Description

Quick Summary:

Cronos is a Canadian cannabis producer and distributor based out of Toronto, Canada, with cultivation facilities in the west coast alongside numerous ongoing projects worldwide.  Similar to other Canadian cannabis companies, Cronos produces and sells both medical and recreational dried cannabis and oils through their 3 brands: Peace Naturals, Cove and Spinach.

While other companies are busy expanding their production facilities, Cronos has focused its attention into investing in both R&D and in the international space.

Key points:  

We believe that despite all the talk in investments in R&D and in the international markets, Cronos is far behind in every aspect of the game.  We will outline:

1)      Just how far behind Cronos is with their competition in Canada

2)      International presence is not as significant as they seem

3)      Questionable Partnerships

Even though we have presented some questions on execution towards Cronos, we do respect the fact that they have an enormous pile of cash and that their equity gives them potential to deploy capital.  We are looking to the VIC community to comment on these issues, because we think it is an interesting conversation.

To start, let’s take a deeper look at how far behind Cronos is relative to their competitors.

Note: we are not arguing the merits of growing valuations on the back of capacity (or in other words farming), but merely asking the question, isn’t a history of missed and misguided expectations likely to yield more misses and thus destroy shareholder value?

1) Already behind in the core geographies- Production Facilities Woes:

As we see, Cronos is lacking in Canadian Cultivation in comparison to its competitors:

As Cronos is priced above Aphria and most of the large Canadian LPs, the company’s ‘capacity built’ is lacking in comparison.  Cronos’ capacity built is closer to the likes of Organigram and CannTrust, and even so its, valuation is 5x larger.

Capacity built isn’t the whole story, what’s important is how efficient the grow operations are.  If we take a look at the recent quarterly results, Cronos has been lacking on both a revenue and production standpoint.  Cronos recorded in the last quarter only 1,040 kg sold for both medical and recreational cannabis, while Organigram sold 4000kg+, CannTrust sold 3000kg+ and large players like Canopy was even selling 10,000kg+.   This, in obvious terms translate to a measly $5.6 million revenue in 2018 Q4. This also means that Cronos is a less efficient grower, as they were not able to produce enough to sell even with a comparable capacity built against Organigram and CannTrust.

This issue was also foreshadowed by some of the press material Cronos was distributing to investors.  If you take a look at Cronos’ two brands, they did not outline any of their supply agreements:

Other LPs were much more transparent as they listed their provincial supply agreements.

With the slow rollout and subpar growing from Cronos in the Canadian recreational market, this proves to be a missed opportunity for the company to capitalize on creating a brand and showing both investors and consumers that they are the best LP in the space.

Other than these reoccurring domestic issues, their international initiatives do not seem to be too special either.

2) International Woes:

Below is the list of Cronos’ plans for expanding its international presence.

Many of these partnerships and JV’s in my opinion are not too special.  Let us go line by line on what the competition is doing in the areas.

Australia: Lots of competition in the space, to name a few:

• MYM Nutraceuticals and PUF Ventures owns Solaris Nutraceuticals Pty Ltd, which is building a new 1,200,000 square feet green house in south Wales which could produce upwards to 100,000 kg/year of medical cannabis

• MedReleaf owns 10% of Indica Industries which has received a medical cannabis cultivation and production license

• Aurora Cannabis which owns a portion of Cann Group has already started selling oils to patients in Australia

• Aphria owns 25% of Althea Company Pty ltd, which has a license to produce medical cannabis

• Canopy Growth owns 11% of AusCann group and is cultivation medical cannabis

• Organigram received an export cannabis license to Cannatrek Medical PTY ltd which is a licensed Australian medical cannabis

LATAM- Just to name a few, there has been a rise of Latin American cultivators in the space:

• Aphria LATAM: Occupy 20 acres of property which is to achieve 30,000 kg per year, growing to 50,000 kg with access to micro-scale growers

• Pharmacielo: Colombian growers with over 15 million square feet of land.  They aim to grow over 5,530 thousand KGs according to their latest investor deck (Source)

• Khiron: Colombian grower with capacity of 100,000 kg of dry flower per year (Source)

Germany- This is probably the most crowded space in the ‘international markets’ with many of the big players stamping their flag in Germany to capitalize on the medical market:

• Aurora, Aphria and Wayland winning lots to sell to the German government (Source)

• Canopy growth acquiring MedCann GmbH Pharma and Nutraceuticals, which are German based pharmaceutical distributors (Source)

• Aphria acquires CC Pharma, a leading German Pharmaceutical and Medical Cannabis Distributor (Source)

• Tilray to sign a global partnership distribution agreement with Novartis AG (Source)

Poland- Also crowded with competition:

• Canopy: Spectrum Cannabis Polska successfully completed its first import of medical cannabis after completing a rigorous regulatory approval process to have the product assessed and approved for sale (Source)

• Aurora announced approval from the Polish Ministry of Health.  Aurora Deutschland GmbH will ship products to pain treatment centers and hospitals in Warsaw (Source)

With major players in the same areas of international expansion, coupled with smaller cultivation space and similar distribution agreements, it seems that Cronos’ edge in the international cannabis market is not as great as it seems.   

3) Questionable Partnerships:

With regards to the partnerships that Cronos has gotten themselves into, it is interesting to see that they have had made very minimal progress on these, and the timeline for completion/commercialization seems to be far into the horizon.

Starting with Ginko Bioworks, Cronos claims to be able to synthesize cannabinoids individually, economically and at scale which would allow Cronos to create the most effective cannabinoids in the space, ultimately into the domination of the cannabis medical space.  However, in Cronos’ Q4 earnings call, they suggested that this may take up to September 2021 for Ginkgo to even reach its equity milestones (Source). This R&D effort is to take approximately 2-3 more years from now and costs approximately $22 million.

Another partnership that seems less execution based, and more idea driven is the retail roll-outs with MedMen.  Cronos initially announced a 50/50 joint venture with MedMen to create: MedMen Canada that is alleged to create high premium stores in major cities across Canada.  However, much of this is yet to be realized. We have not seen any material updates on the retail store-fronts from either MedMen or Cronos from this JV. Initial Ontario licenses have already been distributed, and cannabis storefronts all over Canada have already started operations, but again, no updates from the JV.

Many of the initial excitement from Cronos such as the Ginko partnership and the MedMen JV does not seem to have materialized, or when it does, it is years away.

Citron research came out with a report a while back on some of the issues with Cronos such as its (Link):

•  Lack of clarity on its provincial supply agreements
• Lack of international sales in Germany
• Immaterial R&D Spend
• Product Recalls

It will be helpful to read the report and see some of the problems that are presented.   

Valuation:

On a valuation perspective Cronos is overvalued on any listed metric.             

Therefore, we would like to open the discussion to the VIC community, whether Cronos, based on their underwhelming Canadian and International operations deserves such a multiple.

Conclusion: Cronos seems like a great short but to bet against an entity that has great option value, a $100bn backer in Altria, $2bn on the balance sheet, curious as to the communities thoughts.

Some questions to ask the community:

• Who wants to take this paper if Cronos goes out and buy things?

• Are people invested mainly because of the Altria backer?

• Is this the next big thing and this analysis does not see it?
• After the Canopy/Acreage news today, does Cronos have a path to buy a US cannabis co?

Catalyst

Catalyst:

• Disappointing financial results

• Revenue miss

• Bottom line miss   

• inability to allocate capital as they have shown they can't with what they've had thus far