Explore sale to boost value, shareholder tells Gatineau pot producer HEXO

Company, analyst aren’t sounding the alarm
hexo
From left to right, HEXO's team includes co-founder Adam Miron, CFO Ed Chaplin and co-founder and CEO Sébastien St-Louis. Photo by Mark Holleron.

Gatineau-based cannabis firm HEXO is under pressure from one of its largest shareholders after the group, disappointed in what it perceives as an undervalued share price, sent a letter to the firm asking it to consider options including the sale of the firm.

Managers from New York-based Riposte Capital sent a letter Thursday morning to HEXO (TSX:HEXO), which officially changed its name from Hydropothecary last week, asking the licensed cannabis producer’s leadership team to undertake a strategic review of options to boost the firm’s market standing.

Riposte, HEXO’s second-largest public shareholder, writes in the letter that while the group is pleased with the firm’s recent milestones and progress, HEXO is saddled with a “severely depressed valuation.”

It cites a lack of investor awareness and no U.S. exchange listing as preventing the market from recognizing the value of the company’s achievements such as its joint venture with beverage giant Molson Coors and a five-year, 200-tonne supply deal with the Societe des alcools du Quebec.

Riposte believes the firm’s stock price should be as high as $18 per share, roughly three times more than the price before markets opened on Thursday, and that management should act immediately to fix the firm’s “unwarranted equity discount.” The capital group suggests an acquisition or merger with another licensed producer, taking the company private or soliciting a major investment from partner Molson Coors as possible remedies.

HEXO to pursue U.S. stock exchange listing

In response to the letter, HEXO chief executive Sebastien St-Louis didn’t rule out possible M&A plays down the road, noting that the company is always evaluating incoming offers and acquisition opportunities, but expressed his confidence in the firm’s current position.

“HEXO Corp. will be a leader in the global cannabis industry and will build its brand to include edibles, cosmetics, and more,” St-Louis said in a statement to OBJ.

He went on to directly address a few of the letter’s concerns, such as its U.S. and global market presence.

“We look forward to revealing our plans to move into the international market and to list on a major U.S. stock exchange in the near future,” he said, adding that the company is in discussion with other potential partners and will disclose those once agreements are final.

While he agrees that HEXO’s share value is undervalued, PI Financial analyst Devin Schilling says he was “caught off guard” by the Riposte letter. He says he doesn’t see the need for any immediate or sudden change at the Gatineau pot firm, which is currently trading at an all-time high of $6.55, up more than 11 per cent on Thursday.

“I believe HEXO’s going to continue, as we’ve seen from day one, to execute on all its strategic priorities,” Schilling told OBJ. He contrasts the firm to other producers that have come into the space with big plans and flashy powerpoints, but haven’t hit their own lofty targets.

Schilling does see a valuation gap between “tier one” producers such as Smiths Falls’ Canopy Growth and a secondary group that includes the likes of HEXO. He puts HEXO at the top of that second tier and expects the value gap between those groups of firms will contract in due course.

Market valuation should catch up: analyst

Gatineau’s HEXO has two big advantages that separate it from other licensed producers in Canada, Schilling says. The first is its agreement to supply cannabis to Quebec’s SAQ, which he believes will start to turn heads later this fall – after marijuana is legalized for recreational use – once revenue from the deal starts showing up on the company’s balance sheets. PI Financial expects that deal to be worth up to $900 million all-told, with Riposte putting the expected sales figures at more than $1 billion.

The second, and perhaps more significant, is HEXO’s partnership with Molson Coors to develop cannabis-based beverages. While the Riposte letter urged the company to solicit a direct investment from the beverage giant – as Canopy Growth did with Corona parent firm Constellation Brands – Schilling says the partnership itself is a significant vote of confidence.

He points out that Molson Coors would’ve shopped its joint venture opportunities around to every licensed producer in the space, and it ultimately decided that HEXO shared its values and had the capacity to bring a potentially industry-altering beverage to market. While some cannabis startups are claiming to have unlocked the secret of pot drinks, he says the alcohol industry’s existing players will likely have the biggest success in this sector.

"These will be the guys that get this done right and scale it."

“These will be the guys that get this done right and scale it,” Schilling says.

The SAQ and Molson Coors deals are not being reflected in HEXO’s share price at the moment, he adds. As long as the company’s management team continues to execute, however, the market will eventually clue into HEXO’s real value.

“There’s no reason to believe this isn’t going to continue,” Schilling says.