Run time – 10:50 (Transcript below)
Published 8/31/2018
Transcript
David Kretzmann: I’m David Kretzmann here at the Benzinga Cannabis Capital Conference in Toronto, and I’m joined by special guest, Afzal Hasan, the President and General Counsel at CannaRoyalty. So Afzal, thanks again for taking the time to talk to us at The Fool. And we last talked a couple of months ago, I think at the end of June. So maybe you can catch us up on what’s happened with CannaRoyalty over the past couple of months.
Afzal Hasan: Absolutely. Thanks for having me back on again. It’s been an exciting few months, we’ve been busy closing some of the acquisitions that we’ve been announcing over the past few months. So during the course of the summer we closed the acquisition of FloraCal Farms, which is our craft exotic cultivation brand. They were one of the most successful brands that we saw in the RVR distribution platform and we really were excited to be able to partner up and then acquire this company. So that was completed during the middle of the summer. They’ve been on our team and successfully contributing into a pretty time in the California market.
So on July 1st, that’s another big event that has happened since we last spoke, there was a shift in the rules. So the way that the rules that were implemented into California earlier this year worked was that on January 1st, when the state went fully recreational legal, there was a set of grandfathering rules that were in play. And those grandfathering rules expired on July 1st. And what that meant was some of the more relaxed standards on testing, on packaging, and a lot of these other requirements, they all fell away. And what that meant was a pretty immense supply shock in the Cannabis industry in California because we went from most companies being eligible and viable for sale to, in some cases our estimates anywhere from 60% to 70% of companies went from a state of compliance to non-compliance. And so supply shrunk tremendously and it was a concerning thing I think for a number of manufacturers that are out there, but we were pretty excited because we had done the hard work of actually trying to secure supply with compliant manufacturers in advance. So we were pretty happy about the fact that we were able to keep the shelves stocked with a lot of the companies that we work with, and be able to take advantage of that contraction in the market to be able to really increase our market share in comparison to what it used to be.
David Kretzmann: Got it. And my understanding is that the ultimate vision at CannaRoyalty is to build brands starting in California, potentially expanding beyond there. So maybe you can walk us through the rationale behind that, and also what types of brands you’re cultivating, and if there’s anything else you’re trying to bring into your portfolio. So the types of products, the different verticals, if you can just give us a picture of what that looks like.
Afzal Hasan: Yeah, absolutely. I mean our long-term ambition, to be clear, it’s to look like any one of a number of analogs out there. You can take a company that’s like Pepsi Frito-Lay, for example, or Diageo, or Rothmans, Benson & Hedges, and these are all examples of companies in different industries that have a commonality to them, which is that they are effectively houses of brands. And we see that being a really lucrative possible outcome for ourselves and a lucrative goal for ourselves because that business model really captures a very powerful asset. And that asset is what we think is the most powerful thing in this industry, which is buying power and demand. So a lot of people are focused on the supply side and the infrastructure side and they perceive that to be a valuable thing, and we absolutely agree that those types of investments and products and companies will have value, but if you’re looking for excess, above-market returns and where the excess value is going to for the sale of Cannabis products, where that goes in most industry is into this concept called the brand.
And so the brand operator is really the one that earns the above-margin returns from it’s sale of the product, even though a product like a Pepsi can might have a hundred different companies that contribute to the making of it. Pepsi is really the one that profits the most, at least in theory, from that product because they’ve been able to engineer that product, and what they control ultimately is that buying power. So that’s where we’re focused in the Cannabis industry, and what we’re doing right now to actually build our way towards it is building the infrastructure that brands need to succeed because our fundamental belief is that a lot of that infrastructure doesn’t exist right now. And because of that, the conditions for brands to emerge in the Cannabis industry have not quite been there. So rather than trying to build brands ourselves and go at it and face the risk that we might not actually get it, what we’re doing is building infrastructure so that we can start partnering with and supporting brands in the hopes of actually creating those relationships and ultimately acquiring those brands.
And that’s a strategy that we’ve already started to execute on with companies like FloraCal, which I mentioned a little bit earlier for example, where it was a long-term relationship that they had with their distributor, a relationship of trust, and when we started to approach them about an acquisition, they were excited about it because they wanted to partner up and be part of that company that had helped them grow and become really, tremendously successful.
David Kretzmann: Got it. And can you walk us through the capital allocation approach at CannaRoyalty. We were talking before taping, within the past couple months you had a sale of an asset to Aurora, talking about stock buybacks, and then just the lay of the land as you’re looking at potential acquisitions, what does that look like and how are you approaching that from a capital allocation perspective at CannaRoyalty?
Afzal Hasan: Yeah, absolutely. If you take a look at us as a company, what you’ll see is that we have been immensely prudent with our share capital and our capital structure. We’ve raised money for stated projects and for states goals and aims so that we have enough money to be able to invest into what we need for our business. But we haven’t been out there trying to raise a war chest. And that’s because of our fundamental belief that our company is undervalued, and when you’re in that type of a position, you don’t want to be raising extra equity money because you’re really handing out extra value that you could otherwise be preserving. So what does that mean for us? I mean we’ve raised some capital and we’ve actually been pretty careful about it, and when we actually sell assets like you mentioned, we recently sold an investment into Anandia Labs to Aurora Cannabis, they acquired the whole company. And our investment of $4 million turned into almost $20 million worth of returns.
And that kind of capital, the excess returns that wasn’t forecasted into our business, we’ve actually announced that we’re using a normal-course issuer bid to try and take advantage of our undervaluation and also be able to return some capital to shareholders that are looking for an exit. Because we’re happy to be able to make that arbitrage trade to say, if an investor does not feel that our stock is worth what it is today, we are very happy to say that it is worth a lot more and put our money where that promise is. And the flip side of it is too, that the number of investment opportunities and acquisition opportunities that are out there are immense, but tremendously overvalued in most cases. For us, we’re not looking to acquire companies based on a 2022 forward projection and buying a 5X multiple on revenues. That’s a bet that we’re likely only going to be able to lose on. Instead, for us the focus is on our core business and investing into that. And we’ve raised the money and the resources that we need to really be successful and immensely successful, we believe, in executing on our core business.
David Kretzmann: And this is a big week for the Cannabis industry. Constellation Brands announcing a $5 billion Canadian dollar additional investment into Canopy Growth. What does that mean for the industry and how does that impact CannaRoyalty’s strategy and prospects, if at all?
Afzal Hasan: Absolutely. I mean it’s great news to the industry generally. Constellation made a big move a number of months ago by first investing into Canopy, and that has been immense, it was an immense catalyst for this industry too. The amount of visibility and legitimacy it attracts is huge. And we benefit just like every other Cannabis company benefits from that visibility and the legitimacy because ultimately this industry does need a lot of that. There is an immense need for more information and more eyeballs on our industry to better understand it. And so moves like that, we applaud them because of the fact that they draw more attention to the industry. It doesn’t really change everything about our business or our plan because Canopy operates in wholly different jurisdictions than we do, but the visibility is great. And as people are saying too, with the tide rising all the boats are going up with it, so we’re happy that that’s the case.
David Kretzmann: At the Motley Fool, we’re a taking a business-focused approach to the Cannabis industry, so when we buy or recommend a company like CannaRoyalty, we do so with a minimum holding period of three years, and ideally five and ten years and beyond. What should we be focusing on or watching for the next three to five years, whether it’s key metrics, trends, developments, to best gauge the underlying health and progress of CannaRoyalty?
Afzal Hasan: Absolutely. So keep an eye out on our revenue initially. We have been seeing immense and tremendous growth. I mean we’re talking about multiples of growth year-over-year in a way that most cannabis companies will not be able to see. We are aiming to be the cannabis revenue run rate leader in this industry, and that’s something that we see as an achievable milestone given where we are right now and given our plans and ambitions and our financing and our capital resources. So that’s going to be the exciting near-term thing that investors should keep an eye out for because it’ll be concrete, verifiable validation that we are successful and that people that we are working with are actually successful too.
Longer-term, taking a look at us, two, three, four, five years out, you’re going to start to see us acquiring more of the brands that we are successfully supporting into the future. So in a year or two, expect to see a lot more of that as they become more successful and we start to negotiate terms with them. Also during that period of time what you should start to see is us launching into other jurisdictions and that’ll be a pretty special effect. Right now we’re building up our portfolio of brands and partners in the hopes that when we do go into another market we’re going to really be able to make a big impact over there. So keep an eye out for that as well as a potential catalyst.
David Kretzmann: Got it. Final question from me, it looks like the music is bumping up here, but a lot of moving pieces at CannaRoyalty, what personally gets you most excited looking out over the next five years?
Afzal Hasan: Working with brands. I’m so excited about the people that we meet and the products that I see in the R&D pipeline. I mean the reason why I come into work every day and do this is because I want to get these products onto the shelves and have consumers try them and tell us through their wallets what they actually believe in. Because that’s a lot of fun. That’s going to be the core value of our business, is those consumers voting with their wallets in California. And over and above that, we get to participate in the process and work with phenomenal people. So it’s a very exciting time and a rewarding exercise for us as a company.
David Kretzmann: Well, Afzal Hasan, President and General Counsel of CannaRoyalty, certainly look forward to following the story in the quarters and years ahead at the Motley Fool. Thanks for taking the time and we’ll keep the conversation going soon.
Afzal Hasan: My pleasure, thanks for having me on board.