When a scandal unfolds in the cannabis industry, this is what you need to know…
CannTrust Holdings (CSE: TRST) is a licensed cannabis producer in Canada, and its stock price has declined 56% in just the past month because of a mounting scandal.
Basically, CannTrust was growing cannabis in unlicensed rooms and shipping the products to customers. Of course, that’s a big no-no. Health Canada seized 5,200 kilograms of dried cannabis, and CannTrust “voluntarily” held back an additional 7,500 kilograms of cannabis.
That adds up to nearly $40 million worth of products.
After that, the scandal quickly snowballed. Within a few days, CannTrust stopped shipping cannabis entirely. Allegations surfaced that CEO Peter Aceto and Chairman Eric Paul knew about the illegal growing.
The board of directors acted quickly, firing Aceto and demanding that Paul resign, which he did.
But it may not be enough to save the company. The board is now “considering strategic alternatives,” which is lawyer talk that means CannTrust is trying to find a buyer that will preserve some equity value for the company.
I don’t have an opinion on what CannTrust might be worth after this scandal because there are just too many variables.
Lessons from CannTrust
This kind of scandal could happen to anyone in the industry, and we have to be aware of that risk.
As you know, I do extensive due diligence on the executives of the companies that go into any of our model portfolios. In fact, my staff published a report about the ideal qualities to look for in the individuals running a cannabis firm.
But due diligence is no guarantee against a potential scandal down the road, especially in the case of CannTrust.
It was not a penny-stock operator. Aceto had a sterling history, co-founding and running ING Direct, which is a bank that was acquired by ScotiaBank. CannTrust earned a listing on the Toronto Stock Exchange and the New York Stock Exchange. It earned a “BUY” rating from some of the biggest brokerage companies covering the cannabis industry. Health Canada had even just approved the company for outdoor growing operations.
Put all that together, and you think you would have a company that is playing by the rules.
But again, that wasn’t the case.
There’s Never Just One Cockroach
The second lesson to be learned from all of this is that there is never just one cockroach. If you ever see one cockroach, you can be confident that there are more – many more – hiding behind the walls. The same thing is true for executive scandals.
You can be sure that illegally growing marijuana was not CannTrust’s only regulatory violation. That’s the main reason I’m so hesitant to put a valuation on CannTrust. I want to see the rest of the cockroaches before I can estimate what the cleanup job will cost.
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And the bad news is still starting to trickle in…
The company exported some of the illegal product to Denmark, which moves the affair from a regulatory debacle to a felony. And a big Canadian newspaper alleges that two executives at CannTrust sold stock after they learned about the illegal growing, but before it became public.
What does all of this mean?
It does not mean that you should sell at the first whiff of scandal. As I’ve written before, there are unscrupulous shorts out there who try to create scandals to induce people to sell their shares, driving the price down and profiting from betting against the stock.
Instead, you should sell at the first indication that a scandal is true. In this case, that would have been at the initial disclosure of the illegal cannabis growing operation Health Canada found. When unethical behavior has been proven, you need to get out.
However, doing that is more difficult than it sounds, particularly in the cannabis industry.
That’s because cannabis is changing from an outlaw status to a highly regulated industry, and some of the laws are still vague. With some of the regulations unclear, we can expect (and even demand!) that the executives of our companies push the line from time to time.
Of course, that’s different from behaving unethically, but sometimes it’s difficult to determine the difference.
I find it helpful to think of football penalties. No one is going to call someone a dirty player if they receive a penalty for being offsides or get flagged for holding. But if someone is caught taking steroids, he can expect a lengthy suspension and have suspicion follow him for the rest of his career.
It’s impossible to get this right every time.
But you can increase your odds of success in determining which transgressions are tough business, which are misunderstandings of an evolving regulatory environment, and which cross the line. My advice is to apply your own set of ethical standards when you see a credible allegation of wrongdoing against an executive with a company you own.
Do you think the allegation amounts to a penalty for being offsides?
If you do, then hold your stock for a while and see if you’re right. You may get a chance to add to your position at favorable prices.
But if you see someone credibly accused of something which outrages you personally, don’t wait around to see what the company will do, because you can be sure that something equally or more outrageous will be reported in the future.
One other lesson.
Just as misbehaving management can kill an investment, a good manager dedicated to compliance can propel a company to the top of the industry. For those of you who subscribe to Cannabis Investor’s Report, our monthly issue is all about the good attributes you want to look for in the management of a cannabis company.
For those of you who have not yet purchased Cannabis Investor’s Report, I want to tell you a little more about our monthly issues. In this industry, you’d be hard-pressed to not only have a newsletter sent to your house and your inbox each month, but there isn’t anything out there that has the type of insight we provide.
From talking about Latin America becoming a cannabis exporting powerhouse back in February to the emergence of what I call “California 2.0,” we keep you informed so you can become a successful cannabis investor with top-notch outlooks.
In the next few months, I’ll be taking a look at edibles, branding in dispensaries, and much more.
You’ll also get our quarterly reviews of the cannabis industry, which focus on the industry economics, stock prices, and regulatory developments. Cannabis Investor’s Report members can access our Q2 2019 report right here.
Executive Director, National Institute for Cannabis Investors
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4 responses to “It’s Too Early to Judge the Full Fallout of CannTrust Holdings”
August 06 2019