A “Short” Story: Not Getting High on Too Much Supply

At the time, its market cap was about $17 billion. Today, about one year later, its market cap has fallen to $4.7 billion. To be blunt, we believe CGC could be worth zero.

To us, this was a classic case of investors getting overzealous and passionate about a “growth industry,” with its “massive potential”—but not objectively analyzing the details of the business’s economics and industry dynamics.

The stock is down over 70% since we started shorting it, and the company will likely go bankrupt… or at best be recapitalized, wiping out all the current investors’ equity and debt. Bold statement, I know. Why do I feel comfortable making it? Sometimes the core business fundamentals are easily overlooked.

Here’s our basic business case for shorting CGC: it takes as much space to grow a pot plant, which

“feeds” hundreds of customers and produces product for years, as it does to grow a head of lettuce, which can only feed two or three people. Therefore, given enough time, pot prices should approximate the price of lettuce over the long run. At the time we got into our position, however, pot was selling for

$600 per pound vs. 55 cents per pound for lettuce.

That kind of irrational imbalance, unsupported by reality, simply can’t sustain itself. Once you realize that, everything else is elementary. It’s all about basic economics.

Usually it takes reams of information and countless hours of research and thought for us to come up with a good idea of a company’s intrinsic value—and then to assess whether it is being mispriced by the market. In this case, however, the key ideas simply flew off the page. The big ideas are always the most important ones to understand when evaluating a company. The details are important too, but in this particular case, the main points were so compelling they stood on their own.

The beautiful thing was that once we understood the main points and started diving more deeply into the supporting facts, the details not only verified our initial thesis but showed us that the situation was much worse for CGC than we even initially thought.

I won’t go into a long dissection of each and every point but I’ll mention just a few…

First of all, pot is now legal in a fast-increasing number of countries. It is being grown more and more openly around the world. Columbia has legalized it. Mexico is growing it. The entire world is taking up the cause. Until now, the only constraint was the land needed to produce pot. Now that America, Canada, and the rest of the world have blessed pot, and are legalizing it, land is no longer the constraint. It’s now just a matter of time – and it only takes six months to grow a whole pot plant! We are only in the first inning of this game. In Canada alone, CGC has enough production capacity to produce enough pot for all of Canada by itself. And there are hundreds of other companies, and thousands of producers, that can supply it as well.

Not only does it take very little space and resources to grow pot, but a pot plant can also be grown fast, and it can be harvested, as I said, for a long time. In six months you have a healthy thriving plant that can supply hundreds of people, in the same growing-space as a head of lettuce. Now add this fact: tens of billions of dollars are being thrown at this product around the world. Because pot has so much sex appeal, and because there is so much enthusiasm behind its becoming legal, the whole world is putting money behind it—all at once.

However, just as in the famous Tulip Mania phenomenon of the 1600s, the enthusiasm is excessive and unwarranted. With so many countries, companies, and individuals growing pot in their fields and back yards (yes, it is now legal in many countries to grow it for yourself), there is going to be such a glut on the market that prices are bound to collapse. During the tulip craze, the price for the prized flower got so far ahead of its intrinsic value that a single bulb of certain strains was selling for ten times the annual salary of the average Dutch craftsman. But tulips weren’t very hard to grow. A correction of this irrational situation had to occur.

Does history repeat itself? Well, it’s clear that the pot bubble is already losing air fast, and that CGC is pretty well doomed—as is the entire industry and anyone trying to make fast money from buying stock in it. We won’t get into a philosophical discussion about the pros and cons of the product itself, but monetarily, it’s game over.

There are numerous other data points and facts that further substantiate our view. For the sake of

brevity, we’ll omit them here. But the central idea—that pot logically should approximate the price of lettuce over time—is so simple. It’s that differentiated business perspective that makes these companies so obvious to us. As with many of our ideas, this thesis becomes obvious after you hear it. The fact is, we haven’t heard anyone else – on or off Wall Street – discussing this aspect of the industry’s economics.

That’s why we love ideas like this. And that is why we “lock on” to investments like this one and are so confident in their future prospects, positive or negative.

If you were alive in the 1500s, would you invest in a company selling hand-printed books for a thousand dollars apiece when you knew the printing press had just been invented? Of course not. We’re in a similar scenario here—cheap, plentiful pot is definitely going to be available; that just makes logical, intuitive, inarguable sense. And we saw it coming sooner than others. We’re not bragging here, just making a point—about our future, and about your comfort level with our ideas and investment approach.

We’ve maintained our short position as CGC has fallen from $17 billion to about $4.7 billion, where it is now. As it approaches $3 billion, due to our conservative risk management parameters, we plan on dramatically reducing our position, even though we think it has further room to fall.