Readers will know we’ve had lots to say about C21 Investments ($CXXI). This self described ‘MSO’ first caught my attention by putting up a slew of anonymous stock promotion, mainly on Twitter and CEO.ca. Reflexively, I looked up their financials. And just like almost all paid promotion, the optimism and promises of the stock going ‘to the moon’ and being a ’10 bagger’ wasn’t anywhere near what the financial statements were saying.

I did a structure in early 2019 and put it out publicly, straight to Twitter. And boy howdy….if one thinks Heritage Cannabis ($CANN) paid supporters are ardent, they can really learn a couple of things from the $CXXI crew. They were taking shots at me for months.

Quick backstory:

$CXXI began with a pitch deck and and a dream, and secured a reasonably large raise ($33MM) during the hype and run of early 2018. They then bought some distressed assets in Oregon, and quickly executed a raft of paper deals using a robust share price to acquire more properties/companies in Washington state, British Columbia, and ultimately added 2 dispensaries in Nevada. By last summer, the pump was real.

Despite all of these assets and ‘award winning brands’ and outdoor and indoor cultivation and claimed extraction capabilities – the company was largely dog-shit. The retail they owned was operating underwater, the grow-ops couldn’t apparently grow dandelions, and when they did grow – faced a saturated market in Oregon of $500lbs; and the all-paper-all-overpriced-all-of-the-time dealmaking they’d done so quickly had left a highly leveraged balance sheet with virtually no earnings to support it.

The exception was Nevada.

Cue Mr. Sonny Newman, the guy who owned 2 dispensaries in the northern part of the state (Reno and Sparks), and had sold them to $CXXI for some $80MM. These were 2 bricks and mortar outlets (one fully up and running, the second in development at the time) in a licence/location constrained region of the state, and had some sales history. The operation could grow weed, they were as vertical as they come, and they competed actively on price in a place where prices are typically held high. Sonny was owed a whack of money on all that paper he was holding, and he must have read $CXXI’s financials at some point along the way. And he saw what I saw.

Now, his dispensaries are good. Like ‘Rock n’ Roll’ good. At sales rates that were looking to be closing in at $20MM/yr (each!), they were the only diamonds to be seen in the pile of coal that $CCXI had become. Their existence was the only thing that held any kind of promise.

Along with the cash required to support interest payments to Sonny, the losses mounting in Oregon and Washington were threatening to sink the outfit. The numerous overpriced paper deals had little in terms of economic viability: most valuations were found to be bunk…..and earn-outs negotiated were going to make them even more expensive through time….no matter the performance of the acquisitions. So, when the then CEO of C21 asked Sonny to forgive interest payments owed to him – “just for a little while, until we get on our feet. C’mon, be a pal” – he did what most people do when they are faced with losing tens of millions of dollars (and can do something about it). He walked in the door, fired the CEO, took his job, and began renegotiating pretty much everything that had been done. Lawsuits – both existing and some brand spanking new ones – began flying, and Sonny spent the latter 6 months of 2019 cleaning house….from top to bottom.

He smoked G&A. Absolutely smoked it. ‘Crushed’ would be a better word. SBC, which had been running hotter than a blast furnace, was suddenly turned off. He re-negotiated deals that either were in the process of closing, and opened up others as well. I swear, Sonny’s desk must be in front of the office supply cabinet. There isn’t a hi-lighter that gets past him without a requisition that was previously signed and budgeted for. Good right?

Well. For investors, this might sound like a ‘good’ news story. It is, kinda sorta. Just like life, it isn’t always in absolutes where happiness is found, it’s as often found in the nuances.

Sonny’s expected tenure was to right the ship and get the capital structure shored up. And he has done a lot to make that happen. He spent all kinds of time negotiating with himself, resulting in an alteration to the interest payments on his debt and extending the term. Yesterday, Sonny announced he ain’t going anywhere. At least for the next 3 years.

The core concern here is about a creditor running a shop.

It’s one thing to have a significant amount of ownership in the hands of executive. It’s another though when the primary debt of a company is owed to the CEO. To Sonny, that means getting paid. It doesn’t mean he’s shooting for accretion in total asset value (although that would be nice I’m sure), and it certainly doesn’t mean thoughts of shareholders takes any space between Sonny’s ears at all. Perhaps they do. To be fair, it probably happens for a couple hours on the day he has to do an earnings call.

But he’s had 8 Capital and CB1 people set up on TV trays in his office for more than 3 quarters now, and I have little doubt that this thing is being structured for Sonny’s benefit, with financial exposures and the underlying equity actively being ‘managed’ by the two capital partners mentioned.

We’ve seen (what I believe) to be CB1’s hand at work at 1933 Industries recently, and what I perceive as management daring creditors to shoot the hostage. Sonny came in with elbows and knees to protect his investment, and these capital firms will be all too happy to hand him (and $TGIF) a baseball bat wrapped in barbed wire in exchange for the consulting fees and positional exposures they can acquire by being close to the source. In $TGIF’s case, I’m thinking there’s an asset (or two) in there that the funds like and/or want exposure to. Something they can trade over. Same with $CXXI. (Caveat: Unlike $CXXI though, God only knows what the funds see in $TGIF…..I sure as hell can’t see anything at this point).

I made a crack on Twitter awhile ago about $CXXI. The angry messages I got back from it set several high water marks in terms of opprobrium. The call centres and those in trapped in religious rapture about ‘their’ particular company horse have called me some nasty things…simply for not sharing their view. These were special nasty though in comparison. Meh. The anger used to stun me early on, but I’ve grown a thicker skin over time.

But the crack was about how thin the totality of $CXXI really is, and that without Sonny’s baubles, the thing isn’t much of anything. And despite the cost cutting and organizational re-jig – those sexy baubles are still not enough to support the dog-shit laying about $CXXI’s yard. So, Sonny is here to stay, and CB1 and 8 Capital are going to help him out all they can.

For a shareholder, one doesn’t have to venture far in their mind to see the potential conflict of interest a creditor has in assuming control of an outfit. Despite concessions around interest and debt repayments, those won’t come without a pound of flesh attached, and those two sexy little cows in the Nevada field will be milked furiously to pay for it. There’s no guarantee that management (read: Sonny) has much interest beyond keeping his dispensaries driving cash flow for his benefit. There never really is, but at least most CEO’s aren’t also the single largest creditor a company has.

Perhaps he can make something of Oregon. Maybe he can translate the over-priced extract brand they got into some sort of success in Nevada.

Either or, as an ‘investment’, shareholders should take note of potential conflicts of interest like this, and invest accordingly. And I’d be very cautious approaching outfits that have funds set up in the employee lunchroom. It’s one thing to buy exposure to an outfit based upon potential cannabis revenues. It’s quite another when the equity you buy is a derivative of a macro-trade put on by funds to backstop a creditor.

That Sonny’s finding it hard to get the cash he needs to buy enough earnings to support the company ‘as-is’ says much. He’ll probably get some sort of deal done. And I fully suspect it’ll be very expensive for shareholders, but not so expensive for him. And now we know his hands (along with CB1’s and 8 Capital) won’t leave the teats of those cows anytime soon.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in $CXXI