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CV Sciences’ (OTCQB: CVSI) ambitions of imminently uplisting to NASDAQ may have been cut short after stockholders voted down the Board of Directors’ proposal to effectuate a reverse stock split. This happened at the just concluded AGM this past week.
What is a reverse stock split and why now?
CV Sciences’ reverse stock split, which was aimed at setting the stage for uplisting, would (if it was approved) merge all outstanding shares of the company’s common stock at a ratio of not less than 1-for-2 and not greater than 1-for-10. By boosting the share price, this exercise was expected to clear the pathway for uplisting to NASDAQ, which as a major national exchange, requires that a listed stock trade at certain levels for acceptance.
Interestingly, CV Sciences is already trading above NASDAQ’s minimum bid price of $1 (at the time of writing, the company was inching close to $3.50 a share). Through the reverse stock split, CV Sciences ostensibly wanted a greater margin of safety with regard to NASDAQ’s minimum bid price. It also seemingly wanted a higher share price that could appeal to large institutional investors. Many large investors, including pension funds and mutual funds, typically avoid stocks that trade below $5 a share.
Given its market positioning, which will be analysed in greater detail in subsequent sections of the article, CV Sciences is ripe for long-term institutional investment. That said, why did shareholders shoot down the reverse stock split, which would have boosted the share price and attracted this institutional capital?
The likely reason is that CV Sciences’ share price can appreciate organically based on the company’s stellar operational and financial performance. Investors want to fully participate in this rally. A reverse stock split would deny them the opportunity, explaining why the proposal was rejected.
Though CV Sciences is now close to ten times the $0.40 share price that it started off 2018 with, it still has more room for growth. The underlying business, which is the strongest long-term driver of any company’s valuation, is performing exceptionally well and prospects of even stronger performance in the mid-to-long-term have never been higher.
Strong business performance
CV Sciences operates in two distinct verticals:
- The consumer product segment where it sells its hemp-derived PlusCBD™ product line. This segment is posting double digit revenue growth, is profitable and has strong cash flow
- The pharmaceutical drug development segment, where continued progress on its pre-clinical program for drug candidate, CVSI-007, could see it disrupt the multi-billion nicotine use and addiction market
The consumer product segment is, at the moment, the primary growth driver for CV Sciences. Thanks to sustained organic growth, the company’s PlusCBD™ brand is now the leading hemp CBD product line in the natural products retail channel, according to data from SPINS® Scan data. This is a significant milestone.
Market leadership means that, all things held constant, CV Sciences will grow in tandem with the overall CBD market—which is growing at a double-digit rate. Tellingly, CV Sciences’ sales for Q2 2018 came in at $12.3 million. This represents a 53% sequential quarterly increase from $8.1 million reported for Q1 2018. Sales have been on steady uptrend since Q1 2017, when they came in at $3.8 million. This steady growth in revenue, which totaled $21 million in 2017 has pushed the company into sustainable profitability. In Q2 it posted net income of $3.8 million, marking its second straight quarter of profitability.
Snapshot of financial performance; Source: CV Sciences investor relations
CV Science’s profitability is a critical milestone for two reasons. First, for the simple reason that it is a rarity in the marijuana space, which like most emerging sectors, is characterised by an overwhelming number of loss-making companies. This profitability is an indicator that the company understands the industry dynamics, making it a top candidate for Wall Street investors looking for an entry point into the fast-growing CBD space. The sector is expected to grow tenfold to $1.6 billion between 2016 and 2021, according to a report by the Brightfield Group. Though attracted by these growth prospects, most institutional investors are still watching from the sidelines due to the scarcity of solid long-term plays—CV Sciences is one of the few exceptions.
The second and perhaps more important reason why CV Science’s profitability is a game-changing milestone is that it based on operational excellence and strong fundamentals; not financial gymnastics, as is the case with some players in the CBD space.
Most cannabis companies, whether in CBD or recreational marijuana, have established a regrettable practice of using dilutive securities such as convertible notes, warrants and options to raise capital. This capital is typically used to subsidize costs, leading to low price points and high sales that evaporate immediately the subsidies stop. The cash burn needed to sustain this model creates a vicious cycle few companies ever get out of—a debt trap that dilutes shareholders.
There is no shortage of marijuana companies that illustrate this. Terra Tech (OTCQX: TRTC), which has been publicly traded since 2012, is one such example. It started recording revenue in 2015. In the Q1 2018 it reported total revenue of $8.6 million, of which $7.3 million was related to cannabis. Despite this seemingly good operational performance through the years, investors have given the stock a wide berth due to its addiction to dilutive securities such as convertible notes. Because of the increase in share count that these securities occasion, Terra tech recently effectuated a reverse split at a ratio of 1-for-15, dampening investor sentiment even further.
It is important to clarify that CV Sciences’ proposed stock split was not aimed at mopping up excess shares caused by dilution—as is the case with peers like Terra Tech— but boosting the share price in preparation for uplisting to NASDAQ. In fact, as per its latest earnings release, the company has de-leveraged and fully repaid all outstanding convertible debt that could have caused shareholder dilution. It also has sufficient cashflow to fund its operations, eliminating the need for resorting to securities such as convertible notes. Its cash flow from operating activities was $5.4 million for the six months ended June 30, 2018.
It is worth reiterating that CV Sciences is a rarity in the cannabis space—it is profitable, is not diluting shareholders and is competitively positioned as the leading CBD brand. While this alone makes it a strong buy, its investment case is further strengthened by its pharmaceutical arm. As earlier mentioned, it is in the pre-clinical stages of developing a promising CBD-based drug in the nicotine addiction space-CVSI-007. Nicotine addiction is a top priority area for the FDA and presents a good long-term opportunity for CV Sciences. There are still a couple of stages to go—clinical research and FDA Drug review—before the drug’s commercial roll out. The growth potential of the pharmaceutical arm, combined with continued strong performance in the consumer arm, could attract long-term institutional capital to CV Sciences. Despite the latest speed bump in its efforts to uplisting to NASDAQ (rejection of reverse stock split), there is still more upside potential for this hot buy-and-hold CBD play.
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