Tilray Short Sale

Before beginning my article, I will first state that I’m a Tilray (ticker: TLRY) short seller.  On January 9, 2019 I shorted 6,047 shares of TLRY at a price of $81.81 per share and on May 29, 2019 I shorted an additional 3,675 shares of TLRY at a price of $41.32 per share.  Now I’ve decided to structure this article in three intertwined stages in order to argue for my high conviction short on TLRY. The first stage is referred to as the “introduction and visibility”, the second stage is “looming industry headwinds” and the third and final stage called “company financials.”  

To begin the “introduction and visibility” stage with regards to TLRY, one must first view the March 18th CNBC interview with CEO Brendan Kennedy.

Link: https://www.cnbc.com/video/2019/03/18/watch-cnbcs-full-interview-with-tilray-ceo-brendan-kennedy.html

Feel free to watch the entire clip, but the point of concern begins at the 5:45 mark.  This is when the CNBC host asks Brendan Kennedy “I mean your talking about all these bullish, exciting opportunities and scenarios Brendan, and thanks to our reporter Aditi Roy who covers this for pointing this out, why have you been selling so much stock, do you have clarity why you pulled millions out of the stock”  The given response was a massive red flag, Brendan Kennedy goes on to give a very bizzare evasive response and has to be asked again by host Wilfred Frost, why he continues to offload shares.  

To me, this clip indicates incompetent management at best and outright lying to shareholders at its worst.  Confidence and belief, I also find is an incredible power within the complex pricing of a stock. If one looks at a list of the top ten companies by market cap, companies such as Apple, Alphabet, Amazon, Berkshire Hathaway, Facebook and JP Morgan Chase come to mind.  Along with these market caps, comes top-talent managers that induce confidence and belief. Think Tim Cook, Sundar Pichai, Jeff Bezos, Warren Buffett, Mark Zuckerberg and Jamie Dimon. These managers/CEOs are critical leaders of their companies and with that, investors feel confident and most importantly feel a sense of safety when placing their capital and savings within businesses with strong leadership and management.  Hence, when viewing such a concerning interview as this, one should not underestimate the power of investors loss in confidence and its relation to pricing of a stock.

With that being said, Brendan Kennedy was the second highest paid CEO of 2018 and received a total compensation package of $256 million.  To further evaluate the skills of Tilray CEO, the definition of the institutional imperative is necessary. “The tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so” – Warren Buffet 1990.  Earlier this year, Tilray purchased Manitoba Harvest for $150 million CAD and 127.5 million CAD in Tilray stock. Unsurprisingly, this deal mimics competitor Aurora Cannabis, which in 2018, purchased Agropro UAB, Europe’s largest hemp producer, and Barela UAB, a hemp processor and distributor.  The deal for was a total $8.1 million and when you compare deals, by doing the conversion $1 CAD=$ .74 US Dollar, Aurora was able to acquire a hemp producer, processor and distributor for roughly 1/25th of what Tilray paid in their acquisition. A quick research into Manitoba Harvest also reveals a stagnant product line of granola, hemp-based chocolate bars, oils and protein.  I find these products to be replaceable and not exactly revolutionary or worth a $277.5 million CAD price tag and it’s certainly not an acquisition that vaults Tilray ahead of the competition. Hence, to wrap up the “introduction and visibility” stage, any beginner investor can easily search the company and will presented with visual evidence and statistics that indicate that Tilray is a company run by a manager who is greatly compensated for his incompetence.  

Now moving on to potential “looming industry headwinds” one should place his concern in the expanding market in Mexico and the FDA.  Mexico’s Supreme Court has ruled 5 times since 2015, that the ban on recreational marijuana is unconstitutional. In Mexico, when the Supreme Court gives a similar decision 5 times on a individual topic, then the standard set by the court must be applied throughout the country.  Therefore, the impending legalization of marijuana in Mexico is expected by the end of 2019. What does this mean for the cannabis industry? A potential flood of legal marijuana grown by low-wage workers in Mexico would cripple the already dwindling profit-margins of the cannabis industry.  This would further hurt Tilray, which operates in Canada with its already high minimum wage. While also, a potential new crop of producers and competition could eat into it’s book of business. As for acquisitions, a dwindling stock price and cash reserves, puts Tilray in a bind if they want to acquire a presence in Mexico.  Competitor Aurora Cannabis has already beat them too it, by acquiring Farmacias Magistrates, the first company in Mexico to receive a license to import, manufacture, store and distribute in Mexico.

Another headwind is potential regulation coming from the FDA with regards to CBD products, specifically CBD oils.  With the current difficulty that exists in identifying CBD derived from hemp and CBD derived from cannabis, which includes traces of THC, the FDA held its first and highly publicized hearing on CBD products.  After the hearing, Dr. Scott Gottlieb, former commissioner of the FDA, conducted an interview on Squawk Box, in which host Rebecca Quick asked “When you see things like these pot stocks taking off, what do you think?” Dr. Scott Gottlieb replied:

“I think it’s getting ahead of where the regulation is right now.  Ultimately I think that there is such an impetus behind this, there is going to be a pathway at least for the CBD.  I think the issues around THC and some kind of Federal Framework around that, that is a long way off. It’s going to take one or two more administrations, but at least with CBD I think there is going to be a pathway but it’s going to take a couple years and I do believe that the companies are gonna have a hard time coming up with scientific data, not just to demonstrate the safety of these products, but frankly to demonstrate the benefits.  All these uses that they are perporting right now, the fact that it’s being put in dog food and pet food, I don’t think they are going to come up with any evidence to support that. Now if its a food additive they could potentially put it in a food as long as its careful with the claims that they are making, not to say it has a therapeutic effect, they could have a legal pathway to do that but right now the claims that they’re making probably violate the law.”  

“They are (consumers) not getting a benefit.  They spent $2 billion dollars last year. Cowen did a survey that said 7% of all Americans have reported trying some CBD product, they are doing so without a therapeutic benefit.”

To watch the full interview, here is the link: https://www.cnbc.com/video/2019/05/31/heres-how-the-fda-might-go-about-regulating-cbd.html

The May 31st FDA hearing even spooked industry leaders.  Colleen Lainer, the executive director of Hemp Industries Association, said “In the 10 hours of testimony, I think the panel was given some good information and bad information.  So, it is a risk at this point.” In order to find information on just how much CBD plays into Tilray plans for future growth, I went through their past earnings call. Now, before pulling quotes from the call, I will note that most of it was mundane back and forth business jargon, but in the 05/14/19 earnings conference call, Graeme Kreindler of Eighth Capital asked CEO Brendan Kennedy an important question:

“You mentioned about pursuing other strategic partnerships, so I was wondering if you could elaborate on what specific verticals would be higher up in your pecking order and if you’re putting any sort of time line or range of time in terms of when we could see another strategic partnership announced?”

In this conversation, it wasn’t Kreindler’s question that entirely piqued my interest, but rather Brendan Kennedy’s response which stated:

“As we see cannabis disrupting a number of other industries, we’ve been inundated with contracts from Fortune 500 companies who are interested in exploring partnerships with Tilray.  And it’s a range of companies from a broad variety of industries. And generally, the deals that have been done with other companies, we generally talk to those people at some point in their process, right?  Imagine if you’re a business development person at a Fortune 500 company that’s looking at the cannabis industry, that person wouldn’t be doing their job if they didn’t talk to us. So obviously, lots of other tobacco companies are looking at the industry, lots of other CPG companies, and we’re also starting to have lots of conversations with U.S. retailers who are interested in carrying CBD products in the second half of this year.  Some of the conversations are focused around carrying our products and other conversations revolve around essentially contract manufacturing some of their in-house brands using Tilray-sourced cannabidiol.”

You see, Tilray places a big emphasis on retail CBD, but to tie this back to Dr. Scott Gottlieb and Colleen Lainer’s quote, CBD is anything but a sure market right now with the recent movement of the FDA and their potential regulation of the industry.  In essence, Tilray management seems to be placing an emphasis on a market fraught with ambiguity and oncoming regulation. This “all in” CBD strategy is especially backed-up by the companies the recent acquisition of hemp foods maker Manitoba Harvest. Hence, this wraps up my “looming industry headwinds” stage, but keep in mind the industries short-term outlook isn’t exactly a clear rosy picture.  

Now with the “introduction and visibility” and “looming industry headwinds” stages out of the way, I’ll move onto what’s called the “company financials” stage.  Currently Tilray (ticker: TLRY) trades at a market cap of $3.35 billion and has a price/sales ratio(ttm) of 59.06. To me, this still indicates a company that is entirely overvalued.  Additionally, institutional investors have been feeling the stock and now only own 10.10% of outstanding shares and that number is dwindling daily. Also, 24.74% of the float is now owned by short-sellers as of 05/14/19.  In my investigation of the company financials, I also was able to get my hands on a Thomson Reuters Detailed Stock Report, published on 06/03/19, which stated:

  • On 2019-05-14, the company announced quarterly earnings of -0.35 per share, a negative of -38.3% below the consensus -0.25
  • TLRY’s gross margin of 20.6% is substantially below the Pharmaceuticals industry average of 66.7%
  • Tilray Inc, currently has an insider trading rating of 2, which is significantly more bearish than the Pharmaceuticals average of 5.35
  • Since the beginning of the current quarter sales by Tilray Inc executives have totaled $10,410,364
  • TLRY is currently among a group of 263 stocks awarded our lowest score of 1 (keep in mind industry rivals ACB and APHA are given a rating of 4)

Another alarming statistic came from a New Constructs Robo-Analyst Research, published on 5/21/19.  The report detailed what’s referred to as a Free Cash Flow Yield Trailing Twelve Months (FCF Yield ttm).  In order to find the FCF Yield ttm, one computes FCF/Enterprise Value. Now, the New Constructs report states:

“Free cash flow (FCF) reflects the amount of cash free for distribution to all stakeholders.  The level of FCF does not always reflect the health of a business or its prospects. For example, a large amount of FCF can be a sign that a company has limited investment opportunities and, hence, limited growth prospects. On the other hand, negative FCF can be an attractive indication that a company has more investment opportunities than it can fund with internal cash flows. Zero FCF could mean that the company generates just enough cash to internally fund its growth opportunities.”

When looking on the New Constructs website and FCF description page, I found an a list of companies with the most positive/most negative FCF.  

Tilray’s FCF Yield ttm, has it at below -21%, which offers a possible explanation “that a company has more investment opportunities than it can fund with internal cash flows.”  This makes sense that executives wouldn’t place emphasis on their internal cash flow and money management, due to the fact that in their IPO prospectus that stated they will possible need to raise more capital in the future.  

Note, in order to find FCF use the formula: FCF=Cash from Operations – Capital Expenditures (CAPEX).  Then using the formula for FCF Yield= FCF/Enterprise Value, I’ve given a screenshot of how to calculate Enterprise Value below:

A review of Tilray’s balance sheet reveals a multitude of issues.  Negative FCF Yield ttm, significant insider trading and rising revenue with deeping losses are just a few of the many issues facing the company.  This wraps up my “company financials” stage and please note that with regards to the information on FCF Yield and the Detailed Stock Report, I in no way take credit for it and feel free to look into both companies equities research reports at:

  1. Thomson Reuters: https://www.reuters.com
  2. New Constructs: https://www.newconstructs.com/technology

Lastly, in order to complete my Tilray short sellers argument, I had to dig deeper and find the company behind it’s IPO.  Behind Tilray, is private-equity firm Privateer Holdings, which was founded in 2010 by Brendan Kennedy, Michael Blue and Christian Groh.  Privateer Holdings owned roughly 76% of Tilray’s outstanding shares before it’s lockup period passed. In my investigation of Privateer, one of the avenues I explored was workplace reviews from glassdoor.  Now, I don’t think glassdoor reviews should hold much weight, but the 1-star reviews certainly compliment the trend of my perceived managerial incompetence. To avoid using potentially fake or faulty reviews I ruled out any posts from after the IPO date of 7/19/2018, but this still left enough evidence to support my case.

Further research also exposes a lawsuit, filed by a famous rapper, within the Los Angeles County Superior Court against Privateer for “contractual fraud.”  The private-equity firm also has an impending lawsuit with a maryland-based cannabis consultant about an unfulfilled oral contract. I’ll disregard the oral contract issue, seems fishy, but regardless it seems that issues about contracts tend to follow Privateer Holdings wherever they go.  To wrap up my high conviction short argument, I believe Tilray is nothing more than a greedy product of the so-called “Green Rush” and as Bill Beatty, director of the securities division in the Washington State Department of Financial Institutions, stated “Anytime something has cachet and people are paying attention to it, there’s the chance that people with evil intent will take advantage of that.”  I find this statement to fit Tilray perfectly.

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