Activist investor: marijuana cultivator HEXO is undervalued

An
employee cuts cannabis plants in a laboratory at the headquarters
of AGES agency in Vienna, Austria March 15,
2018.
REUTERS/Leonhard
Foeger

• Corporate drama is coming to the cannabis industry.
• Riposte Capital, an occasional activist investor, said last
  week that marijuana company HEXO’s stock is undervalued in a
  letter to management.
• Riposte’s managing partner told Business Insider in an
  interview that these opportunities “rarely happen in someone’s
  career.”

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, or
cash flow, 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 their 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 offered
suffered from a lack of research coverage and investor
awareness. 

In Beydoun’s view, HEXO has the
visibility and 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.”

In August,
Molson Coors entered a joint venture agreement with HEXO to
produce non-alcoholic, cannabis infused beverages for the
Canadian market. 

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 that 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.”

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