Cannabis companies have secret formulas to determine when the U.S. may allow pot sales
The two largest pot companies in the world have developed secret formulas that predict when the U.S. will legalize cannabis sales, or at least officially allow states to sell marijuana.
Aurora Cannabis Inc. ACB, -9.24%ACB, -8.93% and Canopy Growth Corp. CGC, -3.18%WEED, -2.91% included a reference to the secret calculations in their most recent financial statements. The accounting tricks are necessary because both companies “own” U.S. companies that they must put a value on, even though they cannot legally own the businesses yet.
Because cannabis sales are prohibited under U.S. federal law, the Toronto Stock Exchange last year asked all Canadian pot companies listed on its exchange to divest their U.S. weed assets or risk losing their listings. Major cannabis producers such as Aurora and Canopy figured out ways to have U.S. holdings, though, including purchasing warrants and other options in U.S. businesses and spinning off arm’s-length businesses that are able to invest in the U.S. because they are listed on junior exchanges, like Aurora’s Australis Capital Inc. AUSA, +0.00%AUSAF, -10.01% .
Determining the value of those holdings is quite complicated, though. That’s where a formula to determine when the cannabis companies will be able to recognize their investments in the U.S. market comes into play.
Aurora disclosed the use of the secret formula for the first time Wednesday in its disappointing fourth-quarter earnings report, when it revealed a new method of valuing warrants it holds to buy back a stake in one-time subsidiary Australis. Using the formula added almost C$10 million ($7.6 million) to Aurora’s bottom line.
Previously, Aurora valued the cash costs of its warrants in Australis, a venture capital-type unit, at half a million dollars. The change “adjusted for a probability factor of legalization of cannabis in the U.S. under federal and certain state laws” resulted in a C$9.6 million gain, which flowed through the income statement and bolstered the company’s net income. Aurora did not disclose the formula itself, only that it factored in the probability of legalization in the future.
“We’re really looking at ways where we can make, one, Australis more attractive to us, because we envision sometime in the near term that we’re going to be able to access our back-end rights for Australis,” Aurora executive chairman Michael Singer said in a phone interview Thursday.
“[T]wo, I think it really drives how we’re looking at [merger and acquisition activity] vis-à-vis in the U.S. as a real near-term opportunity for us,” Singer added. “I wish I could tell you I knew more about how the regulations were going to change. I do believe they are and we’re hopeful they’re going to change relatively quickly and we want to be ready.”
Singer said that valuing the warrants with the new method was, in part, driven by the company’s adherence to accounting rules.
“We obviously report under [international financial reporting standards] and not U.S. [generally accepted accounting principals], so I think it’s part of the year-end audit with KPMG.”
Canopy Growth, which also uses KPMG as an auditor after switching from Deloitte, also makes a secret calculation about the timing of U.S. legalization, according to its most recently available public financial statements. It uses the formula to adjust the value of Acreage Holdings Inc. ACRGF, -3.60%, which it bought the right to acquire in the future for $300 million, exchangeable shares of TerrAscend Corp. TER, +0.00%TRSSF, -6.37% and Slang Worldwide Inc. SLNG, +0.00%SLGWF, +1.01% warrants.
“We report our financial results in accordance with generally accepted accounting standards and external valuation specialists are engaged to assist management in determining the fair value of complex instruments,” Jordan Sinclair, vice president of communications, wrote in an emailed statement.
Canopy Growth also did not disclose the precise formula, nor when the company expects the U.S. to legalize marijuana, when it announced earnings last month.
See also: Canopy Growth’s remaining CEO talks about pot company’s shake-up, and the search for his replacement
Legalization may not be the actual target for the formula, however. Canopy and Aurora have also recently adopted terminology that suggests they could attempt to enter the U.S. market for marijuana ahead of full legalization. In filings, the companies say they intend to be active in the U.S. market as soon as it is federally “permissible.”
The change in language could be a nod to the STATES Act, which would allow states to make their own rules about cannabis. Though the act has received little attention from the current Congress despite a large push from weed-industry groups, if passed it would allow states such as California and Colorado to operate regulated cannabis regimes without the risk of federal reprisal.
Multistate operators largely support such legislation, though it’s unclear whether large-cap tobacco or food-and-beverage companies that have invested in the industry would also support the law, according to several well-placed people in the cannabis industry. Companies such Altria Group Inc. MO, -0.58% and Constellation Brands Inc. STZ, -1.35% may prefer to back legislation that legalizes pot and allows interstate commerce.
Singer told MarketWatch that the word “permissible” isn’t a perfectly defined term. “It’s what we’ve effectively negotiated with the [New York Stock Exchange] and TSX,” he said.
“We’re not certain about whether the [federal government] are going to make it legal, or whether they’re going to make it permissible and then give the states the ability to sort of decide their own regulations — we think that may be enough,” he said. “But again, we’re still at the mercy of having those discussions with the regulator, though we’ve been able to define permissibility as the right sort of threshold for us to engage in those discussions.”
In a Thursday morning conference call, Chief Executive Terry Booth said that he spends about 90% of his time on opportunities for mergers and acquisitions, adding that the passage of the farm bill has created a significant opportunity for cannabis companies interested in pursuing products with cannabidiol, or CBD, derived from hemp.
Booth said there were “a couple of hurdles” with the U.S. Food and Drug Administration related to products people ingest, but that the company has a “good idea of how its going to go.”
U.S.-traded shares of Aurora fell 9.2% in Thursday trading to close at $5.89, as Canopy stock dropped 3.2% to $26.53. The Horizons Marijuana Life Sciences Index HMMJ, -2.45% fell 2.5% during regular trading Thursday, while the benchmark S&P 500 index SPX, +0.29% rose 0.3%.
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