Let’s Toke Business --- The Commerce of Cannabis --- By Ted Ohashi MBA, CFA
Week ending October 16, 2020
The following is a recent interview Ohashi conducted with Chris Bunka, CEO of Lexaria Biosciences LXRP
In recent weeks, I have been talking about a recovery in the cannabis stock market and it looked like one was getting underway. But along came Aphria last week with a disappointing earnings report and it all came crashing down.
Monday of this week will be the second anniversary of legal adult-use cannabis in Canada. Much of what I have been talking about above reflects how bumpy the road has been for operators over the past two years. 5 Investors have had even a more difficult time as the current bear market is closing in on the three year mark and has carried most indexes back to the levels that prevailed some six years ago. But let’s not forget there has been real progress over the past few years and cannabis now contributes $9 billion a month to the Canadian economy. There are taxes being generated as a result at a time when government spending is rocketing up and government revenues have been declining. Let’s hope the next two years are better for cannabis operators and cannabis investors.
Lexaria Bioscience (CSE: LXX) (OTCQX: LXRP) had disappointing news regarding Altria not proceeding to Phase 2 of their research agreement. As I said, I thought the market would initially take this as bad news but might eventually figure out it is all for the good. See my summary of a chat with CEO Chris Bunka below
My personal reaction to this news is if Altria was a person, this is extremely disrespectful behaviour. Yet what does Altria have to be condescending about? This is the company that invested US $12.8 billion to acquire 35% of vape market leader Juul less than two years ago that is proving to be a major disaster.
In less than a year, Altria was forced to take a US $4.5 billion write down in that investment and it may not be over yet. Even for a Fortune 500 company that’s a major hit. It may be a strong indication that Altria has fomented a corporate culture that is inconsistent with modern standards of acceptable behavior and business success.
My most important question for Bunka regarding Altria was “Did you come out of it ahead of where you went into it?”
His answer was “Very much so.” In what amounted to a $1 million research project funded by Altria, we think the scientific work on our technology was an absolute success. LXRP learned a lot about the technology and have already deployed that knowledge into the current DehydraTECH™ formulation to improve it for nicotine, other applications and our intellectual property portfolio. So it was a very worthwhile experience that produced extremely valuable, tangible results.
We then had a discussion of other projects that LXRP is engaged in.
British American Tobacco p.l.c. (London Stock Exchange: BATS) is still in the early stages but we are certainly on schedule. We are in the manufacturing stage and after that there is a lot of testing that has to take place to make sure DehydraTECH™ meets various standards. We will make delivery sometime in November and that’s when BATS’ analysis will start.
LXRP cannot disclose what is being manufactured for them except to say Altria wanted to test the formulation we used in the 2018 animal studies and BATS will be working with a newer version and management is very happy about that.
The current recipe is one or two generations advanced and far superior in our view. I think it is possible we will know something before the end of the year but that would be the earliest. It is more likely we are looking at the early part of 2021.
The Up-Listing Process: this project is underway and Bunka reports some very important progress was made recently. We have been held up a couple of weeks but it is still very possible that it will be done by December.
Based on the timing we may have to make some decisions as to whether we want to be dealing with this during the Christmas holidays but it is very much in play. There is nothing I’m aware of that would be a hurdle to making a December date,but realistically, we have January as our fallback position.
The lawyers are working on the registration statement and there are multiple other matters to be done but everything is proceeding pretty much as expected.
The CBD products: it is difficult to talk about the revenue potential of this product. LXRP has announced an order for 4.4 million servings that will be fulfilled in the quarter ended November and verbal orders of approximately 56 million servings for calendar 2021. There are competitive issues to think about as well as normal business matters such as relationships with customers. There are different approaches that impact prices and costs:
1. Some customers that want beverages that involves making the powders and emulsifying them into a concentrated version in preparation for being placed into beverages. The work and costs in this case are substantially higher.
2. Making the powder for the consumer to add to their beverage of choice is considerably less work and less costly.
3. Then there are product formats that are somewhere between the 1. and 2. 4.
4. The revenue potential for 1. above might be, for example, 1 while the revenue potential for 2. above will be .1 while point 3. would fall somewhere between the two. In actuality, the revenue potential could be as low as $.03 per serving and as high as $.85 per serving. So the makeup of our order book can make a difference that will produce a result that is orders of magnitude higher or lower in revenue.
5. Outside of the DehydraTECH™ formulation, for some customers we do no further “manufacturing” and for others we do quite a lot. So for LXRP, we make a royalty-type return on the sales of our technology that is very high margin and on the manufacturing, a relatively low gross margin of say 20% or perhaps slightly more. So our profit margin is going to range from something like 20% to as much as 95% if it is mainly a royalty payment.
We referred a couple of years ago to a report from the American Dental Association that something in the range of 90% of the drinks you can buy at a 24-hour type of store are acidic. The manufacturers of such drinks such as Coca Cola or Red Bull add acidity to their drinks because organisms can’t grow and/or survive in an acidic beverage. So they can extend the shelf life of their drinks to many months by making them acidic.
But there is a huge problem with acidity with cannabis beverages because THC, for example, breaks down. So how do you get stability in an aqueous solution? Everyone knows how to do it but it’s difficult, it’s expensive and it doesn’t last 12 months. Lexaria doesn’t think making cannabis beverages is worth it and at the end of the day it’s going to be really hard to make a profit. But if you talk to people in the cannabis beverage industry today, they can’t accept this because they have invested hundreds of millions and perhaps billions into cannabis beverages.
So LXRP thinks the mix-and-serve approach is the way of the future, and I agree with Lexaria on this.
If I prefer Diet Coke to Diet Pepsi, when it comes to a cannabis beverage, I want Diet Coke. I certainly don’t want the equivalent of a no-name cola as my cannabis cola drink. That’s what the LXRP CBD powder provides. If it’s coffee or tea or beer or wine or an energy drink or even water, I want what I normally drink as a consumer. I have seen it and it is no more difficult that opening a package of sweetener and adding it to your coffee. Not only that you don’t need to restrict its use to beverages. You can add it to a candy, a protein bar, whatever you want.
Projects with anti-viral, COVID medicines. The animal anti-viral testing is underway and we are hoping for results that we can release by Christmas. With the animal study, we are looking for:
1. The most important thing is can we get more of the anti-viral drug into the bloodstream with our technology than without?
2. The second most important thing is does the DehydraTECH™ change the level of toxicity or create adverse effects compared with the non-DehydraTECH™ results?
3. The third is how quickly does it get into the bloodstream?
The results of this study are used as inputs prior to receiving approval for the human study, in other words, did the animals die, were there adverse effects, and so on? We also have to explain at this point and make our case for what we are trying to accomplish. To get this in place we’re looking at mid-2021 or the second half of next year. Everyone is aware of the work going on in the search for a vaccine or the preventative side of things. But there is also as much or more work being done on helping people once they have it. Both will always be needed.
If and when we have a vaccine, let’s say 70% of the people will take it and 70% of those people don’t get sick. That’s 49%. That still leaves around half the population that might get sick. That’s where we are targeting our efforts. Treating those people. That will never disappear. It’s like the flu shot that many people take. Many of them don’t get the flu but some do and those who didn’t get a flu shot might get it as well. Those people still go to the doctor or pharmacist or use over-the-counter medicines to treat their symptoms.
Conclusion: The market clearly interpreted the news from Altria negatively as I suggested it would if this was the eventuality. But based on the market action, I believe at a level of around CA $.20 to $.25 per share for LXX or US$.15 to $.20 per share for LXRP, the stock is oversold. This means, future developments should be accretive to the stock price from its current valuation. Between now and the end of the calendar year, there are three events that could produce a positive response in the markets. First is the up-listing that is underway and mainly under the control of the company.
If it proceeds as I expect it will, Lexaria shares will be exposed to a very large group of new, prospective investors that are more inclined to invest in a pharmaceutical/technology company. This is prospectively promising for investors. Second, there is some possibility that there will be a positive response from British American Tobacco although Bunka suggests it is more likely to be January/February 2021. Third, the results from anti-viral testing on animals is likely to be known in December. Again, this associates LXRP with COVID-19 and this will develop further moving forward. As a result, I believe LXRP has outstanding prospects from current levels for existing shareholders or new investors.
Source: Corporate news email letstokebusiness@gmail.com
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