The Reddit Gang Finds Weed
The Bengal Bite
“In ‘Confessions of a Winning Poker Player,’ Jack King said, ‘Few players recall big pots they have won, strange as it seems, but every player can remember with remarkable accuracy the outstanding tough beats of his career.’ It seems true to me, ‘cause walking in here, I can hardly remember how I built my bankroll, but I can’t stop thinking of how I lost it.” - Mike McDermott, Rounders
Reddit’s online trading forum, Wallstreetbets (WSB) has moved on from Gamestop with some members now attempting to short squeeze major Canadian LPs. As this was originally being drafted, Canadian LP stocks shot through the roof, while US MSO stocks had solid but more muted gains. MSOS, an ETF made up of mostly US MSOs (which we recommended as our favorite cannabis ETF last week) was up 14% over the last five trading days ending on February 10 while MJ, an ETF that holds mostly Canadian LPs with no MSOs, was up 42% in the same time. By close on February 11, as this was being finalized, MSOS was down 7% while MJ was down 25%, leaving them almost neck and neck over the last five days - 3% gain for MSOS and a 5% gain for MJ (see 5-day performance chart below).
These swings are more reminiscent of all-ins at the World Series of Poker than the efficient market of finance classrooms. To riff on Jack King’s wisdom, the intrepid traders of WSB may end up remembering their LP trades much more vividly than their (hopefully) winning Gamestop trades.
A common thread worms its way through all of this: liquidity. Canadian LPs, which operate in federally legal markets, presence on the NYSE and NASDAQ creates some significant differences between them and MSOs:
- NYSE and NASDAQ listings mean LPs can be traded on Robinhood, the (in)famous brokerage/trading app preferred by the daytraders of WSB, while individual MSOs can not because Robinhood does not trade OTC stocks. Although MSOS, the NYSE-traded ETF, is certainly driving some increased volume and is accessible to Robinhood users, it is not enough to match the ability to bet on individual LPs.
- Those same major exchange listings mean that LP stocks can be used as collateral for margin loans. Brokerages can loan up to 50% of a stock portfolio’s value to a trader, and Robinhood traders are famously prodigious users of these loans (indeed, these margin loans were likely a major reason for Robinhood’s temporary shutdown of Gamestop trading). Even if a brokerage allows trading in OTC stocks, they seldomly allow margin loans collateralized by them (e.g. Charles Schwab).
- Margin runs both ways, so LPs can also be shorted much more easily than MSOs. While nowhere near Gamestop, the short interest of major LPs was significantly higher than the average stock largely because many of the Canadian LPs are likely fundamentally overvalued, many aggressively so, particularly the most liquid ones; based on this lack of underlying fundamental valuation support, these shorts have become a more popular hedge fund position of late. As the nomads of WSB pulverized Gamestop shorts, they fanned out to find new targets, seemingly including some LPs, even those not well known and not well regarded. Tilray and Aphria short interest were already elevated because of a hedge fund strategy called merger arbitrage, which usually involves shorting one side of a public company merger.
- LP stocks’ broader name recognition versus MSOS (CNBC only recently started having MSO investors and executives on the channel).
- Major investor misconceptions about how much LPs stand to benefit from any potential US legalization, like in this CNBC article with the subheadline “[Major Canadian LPs] have also gotten a boost from the Democratic Party’s intentions to legalize the plant at the federal level” (a topic that merits a deeper writeup on why it is wrong another time, maybe next week).
Ultimately, these differences amount to significantly increased liquidity for LPs compared to MSOs, and that in turn leads to richer valuations. As the graphic below shows, the difference is stark.
But this is not so much a continuation of the Gamestop story as it is maybe an inverted version of it. The storyline around Gamestop was a valiant band of internet traders coming together to trounce an evil hedge fund that was trying to drive an unexciting, unglamorous but honest business of little stores that sold video games into extinction - WSB were the good guys in this story. But here major LPs are the ones that raised billions of dollars in capital, did flashy but ultimately written off mergers, and burned through shareholder money while enriching their promoters and executives. Arguably, it is the shorts that should be the heroes here.
Flush with winnings from Gamestop, AMC, and others, WSB short squeezing may be a little, as the poker players say, “on tilt.” Whatever happens next (and by the time this hits inboxes, whatever that is will have likely happened), the recent ride will certainly be remembered by some.
“They're trying to goad me, trying to own me. But this isn't a gunfight. It's not about pride or ego. It's only about money. I can leave now, even with Grama and KGB... and halfway to paying Petrovsky back. That's the safe play. I told Worm you can't lose what you don't put in the middle. But you can't win much either.” - Mike McDermott, Rounders
This week's Bite:
- WSB roller coaster reaches cannabis: Retail activity led to massive volumes being traded in the cannabis space this past week. Tilray’s price action was emblematic of the increased volatility, gaining 150% from open this past Monday, to now being 50% off its high. In general, the market fell back to reality on Thursday and it remains to be seen how the coming earnings season will impact the recent rally. (CNBC | Forbes)
- Institutions continue to support GTI: Midwest MSO, Green Thumb Industries, announced the sale of $100m worth of shares to an undisclosed institutional investor at $32.3 per share. This marks the second time that an institution has participated in a private purchase with GTI. It is no wonder more investors are looking at the blue-chip cannabis companies with federal cannabis legalization seemingly looming on the horizon. (Marijuana Business Daily)
- Legal Encroachment: In an exciting validation of the ongoing illicit to legal cannabis market transition, legal Canadian cannabis sales outstripped illegal sales of cannabis for the first time two years after legalization in Q3 of 2020. Overall illicit market sales are down by 42% since legalization, from C$1.3B to C$785M while legal sales are up to C$824M. It is interesting to note that there is a C$300M difference between the decrease in illicit sales and the increase in legal sales showing that the legal market is indeed attracting new consumers or increasing spending. (Marijuana Business Daily)
- Jazz Hands GW $7.2B in Acquisition: Jazz Pharmaceutical now holds the record for initiating the largest transaction in the cannabis industry in its bid to purchase Epidiolex (seizure medication) maker GW Pharmaceuticals. (MarketWatch | LA Times)
- Cheesehead Cultivars? Democratic Governor Tony Evers of Wisconsin proposed legalizing medicinal and recreational cannabis by legislation this past week. Given the overwhelming support for medicinal and recreational cannabis in the badger state and across the U.S. one would think cannabis legalization in Wisconsin would be a slam dunk. However, the statehouse and senate remain firmly in GOP hands, which are historically unfriendly to cannabis. That said, with cannabis legal in nearby Michigan and Illinois, there is a chance that the Republican legislature will act in pursuit of new tax revenues. (WEAU | Marijuana Moment)
- Virginia is for Cannabis (in 2024): Pending an expected signature from Gov. Ralph Northam, Virginia will be the next state to legalize recreational cannabis in the United States. While legalization will begin as soon as this summer, dispensaries will only be licensed to operate by 2024. (Rolling Stone)
What's in your ETF?
from the bengal bite
The largest Canadian licensed cannabis producers (LPs) trade at significantly higher multiples than their cousins, the largest US cannabis operators, commonly called Multi-State Operators (MSOs). The chart below tells much of the story. Not to paint all LPs with one brush, since there are some that have significant potential for growth from both Canadian market share and global opportunities (U.S. companies will likely not compete globally for quite some time). But, the largest LPs trading at such aggressive premiums over the largest MSOs suggests that the Canadian market, which has been operating for almost two years, will grow faster than U.S. markets, including newly legalized Illinois and Michigan (which combined hold 60% of the population of Canada). Based on fundamentals, this is not the case.