Activist investors are starting to set their sights on the booming cannabis industry.
Riposte Capital, a long-short fund and occasional activist investor, is pressuring Canadian marijuana cultivator HEXO to sell itself or to consider an investment from a large beverage company.
Riposte, which is the second largest shareholder in HEXO with a 2.5% stake, said in a letter last week that the company's stock is wildly undervalued compared to its competitors.
HEXO's market cap is "five or six percent" of the largest in the industry, Khaled Beydoun, Riposte Capital's managing partner, told Business Insider in an interview. "The only reason for that was not because of management incompetence. It was purely because there wasn't enough focus on the story."
He noted that for example, Canopy Growth, the largest publicly-traded marijuana cultivator, is trading at a multiple of 89 times its 2020 forecast EBITDA, a measure of a company's operating performance, whereas HEXO is trading at around 8 times its EBITDA. Canopy's market cap is over $24 billion, while HEXO's is hovering around $1.4 billion as of last Friday.
"What happened in the last two to three months was quite extraordinary," Beydoun said. "The valuation gap that emerged between HEXO and some of its peers became beyond abnormal, in the sense that these things rarely happen in someone's career where something is trading on 8x EBITDA, and the leaders in the sector are trading at 85 to 95 EBITDA."
Beydoun said that HEXO suffered from a lack of research coverage and investor awareness.
In Beydoun's view, HEXO has a footprint that could make it "one of the top three players in the world."
What's in the letter?
Beydoun's firm isn't alone in the view that HEXO offers unlocked value. Robert Fagan, an analyst at GMP Securities, said in a research note that HEXO's recent "corporate achievements" could "argue strongly for HEXO to be ranked amongst Canada's top five licensed producers, however this is not yet reflected in valuation in our view."
HEXO also recently inked a potential $1 billion supply deal with SAQ, the province of Quebec's liquor and cannabis distributor.
In its letter, Riposte recommends that HEXO's management consider taking the company private — in a way that allows the fund to keep its stake — or sell up to 20% of the company's equity to Molson.
It pointed to Canopy Growth, the largest publicly-traded marijuana cultivator by market cap, which landed a $4 billion investment from Constellation Brands in August in a huge bet in pot-fueled beverages. That was on top of the $191 million Constellation paid for a 9.9% stake in the company last year.
"One of the things they didn't do with Molson, which is what Constellation did with Canopy, is sell them a big percentage of the company," Beydoun said. "We feel that at this point if you have an anchor investor like Molson or like Constellation, you really set yourself apart from the competition."
Riposte is one of the first activist investors rattling the cannabis space.
"It's a new industry and no one has really done what we have done," Beydoun said. "It's only because of the dramatic divergence in the valuation that we've done this."
Riposte isn't targeting any other cannabis companies at the moment.
"For us, this is genuinely the one that stands out like a sore thumb," Beydoun said. "Whilst there are some other players that aren't trading at ridiculous valuations, it's very much a jump-ball exercise today in Canada."
Read more of our cannabis industry coverage:
- Hedge fund legend Leon Cooperman is investing in the marijuana industry — and it's another sign the sector is heating up
- One of the world's largest beer makers is about to start producing marijuana-infused drinks
- The CEO of the first marijuana company to IPO in the US reveals why this was the right time to go public
- Beer giants like Heineken and Constellation Brands are duking it out in the billion-dollar market for marijuana-infused drinks
- The rising stars of marijuana's investment scene that everyone from Wall Street to Silicon Valley should know
