Medicine Man Technologies (OTCQX:SHWZ) is a “show me“stock not worthy of investment consideration at this time for several financial and operational reasons discussed in this article
Investment thesis
In my article of 10/27/19 entitled “Smoke Signals Will Cloud Medicine Man Technologies in 2020“I expressed my viewpoint that the valuation of the company (OTCQX:SHWZ) was “ahead of their skies.“I urged readers who had gains in the stock (which had increased 170% TYD) to consult with their tax professional about “tax gain harvesting.“This advice was well-founded as SHWZ decreased by 20% and closed 2019 at $2.68. I also stated that “the company’s operating results for the next 4 quarters (Q3 and Q4 of 2019 and Q1 and Q2 of 2020) will be bellwethers“going forward. I decided to write this article before the company releases Q2 earnings as a caveat to readers that Medicine Man has reached a “tipping point” and that it is time for SHWZ needs to “go big or go home.” But before I drill down on the reasons which support my thesis, let‘s look at the company’s “wayback machine” shall we?
From humble beginnings to a publicly traded company
SHWZ traces its roots to the vision and hard work of Andy Williams, who co-founded the company with his brother Pete in 2014 and parlayed a $150,000 loan from his mother and stepfather into a publicly held company with a market capitalization of ~ $170M on 9/9/19. However, this local boy makes good story ended abruptly as Mr. Williams exited the company in February 2020, less than 3 months after being named President and Vice Chairman to ” pursue other opportunities with a scant 5.4% ownership interest. His saga is a cautionary tale regarding the dilutive nature of the capitalization process which oftentimes results in this outcome. The industry owes him a debt of gratitude for his pioneering efforts and tireless work in spearheading the passage of Colorado regulatory reform law HB19-1090, and I wish him the best of success in his future endeavors.
Selling the “sizzle“
Medicine Man has a history of being a very promotional company and Andy Williams’ goal of the company becoming the “Costco of marijuana” gained him widespread media access to proselytize his message. But the sobering fact is the company has simply not shown a clear path to profitability, and in today’s environment that is a potential existential threat to SHWZs future.
2020 company stock performance
The above chart shows that SHWZ initially traded down after Andy Williams left the company and the circumstances surrounding his sudden departure have been the subject of much speculation on various stock message boards. My only input in this regard is that the timing was curious since he had been named as president and vice chairman of the board of directors on 12/9/19. The stock currently trades at $1.53, which is relatively unchanged from SHWZs press release of 2/28/20.
Mesa Organics Acquisition
On 4/20/20 On 4/20/20 SHWZ announced the closing of the Mega Organics acquisition and noted that the company became the first publicly traded company to complete transactions under new Colorado HB19-1090 “PubCo” bill. The proposed purchase consideration of $10,324,938 includes goodwill of $1,837,354 per the company’s SEC filing of which includes a note from Mesa’s audit firm which states that “the company’ lack of liquidity raises substantial doubt about its ability to continue as a going concern.” As a former CPA with significant audit experience, I can attest that a note of this nature is a serious “red flag.” Mesa Organics audited balance sheet of 12/31/19 shows total current assets of $2,148,430 and total current liabilities of $2,179 226 which means that the company had a negative working capital balance of $30,796. Mesa’s gross profit % for the year ended 12/31/19 of 47.6% decreased to 30.2% for the 3 months ended 3/31/20. These metrics are both warning signs regarding the financial condition of Mesa going forward. Q2 results will be the first full quarter of the COVID-19 environment, and shareholders will find out the company’s performance likely within a few weeks.
12/31/19 audited financial statements
Medicine Man’s 12/31/19 balance sheet showed marked improvement since 6/30/19 and Y/O/Y. The company had a working capital balance (current assets – current liabilities) of $9,987,256 and a current ratio (current assets/current liabilities) of ~2.8 which are indicative of financial stability in the short term as shown below:
However, SHWZs consolidated statement of comprehensive (loss) and income shows that 2 key financial metrics which I broached in my prior article have become more problematic as follows:
I also noted in my prior article that the company’s gross profit margin has been spiraling downward since Q3 of 2018. This trend has continued unabated throughout 2019 and Q1 of 2020 as shown above as the company’s 2019 gross profit margin of 38.5% was significantly less than their 2018 gross profit margin of 72.7%, despite an increase in 2019 operating revenues of 21.5%. In addition, my review of the company’s 10-Q for the 3 months ended 3/31/20 indicates that the gross profit margin has further declined to 32.9%, which is more compelling evidence regarding SHWZ lack of progress in being able to control costs.
The company had a woeful “bottom line” in 2019 and Y/O/Y as shown above, as there was a $17,924,657 difference between their 2019 loss of $16,975,742 and their 2018 income of $948,915 which does not bode well going forward. It would appear to me that additional stock dilution is likely to be on the horizon in order to deal with their worsening financial condition
2 planned acquisitions won’t happen
A recent THCnet.com article stated that “High Country Supply, which owns several recreational cannabis dispensaries under the Colorado Harvest Company banner, terminated its $12.5 million sale to Schwazze. Dispensary group Strawberry Fields also terminated its $31 million sale to Schwazze on April 20, 2020.” This reinforces my base case regarding SHWZs aggressive acquisition and roll-out strategy.
Termination of material definitive agreements
The company filed a SEC Form 8-K report on 7/1/20 which stated in part that the company had terminated the following binding term sheets:
The “Dabble Term Sheet”) with Cold Baked, LLC and Golden Works, LLC (d/b/a “Dabble”), each a Colorado limited liability company
The “Los Suenos Term Sheet”) with Los Suenos, LLC (“Los Suenos”) and Emerald Fields Grow, LLC (“Emerald”), each a Colorado limited liability company
The “Farm Boy Term Sheet”) with Farm Boy, LLC (“Farm Boy”) and Baseball 18, LLC (“Baseball”), each a Colorado limited liability company,
I believe that these events underscores SHWZs lack of rigor in performing their due diligence and further clouds the execution of their business plan.
Star Buds
On 6/5/20 SHWZ issued a press release to announce a definitive acquisition agreements for Star Buds’ Colorado locations. On 7/2/20 SHWZ filed a SEC Form 8-K which stated that the purchase price was approximately $118M, subject to adjustment upon the closing of the purchase. The company has indicated that this transaction is expected to close in Q3 of 2020, which ends on 9/30/20.
This ambitious plan means that time is of the essence in this regard and it is likely that the company will need to issue additional shares, thereby diluting present shareholders.
Conclusion
Based on the foregoing financial and operational concerns regarding SHWZ, my base case as articulated in my prior article is unchanged. What is of seminal importance now is the company’s need for a substantial infusion of capital at a time when the stock price is severely depressed. In order for the company to close their existing binding term sheets with per-announced acquisitions, they will be subject to onerous terms given their constrained financials. In my view, SHWZ is in a “catch 22 “scenario caused in large measure by their blatant hubris displayed in prior investor presentations. Their lofty stated goal of $170M in revenue revenues with 20-30% EBITDA margins becomes more unlikely as time goes by, and their potential sources of capital have virtually all of the leverage. In my view, it truly is time for SHWZ to “go big or go home.”
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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