zone?

Mike: The rebranding of ITZ will be released in the coming weeks and we’re excited about what our marketing team has put together. From a cultivation perspective, we’ve surpassed 300 grams per square foot on an annualized basis, and ITZ products are receiving tremendous reviews from patients. Needless to say, the pilot facility has been a huge success and we’re looking forward to replicating that model on a larger scale.

At Peace, we optimized the two purpose built facilities (B2 and B3) and have seen extraordinary increases in yields and metabolites. For example, one of the Peace cultivars (Infinity) was typically around 18% THC before we implemented our new production methodology and we just recently released an Infiniti lot at 26% THC with 7x the annualized yield/sq foot versus a year ago. We also repurposed the original facility to provide for two-tier hydroponic cultivation.

We now post weekly video updates on our new 315,000 square foot expansion on the Cronos Twitter account. The greenhouse structure is largely complete and is still on track to be fully operational this year. The new indoor facility is going up on schedule, but I’m starting to worry that I’ll either need to get back into shape or get a Segway so I don’t get winded when I give tours.

Alan: The world is about to change for your company and your competitors with legalization for adult-use in less than a year (presumably). How is Cronos Group positioning for the market as it evolves beyond just medical?

Mike: Whether it’s medical or recreational, we think the most important thing is to focus on product quality. That is, and will continue to be, our number one priority. Continuing R&D and finding different ways to maximize terpene expression will allow us to deliver consumers flavorful and aromatic strains. It’s not difficult to grow (or extract and fractionate) a high THC strain. And while that is what a lot of consumers are valuing today, I think that will change quickly. Quality and potency are two different things. Our focus is on the whole experience – the look, smell, taste and effect in order to deliver a range of options for our consumers that meet multiple occasions. We are constantly experimenting with different techniques that harness the entourage effect of different cannabinoids and terpenes.

ITZ is well positioned to target the recreational market. We’re intentionally reserved about some of the details of our branding strategy, but I can tell you that we will launch two brands– one mainstream and one premium – and I think that the mainstream rollout will be the biggest splash Cronos has made thus far. What I look forward to most when recreational legalization arrives isn’t increased demand (we’re more than okay on that front with just medical). It’s the ability to launch new products and unveil new platforms. We expect to create a competitive advantage with our vaporizer pens.

Alan: The Cronos Group was Canada’s first bi-coastal cultivator, though some other LPs are now in or are set to be in a similar position. How important will it be under legalization to have production across Canada?

Mike: It’s certainly helpful for distribution and the physical presence is great for brand awareness, but I don’t think those aspects become any more or less important when rec arrives; that’s not really why we did it.

We believe medical and recreational cannabis are two different industries and the fundamental objective of a company targeting the medical market is different than the objective of a company targeting the recreational market. As a mission driven company we want our teams to be passionate about the vision of the future for each of our businesses. This separation enables us to build one team that is truly passionate about medicinal cannabis at Peace Naturals and an equally passionate team focused on recreational cannabis at ITZ. When it comes to recreational cannabis, there’s no better place to find passionate experts than British Colombia – especially the Okanagan Valley.

The synergies come from having two distinct companies that can leverage shared infrastructure while delivering value to our shareholders. By having separate entities it also awards us flexibility in the event that a potential acquirer approached us with a viable offer. Big alcohol and tobacco companies could target the recreational market whereas pharmaceutical companies would be interested only in the medicinal market.

Alan: In addition to Peace Naturals and In the Zone, you have investments in ABcann, the recently licensed Evergreen Medicinal, Hydropothecary and Whistler. What are your thoughts on these holdings, especially publicly-traded ABcann and Hydropothecary, and is there any synergy created between the various Cronos Group holdings?

Mike: There are certainly synergies and I think that as each asset continues to focus on different areas of the value chain, the opportunities for collaboration will only grow stronger. We have a very close relationship with the Whistler team and have always admired their commitment to product quality and company culture. I’ve also become much closer with ABcann since Aaron took over. The market may not have realized it yet, but he is doing a great job. ABcann has always been strong on the scientific side, but Aaron has added a lot in terms of positioning the company to take advantage of the global medicinal market. Hydropothecary is very savvy and offers differentiated value as the only LP in Quebec with unique products and a strong brand.

Alan: Peace Naturals has been a supplier to Germany. How big of an factor will exports and international expansion generally be for Canadian LPs, and what is the Cronos Group strategy?

Mike: I can’t speak for other LPs, but it’s huge for Cronos. International expansion is our biggest corporate priority. We consider ourselves a global cannabis company with a headquarters in Canada. We’re the number one exporter to Germany because we think it’s such a valuable market for distribution. However, Germany is only the beginning. Long-term, I don’t think product exports from our Canadian operations will represent a large portion of our business, but Canada will always be our center of excellence. Our objective is to leverage our IP across our global business based on the competitive advantages we possess in each jurisdiction. Some places are advantageous to produce, some places are advantageous to do R&D, some places are advantageous to distribute, etc. We’re relentless about optimization and will go anywhere in the world that will help us deliver incremental shareholder value.

Alan: One of the big financing innovations to hit the Canadian cannabis sector has been the creation of “streaming” vehicles, including Cannabis Wheaton, Canopy Rivers and others. What is your take?

Mike: I think it just goes to show that even on the financial side, the emerging cannabis sector has some of the most creative entrepreneurs out there.

Alan: Another big topic is consolidation. So far, Canopy Growth has played that role most actively (Bedrocan Canada, Mettrum and rTrees), though other LPs have done some M&A of late-stage ACMPR applicants. What is your outlook for market structure over the next few years, and do you see Cronos Group as a consolidator?

Mike: Since my background was in M&A, I think the market expects Cronos to be an aggressive consolidator. We’re opportunistic and will always do whatever is best for the company, but I think we’re more likely builders than buyers over the next few years.

I look at everything through the lens of accretion versus dilution. When it comes to consolidation in Canada, does the other company have patented technology or advanced clinical trials? Is it in close proximity to a great ski mountain (joking!)? If it’s just production capacity, how much would it cost me to build that capacity and how long would that take versus acquiring? What liabilities might I be inheriting if I acquire that company? I value our stock more than cash because I think we’re undervalued, so I won’t pay more simply because the seller would take stock instead of cash. If an LP costs $500M to acquire, what could I build out on my own property for $500M instead?

For example, when we looked at Peace, I asked myself similar questions. The answer was that it would be better to acquire than to build at the purchase price. To be sure, less than a year later we were able to lever against Peace and raised $40MM in debt without any dilution. That is more than the acquisition price and the follow on equity raise combined. If we see a similar opportunity, we’ll consolidate again.

Alan: Cronos Group has a fairly straight-forward capital structure. Some LPs have issued only equity to fund expansions, while others have relied on convertible debt. How do you view the differing capital structures among the LPs?

Mike: There are pros and cons to traditional equity versus traditional debt, but I think convertible debt is significantly worse than either. As a public company, we would not issue convertible debt unless traditional equity or debt were unavailable. From an issuer perspective, convertible debt has the downsides of both traditional equity (dilution) and traditional debt (interest payments and subordination).

There is a balance between attracting new investors and protecting existing investors. Traditional debt is good because you can fund projects without dilution. Since the investor doesn’t have equity upside, they get payment priority over equity holders and a fixed payback. While equity is good because there is no fixed payment obligation, the investor gets a piece of future profits to compensate them for their risk. However, when companies can’t raise traditional debt or equity, they offer convertible debt.

With convertible debt, investors are compensated with interest payments, downside protection and equity upside. If the stock goes down the investor can get back their money plus interest. If the stock goes up the investor gets the interest plus the difference between the conversion price and market price. Sophisticated investors can also hedge and lock in their interest rate as a safe return (that’s why companies that issue convertible debt are often heavily shorted). And if the convert has warrants, the investor can hedge to lock in their interest rate and still get equity upside. However, that dilutes the common shareholder twice as much while still subordinating them.

Converts are great for the new investors, but not for existing common shareholders. Existing common shareholders get subordinated, but unlike traditional debt, they will also be diluted if the stock goes up and the converts are exercised. If the stock doesn’t go above the conversion price, the investors won’t convert the debt. And unless the company has enough cash on hand to repay the convert, the company will need to refinance, do an extremely dilutive down round, or declare bankruptcy.

Ultimately, if it’s available, I think the best way to finance expansion is with debt. If you are confident in your upside, you can borrow the capital and use the benefits of the cash without diluting your shareholders. It’s hard to find in this industry; fortunately, we were in a position to borrow $40M for our expansion, which I believe is the largest debt package ever in the industry.

The way we structured it is much different than a convertible note. First, our shareholders don’t get diluted if the stock goes up. Second, we can minimize interest payments by only drawing the loan as we need it – the interest only accrues on money as we take it. So while 12% may be a higher interest rate than what you typically see on convertible debt, the effective interest rate is actually lower. Finally, we maintain the optionality. If we generate the cash we expect from our expansion, we can prepay the loan with a one-month interest penalty at any time. When the big banks start lending we can refinance. Or if at the end of the two years we don’t want to repay/refinance, we can extend for another year. If the stock goes to $100 next July, we can raise equity (not converts!) to repay the loan with minimal dilution and I’ll personally cover all of your readers’ first ITZ purchase. So I consider this to be the most accretive financing we’ve done yet and am extremely excited we were able to do it.

Alan: That’s a generous offer. We have lots of readers, so be careful! There are now 56 licenses issued to 46 companies in Canada. 22 companies are traded publicly, with a few more on the way, and it’s getting harder and harder to stand out from the crowd with investors. How do you differentiate Cronos Group from peers?

Mike: Focus on execution, not promotion.

Alan: Mike, thank you so much for sharing your perspective with our readers! Good luck to you and Cronos Group over the balance of the year, and we look forward to checking in again with you soon.

Are you a cannabis industry thought leader and want to be heard? Let us know your story.

Get ahead of the crowd by signing up for 420 Investor, the largest & most comprehensive premium subscription service for cannabis traders and investors since 2013.

Exclusive article by Alan Brochstein, CFA Facebook | LinkedIn | Email Based in Houston, Alan leverages his experience as founder of online communities 420 Investor , the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures , he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha , where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter