By: Dr. George S. Mack, Principal Analyst at BioDecade
All the people at Victoria, British Columbia-based Emerald Health Therapeutics, Inc. (TSXV:EMH; OTCQX:EMHTF) awakened on June 19 to watch and celebrate the Cannabis Act becoming law and dramatically changing the landscape for recreational marijuana use in the land of maple syrup and cold weather. It’s no secret that Canada has always been progressive vis-à-vis the United States with regard to social issues and healthcare in general. The impending legal validation of cannabis for non-therapeutic purposes is an outgrowth of that idea, and passage of that law is the wind powering a new, growing industry where small-cap investors can reap profits.
Yes, it’s almost a reality. On the effective date of October 17, 2018, wholesale and retail marketing of cannabis will begin nationwide in Canada. Keep in mind that as far back as 2001, Canada legalized cannabis for medical purposes, and that got the industry moving. What that means is that companies are not starting flatfooted but rather with know-how and facilities in place. The Cannabis Act, i.e. Bill C-45, moved the dial way ahead of medicinal usage, and adults 18 or 19 years of age, depending on the province, will be able to possess 150 grams of fresh cannabis and equal concentration amounts of dried, edible or liquid product. Selling of recreational products will differ from province to province. Some provinces will own stores, some will distribute to independent licensed retailers, and some will have both. The provinces are establishing supply/purchase agreements with licensed producers.
So, Canada’s friendly jurisdiction is the place to be for investors who want to own shares of cannabis producers, and there’s a fairly wide choice of companies to choose from. In a moment, I’m going to show you why Emerald is your best choice, but a bit of background is in order.
Emerald is already a licensed producer of dried and oil-based cannabis used as medicinal agents under Canada’s Access to Cannabis for Medical Purposes Regulations, but now it’s gearing up to produce and sell cannabis products for adults in much the same way wine, beer or spirits are legally managed and regulated.
The idea of Canadian lawmakers passing C-45 was to take cannabis off the black market and bring it out of the shadows so that it is regulated. The government will ensure GPP (Good Production Practice) compliance, with purer, safer products grown in a controlled environment without pesticides. Although liberalization in the U.S. will be much slower as a national program, the winds seem to be blowing in the same general direction. Just one week after Canadian lawmakers approved recreational pot, the U.S. FDA approved GW Pharmaceuticals plc’s (GWPH) Epidiolex (cannabidiol (CBD)), a cannabis-based prescription product for children suffering from a rare genetic seizure disorder called Dravet syndrome. This was a milestone because approving a cannabis-based drug was a first for the FDA. Just as an aside, Epidiolex is 98% pure CBD, a cannabinoid which will not produce a high or euphoria; however, the directional drift in the U.S. is new, and it’s positive if you’re thinking about cannabis trends.
Big Four accounting and consulting firm Deloitte conducted a survey of current and likely recreational users of cannabis for a 2018 report to determine Canadian demand for cannabis products, and it turns out that the market could be quite significant. Keep in mind, for a moment, that the 2016 population of Canada was only 36.2 million, roughly a tenth the population of the U.S. In Canada, Deloitte says, the cannabis market could reach close to $7.2 billion by 2019, with legal sales of more than half of that figure. Over time, it’s anticipated that customers will become more accustomed to the legal channels and begin using them more, but Deloitte is saying that an entirely new market will emerge for that legal slice of revenue. The study indicates that “middle-aged, university-educated Canadians” will partake at times, whereas some may not have when the products were illegal.
In small-cap specialty pharma, success is a product of management’s vision and competence, which means getting ideas accepted and having the skill to cut through regulatory roadblocks. Government legalization makes Canada the world’s largest nationally-sanctioned market for recreational cannabis, and Emerald has an experienced team of leaders in both agribusiness and pharma, including CEO Chris Wagner who has a quarter century of know-how in launching and commercializing drug products. Wagner was a global team leader at Eli Lilly (LLY), where he shepherded 15 small-molecule and biologic products to market. Some of these products will be familiar. They include Prozac (fluoxetine) for major depressive disorder, Cialis (tadalafil) for erectile dysfunction and Zyprexa (olanzapine) for schizophrenia and bipolar disease. All of these products were blockbusters (single products generating $1 billion or more per year in revenue). Wagner also played an instrumental leadership role in three startup biotechs as well, one going from a raw start-up to billion dollar valuation and then a buyout in five years.
Under Wagner’s direction, Emerald is now in the process of increasing crop-growing and processing capacity to meet anticipated needs for a brand-new era of regulated recreational cannabis for adults. Emerald’s stated goal is to develop “large-scale, high-quality, low-cost cannabis production” through several projects and channels:
- The company is currently updating its half-owned 1.1 million square foot greenhouse in a joint venture called Pure Sunfarms in Delta, BC. This facility received its cultivation license for this facility in early March, meaning that Health Canada monitors its activities to ensure compliance with the law. Emerald expects that this facility will receive its sales license in the near future.
- At the end of April, the company entered into a supply agreement with Pure Sunfarms and will thereby purchase 40% of its production in 2018 and 2019.
- In early May, Emerald committed to invest $90 million to acquire 100% of the shares of Agro-Biotech, a licensed producer which already has a cultivation license. Agro-Biotech has a 75,000 square foot facility in Saint-Eustache, Québec. Note: on April 24, 2018, a statement of claim was served on Agro-Biotech and its former shareholders by a party with whom Agro-Biotech and its former shareholders had previously entered into a non-binding letter of intent with respect to a potential sale of Agro-Biotech. Emerald believes the claim is without merit.
Between January 9 and May 22, 2018, the company raised CA$67.5 million in equity from share sales and warrant exercises. Now with CA$74 million on its balance sheet, Emerald is flush with a cash runway that would extend well past the beginning of cannabis sales in October.
There are a few important issues investors should keep in the forefront of their minds. Emerald has a huge cultivation operation. It is in a joint venture (JV) with Village Farms International, Inc. (TSE:VFF) that gives the company access to the expertise of one of the largest greenhouse producers in North America. Its Pure Sunfarms joint venture has a 1.1 million square foot greenhouse currently moving toward full production, with an option to purchase to sister greenhouses with an additional to 3.7 million square feet. One quarter of the first- facility has been converted to cannabis production, is covered by a Health Canada cultivation license, and will have product ready for sale when the Cannabis Act goes into effect on October 17. The full 1.1 million square feet should be completely developed by year end. Although Aurora Cannabis Inc. (TSE:ACB) and Canopy Growth Corp. (TSE:WEED) are major competitors, Emerald’s Pure Sunfarms JV, with its existing and optioned facilities, could actually have the largest greenhouse complex in the world for cannabis production. Importantly, however, the company intends to assess and potentially access all possible sources of cannabis that will assure suitable quality and low-cost supply. These sources may involve outdoor growing in Canada and could also involve sourcing dried flower or extracted product from other global sources. Its agreements currently allow Emerald to choose either, which means the company will be able to choose the most profitable method of production going forward.
Emerald has a coveted management and scientific team, highly experienced and credentialed in the world. Its Executive Vice President of Sales, Marketing and Operations, Paul Dillman, worked for Coca-Cola, Kraft, Big Tobacco, and Big Alcohol. On the innovation side, as mentioned, CEO Chris Wagner was involved in key product development projects and launches at Eli Lily and other companies. Emerald’s scientific advisory board has been entrenched in cannabinoid research for more than 12 years.
With Mr. Dillman’s lead, the company is now working with one of Canada’s most acclaimed branding and advertising agencies, DDB Canada, to create an effective marketing strategy in this emerging legal recreational environment that limits branding and advertising. One unique element of this strategy involves the introduction of a nutraceutical product line as part of a recently formed joint venture called Emerald Health Naturals. The nutraceutical formulations will not contain THC or CBD, which means the products can be advertised and sold in natural health, pharmacy and grocery stores. The high-margin nutraceutical line should function as a trustworthy brand-builder displaying the Emerald name and trademark to consumers in both ads and on store shelves in these channels which are not permitted to sell cannabis-based products. In a market in which six of 10 cannabis consumers are also natural health product users, this approach is creative and compelling.
Emerald is not planning to be a biotechnology company, which would involve decades-long trials where investor capital is always in peril. The company is, however, focused on product innovation, which could involve developments in formulation, precise dosing, delivery and applications. The company’s life sciences expertise is ideally suited to enable this type of development. Emerald has already filed for intellectual property protection for certain new product concepts.
The Company’s stock fell nearly thirty percent last week, when the Emerald was not included in an initial list of suppliers that had executed agreements with British Columbia. The agreements pertain specifically to the sale of recreational cannabis to the provincial government.
We aren’t really sure why the market reacted so dramatically to the announcement. The company’s business model is fundamentally still intact, the list wasn’t final (meaning negotiations may still be ongoing), and based on the strength of management team, it’s reasonable to assume that there’s a deliberate method to Emerald’s negotiating strategy. After all, British Columbia isn’t the only province in play, and the company could very well have a more comprehensive approach that includes other provinces in Canada.
Either way we view the market’s response as a possible over-reaction, and the announcement does not change our assessment of the business or its potential.
Dr. George S. Mack, the author of this report is an independent contractor. Dr. Mack was compensated by Sylva to author this report. He owns, or his family owns, shares of the following companies mentioned in this article: None.
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