The baton has officially been passed. No longer are cryptocurrencies and blockchain the darlings of Wall Street. It's now marijuana stocks.
It's not hard to understand why pot stocks have ascended to the heavens since the beginning of 2016. Our neighbor to the north, Canada, passed legislation to legalize recreational marijuana in June. In a mere 28 days, on Oct. 17, recreational weed will go on sale in licensed dispensaries, opening the door to what should be billions of dollars in added annual sales, atop what the industry is already generating from medical pot sales and via exports to foreign countries that've legalized medical cannabis.
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This marijuana stock is partying like it's 1999
However, no two marijuana stocks are alike, and there have clearly been outperformers. For instance, no pot stock has done better (or even come close, for that matter) than Tilray (NASDAQ: TLRY) since its initial public offering on July 19. After pricing its shares at $17, Tilray hit $300 a share in intraday trading on Wednesday, Sept. 19. For those of you keeping score at home, we're talking about a gain of more than 1,600% in a span of two months. With the exception of cryptocurrencies during the fourth quarter of last year, the last time we've witnessed a meteoric rise like this for an individual stock, and the industry as a whole, was during the dot-com boom in 1999.
To be clear, Tilray as a business is one that marijuana stock investors can come to appreciate. It was one of the first growers to receive a cultivation license from Health Canada, and it has therefore had more time than many of its peers to develop its brand and build a healthy patient following. Differentiation is incredibly hard to come by in the cannabis space, and Tilray is one of the few growers that's been able to do it, thus far.
Tilray has also been fueled by dealmaking speculation. Following Molson Coors Brewing Co.'s joint venture announcement with HEXO Corp. and Constellation Brands' game-changing $3.8 billion equity investment in Canopy Growth Corp. (NYSE: CGC), it's believed that Tilray, due to its strong brand presence and presumed top-tier production capacity, should be next on the list.
We also can't overlook the obvious: Betting against Tilray has been painful, if not virtually impossible. Data analytics firm S3 Partners a few days ago noted that annual borrowing costs on Tilray hit 370%. A tweet I saw posted on Wednesday showed an account where an unnamed brokerage wanted to charge a 565% APR to borrow against Tilray. Then there are the options contracts, where put options are priced so high, you'd need the stock to drop in excess of 50% to 60% in nearly all instances just to have any intrinsic value on your contract.
All of these factors have worked together to push Tilray to a market cap of more than $26 billion at one point. For added context, that's larger than CenturyLink, Kroger, Deutsche Bank, and Hershey, to name a few prominent businesses.
Sorry, folks, but this won't end well
Though this move higher has truly been something to marvel, it almost certainly won't end well. The dot-com bubble, genomics collapse, 3D-printing derailment, and cryptocurrency nosedive all serve as evidence to this point.
Fundamentally, even with Tilray operating at full capacity, a $26 billion valuation isn't remotely conceivable. The company expects to be operating 912,000 square feet of developed land at the end of the year. Some 56,000 square feet will be devoted to processing, with the remainder for growing. Being generous, this suggests that Tilray could be on track to produce 75,000 kilograms to perhaps 85,000 kilograms per year.
Tilray does have the ability to quadruple its growing space, should it choose to do so, based on its land. Understandably, doing so would probably take a good 12 to 24 months to complete. Even in such a utopian scenario, Tilray isn't going to be generating more than, say, 300,000 kilograms annually (without an acquisition) prior to 2021, in my view. Comparatively, Aurora Cannabis and Canopy Growth Corp., which don't even come close to Tilray's market cap when combined, have peak production potential of north of 500,000 kilograms. And to boot, Aurora and Canopy Growth will achieve closer to 500,000 kilograms of peak production much quicker than Tilray would achieve near, say, 250,000 kilograms or 300,000 kilograms.
Tilray's recent news announcements also aren't as big of game-changers as the market is making them out to be. For instance, having first-mover advantage in shipping dried cannabis and cannabis oil to Germany is great, but it's not necessarily going to be a major needle-mover for some time. Also, being the first Canadian pot stock to be granted approval to import medical cannabis into the U.S. for a clinical study on essential tremor is a feather in the company's cap, but it's not necessarily going to do much for the Tilray's bottom line anytime soon, if ever.
The company also has a lock-up expiration in less than four months. When Jan. 15, 2019 hits, insiders will be free to cash in some, or all, of their shares. Given how much Tilray has appreciated, it's a near-certainty that we'll see selling on this date.
The biggest factor here that investors need to understand is that most of this run-up is probably due to high-frequency trading (HFT) programs being run by institutions. Though bulls would like to think that optimists are cheering on Tilray by entering buy orders, the truth, according to JPMorgan in 2017, is that just 10% of daily volume for the entire market is regular trading; the rest is from HFT programs.
These HFT programs are designed to operate within certain parameters and provide a healthy amount of liquidity to the market. However, when a stock like Tilray, which has gone nearly vertical over the past month, gathers even the slightest bit of headwind to the downside, these HFT programs are probably going to halt trading and cause liquidity to dry up. In essence, it's going to create a Tilray "flash crash." There have been a handful of documented instances where the stock market as a whole has been briefly clobbered due to HFT programs halting and failing to provide liquidity. My personal suspicion is that this is what'll happen to Tilray in the not-too-distant future.
In short, this is a business model I really do like, but a stock I absolutely can't stomach. Shorting it or buying puts simply doesn't make sense because of the radical costs involved, but it's pretty evident, fundamentally and historically, that this run-up will not hold over the long run.
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