Investment Thesis
As is common in young, high-growth businesses, the cannabis industry is going through a rough patch as its members spend heavily to scale their businesses and gain market share. While legal in many US states, cannabis is still federally illegal in the US and an array of regulations are impeding the growth of this market. Cannabis companies are unable to access traditional means of financing and are starved for cash, often issuing stock to raise much-needed liquidity. The valuation of the publicly listed cannabis companies has suffered, as evidenced by the price chart of ETFMG alternative Harvest ETF (MJ).
Price Chart of MJ
Source: Bloomberg.
The selloff provides an ideal backdrop for investors in SPAC vehicles, such as Tuscan Holdings Corp (OTC:THCB) and Silver Spike Acquisition Corp (SSPK) to source and complete business combinations at a reasonable valuation. However the warrants of both THCB (THCBW) and SSPK (SSPKW) are mispriced as they track closely with MJ while in reality they should be negatively correlated because the lower MJ is, the better off THCB and SSPK. At the current price of 40-50 cents per share, both warrants could have 3x-5x upside upon a deal announcement which could happen at any moment over the next 7 months.
Price Chart of THCBW and SSPKW vs MJ
Source: Bloomberg.
SPAC Profiles
Both OTC:THCB and SSPK are special purpose acquisition companies (SPAC) that focus on completing an acquisition in cannabis industry over the next seven months. The structure and terms of these two SPACs are fairly similar which are summarized in the table below:
|
THCB |
SSPK |
|
|
IPO Date |
March 2019 |
August 2019 |
|
IPO Proceeds |
$276 MM |
$250 MM |
|
Liquidation Deadline |
December 7, 2020 |
February 12, 2021 |
|
Targeted Industry |
Cannabis |
Cannabis (non-plant touching sectors) |
|
Warrant Strike Price |
$11.50 |
$11.50 |
|
Warrant Redemption Trigger |
$18.00 |
$18.00 |
|
Warrant Expiration |
5 years after the business combination |
5 years after the business combination |
|
Warrant Crescent Term |
Trigger price $9.5 and strike price adjustment 115% | Trigger price $9.5, strike price adjustment 115% and redemption trigger adjustment 180% |
Source: Bloomberg and company SEC filings.
THCB is sponsored and managed by Tuscan Holdings Acquisition LLC. Its Chairman and CEO, Stephen Vogel, is a SPAC and private equity veteran. THCB is his third SPAC with the previous two being Twelve Seas Investment Company and Forum Merger Corporation. Concurrently, he is also Chairman and CEO of Tuscan Holdings Corp II, another cannabis-focused SPAC with a liquidation deadline of April 16, 2021. THCB also has a Board with deep operational and finance experience, for example, one of the Board Directors is Stefan Selig, who used to serve as the Under Secretary of Commerce for International Trade at the U.S. Department of Commerce and was also former Executive Vice Chairman of Bank of America Merrill Lynch.
SSPK was sponsored and managed by Silver Spike Capital, a cannabis focused asset management firm formed in 2019. Its founder and SSPK CEO Scott Gordon has extensive experience with several high profile Wall Street firms before shifting his focus on investing in the cannabis industry, including co-founding Egg Rock Holdings, parent company of the Papa & Barkley family of cannabis products. One of SSPK’s Board Directors, Dr. Orrin Devinsky is the director of the NYU Langone Comprehensive Epilepsy Center, a Professor of Neurology, Neuroscience, Psychiatry and Neuroscience at the NYU School of Medicine and the Chair of the Medical Advisory Board at Tilray, Inc. (TLRY), a publicly listed cannabis company, since 2016.
Cannabis Industry
According to the cannabis industry research company BDS Analytics (BDSA), the global legal cannabis market was approximately US$14.7 billion in 2019 and is expected to reach US$20.4 billion in 2020. BDSA forecasts that the industry will continue to grow at a CAGR of 21% from 2019 to 2025. The US market alone will grow at a CAGR of 18% and by 2025 will be the largest market in the world, commanding a 72% market share.
The potential impact of COVID 19 on the industry is not reflected in these BDSA forecast data above. However, based on the recently reported data, the COVID 19 outbreak actually spurred demand for cannabis in Canada and the US. Recreational cannabis sales averaged about C$180M per month in March and April 2020, up almost 20% sequentially from January/February levels per Marijuana Business Daily. Many states in the US saw similar demand surges, with cannabis deemed an essential business by most state governors and consumers finding more time on their hands.
Despite the scale and growth potential, the cannabis industry in the US is subject to a complex legal and regulatory framework. Unlike Canada where the cannabis industry enjoys full federal legalization, only 36 of the US states allow for some type of legal use under state law and cannabis is still illegal at the federal level as a Schedule I drug under the 1970 Controlled Substances Act.
However, the recent outbreak of COVID 19 could potential provide some tailwinds to the cannabis industry in the US, both in terms of demand and the regulatory environment as commercial cannabis has been a meaningful source of tax revenue and job creation. On May 12, 2020, the US House of Representative introduced a $3 trillion relief package (the Heroes Act) that included the provisions of the SAFE Banking Act that protect banks servicing marijuana-related businesses from being penalized by federal regulators. This potentially legalized access of cannabis businesses to banking services will be one important accelerant to growth in the US as the major US banks will be able to provide banking services, corporate lending and stock listing, etc to US-focused cannabis companies.
Another potential catalyst in favor of the industry could be the upcoming Presidential Election in November. Though the current President has mixed statements on cannabis legalization, it could not be ruled out that he would push to legalize marijuana at the federal level to boost his support if he is lagging further in the polls over the next few months.
Key Risks
1) If THCB and/or SSPK are not able to complete a business combination by their respective deadlines, the SPACs will be liquidated and their warrants will be worthless.
2) SPAC warrants are often not as liquid as underlying common shares, and warrant investors could be exposed to liquidity risk, especially in the volatile market environment.
3) THCB and SSPK are cannabis-focused SPACs and their success will be partially contingent upon the legality of the cannabis industry. The potential business combinations could be negatively impacted and significantly delayed due to negative regulatory and/or legal developments.
Conclusion
Both THCBW and SSPKW are mispriced as they have closely tracked the cannabis ETF MJ which has been under extreme downward pressure. In reality, THCB and SSPK will benefit from a lower industry valuation as it will enable them to identify and complete acquisitions with ample choices and more reasonable valuations. THCBW and SSPKW could potentially generate 3x-5x returns upon deal announcements and completions over the next 7 months. Like all other SPACs, the risk of owning warrants is that they could expire worthless in a liquidation scenario.
Disclosure: I am/we are long SSPKW THCBW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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