Cannabis Short Selling, Past and Present
Short selling has gained renewed steam in 2021 as online traders join forces, but the cannabis industry has had its fair share of dealings with short sellers in the past.
Taking a bearish posture on particular names in the cannabis space is a viable and at times very profitable way to play the odds in the emerging sector.
With targeted short selling now seeing traction once again, the Investing News Network offers a look back at several instances of short selling attacks in the cannabis industry.
Short selling can be profitable, but potentially dangerous
Short selling is an investment tactic in which an investor borrows shares of a company from a broker with the expectation that they will decline in value. In a successful short sale, the investor will sell the borrowed shares, then buy them back at a lower price before they must be returned.
According to a report from S3 Partners, a research firm dedicated to evaluating short selling moves, cannabis short selling netted almost US$1 billion in 2019.
S3 Partners’ analysis shows that shorting Aurora Cannabis (NASDAQ:ACB,TSX:ACB), Cronos Group (NASDAQ:CRON,TSX:CRON) and Tilray (NASDAQ:TLRY) proved to be the most effective moves that year. The spate of short selling in 2019 was driven by lackluster results from these companies contrasted with the level of valuation placed on the entire cannabis sector.
During a cannabis conference in early 2019, one analyst suggested that the reason cannabis stocks had attracted short sellers was due to the high level of attention the industry was receiving overall.
Neal Gilmer, an analyst with Haywood Securities, said the increasing speed at which cannabis companies were reaching considerable valuations had most likely intrigued short sellers.
Of course, while shorting cannabis stocks can be beneficial, there is a substantial amount of risk in using this strategy. As Investopedia explains, it leaves investors open to “unlimited losses”:
If you short a stock at $50, the most you could ever make on the transaction is $50. But if the stock goes up to $100, you’ll have to pay $100 to close out the position. There’s no limit on how much money you could lose on a short sale. Should the price rise to $1,000, you’d have to pay $1,000 to close out a $50 investment position. This imbalance helps to explain why short selling isn’t more popular than it is. Wise investors are aware of this possibility.
Aphria faces questions over Latin America assets
As the statistics above show, there have been many incidents of short selling in the cannabis industry despite the potential pitfalls. One of the most explosive attacks took place when Aphria (NASDAQ:APHA,TSX:APHA) was accused of negligence in regards to its Latin American assets.
In December 2018, a coalition of investment market researchers, Quintessential Capital Management and Hindenburg Research, went public with accusations against Aphria for what they deemed to be overvalued assets across Colombia, Argentina, Jamaica and Brazil.
From the get-go, Aphria defended itself from the attack, but the company’s stock still took a hit amid all the speculation. Eventually doubtful sentiment surrounding the company’s management took over as a shared perspective in the cannabis analyst community.
“We believe that management’s credibility may have been impacted by the allegations raised in this report. It is unclear at this point how the company will re-establish trust with investors,” BNN Bloomberg quoted GMP analyst Martin Landry as saying at the time.
Following the creation of a special independent committee to review its business operations surrounding the short seller claims, Aphria made the stunning decision in January 2019 to announce the transition of co-founders Cole Cacciavillani and then-CEO Vic Neufeld.
The company never tied the retirement of Cacciavillani and Neufeld to the short seller claims.
Irwin D. Simon took over as CEO of the cannabis producer, a role he holds to this day.
Gabriel Grego, managing partner at Quintessential Capital Management, spoke to Bloomberg at an investment conference in May 2019 to reaffirm the stance held in his research. He had previously called for the stock price of Aphria to go down to $0.
A Bloomberg report from June 2019 claims to have found the cannabis operating assets called into question by Quintessential Capital Management and Hindenburg Research. In its most recent quarterly report, Aphria confirmed it still retains these Latin American assets.
Cronos disputes short seller report
Another key cannabis short selling event came in August 2018, when Cronos became the target of notorious short seller Andrew Left of Citron Research, who published a report condemning the company.
Left was one of the first short sellers to go against cannabis names like Tilray and Canopy Growth (NASDAQ:CGC,TSX:WEED). When the Cronos report came out, he already had a reputation as an advocate for short selling, giving severe stances on companies he deemed weren’t up to snuff.
“Why would I not short the stock? It’s a very competitive industry. I think they are a subpar player. I think they have a lot of issues,” Left said about Cronos during an appearance on CNBC’s Fast Money.
He called into question the provincial agreements for cannabis distribution in Canada that Cronos had signed, like many of its peers at the time. Left’s main line of criticism came by way of a lack of disclosure on how much product would arrive to the company’s provincial partners.
Left also spent some time critiquing the rate of cannabis investments, calling into question valuation sizes and the overall speed of the “green rush,” which ultimately ended up causing severe reductions in operations for the biggest cannabis names in Canada.
A report from the Globe and Mail indicates that research firm PI Financial called into question the claims from Left in his report on Cronos.
“We felt the (Citron) report was light on meaningful content and had numerous red herrings,” Jeremiah Katz, managing director at PI Financial, said.
While debate ensued about the claims made by Left, Cronos shareholders took a hit as the company declined nearly 30 percent in value after the report was published.
Cronos’ share price is currently above its mid-2018 levels. For his part, Left made headlines earlier this year after he announced Citron Research would no longer publish short selling reports. This decision was made in the wake of the recent GameStop (NYSE:GME) stock saga.
Short selling can be profitable, but the tactic is also sometimes frowned upon in the investment community — after all, not everyone agrees with betting against a company.
However, short selling has also undeniably led to critical changes in the cannabis space. In the case of Aphria, for example, the cannabis producer was forced to adjust its public image and undergo executive changes after it was attacked. While the dispute about its assets was eventually cleared in favor of the producer, the firm did have to do damage control.
Other corporations, such as Cronos, have faced similar public short attacks or have received attention from short sellers, but have instead carried on with little to no fanfare in response.
Each case is different, but with short selling in the cannabis arena unlikely to let up, market participants should be prepared to consider how the companies they have invested in may react in the face of an attack, and what that may mean for their investment.
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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.