Part 2 of 2- AREV 37 cents: Cali Cannabis $$$

AREV Brands (AREV:CSE 37 cents) / BC Bud Depot (BCBD – AREV Division) – www.arevbrands.com – Market Cap $19M

As per recent news, AREV is working to close two strategics partnerships in California. Once these are complete, it would make sense that we see a significant revision higher in the valuation of AREV.

They will be partnered (likely at or near 50/50) on an extraction facility only minutes from the Port at Long Beach. This is a fully licensed facility – including (critically important) Cannabis transportation licensing for the State of California.

The second partnership is on 100 acres of outdoor grow near Santa Barbara. This could have “significant” value to AREV shareholders – I explain why at the end of this report.

This is their first deal in California and a leading indicator of what to expect for the remainder of 2019. They currently have several other companies at the table (under negotiation) but AREV wants the share price higher to save excessive dilution to existing shareholders.  

They also plan to finance at some point – but same issue – preferably not at these prices – other than a very small one this month for additional working capital and legal fees. There are plans in the works (May to July) to try and get this share price to a fair valuation. If successful, I assume we will see a financing sometime this summer. And then I assume more partnerships nailed down in California and possibly elsewhere.

INSIGHT ON CALFORNIA

Since full legalization November 2016 (medical and recreational use) in the state of California, the industry has gone through major upheaval in regulation, taxation, etc.  And while the industry remains in transition, it is allowing legal operators to capture “legal” market share from those operating underground or going out of business.

California Cannabis Control has sent thousands of cease-and-desist letters to unlicensed retailers and the bureau is evaluating its next steps – which will likely include shutting off water and power to those operating any kind of Cannabis facility without a license. In L.A., city officials have estimated illegal storefronts outnumber legal ones by a factor of 10.

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[NY Times April 27, 2019] – Relevant Excerpts

Efforts Continue to Shut Down a Booming Grey Market in California. As these efforts continue, the illegal supply will tighten, and legal companies will grow.

“California’s governor, Gavin Newsom, has declared that illegal grows in Northern California “are getting worse, not better” and two months ago redeployed a contingent of National Guard troops stationed on the border with Mexico to go after illegal cannabis farms instead.”

Los Angeles, San Francisco, San Jose and San Diego have laws allowing cannabis businesses, but most smaller cities and towns in the state do not — 80 percent of California’s nearly 500 municipalities do not allow retail marijuana businesses.

Of the marijuana grown in California annually, only a fraction — is consumed in California. The rest seeps out across the country illicitly, through the mail, express delivery services, private vehicles and small aircraft that ply trafficking routes that have existed for decades.

This illicit trade has been strengthened by the increasing popularity of vaping, cannabis-infused candies, tinctures and other derivative products. Vape cartridges are much easier to carry and conceal than bags of raw cannabis.

The federal government still considers marijuana illegal and the Drug Enforcement Administration says it still investigates marijuana-related crimes. But a spokesman, Rusty Payne, said the agency has a bigger crisis to attend to.

“We’ve got our hands full with the opioid epidemic to be honest,” Mr. Payne said. One strategy is to turn off water and power services to noncompliant businesses. “We can’t do Drug War 2.0,”

CALIFORNIA STATS – forecasts vary a bit but are close approximations

The following California stats on Extracted products are a couple years old and flower consumption is higher here than what I have seen elsewhere. Analysts currently estimate about 60% flower (smoked) on averaged.

Edibles earn higher revenues and often account for 25 percent to 60 percent of a dispensary’s profits

Once AREV Closes Their Partnership on 100 acres of Cannabis Grow, the Annual Revenue Potential is Huge

April 1st CBC ran a report on California wine growers getting into the outdoor Cannabis business. Their research showed that one hectare of grapes grown in Sonoma County can be worth up to $460,000 annually. The same area of cannabis can be worth $2.75 million!

These wine growers are great at running a winery – but they have very limited (if any) experience with Cannabis extraction. They can sell their dried flower for smoking, but they are not able to address a very large, and growing, demand for extracted products (oils and distillates). But this does mean they are helping to keep the wholesale cost of biomass (plant material) down and this lowers the input cost for companies like Arev who specialize in extraction (as noted in my Arev research report earlier this week).

Because Canada was one of the first countries to make Cannabis fully legal, the media (and public company) attention has been on Indoor Growing. For obvious reasons we cannot grow year-round in Canada and in British Columbia, the volatile weather makes it higher risk and very seasonal. California by comparison has the best outdoor growing conditions in North America.

A year ago, California growers were getting USD 1200 per pound and this year should get around USD 600 per pound. This will become a common scenario in the Cannabis world as more growers come online and dried flower becomes an agricultural commodity. The prices in Canada will remain somewhat tighter because outdoor growing is not an option outside of British Columbia (although Hemp is).

It is important to note that Cannabis demand in the state of California is as large (or larger) than the entire country of Canada.

In California, for extractors like Arev (think of refiners or brewers), a drop in wholesale flower cost means lower input costs. And as I have been discussing recently, I believe future high margin cash-flow in this business will be made by those with serious extraction expertise – and high-tech extraction equipment / technology. AREV has this but they will also have a very strong online strategy to give them critically important retail distribution channels.

THE ECONOMICS OF A 100 ACRE CALIFORNIA CANNABIS GROW

AREV would still like to control (and profit from) growing its own genetics – and they can keep capital and operating costs WAY down by doing so outdoors. While the risks due to mother nature are much higher, the offsetting rates of return can be exponentially larger because of sheer volume.

With respect to pest control, California only allows limited pesticide use on Cannabis – but does allow most natural (organic) methods of pesticide control.  https://www.cdpr.ca.gov/docs/cannabis/can_use_pesticide.pdf

California growers, which include 1000’s in the grey (illegal) market, who use illegal pesticides or exceed limits, are not allowed to sell ANY of their dried flower or extracted products through legal dispensaries (or online).

BC Bud Depot (and friends) developed their own natural (organic) methods to replace chemicals / pesticides. These have been developed over decades of trials during breeding and indoor/outdoor growing. These “natural alternatives” are expected to work very well for them in California.

And through decades of outdoor growing experience in British Columbia, and through friends in California, they have also perfected the genetics that grow best outdoors – higher resistance, higher yield plants that do exceptionally well in natural sunlight. The plant shown here is a perfect example of this expertise.

This image shows a typical growing season for outdoor Cannabis, and it should be applicable to California. Likely this is the cycle that even the wine country growers follow in Sonoma. For sake of estimating potential revenue from a 100 acre grow in California, I will utilize this chart and assume Arev could harvest one full crop in any given year.

The company is not in a position (or even allowed) to provide financial forecasts yet – simply because the transaction has not closed. However, that does not mean I cannot run our own numbers for sake of speculating in this .30’s price range. Assuming the transaction closes, they can provide investors with their own financial modelling at a later date.

For now, it is possible to speculate ahead of time while the stock is at a lower valuation. If the transaction closes, and these numbers are even close, we could see a dramatically higher valuation on AREV because the numbers are extremely strong.

Assumptions I used:

1) wholesale Cannabis in California will sell for 600 USD on average in 2020/21 (Arev season too late for 2019)

2) seeds would be planted on 6-foot centers using 49 sq. Ft per plant

3) the full 100 acres would be planted

4) I allowed 70% for crop loss (weather damage, etc.)

5) plant yield using their superior genetics would produce 3 pounds of dried flower per plant

THREE DIFFERENT SCENARIOS – SIMILAR OUTCOME

NOTE: Aside from the huge operating cost savings of an outdoor grow, there is enormous capital cost savings. One acre of land is 43,560 square feet. A good size indoor California grow operation is about half that square footage (half an acre). Cost of land, building and equipment is typically in the range of $15 to $18 Million CDN.

ALSO NOTE: These numbers will be highly speculative as we don’t know specifics like soil type, location, strains, open grows or greenhouse, etc. But this provides a good handle on potential and how much money this industry can generate. It is also important to know that the folks at BC Bud Depot (BCBD) are brilliant at growing Cannabis.

Scenario 1) The CBC story from April on California wine growers turning to Cannabis, provided the following insight:

One hectare of grapes in Sonoma County can be worth up to $460,000 annually. The same area of cannabis can be worth USD $2.75 million.

$2.75 Million / 2.47 acres per hectare = $1.11 Million U.S. per acre x 100 acres = Gross Potential Revenue of USD 111 Million annually on 100 acres (assuming 100% efficiency on 100 acres)

Scenario 2) Assume 6ft centers when seeding which would use approx. 49 sq. Ft per plant

43,560 sq. Ft per acre / 49 sq. Ft per plant = 889 plants per acre X 100 acres = 88,900 plants

Assume only 70% survive a harvest season = 88,900 x 70% = 62,230 Productive Cannabis Plants

62,230 plants x 3 pounds per plant (avg) = 186,690 pounds of dried flower

186,690 pounds X $600 U.S. per pound wholesale = $112 Million U.S. per annual harvest ($151M CDN)

Scenario 3) Spreadsheet calc using typical farming methods – using 7 foot spacing for planting

All 3 Modelling Options arrived at similar revenue per acre. Obviously outdoor growing is far higher risk – but there is an excellent trade-off considering the high costs of capital and operating associated with indoor grows. And when you have people like BCBD running this, you mitigate the risks substantially.

If we were to de-risk this even further, we could assume the following:

1) 100 acres based on the above could “in theory” generate almost $150 Million CDN annually in high margin revenue

2) Assume those numbers are off (for whatever reason) so we slash in half to $75 Million CDN

3) Assume deal closes and split with California partner is 50/50 – AREV share is half of $75 Million CDN annually

If 100 acres of outdoor grow can generate $37 Million in annual revenue from Cannabis flower sale, that is a great number. However, I would expect this plant material would be extracted into oils, edibles, etc. That likely means the crop becomes an input cost for the “refining” process and typically you would turn that biomass into something far more valuable – I suspect double or triple the value.

Now instead of growing just dried Cannabis flower for resale on 100 acres (as a wine grower might do on a few acres), you now turn that Cannabis crop into something “extremely” valuable.

If that scenario plays out – and it very likely could – the valuation of AREV will be dramatically higher than what we are currently seeing near $15 Million CDN. Realistically with those type of numbers (and based on peer comparisons within the industry), that type of revenue could value AREV in the range of $100 Million to several hundred Million dollars.

It is scenarios like this that are driving incredibly high valuations on Cannabis companies. But you can see why as the numbers are grossly high. At the end of the day, Cannabis is a very valuable plant on a per pound basis – and even more so when it is distilled / refined down to vaping cartridges, etc. (the extraction process).

This is why I have been so bullish on AREV as the potential is definitely there. And as they close deals (like this first one in California), the capital gain potential from this level is significant.

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Danny Deadlock / MicroCap.com

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