Isodiol International Inc. (CSE: ISOL/ OTCQB: ISOLF/ Frankfurt: LB6A): Further Vertical Integration Through Acquisitions
Fundamental Research Corp has issued a report entitled “ Isodiol International Inc. (CSE: ISOL/ OTCQB: ISOLF/ Frankfurt: LB6A): Further Vertical Integration Through Acquisitions ” and dated August 17, 2018. The full report is now at www.researchfrc.com .
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Siddharth Rajeev, B.Tech, MBA, CFA
Anthony de Ru
ijter, B.A. Econ
August
1
7
, 2018
2018 Fundamental Research Corp.
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F THIS REPORT
Isodiol International Inc.
(CSE: ISOL/ OTCQB: ISOLF/ Frankfurt: LB6A): Further
Vertical
Integration Through Acquisitions
Sector/Industry: Cannabis
www.isodiol.com
Market Data (as of August 17, 2018)
Current Price
C$3.21
Fair Value
C$10.10
Rating*
BUY
Risk*
4
52 Week Range
C$
2
.
40
-
C$
18
.
00
Shares O/S
3
9
,
580
,
349
Market Cap
C$
1
2
7
.
0
5
mm
Current Yield
N/A
P/E (forward)
N/A
P/B
2
.
66
x
YoY Return
1
0
.
0
0
%
YoY
TSXV
-
1
2
.
44
%
*See back of report for rating and risk definitions
* All of the figures are in C$ unless otherwise spe
cified.
Highlights
Isodiol International Inc. reported FY2018 revenues
and a net
loss of $19.14 million and $36.16 million (EPS: -$1
.73),
respectively. This reflects YoY revenue growth of 1
35.11%.
Our forecasts for FY2018 revenue and net loss were
$20.77
million and $10.54 million (EPS: -$0.50), respectiv
ely.
We have lowered our FY2019, and FY2020, revenue for
ecasts
to $39.81 million and $66.19 million, respectively.
Our
previous forecasts were $54.60 million and $80.02 m
illion,
respectively.
The company has revealed plans to aggressively expa
nd their
recently acquired KURE Corp. vaporizer-focused subs
idiary.
Isodiol plans to expand the brand by an additional
7-10
locations before calendar year-end.
The company has received approval from the U.K. gov
ernment
for the manufacturing of CBD as an Active Pharmaceu
tical
Ingredient. The company plans to utilize this appro
val to grow
as a CBD contract manufacturer, and is set to suppo
rt this
initiative with the build-out of one of the world’s
largest CBD
processing facilities.
We are revising our fair value per share estimate t
o $10.10
per share.
Key Financial Data (FYE - Mar 31)
(C$)
FY-2018
FY-2019E
FY-2020E
Cash
15,549,664
$
7,230,939
$
20,994,616
$
Working Capital
16,140,738
$
11,577,803
$
26,638,803
$
Assets
54,468,345
$
147,569,809
$
170,024,213
$
Total Debt
612,656
$
612,656
$
612,656
$
Revenues
19,137,266
$
39,805,581
$
66,185,013
$
Net Income
$ -36,160,820 $ -950,7
41
$ 11,878,943
EPS (basic)
-1.73
$
-0.02
$
0.30
$
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Isodiol to
Expand Kure
Subsidiary
Acquires
Azure
Bottling
On June 5, 2018, the company announced expansion pl
ans for its recently acquired
subsidiary KURE Corp. (“KURE”), a U.S. vaporizer br
and that specializes in custom
formulations. The acquisition of Kure was completed
on May 1, 2018, with Isodiol issuing
a total of 2.38 million common shares at an estimat
ed price of $8 per share, valuing Kure at
$19.05 million. Isodiol reported that KURE’s existi
ng 12 stores produced an average of
$0.99 million per annum per store, based on unaudit
ed FY2018 revenues of $10.70 million.
The company have advised that annualized revenues o
f KURE’s 12 existing stores have
grown to US$0.90 million per store, or $1.13 millio
n per store, for the months subsequent to
the company’s fiscal year-end.
On August 9, 2018, the company expanded on their Ju
ne press release by announcing that
they would be opening seven locations in the Greate
r Phoenix area in the state of Arizona.
The initial seven stores are expected to open in mi
d-September. Furthermore, the company
expects that they will open a total of ten retail l
ocations within the Greater Phoenix area by
the December holiday season, including the seven in
itial locations. Each KURE location
will be designed to incorporate a CBD section and H
emp beverage section, which will serve
as a point of sale for Isodiol’s products. Accordin
g to the company, the CAPEX cost
associated with the new stores is expected to be US
$0.30 million.
Apart from introducing a new vertical to the compan
y’s business strategy, the acquisition
and pending expansion of KURE gives Isodiol access
to the high growth vaporizer/ E-
cigarette segment. The table below outlines vaporiz
er/ E-Cigarette-focused companies that
are publicly-traded. Note that mCig Inc. (OTC: MCIG
) is a cannabis vaporizer focused
company.
Company
Market Cap (US$)
EV (US$)
EV/ R
EV/ EBITDA
P/S
P/
E Gross Margin Net Margin Revenue 3-year CAGR
mCIG Inc.
125,342,000
$
125,079,000
$
14.64
86.80
14.67
106.13
40.33%
13.82%
129.90%
Turning Point Brands Inc.
599,800,000
$
794,900,000
$
2.71
15.11
2.05
28.03
44.00%
7.30%
13.50%
VPR Brands LP
5,574,000
$
6,033,000
$
1.58
1.46
3.79
-
36.70%
-38.40%
1390.10%
Source: FRC, Public Disclosures
On March 26, 2018, the company announced that it ha
d entered into a Definitive
Agreement to acquire 100% of Azure Bottling LLC thr
ough its wholly owned subsidiary
IsoBev Inc. Azure Bottling is a water bottling faci
lity located in Leesburg, Florida. Isodiol
acquired Azure Bottling for $1.3 million in cash, a
nd $1 million in stock (estimated price of
$11.40 per share, implying total stock issue of 87,
719). Of the cash component, $1 million
will be paid upfront, while the remaining $300,000
is to be paid six months after the
Definitive Agreement.
The facility currently has a production capacity of
5.3 million bottles per month, which the
company expects to increase to 8.58 million bottles
per month upon improvements to the
facility’s efficiency and production space. Azure B
ottling, apart from being recognized for
the water quality of it products, also has manufact
uring and distribution agreements with
Sysco Corp. (NYSE: SYY), McArthur Dairy/ Dean Foods
(NYSE: DF), and Dollar General
Corp. (NYSE: DG) stores throughout the U.S.
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Receives
Government
Approval,
Announces
China
Facility
The agreement presents three significant advantages
to the company:
Expansion of manufacturing facilities and productio
n capacity.
Expansion of distribution with strong partners.
Potential to expand product offerings of IsoBev.
On April 26, 2018, the company announced that their
subsidiary, BSPG Laboratories Ltd.,
had received government approval for the manufactur
ing of CBD under certificate number
UK API 48727. This is a material development as it
provides Isodiol with the approval
necessary to begin exportation of pure, natural CBD
to any global jurisdiction, subject to
pharmaceutical regulations. This allows Isodiol to
become the go-to CBD supplier for CBD
drug development, R&D, clinical studies, clinical t
rials, and other pharmaceutical
applications.
Capitalizing on their newly secured government appr
oval, Isodiol announced that they plan
to build a CBD processing facility in Yunan, China.
The facility is expected to exhibit a
hemp processing rate of over 15 metric tons per day
, with expected annual CBD production
at 20,000 kilos per annum, making it one of the lar
gest capacity CBD processing facilities
in the world. The company has disclosed a CAPEX bud
get totaling US$12.5 million and an
expected completion date in Q1-2019. Isodiol has ea
rmarked a portion of a recently closed
financing in order to finance the build-out of the
facility.
In conjunction with existing CBD processing facilit
ies, Isodiol exhibits the potential to
become one of the largest CBD contract manufacturer
s globally. With the focus now
shifting to securing purchasers as opposed to secur
ing supply, the company has announced
several Letters of Intent (“LOI”) to supply their I
SO99 CBD isolate, with the CBD isolate
to be imported to Canada from the company’s BSPG La
boratories Ltd. facility in the U.K.
The company signed agreements with the following co
mpanies:
An LOI with Pure Cannabis Inc. (TSXV: PURE), signed
August 2, 2018. Pure
Cannabis Inc. is a Canadian cannabis company with a
subsidiary that is a Licensed
Producer (“LP”) under ACMPR. Upon successful import
ation and product testing,
the two parties intend to establish a Definitive Ag
reement for ongoing CBD supply.
An LOI with Sundial Growers Inc. (“Sundial”), signe
d May 24, 2018. Sundial is a
privately held LP with operations based in Alberta.
Isodiol’s deliverable is to be
imported through an ACMPR Licensed Dealer (“LD”), a
nd both parties intend to
follow the LOI with a Definitive Agreement.
An LOI with Zenabis Ltd. (“Zenabis”), signed May 4,
2018. Zenabis is a privately
held LP with production facilities in British Colum
bia and New Brunswick. Zenabis
will import a minimum of 3 kg per month of pure CBD
isolate from Isodiol. The
CBD is to be used for R&D and product formulation.
A Definitive Agreement that
expands the scope of the collaboration between the
two parties, as well as the
ongoing supply, is expected to follow.
An LOI with Agrima Botanicals Corp. (“Agrima”), sig
ned April 6, 2018. Agrima is
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Expands
Hemp
Farming
Initiative
a Canadian LP. Agrima will import a minimum of 5 kg
per month of pure CBD
isolate from Isodiol. A Definitive Agreement is exp
ected to follow.
Apart from representing an additional revenue sourc
e (assumed, as pricing is undisclosed)
to Isodiol, the supply agreements allow the company
to establish future points of sale.
Though the amounts concerned appear to be relativel
y insignificant, the LOIs may establish
Isodiol as a key supplier of CBD isolate to the can
nabis industry. Assuming that these LOIs
are developed through to full fledged supply agreem
ents for significant amounts of CBD
isolate, we anticipate that other LPs may look to s
ource their CBD from Isodiol as well,
instead of processing their own.
Expanding the scope of their existing business to c
over seed to sale, the company has made
significant strategic investments into the U.S. hem
p farming space. With the company’s
significant processing capability, Isodiol appears
to have also made securing raw hemp a
priority. The company, to date, has made two strate
gic investments in the hemp space:
An investment for 51% of Round Mountain Technologie
s LLC. (“RMT"), a
Nevada-based, state-licensed cultivator of organic
hemp. The RMT property
consists of approximately 155 acres, of which, both
parties plan to plant 70 acres
initially. Isodiol entered into a binding agreement
with RMT on June 12, 2018, and
issued US$0.25 million in stock in return for 51% o
wnership of RMT. Furthermore,
Isodiol committed US$0.40 million in cash to RMT fo
r working capital, though it is
unclear if RMT will be obligated to repay Isodiol.
An investment for 51% of Farmtiva Inc. (“Farmtiva”)
, a California-based cultivator
of hemp. Through Farmtiva’s partnership with a non-
profit group, Imperial Valley
Conservation Research Center, Farmtiva is able to c
ultivate hemp as an “established
agricultural research institution” under the Food a
nd Agricultural Code Section
81000. Since California has yet to establish regula
tions regarding the legal
cultivation of hemp, Isodiol believes Farmtiva may
be one of the first growers to be
cultivating hemp legally in California. Farmtiva, a
long with their partner, have
already planted 60 acres in a facility totaling 160
acres. In return for 51% ownership
of Farmtiva, Isodiol issued US$1.50 million in stoc
k. The investment was completed
on June 4, 2018.
By investing in the hemp cultivation, the company s
ecures raw material supply for future
CBD processing and extraction. This is important as
it allows the company to reach internal
economies of scale whilst also vertically integrati
ng Isodiol’s business. Furthermore, a
supply of legally compliant hemp will allow the com
pany to hedge against movement in the
price of crops, which would otherwise be an issue i
f the company were to remain reliant on
external sources of hemp for their CBD products.
Given that cannabis remains illegal at the federal
level in the U.S., however, we do note that
these investments could potentially raise the risk
profile for the company as they increase
their U.S. exposure. Continued investment of capita
l into the U.S. increases Isodiol’s capital
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Share
Consolidation
Industry
at risk in the event that the federal government fa
ils to relax their stance on cannabis and
hemp. However, we speculate that this risk may be p
riced in to the valuations of U.S.
cannabis operations, suggesting a better deal relat
ive to jurisdictions where cannabis is or
will be legal.
On July 24, 2018, the company announced that it had
finalized their share consolidation on
a one share for ten shares basis. Following the con
solidation, issued and outstanding
common shares will be reduced from 395.80 million t
o approximately 39.58 million. We
believe the consolidation was undertaken in hopes o
f up-listing the company’s common
stock to a major stock exchange in the U.S. We spec
ulate this may be the NASDAQ
exchange.
In a momentous event for the CBD industry, GW Pharm
aceuticals PLC (NASDAQ:
GWPH), a pharmaceutical company based in the U.K. t
hat develops drugs with cannabis as
the main API, received FDA approval for their Epidi
olex drug. The Epidiolex drug, which
is derived from CBD and has been developed as a tre
atment for two rare forms of childhood
epilepsy, is now awaiting approval from the U.S. Dr
ug Enforcement Agency (“DEA”). The
DEA have up to 90 days to weigh in on the FDA’s app
roval, once the FDA has
recommended how CBD should be scheduled as a drug.
Pending the DEA’s approval,
Epidiolex has the potential to kickstart growth for
the CBD industry, which in the U.S.
alone was estimated at US$820 million in 2017.
Source: Hemp Business Journal
However, not all news has been good for the CBD ind
ustry, especially in the U.S. where
Isodiol records its sales. Despite the full legaliz
ation of cannabis in California at the
beginning of 2018, the California Department of Pub
lic Health placed a ban on the
incorporation of CBD into any food or pet food prod
ucts sold in the state. As a result, edible
or imbibed CBD products, which we believe represent
s a large portion of the current and
potential CBD industry in California, remains illeg
al. In addition, CBD may not be sold as a
dietary supplement, further restricting the forms i
n which CBD can be sold to the public.
Whilst we are unsure of how the ban affects non-edi
ble CBD products such as topical
creams (like the company’s ISODerm product), we bel
ieve that the ban may stifle the
growth of California’s CBD industry. This could imp
act the grow
th of the U.S. CBD
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Revenues
industry significantly, as California is expected t
o exhibit one of the highest cannabis-
related sales of any state in the U.S.
Isodiol’s Q4-FY2018 revenues decreased 7.73% QOQ. Y
OY, the company reported Q4-
FY2018 revenues of $5.44 million versus Q4-FY2017 r
evenues of $100,212. Though this
implies tremendous YOY growth in sales, readers sho
uld note sales of Isodiol’s core
operating subsidiary were only recorded after ISO I
nternational LLC’s acquisition in May
of 2017. As the company’s financial year ends March
31
st
, the sales of Q4-FY2017 do not
reflect sales of Isodiol as the company currently o
perates, and do not warrant fair
comparison.
The company reported full year revenue of $19.14 mi
llion for FY2018, versus $8.14 million
for FY2017, reflecting YoY revenue growth of 135.11
%. Note that for FY2017, we use the
recorded revenue of ISO International LLC, which we
believe provides for a more accurate
comparison.
The company’s FY2018 revenue of $19.14 million did
not meet our
previous FY2018 revenue forecast of $20.77 million.
As a result, we have adjusted our
revenue projections
. Our new revenue forecasts for FY2019, and FY2020,
are $39.81
million and $66.19 million, respectively.
Our previous revenue forecasts for FY2019, and
FY2020, were $54.60 million and $80.02 million, res
pectively. We have lowered our
forecasts, and reasons are discussed in the valuati
on section of this update.
STATEMENTS OF OPERATIONS
(in C$) - YE Mar 31st
2019E
2020E
Revenue
39,211,476
54,734,294
COGS
19,605,738
27,367,147
Gross Profit
19,605,738 27,367,1
47
EXPENSES
SG&A
19,605,738
13,683,573
Shipping Costs
392,115
301,039
Share-based Compensation
3,921,148
2,736,715
Research & Development
115,462
121,235
EBITDA
(4,428,725) 10,524,585
Depreciation
Amortization
174,889
339,911
EBIT
(4,603,614) 10,184,673
Financing Costs
-
-
EBT
(4,603,614) 10,184,673
Non-Recurring Expenses
Taxes
Net Profit (Loss)
(4,603,614) 10,
184,673
FOREX Translation
Net comprehensive Profit (Loss)
(4,603,614
) 10,184,673
Weighted Average Shares
39,580,349
39,580,349
EPS
0.12
-
0.26
Source: FRC
The notable increase in revenue in FY2018 compared
to FY2017 is due to the company’s
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Margins
growth in retail sales as Isodiol continues to expa
nd its international footprint. Furthermore,
the company undertook several major acquisitions du
ring the year. Many of these
acquisitions are purportedly cash-flowing entities
with track records of sales and
profitability, according to management. As a result
, we believe that the acquisitions were
accretive to the company’s revenues and will contin
ue to bolster revenue growth. The table
below outlines acquisitions undertaken in the perio
d.
Acquisition Target
Date of Acquistion
Stock Paid
Cash
Paid
Total Transaction Value
Round Mountain Technologies (51%)
June 12, 2018
US$250
,000
US$400,000
US$650,000
Farmtiva (51%)
June 4, 2018
US$1,500,000
US$1,500,000
Kure
May 1, 2018
C$19,050,000
C$19,050,000
Azure Bottling
March 26, 2018
C$1,000,000
C$1,300,000
C
$2,300,000
Biosynthesis Pharma Group
March 12, 2018
US$37,000,00
0
US$12,500,000
US$49,500,000
CN Pharma (100%)
February 15, 2018
C$6,000,000
C$6,000
,000
C3 Global Bioscience
December 8, 2017
US$826,522.45
US
$826,522.45
CN Pharma (25%)
December 6, 2017
C$1,000,000
C$500,000
C$1,500,000
Be Trū Organics (Terminated)
December 1, 2017
US$2,00
0,000
US$2,000,000
Bradley's Bioscience
November 22, 2017
US$380,000
US$3
80,000
Pot-O-Coffee
June 12, 2017
C$2,512,500
C$250,000
C$2,76
2,500
Source: Company
The table below outlines the company’s revenue and
revenue growth for FY2018:
FY2017
FY2018
YoY Growth
Revenue
8,139,558
$
19,137,266
$
135.11%
COGS
4,824,545
$
10,253,530
$
112.53%
Gross Profit
3,315,013
$
8,883,736
$
167.98%
EBITDA
1,088,241
$
-33,255,044
$
-3155.85%
EBIT
1,058,874
$
-34,361,416
$
-3345.09%
Net Profit
649,597
$
-36,160,820
$
-5666.65%
Gross Margin
40.73%
46.42%
EBITDA Margin
13.37%
-173.77%
EBIT Margin
13.01%
-179.55%
Net Margin
7.98%
-188.95%
Source: FRC, Financial Statements
Gross margins decreased substantially QoQ in Q4-201
8 to 25.73% compared to 54.43% in
the previous quarter. For the full year ended, the
company’s gross margin was 46.42%,
compared to ISO International LLC.’s gross margin o
f 40.73% for FY2017. According to
management, reasons for the improvement in the comp
any’s gross margin are due to the
integration of the entities acquired during FY2018.
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Cash Flows
Q3-FY2018
Q4-FY2018
QoQ Growth
FY2017
FY2018
Gross Margin
54.43%
25.73%
40.73%
46.42%
EBITDA Margin
3.44%
-583.18%
13.37%
-173.77%
EBIT Margin
3.43%
-602.59%
13.01%
-179.55%
Net Margin
2.79%
-466.15%
7.98%
-188.95%
Source: FRC, Financial Statements
SG&A expenses (excluding stock-based compensation)
were $28.45 million for Q4-
FY2018, representing an SG&A margin of 523.12%. For
the full year ended, SG&A
expenses amounted to $35.10 million, representing a
n SG&A margin of 183.43%. The
largest contributors to the high SG&A margin were:
$13.05 million in consulting fees.
$11.47 million in acquisition advisory fees.
$3.5 million in wages and salaries.
$1.61 million in advertising and promotions.
$1.14 million in travelling expenses.
The company’s operating expenses increased dramatic
ally in Q4-FY2018. This was due to
fees incurred in relation to the closing of the new
ly acquired subsidiaries, ISO International
LLC, BSPG and other acquisitions. The closing of th
ese acquisitions, and subsequent ramp
up of operations, also resulted in the recognition
of new expenses.
The company reported a substantial net loss in FY20
18 of $36.16 million (EPS: -1.73),
compared to ISO International LLC.’s FY2017 net ear
nings of $0.65 million. The actual
net loss was significantly higher than our forecast
ed net loss of $10.54 million (EPS: -
0.50).
Our new net earnings forecast for FY2019, and FY202
0, are -$0.95 million
(EPS: -$0.02), and $11.88 million (EPS: $0.30), res
pectively.
Our previous FY2019 and
FY2020 net earnings forecast (after adjusting for s
hares outstanding) were $12.00 million
(EPS: $0.30) and $12.98 million (EPS: $0.33), respe
ctively.
Free cash flows (“FCF”) were -$40.12 million in FY2
018. The substantial outgoing FCF is
attributable to the numerous acquisitions undertake
n in the fiscal period. We expect that
Isodiol will need to rely on equity and debt financ
ings to fund near-term operations.
Summary of Cash Flows
($, mm)
2017
2018
Operating
$0.53
-$23.48
Investing
-$0.61
-$16.64
Financing
$0.19
$55.09
Effects of Exchange Rate
$0.00
-$0.14
Net
$0.11
$14.83
Free Cash Flows to Firm (FCF)
-$0.08
-$40.12
Source: FRC, Financial Statements
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Balance
Sheet
Stock Options
and Warrants
Valuation
and Rating
At
the end of FY2018, the company had $15.55 million i
n cash. Working capital and the
current ratio were $16.14 million and 3.41x, respec
tively. The company has a related party
payable which we account for as debt.
(in CAD$) - YE Dec 31st
Liquidity & Capital Structure
2017
2018
Cash
718,648
15,549,664
Working Capital
984,111
16,140,738
Current Ratio
3.62
3.41
LT Debt
-
-
Total Debt
250,000
612,656
LT Debt / Capital
-
-
Total Debt / Capital
0.12
0.01
Total Invested Capital
1,435,749
32,833,003
Source: FRC, Financial Statements
We estimate that the company currently has 1.72 mil
lion options (weighted average
exercise price of $2.22), and 11.50 million warrant
s (weighted average exercise price of
$9.76) outstanding. All the options and 2.35 millio
n warrants are currently in-the-money.
The company has the potential to raise $9.71 millio
n if all the in-the-money options
and warrants are exercised.
The below outlines our updated revenue forecasts fo
r the company.
STATEMENTS OF OPERATIONS
(in C$) - YE Mar 31st
2019E
2020E
2021E
2022E
2023E
2024E
2025E
2026E
Revenue
39,805,581
66,185,013
79,422,015
95,306,419
114,367,702
137,241,243
164,689,491
197,627,389
COGS
19,902,791
33,092,506
39,711,008
47,653,209
57,183,851
68,620,621
82,344,746
98,813,695
Gross Profit
19,902,791 33,092,5
06 39,711,008 47,653,209
57,183,851 68,620,621 82,34
4,746 98,813,695
EXPENSES
SG&A
15,922,233
16,546,253
19,855,504
23,826,605
28,591,926
3
4,310,311
41,172,373
49,406,847
Shipping Costs
398,056
364,018
397,110
476,532
571,839
686,206
823,447
98
8,137
Share-based Compensation
3,980,558
3,309,251
2,382,660
2,430,314
2,573,273
2,744,
825
3,293,790
3,952,548
Research & Development
115,462
121,235
127,297
133,662
1
40,345
147,362
154,730
162,467
EBITDA
(513,518) 12,751,750
16,948,436 20,786,097
25,306,469 30,731,917 36,900,40
5 44,303,696
Depreciation
Amortization
437,223
872,806
879,166
885,208
890,947
896,400
901,580
90
6,501
EBIT
(950,741) 11,878,943
16,069,270 19,900,889 24
,415,521 29,835,517 35,998,825
43,397,195
Financing Costs
-
-
-
-
-
-
-
-
EBT
(950,741) 11,878,943
16,069,270 19,900,889 24,
415,521 29,835,517 35,998,825
43,397,195
Non-Recurring Expenses
Taxes
6,348,036
7,757,235
9,359,695
11,283,271
Net Profit (Loss)
(950,741) 1
1,878,943 16,069,270 19,900,889
18,067,486 22,078,283
26,639,131 32,113,924
Source: FRC
Differences in our assumptions from our previous re
port include:
Revenue has been lowered significantly. Our reasoni
ng includes:
o
Overly aggressive forecasts in our previous reports
. This is due to an overly
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F THIS REPORT
optimistic growth rate for the CBD industry that we
had previously assumed.
We have adjusted the growth rate during the forecas
ting period to 20%. We
believe that this is reasonable given the implied C
AGR of 18.30% based on
recent estimates by the Hemp Business Journal.
o
We have increased our implied EV/ revenue to 5x, ve
rsus our previous EV/
revenue of 3.77x. This reduces the implied revenue
from acquired entities.
Tax expense has been moved further into the future
to reflect the large deficit
accumulated.
Our DCF model is shown below:
DCF Valuation Model
2019E
2020E
2021E
2022E
2023E
2024E
20
25E
2026E
Terminal
EBIT (1-Tax)
-694,041
$
8,671,629
$
11,730,567
$
14,527,649
$
17,823,331
$
21,779,928
$
26,279,142
$
31,679,952
$
NCC
4,417,781
$
4,182,057
$
3,261,826
$
3,315,521
$
3,464,221
$
3,641,225
$
4,195,370
$
4,859,049
$
Investment in WC
-3,755,790
$
-1,297,323
$
-650,987
$
-781,184
$
-937,421
$
-1,124,905
$
-1,349,886
$
-1,619,863
$
CFO
-32,050
$
11,556,363
$
14,341,407
$
17,061,986
$
20,350,130
$
24,296,247
$
29,124,626
$
34,919,137
$
CAPEX
-26,029,972
$
-1,000,000
$
-1,000,000
$
-1,000,000
$
-1,000,000
$
-1,000,000
$
-1,000,000
$
-1,000,000
$
FCF
-26,062,022
$
10,556,363
$
13,341,407
$
16,061,986
$
19,350,130
$
23,296,247
$
28,124,626
$
33,919,137
$
34,936,712
$
PV
-24,742,272
$
9,222,233
$
10,725,406
$
11,882,333
$
13,172,757
$
14,593,824
$
16,212,882
$
17,993,208
$
326,860,736
$
Discount Rate
8.67%
Terminal Growth Rate
3%
Total PV
395,921,107
$
Cash - Debt
32,937,005
$
Equity Value
428,858,112
$
Shares O/S (dil)
40,628,937
Value per share
$10.56
Source: FRC
Our updated DCF models give a new fair value estima
te of $10.56 per share, versus our
previous DCF fair value estimate of $25.10 (adjuste
d on a 10 for 1 basis). The significant
downward revision is due to the substantial lowerin
g of revenue forecasts, as well as new
CAPEX expenditures associated with the new acquisit
ions and capital projects outlined
earlier.
Our comparables and precedent transactions valuatio
n models are given below:
2025 Forecast (Gross
Revenues)
$ 197,627,389
2025 Forecast (EBITDA)
$ 44,303,696
Average EV/ Revenue
3.77
Ave
rage EV/ EBITDA
15.50
Expected EV (CDN$)
$ 745,055,258
Expected EV
(CDN$)
$ 686,707,284
Discounted EV (CDN$)
$383,099,114
Discounted EV (CDN$
)
$353,097,236
Expected Market Cap
$416,036,119
Expected Market Cap
$
386,034,240
Value per Share (C$)
$ 10.24
Value
per Share (C$)
$ 9.50
Comparables Valuation
Source: FRC
We are revising our fair value estimate from $25.10
to $10.10 per share, which is the
average across all our valuation models. We are rei
terating our BUY rating on the
company.
Though we have significantly reduced our fair value
estimate on the company’s
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F THIS REPORT
Risks
shares, we believe that there is still substantial
upside for investors, as the company begins
to integrate their acquisitions and transition to o
rganic growth as a CBD industry leader.
We believe the company is exposed to the following
risks (list is non-exhaustive):
The company operates in an industry that is highly
regulated and subject to material
change from governmental intervention.
Details of operating performance of the recently ac
quired companies are yet to be
disclosed.
Exchange rate risk.
Access to capital and share dilution.
We are maintaining our risk rating of 4 (Speculativ
e).
Page 12
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Appendix
STATEMENTS OF OPERATIONS
(in C$) - YE Mar 31st
2017*
2018
2019E
2020E
Revenue
8,139,558
19,137,266
39,805,581
66,185,013
COGS
4,824,545
10,253,530
19,902,791
33,092,506
Gross Profit
3,315,013 8,883,7
36 19,902,791 33,092,506
EXPENSES
SG&A
2,159,892
35,102,591
15,922,233
16,546,253
Shipping Costs
627,940
398,056
364,018
Share-based Compensation
5,805,689
3,980,558
3,309,251
Research & Development
66,880
602,560
115,462
121,235
EBITDA
1,088,241 (33,255,044)
(513,518) 12,751,750
Depreciation
29,367
Amortization
1,106,372
437,223
872,806
EBIT
1,058,874 (34,361,416)
(950,741) 11,878,943
Financing Costs
40,837
2,205
-
-
EBT
1,018,037 (34,363,621)
(950,741) 11,878,943
Non-Recurring Expenses
368,440
1,504,722
Taxes
292,477
Net Profit (Loss)
649,597 (36,1
60,820) (950,741) 11,878,943
FOREX Translation
Net comprehensive Profit (Loss)
649,59
7 (36,160,820) (950,741)
11,878,943
Weighted Average Shares
20,940,111
39,580,349
39,580,349
EPS
1.73
-
0.02
-
0.30
*indicates years in which Isodiol operated as a pri
vate entity.
Page 13
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BALANCE SHEET
(in C$) - YE Mar 31st
2017
2018
2019E
2020E
ASSETS
CURRENT
Cash and Cash Equiv.
718,648
15,549,664
7,230,939
20,994,616
A/R
150,579
1,676,940
4,975,698
8,273,127
Inventory
430,915
1,839,439
2,487,849
4,136,563
Due from Related Parties
2,068,571
2,068,571
2,068,571
Loans Receivable
1,229,235
1,229,235
1,229,235
Prepaid Expenses
59,297
475,223
742,996
1,235,384
Total Current Assets
1,359,439
22,839,072
18,735,287
37,937,497
Investment
860,955
865,024
865,024
865,024
PPE
59,331
768,348
17,456,125
17,583,319
Intangibles
8,154,172
11,279,172
14,404,172
Product Development
Leasehold Improvements
290,870
290,870
290,870
Goodwill/ Acquisitions
13,030,831
98,943,331
98,943,331
Level Brands Licensing Agreement
Acquisition Deposits
8,520,028
Total Assets
2,279,725
54,468,345
147,569,809
170,024,213
LIABILITIES
CURRENT
A/P
125,328
5,380,654
5,452,819
9,066,440
Deferred Revenue
409,127
796,112
1,323,700
Due to Related Parties
612,656
612,656
612,656
Loans Payable
250,000
Income Taxes Payable
295,897
295,897
295,897
Acquisition Commitment
Total Current Liabilities
375,328
6,698,334
7,157,484
11,298,693
Total Liabilities
375,328
6,698,334
7,157,484
11,298,693
SHAREHOLDERS EQUITY
Share Capital
14,336,816
90,143,673
179,756,170
182,881,170
Reserves
1,443,654
7,663,231
11,643,789
14,953,040
AOCI
139,947
-
139,947
-
139,947
-
Accumulated Deficit
13,876,073
-
49,896,946
-
50,847,687
-
38,968,743
-
Total shareholders’ equity (deficiency)
1,904,397
47,770,011
140,412,325
158,725,519
Total Liabilities and Shareholders Equity
2,279,725
54,468,345
147,569,809
170,024,213
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STATEMENTS OF CASH FLOWS
(in C$) - YE Mar 31st
2017
2018
2019E
2020E
OPERATING ACTIVITIES
Net Profit for the Year
649,597
36,020,873
-
950,741
-
11,878,943
Adjusted for items not involving cash:
Shares issued for services
8,013,722
Shares issued as acquisitions costs
1,267,980
Share-based Payments
5,805,689
3,980,558
3,309,251
Amortization
29,367
1,106,372
437,223
872,806
Unrealized Loss on Investment
87,574
Loss on Exchange Rate
215,551
Bad Debt
418,559
Impairment of Assets
730,665
Related Party
368,440
Funds From Operations
1,134,978
18,462,335
-
3,467,040
16,061,000
Change in working capital
A/R
298,417
-
2,982,271
-
3,298,758
-
3,297,429
-
Prepaids
256,544
-
415,926
-
267,773
-
492,388
-
Inventory
129,040
-
1,832,177
-
648,410
-
1,648,714
-
A/P
416,033
206,024
-
72,165
3,613,621
Deferred Revenue
654,123
409,127
386,985
527,589
Temporary Investments
570,604
-
Income Tax Payable
295,897
Related Parties
419,431
-
281,465
-
-
-
NET CASH USED IN OPERATING ACTIVITIES
531,098
23,475,174
-
288,750
-
14,763,678
INVESTING ACTIVITIES
Capital Assets
107,592
-
1,207,576
-
17,125,000
-
1,000,000
-
Level Brands Share Issue
Intangibles
443,859
-
1,078,510
-
Goodwill
4,771,174
-
Acquisition Deposits
8,520,028
-
Cash Acquired on Acquisition
161,541
Acquistion-Related
8,904,972
-
Loans
1,229,235
-
Investments
61,500
-
NET CASH USED IN INVESTING ACTIVITIES
612,951
-
16,644,982
-
26,029,972
-
1,000,000
-
FINANCING ACTIVITIES
Proceeds from Common Shares
56,657,974
17,999,997
-
Issue Costs
1,566,855
-
Shares Issued to Level Brands
Cash Received Upon Acquisitions
Related Parties
Proceeds (repayment) from the issuance of Loans Pay
able
190,000
NET CASH FROM FINANCING ACTIVITIES
190,000
55,091,119
17,999,997
-
Foreign Exchange / Others
139,947
-
INCREASE IN CASH FOR THE PERIOD
108,147
14,831,016
8,318,725
-
13,763,678
CASH, BEGINNING OF THE PERIOD
-
718,648
15,549,664
7,230,939
CASH, END OF THE PERIOD
108,147
15,549,664
7,230,939
20,994,616
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Fundamental Research Corp. Equity Rating Scale:
Buy
– Annual expected rate of return exceeds 12% or th
e expected return is commensurate with risk
Hold
– Annual expected rate of return is between 5% and
12%
Sell
– Annual expected rate of return is below 5% or th
e expected return is not commensurate with risk
Suspended or Rating N/A—
Coverage and ratings suspended until more informati
on can be obtained from the company regarding recen
t events.
Fundamental Research Corp. Risk Rating Scale:
1 (Low Risk) -
The company operates in an industry where it has a
strong position (for example a monopoly, high mark
et share etc.) or operates in a regulated
industry. The future outlook is stable or positive
for the industry. The company generates positive
free cash flow and has a history of profitability.
The capital
structure is conservative with little or no debt.
2 (Below Average Risk) -
The company operates in an industry where the fund
amentals and outlook are positive. The industry an
d company are relatively less
sensitive to systematic risk than companies with a
Risk Rating of 3. The company has a history of pro
fitability and has demonstrated its ability to gene
rate positive
free cash flows (though current free cash flow may
be negative due to capital investment). The compan
y’s capital structure is conservative with little t
o modest use of
debt.
3 (Average Risk) -
The company operates in an industry that has averag
e sensitivity to systematic risk. The industry may
be cyclical. Profits and cash flow are
sensitive to economic factors although the company
has demonstrated its ability to generate positive e
arnings and cash flow. Debt use is in line with in
dustry
averages, and coverage ratios are sufficient.
4 (Speculative) -
The company has little or no history of generating
earnings or cash flow. Debt use is higher. These
companies may be in start-up mode or in a
turnaround situation. These companies should be co
nsidered speculative.
5 (Highly Speculative) -
The company has no history of generating earnings o
r cash flow. They may operate in a new industry wi
th new, and unproven products.
Products may be at the development stage, testing,
or seeking regulatory approval. These companies ma
y run into liquidity issues, and may rely on extern
al funding.
These stocks are considered highly speculative.
Disclaimers and Disclosure
The opinions expressed in this report are the true
opinions of the analyst about this company and indu
stry. Any “forward looking statements” are our be
st estimates
and opinions based upon information that is publicl
y available and that we believe to be correct, but
we have not independently verified with respect to
truth or
correctness. There is no guarantee that our forec
asts will materialize. Actual results will likely
vary. The analyst does not own any shares of the
subject company,
does not make a market or offer shares for sale of
the subject company, and does not have any investme
nt banking business with the subject company. Fe
es were
paid by ISOL to FRC. The purpose of the fee is to
subsidize the high costs of research and monitorin
g. FRC and/or companies with related management h
old shares
in the subject company. FRC takes steps to ensure
independence including setting fees in advance and
utilizing analysts who must abide by CFA Institute
Code of
Ethics and Standards of Professional Conduct. Add
itionally, analysts may not trade in any security u
nder coverage. Our full editorial control of all
research, timing
of release of the reports, and release of liability
for negative reports are protected contractually.
To further ensure independence, ISOL has agreed to
a minimum
coverage term including four reports. Coverage ca
n not be unilaterally terminated. Distribution pr
ocedure: our reports are distributed first to our
web-based
subscribers on the date shown on this report then m
ade available to delayed access users through vario
us other channels for a limited time.
The distribution of FRC’s ratings are as follows:
BUY (73%), HOLD (6%), SELL / SUSPEND (21%).
To subscribe for real-time access to research, visi
t http://www.researchfrc.com/subscription.htm
for subscription options.
This report contains "forward looking" statements.
Forward-looking statements regarding the Company
and/or stock’s performance inherently involve risks
and
uncertainties that could cause actual results to di
ffer from such forward-looking statements. Factors
that would cause or contribute to such differences
include, but are
not limited to, continued acceptance of the Company
's products/services in the marketplace; acceptance
in the marketplace of the Company's new product
lines/services; competitive factors; new product/se
rvice introductions by others; technological change
s; dependence on suppliers; systematic market risks
and other
risks discussed in the Company's periodic report fi
lings, including interim reports, annual reports, a
nd annual information forms filed with the various
securities
regulators. By making these forward looking statem
ents, Fundamental Research Corp. and the analyst/a
uthor of this report undertakes no obligation to up
date these
statements for revisions or changes after the date
of this report. A report initiating coverage will
most often be updated quarterly while a report iss
uing a rating may
have no further or less frequent updates because th
e subject company is likely to be in earlier stages
where nothing material may occur quarter to quarte
r.
Fundamental Research Corp DOES NOT MAKE ANY WARRANT
IES, EXPRESSED OR IMPLIED, AS TO RESULTS TO BE OBTA
INED FROM USING THIS
INFORMATION AND MAKES NO EXPRESS OR IMPLIED WARRANT
IES OR FITNESS FOR A PARTICULAR USE. ANYONE USING
THIS REPORT
ASSUMES FULL RESPONSIBILITY FOR WHATEVER RESULTS TH
EY OBTAIN FROM WHATEVER USE THE IN
FORMATION WAS PUT TO.
ALWAYS TALK TO YOUR FINANCIAL ADVISOR BEFORE YOU IN
VEST. WHETHER A STOCK SHOULD BE INCLUDED IN A POR
TFOLIO
DEPENDS ON ONE’S RISK TOLERANCE, OBJECTIVES, SITUAT
ION, RETURN ON OTHER ASSETS, ETC. ONLY YOUR INVES
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WHO KNOWS YOUR UNIQUE CIRCUMSTANCES CAN MAKE A PROP
ER RECOMMENDATION AS TO THE MERIT OF ANY PARTICULAR
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FOR INCLUSION IN YOUR PORTFOLIO. This REPORT is
solely for informative purposes and is not a solici
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is
not intended as being a complete description of the
company, industry, securities or developments refe
rred to in the material. Any forecasts contained i
n this report
were independently prepared unless otherwise stated
, and HAVE NOT BEEN endorsed by the Management of t
he company which is the subject of this report.
Additional information is available upon request.
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