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The partnership between Emerald Health (EMH.V) and Village Farms (VFF.V) was never going to be smooth sailing, glittery rainbows, and under-taint kisses until the end of time. Let’s face it, brothers will always fight, especially when money is involved. However, a betting man might have thought the partnership between these two would make it through two Thanksgivings intact, especially as their ensuing brand of cannabis tops the sales charts.

But it appears Village Farms and Emerald are headed to legal problems as the ongoing feud between the two companies has, in the last month, moved from comical to serious and now threatens to hurt both as they trade daily news releases at each other.

So hard have the lines been drawn that an irate investor hijacked the quarterly Emerald financials conference call today and spoke his mind. You could practically hear the bodyblows being soaked up by EMH management.

Have a listen:

“Stop swinging, he’s already dead!”

It’s getting rough for Emerald out there. Village Farms is kicking their ass every day and will not likely stop any time soon, and investors appear to be taking sides with Village.

WHAT’S THE PROBLEM?

Pure Sunfarms, the company created when Emerald and Village Farms joined forces, is a solid enterprise. It produces, and sells, decent weed, and a lot of it.

But it also loses money currently, which means both parties needed to contribute and cover those initial losses and capital costs related to its buildout, which stack up on Emerald’s side a little higher because it signed a supply agreement with Pure Sunfarms to take 40% of its product at a set price.

While that made for a good news release back in the day, currently Emerald has no use for that weed, let alone the money to pay for it, and that’s put them in peril with their partner who finds themselves able to bully the table.

In short, four out of every 10 grams Pure Sunfarms grows is supposed to go to Emerald Health for a premium price. On current production, that’d be 30k kilograms annually. Emerald couldn’t move that much weed if they owned a railway.

So they just stopped buying it.

That played right into Village Farms’ hands.

Here’s how Village characterizes that decision.

Where Emerald has not exercised its right, either in whole or in part, under a supply agreement between Emerald and the joint venture to purchase 40 per cent of the joint venture’s cannabis production, the joint venture has sold some of that excess production in the spot market at prices lower than the predetermined selling price to Emerald under the supply agreement.

Subject to certain limited exceptions provided for in the supply agreement, Emerald is required under the supply agreement to pay the joint venture an amount equal to the difference between the predetermined selling price for the contracted production volumes not purchased by Emerald and the market price realized (to the extent lower than the predetermined selling price).

As at the date hereof, the joint venture has advised the company that: (i) Emerald currently owes the joint venture approximately $7-million of price deficiency obligations; and (ii) Emerald has advised the joint venture that it does not agree with the joint venture’s position and that it believes it is not responsible for any price deficiency obligations under the supply agreement.

Emerald is, of course, wrong. Nobody signs a supply deal for a set amount of weed at a set price and just lets you decide later whether or not you want to be held to it, without penalty.

But VFF has a solution for Emerald, which is to increase their own stake in the joint venture beyond 50% to make up for the money lost in having to dump weed that was grown for Emerald to whoever will take it on the cheap.

And selling weed cheaply is no problem for VFF.

Their cost per gram to grow cannabis is just north of $0.60.  They could shoot cannabis across the country for $1.50 per gram, undercut the entire wholesale market by 3x, and still run a profit – and that’s before Emerald makes up the difference.

Or before they’re SUPPOSED TO make up the difference.

From Emerald’s financials, released late Friday because that’s when you bury your aborted children:

  • Net loss of $17.5-million impacted by $2.8-million inventory writedown and decrease of $9.1-million in fair value adjustments of biological assets.
  • Total selling, general and administrative expenses of $10.1-million lower than Q2 expenses of $12.4-million.

Amateur hour.

Village could probably have PSF grow less cannabis, or vault what it has grown, or rework the agreement, but why bother going out of their way to limit things when Emerald made their big stupid deal to take the weed at a premium?

Meanwhile, Emerald is so damn dysfunctional they’ve no better solution than to just put their fingers in their ears and pretend not to hear anything to the contrary.

Late yesterday evening Emerald received notice from Village Farms stating that Village Farms had advanced $5.94-million to PSF for additional equity. Village Farms claims that it has the right to acquire these shares under the PSF shareholders agreement. In fact, Village Farms has no such right. Despite Village Farms’ claims, Emerald continues to hold a full 50-per-cent ownership interest in PSF.

Did you catch the reason Village Farms ‘has no such right’?

Me either.

It’s a sibling war, for sure. The problem for Emerald is, one brother is on the varsity wrestling team and benches 300 lbs, while the other gets baked with the skids behind the propane tank. When fists are swung, they’re going to land hard.

A DEAL THEY DIDN’T EXPECT TO WORK?

My suspicion with Emerald Health has long been they were a weed company that didn’t want to be bothered with the business of actually being a weed company, and my suspicions on this are backed by the straightest revenue line of any weed company, ever, matched with the most insane valuations ever, through much of 2017/2018.

Mar 2017 $201k – $200m market cap
Jun 2017 $245k – $200m market cap
Sep 2017 $211k – $200m market cap
Dec 2017 $279k – $750m market cap
Mar 2018 $373k – $1 billion+ market cap
Jun 2018 $321k – $900m market cap
Dec 2018 $1.1m – $450m market cap

Sep 2019 $4.6m – $65m market cap

Let’s not forget, Emerald has had a license since 2014. It took three years to be producing and, for 18 months after that point, this outfit made less money every month than my corner laundromat. It managed an off the charts jump in valuation based almost exclusively on Pure Sunfarms progress during that time, even though the actual core business was treadmilling.

By the time money started actually being made at Emerald HQ, their valuation was already in a nosedive, and it has been ever since.

In 2017, Pure Sunfarms projected they’d be growing 75k kilograms of weed by 2020. Earlier this year, that was adjusted to 150k kilos.

That’s a WHOLE LOAD of weed, and that’s problematic for Emerald, which isn’t just selling far less than PSF are growing, but has had to take back a large chunk of the product it has previously sold to the provinces because it’s rotting on the shelf.

Gross margin loss was further compounded by the fact that an inventory write-down occurred during the quarter, to the tune of $2.8 million. The write down consists of $801,197 in dried cannabis that was related to product deterioration and limited remaining shelf life. An additional $2,022,781 was written down due to harvested hemp not meeting quality standards for being extraction grade.

If Emerald’s plan was to big note their agreement when they made it, thinking it would bring in hundreds of millions in market cap but never really materialize into actual business that they’d have to worry about, they picked the wrong partner for a patsy. Village Farms are serious operators and, it seems, smart market players. While all around them were failing to reach their production targets, Pure Sunfarms knocked theirs out of the park, and rather than trim things back to slowly match demand, they appear set on a course to almost deliberately commodotize cannabis for everyone.

You can do that when someone has volunteered to make up the difference. Sell it for 10c a gram if you want, and bill Emerald the remaining $4.90.

Over time, VFF will just shoulder Emerald out of the deal, which is fine for them. But what happens to other LPs when VFF dumps all that cheap weed into the market is also worth noting. With Emerald’s subsidy program in place, they can torch the market for everyone.

Of course, Emerald could try to raise some money and get back in the black, but they just did that, and couldn’t get enough dough to cover their quarterly JV costs.

Here’s how this ends: An asset sale.

Emerald can only prolong the inevitable for so long, they’ll lose in a courtroom and know it, and if their only option is to watch their percentage get whipsawed every quarter until it’s at zero, they’ll have little option but to find a bigger player to take over in the near term.

And that’s a problem because Pure Sunfarms is pretty much all they have worth a damn.

— Chris Parry

FULL DISCLOSURE: No commercial relationship to anyone mentioned.

 

 

 

Disclaimer: ALWAYS DO YOUR OWN RESEARCH and consult with a licensed investment professional before making an investment. This communication should not be used as a basis for making any investment.

Chris Parry

Chris Parry is a two-time Webster Award winning journalist who has been featured in the pages of The Vancouver Sun, The Province, National Post, Spin, Hollywood Reporter, FHM, Stuff, and Stockhouse. He was the first business journalist to identify and focus on the move to marijuana as an investment opportunity, and started Equity.Guru as a venue for honest, no punches pulled coverage of the North American public markets.

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1 Comment on "Emerald Health (EMH.V) shareholder call goes somewhat poorly, as JV death spiral looms"

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Jay
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We as shareholders of both VFF and EMH need to work together and bring management from all three parties (EMH , Pure Sunfarms and VFF) and have them settle this dispute offline. Every party needs some give and take but all three parties need to be successful for everyone sake (Companies, Employees, Shareholders and Customers) This dispute of $7-$17 million is peanuts compared to where these stocks were once valued at. Lets all work together – email the investors relations / management and encourage them to work this out. Not everyone will survive this market, lets work together to ensure… Read more »