Value Investors Club / CANNABIS WHEATON INCOME CORP (CBW.)

Description

Let me start with a basic premise; while certain groups will make stupendous profits on the legalization

of cannabis, the basic economics for the average cannabis grower will roughly resemble the economics

of growing broccoli, but with added government regulation and negative margins for years into the

future as excess capital is dumped into the sector.

I think that the alcohol sector following prohibition is a useful template for what will ultimately happen

to cannabis in the future. If you look at who succeeded; those with branded products or distribution did

well—those with both branded products AND distribution did amazingly well—those growing wheat,

barley, hops and other crops earned a mediocre return on capital, with endless boom & bust cycles that

bankrupted many families along the way. What profits did accrue to growers, were mostly attributed to

land inflation, as opposed to actual gross margin from production. With that in mind, let’s talk about my

favorite overvalued broccoli producer.

In the true tradition of Vancouver, the “Vancouver Boys” have rolled out dozens of dubious stock

promotion vehicles to take advantage of retail investors looking for exposure to the cannabis industry.

However, no stock has quite succeeded like Cannabis Wheaton Income Corp (CBW-V). Why should it not

succeed as a stock promotion—with a name that includes “Cannabis,” “Wheaton,” (in reference to

amazingly successful Silver Wheaton) and “Income” (which is what every retail investor is desperately

seeking out). I’m almost surprised they couldn’t somehow work Lithium into the name—or maybe that’s

still coming?

Despite having traded under the ticker symbol of CBW for all of 10 days, it has now produced 6 press

releases and dozens of interviews, that say very little about the actual business, but with a lot of fluff

about future ambitions. (In fact, it’s hard to tell what’s an actual press release is and what is a gushing

news story by an “independent journalist” as they seem to roughly be the same thing).

Based on filings from predecessor companies, this is the rough market capitalization.

Cash- $250k ($300 at year-end 2016 + $2.4m raised in financings - $2.2m for acquisitions – management

bonuses of $250k)

Shares- 150.9 million

Employee Options – 12.7 million with an exercise price of 2.5 cents

Warrants- 133.1 million with an exercise price of 2.33 cents

Total FD shares - 296.7 million (though a full exercise would bring $3.4 million of cash into treasury).

Market Cap- $469 million (at Friday’s close of $1.58)

So what do you get for such a market cap? I’ll be honest, I’m sort of stumped. The company claims to

have “streaming deals” with 14 cannabis producers with total cultivation space of 1.3 million square

feet. However, this is misleading as they have not actually funded any of these deals, the company does

not have anywhere near enough capital to fund even one of these deals and only five of the streaming

partners have even received their cultivation or sales licenses in the first place. Based on conversations

with industry sources, it would take somewhere between $97.5m and $130m to fund production of 1.3

million square feet at a cost of $75 to $100/ft depending on how high tech it is.

For that matter, it’s not clear if the company would even want to fund them. Based on a corporate

presentation on its website, which is the only description of how the business is intended to work, it has

the following key bullet points of a “Stream Overview”;

-Finance of expansion for ABC Streaming Partner

-Investment size of $30m at an illustrative valuation of 3x current market value (value of equity is

~$10m)

-Fully funds the Capex for a 150,000 square foot facility that produces an estimated 15,000 kg/yr with

Cannabis Wheaton being entitled to 33% of the annual output

I take that to mean that a grower puts up $10m of equity, CBW puts of $30m and then gets 1/3 of the

economics, despite putting up 75% of the capital. Though it could also mean that CBW puts up $30m,

the grower puts up nothing and CBW gets 1/3 of the annual output despite putting up 100% of the

capital. I’m assuming the former as it’s more favorable.

This leads to many more questions than answers about the logic of this business model. However, I

doubt much thought has been put into the business plan and instead, it has been contrived to fit into

the concept of CBW being a “streaming vehicle,” made amazingly popular by the successes of Silver

Wheaton, Franco Nevada and Royal Gold.

What makes a mining company a good streaming asset is the fact that good mining streaming assets

have very long mine lives and over time, as industry costs rise and global average grades decline,

commodity prices rise and the future income stream is effectively on the right side of inflation over

industry costs during that elevated mine-life where the cash cost is locked in. What makes a Cannabis

stream idiotic is that the whole industry is experiencing massive production and operating cost declines

as growers get more efficient and new technology comes online. Additionally, due to the laws of supply

and demand, supply is growing more rapidly than demand—which is clearly reflected in overall retail

cannabis pricing where prices have continued to drop rapidly. Why would anyone want to pay a

premium to current equipment costs in an industry where equipment rapidly depreciates and has a

strong trend towards obsolescence?

On another note, my industry sources tell me that all of Canada needs somewhere between 10 and 15

million feet of growing capacity—even assuming a not insignificant leakage of product into the US. At

1.3 million feet of future production, CBW would be 10% of the market which seems like a huge market

share to grow into what is already a somewhat saturated market. If they actually build it, margins may

be negative and there would be no royalty stream anyway. Nothing shows this better than their slide

#16 where the publicly traded industry average already has an adjusted EBITDA per gram sold of -$2.12.

Effectively, no one makes money at this already. However, CBW is expecting to make $5.25 per gram.

How? “Adjusted EBITDA does not equal the Average Selling Price minus COGS and OPEX per gram due to

how Licensed Producers account for revenue using FV adjustment to biological assets.” I guess I’d have

to be pretty stoned to understand how FV adjustments ensure that Sale Price – Costs does not equal

Adjusted Ebitda over any elongated period of time. I’m simply stumped and there is no more

clarification on this point. Unfortunately, none of their 6 press releases describes the actual business

plan (hopefully, that will come soon).

More likely, this is just another Canadian stock promotion that has gotten waaaaay ahead of reality and

will come crashing back to reality.

Why now? Why CBW instead of any of the other Canadian stock promotes?

To start with, Interactive Brokers has six-figures of CBW to borrow—so you can actually short it. More

importantly, CBW seems far more overvalued for a “business plan” of far more dubious value than most

competitors. Most importantly, starting on July 15, 76 million shares with a cost basis of 1.83 cents and

76 million warrants with a strike price of 2.33 cents will become free trading. Let’s just assume that

whoever was brilliant enough to buy those shares, is also smart enough to understand the limited value

of the company at this stage. Furthermore, based on filings by the company, it would seem that there

were only about 1 million shares in the company’s float before this “business” was vended into it.

Everything else is owned by participants of the two private placements and 61 million shares and 61

million warrants are already free trading. Based on the 34.3 million shares that have traded since the

name change on May 8, it seems likely that someone has already been selling as fast as they can.

What finally busts this CBW bubble? Like most other Canadian promotions, once there are more shares

for sale, than suckers to buy them, it is game over. At worse, there are less than 2 months to wait…

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Stock Unlock on July 15

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			2017	2018
Price:	1.58	EPS	0	0
Shares Out. (in M):	297	P/E	0	0
Market Cap (in $M):	469	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	469	TEV/EBIT	0	0
Borrow Cost:	Tight 15-50% cost