A Probability Play on CannTrust’s Stock Price

Everyone and their grandmother is speculating on what will happen to CannTrust. With bagholders being most vocal, likely influencing the narrative, it’s hard to tell how the story will play out.

This has caused a number of FinTwit investors to tweet polls to gauge the underlying sentiment. The results suggest two-thirds of people believe a license suspension or revocation is imminent.

While these results don’t ultimately affect how the story will play out, it does provide an opportunity for an interesting thought experiment.

A Probability-Weighted Stock Price

Many investors are wondering if and how they should play CannTrust. With Health Canada ultimately deciding the company’s fate, it’s anyone’s guess.

In the meantime, investors can look at the current stock price through a probability-weighted lens.

Capital 10X did a quick review of CannTrust’s balance sheet to attribute a share price under the scenario that their license is lost and they are forced to liquidate their assets.

Within this bearish scenario, we assumed they were able to liquidate their current and long-term net assets at a price equal to their book value. However, we saw two distinct cases playing out related to their recent public offering (PO).

If we assumed CannTrust keeps the proceeds from their $160M public offering, a “no license” scenario would yield a stock price of $2.38/share. However, if we assumed the buyers of the offering are able to pull their money back, the stock price drops to $0.87/share.

To keep things neutral, we looked to the banks for the bullish price targets. Currently, price targets are $5/share for RBC, $6/share for BMO and $7/share for Scotia. We assumed $6/share for our analysis.

Recalling that two out of three investors believe Canntrust will have their license suspended or revoked, you can calculate a probability-weighted stock price based on this sentiment.

The following infographic breaks down the results of the analysis.

Much to our surprise, it appears as though investors have bid CannTrust’s stock relatively close to the probability-weighted price that assumes they keep the proceeds from their recent public offering.

This analysis obviously doesn’t predict the end results of the CannTrust story. However, it can help investors frame their thinking on the current stock price relative to asset value and investor sentiment.

It also highlights the importance of their recent PO. Investors need to watch for signs that buyers of the PO are looking to reclaim their investment.

Our Take – Litigation Leads to Losses

A quick google search shows us that there are already multiple class-action lawsuits being filed against CannTrust. These are from Canadian and American investors who bought in as far back as November 2018.

Buyers of the more recent public offering are not going to sit idle while their cash is burned. We expect these buyers to take all possible legal steps to try and recoup as much of their investment as possible.

Based on the severity of CannTrust’s transgressions, we believe buyers of the PO will be largely successful at reclaiming their money.

Given these risks, we see CannTrust’s current stock price as overvalued. It should be much closer to the bear case price target of $2.58. We believe CannTrust’s stock has more room to fall even before Health Canada releases their verdict.

Overall this analysis is simple and readers should feel free to discount/augment price estimates as they see fit. We also recognize that FinTwit surveys are as accurate as cannabis companies’ revenue estimates.

In the end, it’s for investors to decide whether they play CannTrust as the story develops or watch from the sidelines.

Employees of Capital 10x are short CannTrust.

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The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Capital 10X hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.

Evan Veryard has a Bachelor's of Chemical Engineering from McGill University and a MaSc. of Chemical Engineering from RMC. He has over 6 years of research experience focusing on industrial materials. Address: 682 Indian Road, Toronto, Ontario, M6P 2C9. Phone: 416-721-8257.
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