Tweed Marijuana Inc. (TWD.V), Bedrocan Cannabis (BED.V), T-Bird Pharma (TPI.V), OrganiGram (OGI.V) And Mettrum Discussed By Khurram Malik, Jacob Securities Co-Head Of Research Written By: James West
November 4, 2014
Jacob Securities Co-Head of Research Khurram Malik talks about the Canadian Medical Marijuana trade from the perspective of an institutional investor, and sheds light on which of Tweed Marijuana Inc. (TSX.V:TWD) (OTCMKTS:TWMJF), Bedrocan Cannabis Corp (TSX.V:BED) (OTCMKTS:BNRDF), OrganiGram Holdings Inc. (TSX.V:OGI) (OTCMKTS:OGRMF), T-Bird Pharma Inc. (TSX.V:TPI) or Mettrum Health Corp (TSX.V:MT) will succeed in the competitive environment.
Full Transcript of Interview
James West: My guest today is Khurram Malik. He is the co-head of research for Jacob Securities in Toronto, Ontario. Khurram, thanks for joining us today.
Khurram Malik: Pleasure to be here.
James West: Khurram, let’s talk a little bit about the medical marijuana sector in Canada. We’ve got, at this point, 13 licensed companies under the MMPR rules, Marijuana for Medical Purposes Regulations. Of those, 5 have now gone public in Canada. What’s your general take on the sector?
Khurram Malik: I think it’s interesting. The sector in general is one of those odd things that come around every once in awhile, not very often, where an industry is birthed very quickly and it goes from zero to potentially a multi-billion dollar industry in a very short period of time. And in addition to that, oftentimes when industries are created because of regulatory action, there’s always a lot of risk that future regulatory action could have an adverse effect on them. This is an industry where most of the regulatory risk is toward the positive end of things, where things are a lot more liberalized, what you do to access, etcetera, etcetera. So they’re all trending in the right direction, so what you see right now is probably as bad as it gets, and it’s all going to, depending on how the elections go, it’s all going to go in one direction. So that’s pretty good. When you look at the industry in general, you can have a lot of comfort saying it’s going to grow quickly –
James West: Yeah.
Khurram Malik: And it’s going to be successful. The question then is, and this is the unknown, is who in that large pie are going to be the winners.
James West: Right.
Khurram Malik: And that we’ll find out in the due course of time.
James West: Okay. So do you think that the Health Canada estimate of roughly half a million MMPR licensed patients by 2020 is a conservative or a rather hopeful number?
Khurram Malik: It’s a very conservative number, considering the size that our MMAR was growing quicker than what Health Canada’s growing MMPR at. As you know, MMAR is considerably more restrictive in terms of getting access to the medical marijuana than the MMPR is. It’s going to get to 500,000 considerably sooner than 2020 or 2022. The way they came up with that number is, there was a government study done about narcotics in general a few years ago and it showed that the black market for medical marijuana, users that use medical marijuana on a regular basis, was roughly about 100,000 individuals. So they just plunked it out ten years and applied a growth rate together.
James West: I see.
Khurram Malik: That’s all that is. From a government standpoint, you appreciate them being conservative, but I’m paid to be a little more realistic.
James West: Right.
Khurram Malik: So I think we’re going to get there considerably quicker.
James West: Hmm. Okay. So then, how important do you think it is that the Supreme Court challenge that is going to be decided, or rather begin to be deliberated again on February 15th, 2015 – how important do you think it is that Health Canada prevails in that MMPR is, in fact, enforced as the sole source of medical marijuana for all of these patients?
Khurram Malik: I think I would say a lot of people would give it a lot of credence, a lot of attention; I really don’t care. It’s a tiny drop in their bucket in terms of how many patients are there. The real prize is everyone from this point forward that enters the program, that wasn’t part of the MMAR in terms of conception. And frankly at the end of the day, the folks that have brought the legislation forward have a good case. They’re really, really heavy users.
James West: Yeah.
Khurram Malik: Having to pay MMPR prices, that is very detrimental to their ability to get access to medicine that they need to function to on a daily basis. We’re talking individuals that consume 10 grams a day, 15 grams a day, 20 grams a day — legitimately consume that much for their various illness. And at some point it’s over $100,000 in annual expenses if you have to pay $7 a gram or $8 a gram for your medications. Being able to grow it at home, which would still be cheaper, has other disadvantages to it. I think it is reasonable – the way I’d like to see it played out is, they get grandfathered in. Again, a very select group of people. But everyone else, I think the MMPR program is a very legitimate way of getting their marijuana. It’s really not trampling on their rights.
There’s a small group of people that have a legitimate case, but on the whole, the others don’t. And even if they were all grandfathered in, it would make almost no difference to the LPs and future LPs. It’s just a tiny piece of the target. We’re talking half a million people versus somewhere less than 20,000 people.
James West: Right. Okay, so now let’s talk Federally and about the decriminalization of marijuana.
Khurram Malik: Right.
James West: Obviously Justin Trudeau has indicated that if he is elected he’s going to decriminalize marijuana and legalize recreational marijuana.
Khurram Malik: Right.
James West: How likely do you see that?
Khurram Malik: He’d have to win first. I do see it happening at some point; it’s inevitable. I think we’re moving in that direction. Most Canadians are in favour of it.
James West: Right.
Khurram Malik: At this stage, over 50 percent; I think it’ll be 60 percent in the next year or two. So again, we are a democracy, and the majority rules. It’s going to move in that direction. When it happens…we’ll see. Even if Trudeau wins, it may not happen right away. But what’s interesting about this industry is, we’re talking about $1.5 billion or $1.8 billion in revenue just from the black market in medical marijuana right now. So there’s a lot of room for existing LPs to grow into, whether recreational comes around a couple of years from now or five or ten years from now.
So it really doesn’t matter, because the market is pretty large now for medical. And frankly, the way clinics are coming online, the doctors are somewhat starting to get comfortable with it. It’s not that difficult even for a recreational user to get access to it, at the end of the day. I think whether it becomes truly decriminalized or not, there’s a lot of room for a company to make a lot of money.
James West: Sure.
Khurram Malik: And we’re just at the nascent stage of it.
James West: Okay. So how do you think that these guys, who are not allowed to advertise, how are they going to compete for and retain clients without being able to advertise?
Khurram Malik: Yeah. That’s very interesting, actually. See, at the end of the day, the consumer chooses a supplier. This is a consumer branding exercise at the end of the day, but unlike most industries, you’re so handcuffed in how you reach the end consumer. But also the flip side of it, in this day of social media, with a very finite number of producers that are going to ultimately be supplying the market whether today or in the next couple of years, it shouldn’t be too big of a challenge. The key for them is to figure out how to get out there and provide consistent quality strains from Day One with uninterrupted supply. That’s how you build a brand. And being a public company is another interesting way of doing it, because you can get out there without skirting the rules in any way, shape or form.
Now typically in most industries, we tell people not to go public until they have a certain amount of revenue going. In this industry we make an exception to the rule because, you know, being public is a key part of your branding strategy because there are only so many ways you reach your end consumer. And also, if you’re an investor in a better [unintelligible, 0:06:50] chances are you’re going to be a loyal customer as well.
James West: Huh. That’s interesting. So do you think that the limited number of licenses that has been granted by Health Canada is, in fact, the government trying to regulate the number of producers that come to market? And are they sort of putting their hand on the spigot of licenses in tempering the rate at which people are licensed until they see what the market can bear because they don’t want to put companies out of business?
Khurram Malik: Yeah. It’s all about – first of all, the first 13 that got licensed – well, 14; one had their license suspended really – it’s in the government’s best interest to make sure this first batch of licensees succeed. It’s a bit of a political pitfall, a bit of a nightmare if some of these fall by the wayside, if they act up badly enough to get their licenses yanked, they need these to succeed to legitimize what they’re doing. It’s a medium for the Conservative government, it’s a bit of a wedge issue. On the one hand they distance themselves from it, on the other hand they need it to succeed to sort of balance out what Trudeau may do down the road.
So yes, so that’s one of the reasons it’s limited.
The second reason they’re limiting it is, there are some very large licenses that have been proven in terms of capacity of what they’re approved to produce, whether it’s the tweed or [unintelligible, 0:08:04] or some of the other ones out there. So Health Canada knows exactly what the license supply number is, and they know exactly what the demand number is, which obviously they track on a regular basis. There’s no rush to grant additional licenses; these guys can produce a lot of products. That’s the other side of it.
So the demand has to come out a little stronger and frankly, it’s ahead of schedule by most people’s estimations and I think as the year unfolds, we’re going to see another batch. What the magic number is, whether it’s 25, 30, 35, 40 – I’d be surprised if it’s more than 35, 40 – we will see. And ultimately our philosophy on this is, in a couple of years there’ll be a lot of carnage, a lot of M&A activity, and you’ll be up with five large guys and a couple of the niche-y players.
James West: Yeah.
Khurram Malik: And then when they reach a certain size, if Big Pharma and Big Tobacco are going to come in and buy consumer brands and establish a following, and then grow to the next level.
James West: Okay. So what do you think about all these tiny juniors, a lot of them former zombie mining companies that have lost the ability to raise capital, you’ve got a lot of them out there saying ‘Well, we’ve hired this guy and that guy and now we’re a medical marijuana company, we’ve applied for a license.’
Khurram Malik: Yeah.
James West: And meanwhile, the monthly burn is consuming the capital that they’ve raised from investors and there’s really no way to tell when Health Canada’s going to resume the issuance of licenses. Do you think that that’s a legitimate way to go about raising money, in the first question, and the second part of the question is, do you think that Health Canada is holding back licenses till at least the outcome of the Supreme Court challenge?
Khurram Malik: I have somewhat of a problem with mining companies trying to reinvent themselves and just go out – I’m fine with a lot of it, but when people go out and say ‘Right, we’re going to go hunt for a license’ and then their stock starts popping, and then nothing happens as a result of that, that stuff irritates me.
On the other hand, if they’ve vended into a license with an equity say, at 100 percent or 50 percent or whatever the case may be, and they convey that properly and an investor invests in that after doing their due diligence properly, provided it’s a transparent sort of company, I have no problem with that. Because at the end of the day, and mostly they’re on the CSC, right? You’re investing in a speculative name, and the burden’s on the investor to do their homework.
Raising money for early stage companies on these junior exchanges is a legitimate way of doing it, provided everything’s above board. But we tend to work with more of the advance players. We’ve done a few earlier stage companies; we’ve done about 8 deals so far in the past few months, most of them LPs, but the ones that we’ve done pre-license have some unique aspect to them in terms of where they’re at in the application process or how they get customers or how they grow.
It’s mostly institutional investors investing in them, who understand the risks of licenses that may or may not come at the end of the day. So as long as you’re doing your due diligence, as one would expect any investor to do who’s investing in an early stage company, it should be fine. But companies that are walking around saying ‘We’re going to get a license’ just to get a pop in the stock price, just on that alone? That, I have a lot of issues with.
James West: Okay. So now, then, what about the idea that Health Canada is actually holding up the issuance of licenses based on waiting for the outcome of the Supreme Court challenge?
Khurram Malik: I think it’s the other way around. I think it’s in Health Canada’s interest to now think you will see more licenses granted before the court case goes live. It’s in their interest to show that they have provided enough licenses so most of Canada can easily get access to medical marijuana. I think the first 13 are pretty large when you put them all together, but it’ll strengthen their case if they grant a few more. So I would expect to see more before the New Year rolls around.
James West: Sure.
Khurram Malik: And that being said, plenty of companies that we’ve talked to and we’ve studied with a lot of detail that have rights to build, have already built things, and have scheduled inspections.
James West: Sure.
Khurram Malik: Or the next batch are pretty much ready to go; it’s just a question of when Health Canada wants to pull the trigger.
James West: Okay. Would you be able to comment on each of the five publicly traded LPs currently in the Canadian market?
Khurram Malik: I can comment on four of them. Thunderbird, I don’t know very well; that was capital raised primarily in Vancouver with a retail investors. Didn’t get much Toronto exposure to it, so I haven’t looked at it very closely, but the other four I know pretty well.
James West: Okay, so let’s start with Tweed.
Khurram Malik: Okay, so Tweed’s unique situation is, they were first in a lot of ways in terms of other brands. I still think they have the largest brand in Canada, particularly for consumers that are entering the market for the first time; it’s on the tip of their tongue.
James West: Yeah.
Khurram Malik: They’ve got an interesting leap, and also they’re going to have twelve grow rooms up and running by the end of the year, which is a lot of grow rooms, right? That’s roughly a 40 million revenue run rate. So they’ve got an early lead in terms of branding and market presence. It’s really up to them to capitalize on that and actually start getting product out the door, which they’re behind schedule on just like everybody else, almost. It’s not just a Tweed situation.
James West: Right.
Khurram Malik: But we have strong aspirations for that one. We think it’s in good shape to be one of the five that are standing at the end of the day.
James West: Okay.
Khurram Malik: It purely comes down to execution: so scale, ability to marry that with a brand, and provided they can provide take the scale from high quality product, they should be in good shape. If they can’t, then that’s going to be an issue, because that brand only last so long. Everyone else is nipping at their heels.
James West: Right. Okay. How about Bedrocan?
Khurram Malik: Bedrocan is a different animal entirely; it’s a very buttoned up pharmaceutical kind of company, to the point that they irradiate all their product by choice. And that’s fine; they’re not really going after the more casual user, it’s very sort of hard core, pure play pharma company going after people that are truly, truly sick. It’s a niche-y player; that being said, if they get their licensed approved for the new facility they’re going to expand at a reasonably quick pace. It’s not going to be niche-y in terms of volumes per se.
They’ve got some of the best strains in the world that they get out of their European affiliate. And frankly, everyone else is a start-up; they’ve got a little bit more with the operational expertise coming out of Europe than the others do, so there’s a little less risk there in terms of an operational standpoint. That being said, they still need their application approved for their actual production facility, which hasn’t come in yet.
James West: Okay. Let’s talk about OrganiGram.
Khurram Malik: Yes, OrganiGram. That was the last LP we financed. We like OrganiGram for a lot of reasons; one, it’s organic. Secondly, it’s got the lowest cost of all the 13 producers because it’s Moncton, new Brunswick – lower labour costs, lower building costs, lower power costs. So in theory, they should probably have the highest margins because they can charge more for an organic product if they want to, not saying they will. But at the same time, they’ve got the lowest [unintelligible, 0:14:27] cost, probably less than a buck if my number-crunching is correct. Which is interesting, whereas pretty much the rest of the bunch are in that $1.20 to $1.80 range. So that makes a difference if you think the sector’s going to commoditize at some point, being low cost is important.
Plus, they’ve got some unique customer acquisition strategies, innovation when it comes to how they grow, which the others in my opinion do not have, which we will learn a little more about in the flow of time. Between now and the end of the year, I think when you look at which ones are going to be the most newsy to help support their market valuations, I think it’s going to be Tweed and OrganiGram. And then Bedrocan and Metro will be a little more quiet, if for no other reason than they need their new facilities approve before they have really a lot of flex to talk about.
James West: Sure. Okay. Then let’s finally touch on the one that most recently started trading: Mettrum.
Khurram Malik: Yes. Also one of our clients. Big stand and fundamental story: they actually, last I checked, they have about 2,000 patients, which effectively means they are the largest supplier in the Ontario region. I think they’ve got about a third of the market, based on the latest industry stats.
One of the early movers, and it’s got an interesting branding strategy. Their new facility’s going to be able to do about 6,000 kilograms, which I think they’ll be able to easily meet with customer demand.
Again, I think possibly one of the leaders in the space, which is why we like them a lot. A fundamental story. So the question is, can they get the facility – again, like Bedrocan, can they get the new facility approved in time, i.e. by the end of the year, so they can start producing early next year to capitalize on their early lead, or is it going to take longer and the others that are nipping at their heels will catch up, which could be an issue going into 2015.
It’s interesting: the 2014 market right now is just fits and starts. It’s not really a true supply and demand market, because there’s not a lot of supply out there. Anything that you make today, you’re going to sell, even if it’s poor quality. Next year, when there’s a heck of a lot more supply online, that’s when you get a proper dynamic. Then the question comes: can you scale up quickly enough? And how are you going to get customers? Because very few of these 13 LPs have a truly defined customer acquisition strategy. It’s very theoretical, and they are sure about hiring farmer reps, which I don’t think will work. So they’re going to have to figure out something else.
James West: Interesting. Okay, Khurram. Let’s leave it there for now. I’m going to come back to you in about a quarter’s time and we’ll see how our companies are doing. Thanks for joining us today.
Khurram Malik: No problem. Take care.
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