Short Stop

Short seller protection

Transparency, proper accounting and getting ahead of bad news can help cannabis companies prevent their stocks from being ravaged by short sellers

Critics have attacked short sellers as Wall Street villains for decades. Shorts, as they’re known, were attacked after the 1929 stock market crash. More recently, Tesla CEO Elon Musk blasted short sellers as “jerks who want us to die.” So, it was only a matter of time before shorts began targeting the rapidly growing cannabis industry, betting heavily against the stocks of major Canadian marijuana producers.

In December, shares of Ontario-based Aphria tumbled more than 25% in one day because of a critical report published by short sellers Quintessential Capital Management and Hindenburg Research. The two firms charged that Aphria’s management is part of a shell game controlled by insiders raiding company coffers to line their own pockets. Aphria called the allegations “malicious.” Ontario-based Cronos Group, meanwhile, watched its shares plunge almost 30% last August after short seller Andrew Left’s Citron Research issued what it called a “reality check.” Cronos’ stock has more than recovered, while Aphria’s shares remain under pressure.

A short sale involves selling a stock that has been borrowed. The short seller can later profit from the deal by buying back the stock at a lower price and pocketing the difference. In effect, the short seller is wagering the borrowed stock will fall after it’s been sold so it can be scooped back up at a bargain.

To highlight how cannabis companies can fend off short sellers, Marijuana Business Magazine interviewed Scott Greiper, president of Viridian Capital Advisors, a New York-based financial and strategic advisory firm, and Martin Landry, an analyst at the Toronto-based boutique investment firm GMP Securities.

Landry began with this warning: “There is no secret sauce to prevent a company from being the target of short sellers.”

Below are four things to know to help protect your company’s stock from being the target of short sellers.

 

1. Shares of publicly traded cannabis companies are natural prey for short sellers.

“Those more likely to be a target are rapidly growing companies with high share-price volatility and high trading volumes,” Landry noted.

That’s not good news for cannabis executives, because marijuana stocks are particularly volatile for a few reasons:

  • Cannabis is a fast-growing new industry.
  • Regulations are changing frequently at the state and—in the case of a country such as Canada—federal levels.
  • Nosebleed valuations of cannabis companies often are driven more by news and hype than by technical analysis and a business’ bottom line.

It’s also worth noting that extremely rapid growth can overtake a company’s corporate governance practices, which can undermine a firm’s financial health.

Instead of riding the wave, businesses should stay ahead of the curve and make sure their corporate governance matures along with the growth of the company. For example: It’s not uncommon for companies that grow rapidly to retain their initial founder as both CEO and chairman—a situation that can undermine the value of independent boards and make a company a ripe target for short sellers.

Short sellers, in fact, can have an impact on a company’s corporate governance and management. In the case of Aphria, a special committee in February recommended the Canadian company revamp its board and management practices after short sellers raised a red flag over the purchase of assets in Argentina, Colombia and Jamaica. The short sellers charged that Aphria had overpaid.

The special committee, composed of independent directors, concluded in its report the deal was within an acceptable price range versus similar acquisitions by rivals. But the panel also noted “it appears that certain of the nonindependent directors of the company had conflicting interests in the acquisition that were not fully disclosed to the board.” As a result, the committee recommended Aphria review its board composition, establish a formal process for strategic transactions and “adopt best practices to manage potential conflicts of interest.”

 

2. Be transparent with investors and the general public.

Greiper said companies should hire an experienced investor relations or public relations firm to add process and discipline to the corporate communications strategy.

The cannabis industry, he noted, has seen “overpromotion” on the part of some publicly traded cannabis companies in the form of “fluffy” news releases that have little meaning or are not based on fact. Over time, this can deflate investor confidence in a publicly traded company. Hiring the right investor or public relations firm can help set the right standards for the type of news releases a company distributes, according to Greiper.

He added that the CEO of a publicly traded cannabis company should issue a corporate mission statement or strategy letter. “This establishes communication between the CEO and shareholders and sets the general tone of the company’s goals,” he said. “Of course, the primary goal should be to work for the best interests of shareholders.”

According to Landry, “Companies with great disclosure and good shareholder communications usually will have reasonable expectations built into their stock price. Reasonable expectations often translate into less volatility.” The upshot: A company may well be less susceptible to a short attack.

Landry noted that “managing expectations and avoiding the pitfalls of being too promotional is key.” To defend management’s reputation against short sellers, he said, “having a strong track record of execution will go a long way.”

He added: “Investors will be more forgiving and patient if management has historically rewarded them with good returns.”

 

3. Keep your financial house in order.

Greiper said a company’s website should have a clearly defined “investors” section, where current and potential shareholders can access public filings, announcements of shareholders’ meetings and frequently asked questions, or FAQs.

In addition, the company should hire a strong accounting/audit firm that will provide integrity and accountability to its public financial statements.

Obviously, always filing the financials on time is crucial to reinforcing a company’s credibility with investors. “Lack of doing so usually raises red flags,” Greiper said.

Employing a “strong, experienced (chief financial officer) that will establish strong and transparent financial controls will add credibility to those financials,” he added.

 

4. Get ahead of bad news.

Bad news eventually happens to every company, such as a missed revenue target or a product recall. If you don’t break the news, however, someone else will—think a news organization, a short seller, a website or a social media platform. So, be proactive. If you own your bad news, you can better control the narrative by sharing reasons why the issue surfaced.

“If bad news occurs—or if operations materially missed internal targets—communicate these items with investors rapidly. We have often seen bad news come out on social media and investment websites before a company issues a press release. These things should not happen,” Landry said.

“Transparency will go a long way to establish trust, and transparency starts with clear and timely communications with shareholders.”