This one has been awhile in the making. 

I haven’t had a close look at Auxly since the relative ‘pivot’ away from being a streaming business to what they refer to themselves now as aspiring to be:  (a) “global cannabis leader focused on providing branded cannabis products backed by science and innovation”

Yep. There’s that. But it’d be a misnomer to say the build has been smooth. The Green Relief (GR) deal fell apart for some reason. It was a big one as well – with GR having plans to go public on the back of it. Somehow that went *poof* (I’m guessing they ran into headwinds raising capital driven by attrition within the medical stream, and general market softness). Auxly has a 3 year, 3MM gram purchase option with them at $1.50. Which, is still about $5MM gross short of what they needed for expansion plans.  

FSD Pharma is a laugh track in the background, with a definitive termination of a JV due to (get this) breaches in contract of “FSD’s management and staffing obligations of the (JV) facility”. Well then. Not exactly a ringing endorsement of FSD. Since apparently they only had one job….definitely a Dive Bar candidate for later this year.

Auxly’s acted as a financier in the case of Sundial. An interesting transaction, which saw Auxly lend them $7MM for 6 months in 2018. That turned into a year, and Auxly got the money back, plus $1.9MM on top of it. Deal done, at an implied interest rate north of 25%.

It’s not easy keeping track of the various business pursuits and collaborations and JV’s – there’s quite a few.

I like the general segmentation of the business into ‘upstream’ (production), ‘midstream’ (processing/transformation), and ‘downstream’ (distribution & sales). It’s an analogy anyone familiar with hydrocarbons would identify with. Unlike a vertical though (say an ACB or OGI), the JV’s and strategic ‘partnerships’ allows escape hatches (like the red button that was pushed with FSD Pharma).

And….while the rollout has slowed deployment and revenue growth, creating to whatever degree victims of the huge cashflows that some expected would begin raining from the sky last October 17th, but didn’t. Auxly’s model though has never been about big bang as far I can tell. They’ve appeared (or at least stated it a lot) to have been viewing it as a 10k race – with a longer time horizon in view – rather than as a sprint into formation.  

Their cash position definitely supports a longer term operation. Whether it’s ultimately profitable, that’s another thing. 

To the financials!

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• +$170MM in cash. They’re going to need it at Sunens – a massive project in Leamington that’s promised to produce 100k kgs/yr. Still a year out from commencing production. 
• ‘Long-Term Investments’ at $38MM are a range of companies, notable mutts being FSD and Ascent. 
• Something happened earlier this year with Sunens – with Quiring apparently not thrilled at the prospect of being paid in shares, and asked for convertibles instead (Note 13). Might have been driven by Auxly, would love to know the story behind it. Could be accounting driven. If I was invested, I’d ask.
• In cultivation: Kolab seems to be a replacement for Green Relief’s off-take capability. Robinson is another producer/medical outlet for cannabis – geographically driven (Nova Scotia). 
• Deferred tax liabilities of $21MM on intangibles a hangover from the Dosecann buy
• $7MM in loans out to a US hemp farmer (with a tie into VFF) and a private cannabis producer in Ontario (Note 5). $6.2MM is due August 4th (Monday) from the cannabis producer. I’m curious to hear if it’s paid or extended.
• Inventory negligible. I’d hope their finished goods is ramping like nuts right now.
• Expected selling price under bios $13-$14/g. Aggressive. (Note 6)
• Despite that sexy cash balance, they’re also packing $120MM in goodwill and intangibles. I’m usually less harsh around intangibles, especially if it’s around IP or software. In this case, most of it is in licenses. Blech. (Note 9)
• The business combinations reported are somewhat complex, but I don’t see any major tripwires. Note 10 (i-v) shows what it cost to replace the rimfire they had with FSD (it was $12MM for $2MM in assets. Rest went straight to goodwill). This purchase of goodwill is in a company called KGK.
• And one needs to trust that KGK hit the ground running.
• A loan to Beleave is taking on water with write-downs being made. Cash is/was coming in on it (~=$1.2MM), but….risk of nonpayment is increasing. It’s on the books at $5MM+.
• Notes 16 & 17 are of note to me. They detail the 600MM shares outstanding, as well as another 120MM waiting in warrants and options.
• $3MM in reported in SBC in the latest quarter. Sadly, one has to look pretty hard to find it. Most disingenuous part in all of these financials. These guys are better than that.
• 86MM warrants, mercifully at $1.38 with less than 2 years left on them. Contrast this with the 160MM warrants at $0.02 cents at the beginning of 2018. 145MM of them were struck throughout that year. The 2 cent warrant dishrag has been wrung out fully as of last quarter. (Note 17).
• 42MM options are reported at $0.88, with a average 7 year tenor. Ugh.
• $1.5MM in related party transactions, relatively negligible. Looks like benefits and such. Pricy though. 
• Good disclosure in Note 19 (Financial Instruments & Risk Management). A sign of their fluency within both topics.
• I can’t get much of a handle on the Uruguay hemp business. They tout a guy there whose experience comes from working with Stevia, a substance I’d never even heard about until last week.

Ok, I could go on. These financials are complex, but not a steep climb. Much is laid out, and appears pretty transparent. If and when product sales and segments begin ramping, it’ll bring a new texture. 

I suspect the Green Relief deal came to an end due to two factors: their off-take capability wasn’t improving substantially; and they needed more cash than comparatives. As Kolab and Robinson’s are wholly owned subsidiaries, Green Relief simply became a third wheel.

The $40MM spent on Dosecann has yet to bear fruit, at least in terms of RoR. 

For prospective investors, heavy consideration needs to be paid to Dosecann. Auxly’s buy was a relatively early entry into ‘R&D’, and definitely ahead of peers in terms of strategic planning. It seems odd now, but a 3-5 year horizon for product delivery was considered ‘missing out’ only a scant year ago by many. The effort spent faffing about with FSD not only cost Auxly money, but as importantly: time. With other extractors and companies promising value laden 2.0 products, I can’t help but wonder if initial product suites will be as underwhelming as Tweed’s initial flower offerings last year. If vape carts and tertiary cannabinoid products come out of the gate with low relative value (as seen by consumers), there could be inventory being produced that’ll end up like the non-sales bulge we are witnessing in flower and oils.

If Dosecann has been doing what it’s been billed to – and creates differentiated high-quality product right out of the gate – we’ve seen how early land grabs of consumers attention reflects in sales. ACB might not be known as necessarily having the best product on the market, but the regular Joe Consumer appear to cotton to it far more than Canopy’s at the moment. And competent increases in market share brings momentum, which builds sales, which ultimately builds brands. Auxly’s got none to speak of, at least in terms of the  broader retail market. Yet, while others might be tentative about 2.0, early entry with high quality products could land grab hard, and establish a strong retail one.

The $2MM Auxly spent on FSD Pharma is now book valued at $1.6MM, which realistically, is likely worth nothing at the moment. They’ve spent $1.5MM on ISH as well. I’m not a big fan of ISH per se, but, active risk management is a central theme of the financials. From a distance, they do it as well as anyone in the industry. These investments are immaterial in the large. Might be simply planning for distribution.

Some folks will remark that my mentioning smaller amounts and activities misses the big picture. To that, I say ‘bullshit’. The big picture is the sum of the pixels, and all deals done are representative of the mind of management. Sometimes that mind is in a business unit head who stayed up too late hitting one too many bong rips and went shopping on Amazon for a dope company. Sometimes it’s a united approach of coherence. Either or, deals are the essence of leadership’s mindset and headspace, and I like rummaging around in it.

ISH is opening three corporate stores right now (one in Canmore), and 10 franchisees in the hopper, opening in the next 45 days (I still don’t like them much if you read my Structure on them), but I’m inclined to believe Auxly’s fingerprints are all over ISH’s execution. I doubt their CEO did it on his own. If it was for distribution, I’d expect to see much, much more to be done, especially with geographic dispersion.

At any rate.

I’ve lost track of how many companies are going to be ‘global leaders’ in cannabis. There’s a whack of them. And really, what constitutes a ‘global leader’ anyhow? Sales levels? Market share? Profitability? Innovation? Efficiency? Number of countries operated in? Most comprehensive patent suite?

Auxly is unique in that they are relatively pan-Canadian in asset holdings, they positioned early, and have stayed on target in messaging and intent around 2.0.

For this thing to rock’n’roll – that has to crystallize. Major risks to this company are in low product differentiation, a poorly-aligned pricing strategy, and poor distribution and a lack of shelf space. 

If these guys are able to deliver on all of the promise and produce the product they’ve been promising, it’s got good potential. 

The capital structure is the rust on the frame here, and it’s mitigated by the strike prices somewhat. That they’re 7+ years in tenor could be seen as either aligned with the business model (that’s good), or, a whiffle ball that permits redo after redo (that’s bad).

My take is largely one of ambivalence: I see this in neither overly negative or positive tones. This one is all about fulfilling the promise they made a lifetime ago. It remains to be seen if it will actually deliver.

We won’t have to wait very long.

The preceding is in the opinion of the author, and is not intended to be a recommendation to buy or sell any security or derivative. The author holds no position in Auxly.