The pot stocks plunge when CannTrust's troubles cast shadows on the cannabis sector

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Health Canada surveys are being felt at the sector level with investors who re-evaluate their interest.

Tijana Martin / The Canadian Press

Canadian cannabis stocks fell sharply on Friday, while the CannTrust Holdings Inc. scandal continued to shake investor confidence in the sector and raise concerns that future operations may be at risk.

On Thursday evening, CannTrust announced that it is blocking all sales as federal regulators investigate the company's manufacturing plant in Vaughan, Ontario. The news came four days after CannTrust acknowledged that Health Canada had issued a non-compliance order to CannTrust for the cultivation of thousands of kilograms of cannabis in five unlicensed rooms in its 12-room greenhouse in Pelham, Ontario. between October 2018 and March.

CannTrust shares fell 17.3% on Friday to finish the week by 48.3%, amid concerns that the company could lose its license or, at least, be forced to destroy thousands of kilograms of products for tens of millions of dollars.

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While the fallout was particularly dramatic for CannTrust, the implications of the Health Canada investigation are being felt at the industry level. Institutional investors who were starting to heat up the sector are re-evaluating their interest. Meanwhile, concerns are growing that Health Canada may respond to the compliance breach by increasing regulatory demands.

Canopy Growth Corp. fell 7.99% on Friday, while Aurora Cannabis Inc. lost 5.98%. The fund traded by the Marijuana Index Life Sciences Index, which replicates the Canadian cannabis industry, has fallen by 8.6% since Monday.

CannTrust was considered among the highest quality operators in space.

Tijana Martin / The Canadian Press

"We advise US banks quite a lot in this space, those in business and those who are planning to do business, and the most important issue for them is always legal compliance," said Patricia Olasker, a partner with Davies Ward Phillips & Vineberg LLP which guides the practice of cannabis in the company.

"There has always been some skepticism about the conformity of the Canadian industry. We have always emphasized that this is a highly regulated industry, with strict rules and that this should be a great source of comfort. I think that people have been comforted by this, and then it happens CannTrust and this really shakes people's trust, "he said.

"Any lawyer you talk to will say they have a number of agreements that could be affected by this," he added.

CannTrust, which is led by former CEO of Tangerine Bank Peter Aceto, was considered one of the highest quality operators in space. The company is listed on the Toronto Stock Exchange and the New York Stock Exchange and has collaborations with companies such as Apotex Inc. and the alcohol distributor Breakthru Beverage Group.

In May, CannTrust raised US $ 170 million in a public offering co-led by Merrill Lynch, Citigroup, Credit Suisse Securities (USA) LLC and RBC Capital Markets.

The story continues under the publicity

With the power to suspend or revoke licenses, he is not sure what Health Canada will do.

Tijana Martin / The Canadian Press

"It certainly hurts the confidence of investors. I think people are seeing everything that happens with CannTrust, and probably a question they have in mind is: is this happening with other authorized producers?", Said Ryan Macdonell, an analyst with GMP Securities , in an interview. Mr. Macdonell changed his rating for CannTrust to "under review" on Friday, indicating the inability to analyze the stock, given the amount of uncertainty surrounding the company.

A significant blow to investor confidence could have important implications for a sector where few companies have positive cash flow and most rely on equity financing for both capital expenditure and day-to-day operations.

Eric Foster, who leads the practice of cannabis at the Dentons Canada LLP, said that the implications of CannTrust's problems could go beyond equity markets.

"More and more often we see bigger banks entering and more traditional loan opportunities are available for authorized producers. But something like this will be a diligence problem," he said. "Cannabis companies may find it increasingly difficult to obtain commercial bank debt financing and, therefore, they will have to look at capital markets. With a depressed stock price it can become problematic."

A big stranger in all this is how Health Canada will respond. The federal regulator has the power to suspend or revoke the license of CannTrust, although he has not indicated how he intends to proceed.

It seems that Health Canada has started investigating CannTrust after receiving a suggestion from a former employee who reported the foul.

Tijana Martin / The Canadian Press

"Any serious bankruptcy in a regulated sector will lead to more requirements for everyone else in that sector. Thus, while Health Canada did not say they would do it, it could certainly be a fallout implication," said Karina Lahnakoski, vice president, quality and regulation of the consulting company Cannabis Compliance Inc.

The story continues under the publicity

"I came from (the pharmaceutical industry), where whenever there is a serious failure, regulators have to react by entering more requirements, more reporting requirements, more inspection requirements, updating their guidance documents "Usually it's a reaction. You may not see it right away. But Health Canada will surely take this as a learning opportunity," said Ms. Lahnakoski.

Health Canada has conducted three company greenhouse inspections since the Cannabis Act came into effect in October, Health Canada spokesperson Tammy Jarbeau wrote in a statement to The Globe and Mail.

"Prior to the recent inspection at the CannTrust site (Pelham), which led to a non-compliant evaluation, two inspections were conducted to assess the license holder's compliance with good production practices (for example, product quality) and compliance with odor controls ". . Jarbeau wrote.

The regulatory situation is particularly worrying, said Mrs. Olasker of Davies, because the Health Canada monitoring system does not seem to have caught the infringement. Rather, Health Canada appears to have begun its investigation after receiving a report from a former employee.

The company stopped selling when Health Canada began inspecting the Vaughan plant.

Nathan Denette / The Canadian Press

"Two things we are saying to our customers, is comforted by the fact that Health Canada reacted very quickly. Within a day or two of being informed of the problem, they were responding," Mrs. Olasker said.

"I also think you could point this as a stern reminder to other producers: respect or risk a beating in the stock market, which could make the next guy less prepared to pull the plywood walls for illegal cultivation operations. ".

The story continues under the publicity

In an interview with The Globe on Friday, Aceto, CEO of CannTrust, stated that the company decided to stop selling after Health Canada began to inspect the plant in Vaughan.

"With great caution we decided voluntarily that we would not ship the product out of our facility until we had processed our discussions with Health Canada," Aceto said.

He refused to say what he or the other top knew about illegal growth operations.

"We have this independent board of directors, they commissioned a comprehensive analysis of the causes and until the work was done, we are not in a position to know or articulate exactly what happened," said Aceto. .

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