Emblem Corp is buying capacity rather than building it

Emblem Corp (Emblem Corp Stock Quote, Chart: EMC:TSX) is a small Ontario-based LP that I have followed since it went public with great fanfare, in December 2016. Emblem announced a deal valued at $76 million in cash and stock, to buy a 662,000 ft2 greenhouse development in Leamington, Ontario.

The deal improves Emblem’s 2020 EV/Funded Capacity ratio dramatically to 2.3 (basic) and 2.9 (fully diluted) assuming 70,000 kg/year of capacity. But these days the market does not seem to reward a stock, especially a small cap stock, with increases in dried cannabis flower capacity.

Back in late 2016, the buzz around Emblem was that it would be a pharma-based LP led by John Stewart, who obtained notoriety for bringing the world Oxycontin at Purdue Pharma of Stamford, CT. The then CEO Gord Fox made a big deal about Emblem believing in the “closed box” indoor grow as being the best way to produce cannabis with high standardization and low cost.

The money men that brought us ABcann and Organigram were responsible for forming Emblem, which appeared to me an opportunistic but rather late entry into the cannabis LP sweepstakes. And my judgement was born out, with Emblem never really getting into gear, lagging behind other medical cannabis plays such as CanniMed, MedReleaf and CannTrust.

However, Emblem had the good sense to put in new leadership, in the form of packaged goods and advertising executive Nick Dean. Emblem had amassed a kitty of $83.8 million in cash as of March 31, 2018 from multiple unit deals over the last 18 months. Revenues in Q1 2018 were $1.3 million, with 71 kg of cannabis sold.

I’ve often been tempted to buy Emblem stock, but dilution with a big whack of warrants outstanding plus a $25 million convertible debenture is an issue.

Today, Emblem announced they are buying a Leamington-based 662,000 ft2 greenhouse development owned by licensed cultivator Natura Naturals. The cost payable in $25 million cash, 26.1 million shares and $12.5 million in assumed mortgage debt, is valued at $76 million, or $115/ft2.

Given their neighbour on Talbot Street in Leamington is Aphria with a cost of $50-55/ft2, you can see this is not cheap.

The greenhouse is not finished, with only 150,000 ft2 being developed in Phase I to produce 15,000 kg/year of cannabis. There is no disclosure on what the cost will be to finish Phase I, and the whole 662,000 ft2. Emblem still should have about $55 million in the kitty post the deal. With the Natura deal at the LOI stage, it is not firm. But closing seems likely, as many smaller ACMPR LP’s and late stage applicants look to cash out before the coming deluge of supply.

Emblem plans to kibosh its own 150,000 ft2 greenhouse development which was supposed to be located beside its existing tiny (7,000 ft2) grow in Paris Ontario, just west of Hamilton. Emblem is also planning a 35,000 ft2 infrastructure building in Paris, to formulate pharmaceuticals, do testing (Emblem has a dealer license) and allow space for partner CannTab to produce extended release pills.

The Paris expansion was billed to produce 15,000 kg/yr and cost $45-55 million, but would have taken into 2019 to be finished. The big boost from Natura Naturals would be the potential increase in capacity to 70,000 kg once the whole greenhouse is converted and approved for cultivation and sale. Natura Naturals is supposed to be finished this year, so another benefit for Emblem is the acceleration of capacity availability – good eye candy when pursuing export and supply deals.

Does this deal create the spark to get Emblem’s stock going? I don’t know. I’ve saved a lot of money staying away from Emblem.

The EV/Sales ratios do not change because Natura Naturals did not have a sales license and its development does not seem to indicate any increase in the odds for a sales contract. Emblem appears to have everything it needs to join the ranks of the middle pack of LP’s such as Cronos, Hydro, Supreme and even CannTrust. It has supply deals with Alberta, Ontario, Shoppers Drug Mart, and feelers into the German market. Emblem owns GrowWise, an 18 location cannabis patient clinic chain. And they bought a piece of Fire & Flower, to lock in recreational private store sales.

I am not sure what the spark will be to get a higher EV multiple on funded capacity, which averages more like 10 times capacity for the more senior companies mentioned above.

EMC is opening up 2 cents to $1.20 on 45,900 shares traded on the Venture exchange. The large number of warrants (52 million) exercisable at a $2.02 average price seems to put a damper on the stock. The outstanding post the deal closing would be 145.8 million basic, 215.8 fully diluted, for market caps of $175 million and $258 million respectively.

The problem with Emblem is, there are another dozen LP’s in Ontario, that look just like it. By my reckoning, they all can’t sell 70 tons each of cannabis a year.

Disclosure: Neither Chris Damas or or his company own Emblem nor do we have any business dealings with them.