If you think restaurants or oil stocks have had it bad lately, you haven’t been paying attention to marijuana stocks, which have fallen off of a veritable cliff since the end of March 2019.
Although the long-term outlook for the cannabis industry remains promising — after all, tens of billions of dollars in weed sales are conducted in the black market each year — the near-term outlook isn’t so hot. Regulatory issues in Canada at the national and provincial level have created everything from product shortage to sizable supply bottlenecks, depending on the region. Meanwhile, high tax rates have made it difficult for legal producers in the U.S. to compete with illicit growers. And as the icing on the cake, North American pot stocks are struggling to gain access to traditional forms of financing.
Aurora Cannabis looked poised to be a marijuana leader…
A prime example of these struggles can be seen in the most popular stock in the marijuana space, Aurora Cannabis (NYSE:ACB). Despite the fact that Aurora is the most-held stock by a mile on millennial-focused investment app Robinhood, we’ve learned that popularity is no guarantee of profits over the past year. Since hitting its 2019 high in mid-March, Aurora’s share price has retraced by (drum roll) 92%!
Mind you, this was a company that, at this time last year, was touted as the leading global producer of marijuana and had access to more overseas countries than any other licensed grower. In theory, Aurora looked like it was in perfect position to outproduce its peers, as well as satisfy the medical cannabis needs of foreign markets via exports.
In March 2019, Aurora Cannabis also hired billionaire activist investor Nelson Peltz as a strategic advisor. Peltz, the founder of asset management firm Trian Fund Management, has keen knowledge of the packaged food and beverage industry, presumably making him the perfect person to orchestrate a partnership between Aurora and a brand-name food and beverage company.
… but now it’s a penny stock
Of course, none of these projections came to fruition for Aurora Cannabis, which is a big reason it’s given back most of its market value over the past year. In fact, things have gotten so bad for the company that it received a notice of noncompliance from the New York Stock Exchange (NYSE) on April 8 for having an average share price of below $1 for a period of 30 days. The NYSE requires a minimum share price of $1 for continued listing.
The good news is that Aurora Cannabis’ management team has a relatively easy “fix” to this insufficiency. As outlined in an April 13 press release, Aurora will be conducting a 1-for-12 reverse split, which is expected to be effective “on or about May 11, 2020.” In other words, every 12 shares of outstanding common stock will soon to be consolidated into a single share. With 1.31 billion shares currently outstanding and a share price of around $0.75, Aurora will soon have close to 109.5 million shares outstanding and a $9 share price. You’ll note that splits have no bearing whatsoever on a company’s market cap.
Generally speaking, reverse splits aren’t perceived well by Wall Street, primarily because they’re undertaken when a stock is trading at too low of a share price for continued listing. In essence, reverse splits are almost always a sign of a weakened or broken business model.
Look, another 350 million reasons to keep your distance from Aurora Cannabis
The announced reverse split, however, is far from the biggest worry for investors. Rather, it’s that even more dilution is headed shareholders’ way.
In May 2019, Aurora Cannabis filed a prospectus that allowed it to raise up to $750 million (that’s U.S. dollars) through a variety of means, including at-the-market (ATM) common stock issuances. The first ATM program in the amount of $400 million was recently completed and boosted the company’s cash position to $205 million Canadian (about $147 million U.S.). But according to Aurora’s latest press release, it’s exercising its right to sell up to $350 million more in ATM offerings, thereby taking full advantage of its $750 million shelf prospectus from 11 months ago.
Based on Aurora’s current market cap of roughly $985 million, fully exercising its ATM allotment at the current share price would increase the company’s outstanding share count by 35.5%. Put in another context, this could mean an additional 35.5% downside in Aurora Cannabis’ stock as its outstanding share count balloons higher.
As a refresher, Aurora’s share count stood at only 16 million in June 2014. But if this ATM offering were completed, it would be closing in on 1.8 billion outstanding shares (pre-reverse-split levels). Shareholders have absolutely no chance of generating long-term wealth with a company so hell-bent on raising capital to cover its inefficiencies.
Even with extra cash, Aurora’s balance sheet is a train wreck
Although there’s no question Aurora Cannabis needs to raise cash to cover the expected CA$373.6 million in liabilities forecast over the next 12 months (according to the mid-February-filed management discussion and analysis with SEDAR), extra cash doesn’t exactly make the company’s balance sheet look any more palatable.
You see, Aurora had a nasty habit of acquiring everything within sight between August 2016 and the midpoint of 2019. In making more than one dozen acquisitions, the company clearly overpaid grossly for these assets. Even after writing down CA$762 million in goodwill during the fiscal second quarter, Aurora Cannabis is still lugging around CA$2.41 billion in goodwill on its balance sheet. That’s about twice its current market cap and represents 52% of the company’s total assets.
What’s more, management noted that the bulk of the CA$762 million writedown concerned its Denmark and South American assets. Yet this is a company that paid CA$2.64 billion for MedReleaf and wound up with only 35,000 kilos in annual marijuana output, as well as the rights to a handful of brands. The 1 million-square-foot Exeter greenhouse acquired in the deal, which was supposed to produce 105,000 kilos of weed annually, was never retrofit from vegetable production to grow cannabis and is now up for sale for a measly CA$17 million. Deals like this make another massive writedown a near certainty.
Put plainly, there are more-than-enough reasons to never buy Aurora Cannabis.