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Pot Sector Focus Shifts From Legalization to Legitimacy

After a wild year for the cannabis sector, it’s appropriate that 2019 kicks off with a focus on Aphria Inc., the Canadian pot producer that was attacked by short sellers and is now the target of a hostile takeover bid.

Aphria reports results for the fiscal second quarter on Jan. 11, and there will undoubtedly be plenty of questions on the conference call about the allegations from short sellers that it overpaid for “worthless” assets in Latin America. Aphria called the claims by Quintessential Capital Management and Hindenburg Research “malicious and self-serving.”

The saga took a new twist in the quiet days between Christmas and New Years, when Green Growth Brands Inc. proposed a hostile bid for Aphria, whose stock lost a quarter of its value in December. The potential offer, which has yet to be finalized, raised further questions about Aphria’s links to the much smaller Green Growth, with short-seller Hindenburg Research saying it’s “likely an attempt to generate the appearance of demand in the hopes of spurring credible offers.” Aphria said the offer, valued at C$2.8 billion ($2.1 billion) at the time, “significantly undervalues the company.”

The fallout will affect the sector as a whole, resulting in “greater emphasis on corporate governance, deal due diligence, and M&A valuations,” Andrew Kessner, analyst at William O’Neil & Co., wrote in a recent note.

Aphria played just one part in a hectic year for the burgeoning cannabis sector. At the beginning of 2018, former U.S. Attorney General Jeff Sessions had just thrown a wrench into states’ legalization plans, Canada’s recreational market was still just a campaign pledge by Prime Minister Justin Trudeau and pot stocks were trading well above current levels.

We can sum up the year with three ‘L’ words: legalization, legitimization and listings.

  • Legalization of medical marijuana has spread well beyond Canada to places like Thailand and the U.K. that few people saw coming.

  • Legitimization of the drug has gathered pace at an astonishing speed, with traditional consumer and pharmaceutical companies ranging from Constellation Brands Inc. and Anheuser-Busch InBev SA, to Altria Group Inc. and Novartis AG investing in or partnering with pot firms

  • The number of cannabis listings has soared, with at least 149 companies worth a combined C$54.7 billion trading on Canadian stock exchanges as of Jan. 2. A growing number of those are U.S. firms with market values above C$1 billion.

In terms of stock performance, the BI Global Cannabis Competitive Peers index sank 54 percent in 2018. It was a wildly volatile year for many pot stocks, but none could match Tilray Inc., the only cannabis stock to be listed solely on a U.S. exchange. It closed the year up 315 percent from its July initial public offering, but that represents a major come-down for investors -- at its highest point in September, it was up 1,665 percent. The stock peaked at $300, and now trades close to $70. It still has a market value of $6.6 billion, surpassed only by Canopy Growth Corp. among pot firms.

It’s going to be hard to top the action-packed year that was, though 2019 will have almost as many catalysts for cannabis investors as 2018.

What to Watch This Year

  • The U.S. will dominate the news flow and stock listings: with the recently passed farm bill legalizing hemp, some say it’s only a matter of time before legislators follow suit and legalize cannabis nationwide. Others argue a divided Congress will stymie any real progress. Either way, 2019 will be America’s time in the marijuana spotlight as investor interest rapidly shifts from Canada to the much larger U.S. market, where consumer spending on legal cannabis is expected to reach $20.9 billion by 2021 from $11 billion last year, according to Arcview Market Research and BDS Analytics

  • As the U.S. weighs proposed legislation that could open up bankingand stock exchanges to cannabis companies, institutional investors will feel increasingly comfortable investing in the space. To date, cannabis investments have largely been the purview of retail investors, family offices and specialty hedge funds

  • Legalization of both medical and recreational cannabis will continue to spread around the world, with France, Italy, Peru, New Zealand and even Lebanon on the list of countries thought to be the next movers

  • Clear winners and losers will begin to emerge in Canada as pot producers report their first earnings that include recreational sales. Expect plenty of consolidation and a few outright failures

Upcoming Events This Week

  • AltaCorp Capital and ATB Financial host their 7th Annual Institutional Investor Conference in Toronto with a full day of sessions dedicated to the cannabis industry on Jan. 8. Companies presenting include Hexo Corp., MedMen Enterprises Inc., Aurora Cannabis Inc., Curaleaf Holdings Inc., Cronos Group Inc. and Organigram Holdings Inc.

  • Vivien Azer, one of the leading analysts in the space, hosts Cowen’s Cannabis Outlook on Jan. 8 at the firm’s New York headquarters

  • KushCo Holdings Inc., the California-based cannabis packaging company, reports its fiscal first quarter results on Jan. 8 after markets close

  • Aphria reports results Jan. 11 for its fiscal second quarter. Expect plenty of questions about short-seller attacks and the hostile takeover bid from Green Growth on the conference call, scheduled for 9 a.m. New York timeOntario holds a lottery on Jan. 11 to determine who will be able to open the first 25 retail cannabis stores in Canada’s most populous province. Results of the lottery will be posted online within 24 hours

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