Pot-stock popularity going up in smoke
Cracks form in cannabis surge after short-seller targets Aphria
Pot-stock euphoria appears to be wearing off, with a short-seller report targeting Aphria Inc. raising broader questions about governance and financial disclosure in the adolescent industry.
Aphria’s stock price was chopped in half and several other pot stocks including Aurora Cannabis Inc. and Canopy Growth Corp. fell following the report from Quintessential Capital Management and Hindenburg Research, which alleged Aphria paid inflated prices for assets held by insiders.
The report is adding to concerns that the sector can’t justify the lofty valuations reached shortly before Canada legalized recreational cannabis in October. Since Oct. 16, the day before legalization took effect, the Horizons Marijuana Life Sciences Index ETF has lost 41per cent, pressured by supply shortages and weaker-than-expected earnings.
Gabriel Grego, founder of Quintessential, alleged in his report that Aphria is a “black hole,” and that management overpaid for Latin American assets sold by companies with alleged links to Aphria.
The Leamington, Ont.-based company is vigorously defending itself, saying the purchase was a transaction negotiated at arm’s length and that both companies retained professional financial advisers. It called the allegations “false and defamatory,” and chief executive
officer Vic Neufeld told BNN Bloomberg that it will soon provide a detailed, line-by-line rebuttal of the short report.
On Thursday, Aphria said it appointed a special committee of independent directors to review its recent acquisition of LATAM Holdings Inc., which was targeted in the short-seller report.
In the report, Grego said the short was not “a story about the cannabis industry and its com- mercial potential.” But it’s inevitable that the allegations raise questions about the health of the industry as a whole, said Al Rosen, founder of Torontobased Accountability Research Corp., a forensic accountant and a longtime critic of the cannabis industry’s bookkeeping.
Rosen has criticized cannabis accounting in the past, saying it has produced “audited hallucinations.” One of the issues is the metric known as fair value, which measures the worth of plants as they grow and re- quires management to make several assumptions about growing costs, plant yields and selling price. Because the unrealized value of the plants is factored into gross profit, pot firms can sometimes end up reporting gross margins of more than 100 per cent.
And he warns Canada’s regulatory environment and accounting standards are too lax. “Canada’s your perfect place to prey on investors,” Rosen said in a phone interview,
Still, the Canadian Securities Administrators issued a report in October, warning investors firms were failing to adequately disclose even basic financial information to shareholders. Of the licensed cannabis producers reviewed,100 per cent needed to improve their disclosures, the regulators said.
“The cannabis industry has benefited from increasingly permissive legal frameworks and has grown significantly as an emerging public-market sector,” said the CSA, an umbrella group for provincial regulators. “Our review identified industry-specific disclosure deficiencies, which are notable given the recent rapid growth of this industry.”
Looking ahead to 2019, it appears that the correlation between pot stocks will continue to break down as some companies successfully mature and others fail, Rosen said.
“There’s a small group of companies that will survive and a large number that are going to collapse.”