Growth Capitalist | Pipes for Smoking Pot (Stocks)

PIPEs for Smoking Pot (Stocks) | Growth CapitalistGrowth Capitalist

2/27/14 9:39 AM

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PIPEs for Smoking Pot (Stocks) By: JOE GOSE | February 18, 2014 | Leave a Comment The smoke furling off of joints in a growing number of states and the federal government’s increasingly laissez faire posture concerning pot’s illegality are juicing momentum for a crop of issuers looking to take advantage of the budding marijuana industry.

Despite unease about ex-convicts involved in some companies, the undeniable capacity for rampant fraud, and federal government’s ultimate reaction – under federal law, marijuana use for any purpose is still illegal – publicly traded marijuana issuers have begun to find an audience among investors.

Eight companies linked to the marijuana trade have raised $31.6 million in nine equity private placements since the beginning of 2013, according to PlacementTracker, a division of Sagient Research.

Over the same period, Seattle-based plant extract supplier Plandai Biotechnology (PLPL) and Irvine, Calif.-based indoor agriculture equipment supplier Terra Tech Corp. (TRTC) agreed to equity lines with potential drawdowns of $15.3 million and $5 million, respectively. Lincoln Park Capital and Magna Group Capital Management are investors in those deals.

The issuers were cross-referenced from a list of 40 marijuana stocks assembled by Houston-based 420 Investor. The firms are generating revenues from the pot trade – or have the potential to – and range from those with a dedicated business plan to serve the sector to a more tangential link. Most are penny stocks, and all trade over the counter.

The list is likely to keep growing in the coming months with shell companies and others sprouting on a seemingly daily and “ridiculous” basis, says Alan Brochstein, an analyst and founder of 420 Investor.

The performance of Brochstein’s 420 Investor Cannabis Stock index appears just as ridiculous. The index, which tracks 20 pot-related stocks, soared 328% in January.

It has since cooled, rising only 15% through for the month of Feb. as of the market close on February 14.

The spike in share prices in January coincided with the media’s onslaught of coverage of the first recreational sales in Colorado. It was also sufficient enough to prompt the Financial Industry Regulatory Authority to freshen up and re-issue a marijuana stock alert that it had originally released last summer.

FINRA reiterated its warning about the potential for fraud and the risks of investing in thinly traded pot-oriented companies “about which little is known.” “Regardless

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PIPEs for Smoking Pot (Stocks) | Growth CapitalistGrowth Capitalist

2/27/14 9:39 AM

of industry or sector, any so-called ‘hot’ stock can burn your portfolio,” it added.

On Friday, however, the Obama Administration provided guidelines to banks in states that have legalized marijuana. The move was intended to make it easier for cannabis businesses to access financial services. But it also created more confidence among would-be buyers of pot stocks, as shares of some of the industry’s higherprofile companies soared in the last few trading hours following the administration’s decree.

Among others, the stock of medical marijuana vending machine supplier Medbox (MDBX) skyrocketed 26% to $31.75 a share (still below its $36 share price at the end of January); shares of Medbox vending machine maker AVT (AVTC) climbed more than 15% to $3.90 (the same price at the end of January); and shares of dispensary buyer and lessor Zoned Properties (ZDPY) rose 12% to $4.65 (up 75% over its end-of-January price).

Still, Brochstein remains wary of the eye-popping performance, and at this stage he largely considers the field a playground for traders rather than investors. Certainly anyone taking a scattershot investment approach is most likely, in the immortal words of assistant groundskeeper Carl Spackler from the movie Caddyshack, “stoned to the bejeezus belt.”

“Out of just the 40 companies I’ve been tracking, I think 10 are total scams, 10 are real legitimate and the remaining 20 are – who knows?” Brochstein said. “For some, it’s like the ethanol or biofuel plan didn’t work, so now let’s try marijuana.”

Ground Strategy Growth capital investors so far appear to be taking a measured approach – making small investments or committing a bulk of capital, but divvying it out in tranches.

Rye Brook, N.Y.-based business development company Full Circle Capital Corp.

(FULL) in January raised $11.8 million in a public offering, selling more than 1.6 million shares for $7.13 each. It then turned around and reached a definitive agreement to invest as much as $30 million in Advanced Cannabis Solutions (CANN), a Colorado Springs-based company, through a convertible debt private placement.

Formerly known as Promap Corp., Advanced Cannabis plans to buy marijuana greenhouse facilities in Colorado and lease them back to operators, who heretofore have struggled to secure financing. Advanced Cannabis also considers customized plant nutrient lines as well as compliance and new-license consulting as future business opportunities.

Speaking at Full Circle’s quarterly earnings conference call on Feb. 12, John Stuart, the BDC’s co-CEO and chairman, noted that capital providers were still largely absent in the market, a dynamic that suggests uncertainty over long-term federal policy has trumped signs of obvious growth potential.

In addition to Colorado, recreational sales in Washington are expected to begin this spring or early summer. Twenty states and Washington, D.C., allow the use of medical marijuana, and 11 states allow medical marijuana dispensaries. Throw a http://www.growthcapitalist.com/2014/02/pipes-smoking-pot-stocks/

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PIPEs for Smoking Pot (Stocks) | Growth CapitalistGrowth Capitalist

2/27/14 9:39 AM

dart at a map and it will likely hit a state where legislative efforts aimed at some type of legalization or other reforms are underway, including Wisconsin, Oklahoma, Alaska, Missouri and Rhode Island, according to the marijuana policy organization NORML. “The cannabis space is certainly becoming very much more acceptable, and many, many states . . . are legalizing the sale (of it), and so it’s a huge market opportunity in terms of growth,” Stuart said. “From our perspective, we were focused on what the right way to invest in the market is, by virtue of the fact that there were a number of companies coming and looking for capital.”

Full Circle’s deal with Advanced Cannabis calls for it to buy six-year convertible senior secured notes and make an initial $7.5 million investment in the company.

(The issuer previously had raised $530,000 million in a Rule 506(b) Regulation D sale to retail investors facilitated by Denver-based broker Spencer Edwards.)

At least 95% of the proceeds in the placement must go toward the purchase of properties, and Full Circle will receive a first lien mortgage on the real estate portfolio. The debt features an interest rate of 12% and a conversion price of $5, which represented a 73% discount to Advanced Cannabis’ share price of $18.40 at announcement.

Full Circle also received 1 million three-year warrants with an exercise price of $5.50 a share. What’s more, the BDC has the right of first refusal to participate in future raises over the next few years. The firm anticipates that it will sell off some of the deal to other participants; it already has received inquiries, Stuart added.

“We don’t want to just be a single source of capital (to Advanced Cannabis), but what we want to be is a long term source of capital,” he said. “We’ve got a pipeline of opportunity with just this one company, which far exceeds our balance sheet. And we will bring in partners to support that growth over time.

On Feb. 12, Advanced Cannabis filed a registration statement to sell some 2.4 million shares held by 93 investors. The company’s shares spiked by $3.83 on Feb. 14 to $17.33 a share compared with $1.60 on Sept. 30. Most of the gain occurred in the few hours following the administration’s release of bank guidelines.

Green Shoots and Joint Ventures Other reefer-oriented companies that have hit the PIPE market include Las Vegasbased CannaVest (CANV), a supplier of cannabis extract to the nutriceuticals industry. It raised $1.2 million at $1 a share from unknown investors in November (shares are now trading around $66).

Vancouver-based Enertopia (ENRT), which among other projects is pursing a joint venture to grow medical marijuana in Canada, raised $1.7 million in a common stock in January and February. The shares were sold at 64% discount to the announcement price of 28 cents a share. It also issued two-year warrants for 8.6 million shares with a conversion price of 15 cents a share. Enertopia’s shares were recently trading around 36 cents.

Meanwhile, Terra Tech has been the busiest issuer in the marijuana business over http://www.growthcapitalist.com/2014/02/pipes-smoking-pot-stocks/

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PIPEs for Smoking Pot (Stocks) | Growth CapitalistGrowth Capitalist

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the last year. It is a provider of indoor growing technologies through its GrowOp subsidiary that is competing for permits to operate cannabis businesses in Nevada.

In addition to its $5 million equity line agreement that it entered into with Magna Group, for example, Terra Tech has raised close to $7.8 million in two convertible debt deals.

Terra Tech reached a definitive agreement for the bulk of the convertible debt funding in early February in a $6.5 million deal with Dominion Capital. The financing is broken into 12 tranches over as many months – the first tranche, $800,000, funded in early February.

The promissory notes have an 18-month term and feature an effective interest rate of 16%. The conversion price of a little less than 31 cents a share represented a discount of 42% when the deal was announced. Dominion Capital also received four-year warrants convertible to roughly 1.4 million shares for an exercise price of nearly 31 cents. Aegis Capital Corp. facilitated the deal.

While the astronomical potential for future PIPE financings stemming from the marijuana industry could provide quite a windfall to hedge funds, placement agents and other market participants, it may take several months before the risks are clearly delineated.

That’s particularly the case as issuers get closer to the actual growing, refining and selling of the plant. While fears now center on potentially facing a federal drug or money laundering charge, however, there’s another threat lurking on Tobacco Road, Brochstein notes.

“I don’t know where this is headed, but the companies are prepared for things to change,” said Brochstein, referring to industry scuttlebutt about accommodating federal government policy changes in the works. “But if the federal government were to come out tomorrow and say, ‘Phillip Morris, do what you want,’ then that’s going to be bad for a lot of these companies.”

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