The cannabis industry has been growing at break-neck speed over the past few years, with countless companies jumping in the pool attempting to capitalize off this prolific growth. As a result, the industry is fragmented, comprised of many small players fighting tooth and nail for market share.
Among them is Khiron Life Sciences (TSX-Venture:KRHN), aiming to launch operations in Latin America. The company provides a myriad of products and services based on marijuana, ranging from medical products to “cosmeceuticals”. However, their biggest path to growth seems to be in providing medical marijuana-related products and services to treat patients with unmet medical needs across the region – a number which is pinned to be in the tens of millions.
Just several days ago, Khiron acquired the Latin American Institute of Neurology and Nervous Systems (a.k.a., “ILANS”), a Colombian health service provider network, for $7 million in cash (70%, $4.9 million) and stock (30%, $2.1 million). The name of the game in this deal was patient acquisition, which provides Khiron with immediate revenue and EBITDA recognition. ILANS generated $10.5 million CAD in 2017, and $1.8 million in EBITDA; this puts FY17 EBITDA margin at ~17% up over 600 basis points y/y. Revenue has grown at a CAGR of over 28% since 2012.
The deal provides Khiron with roughly 100,000 patient accounts, and contingencies in place for ILANS to receive more cash ($5 mln) should they meet patient acquisition requirements set in the deal terms. As mentioned before, 30% of the deal was financed by stock, although concerns here are dampened given the 2-year lock up period. Investors need not be worried about immediate selling pressure stemming from the deal – although investors should certainly keep tabs on the lock up expiration date.
As far as immediate cash impact is concerned, the company will be providing 20% of the cash upon closing ($980,000), and the remaining 80% ($3.92 million) over the course of two years. Although exact terms were not disclosed, this would put monthly payments at only $163,000. The structure of the deal appears to be beneficial for Khiron, allowing them to conduct operations with their newly acquired medical clinics with minimal cash impact in the short-term. This gives them the elbow room they need to grow without constraints.
When looking at the industry as a whole in the LatAm region, Khiron only holds a ~2% market share – while some may see this is as a con, the fragmented nature of the business actually provides Khiron with growth potential in consolidating the industry through M&A. Khiron’s healthy balance sheet is another key plus in the thesis. The company is not levered, with a 1x debt/equity ratio, and is solvent with a quick ratio of 1x as well. Working capital is $673K CAD, with a current ratio of ~1.6x. Their investment-grade credit rating further opens the door to debt-financed M&A, and of course, increased market share and revenues.
Their main medical cannabis products are expected to launch in 2019 and 2020, with management expecting annual revenue per patient to be $550 CAD/year. This could translate into potential revenues of $55 million
CAD in 2020 for only the 100,000 patient accounts provided by ILANS. Even if all 100,000 accounts are not successfully converted, the company’s access to capital and M&A abilities could allow it to acquire many more accounts – and turn up even higher-than-expected top-line results, with relatively comfortable debt servicing costs.
In the near term, Khiron Wellness, the company’s cosmeceutical products are planned for 4Q18, with eight of their CBD-based products already approved by INVIMA (think: Colombian FDA). Gross margins on these products are in the low-70% range, and management predicts revenues could reach $29 mln CAD by 2020. When combined, this would put revenue at $84 million in 2020 – with gross margins in the 70-80% range, operating expenses would be what make or break the company’s profitability.
The upside is certainly lucrative, with the primary risk being Khiron failing to translate their M&A efforts into growth, among other things. When connecting the dots, you have a company which is well positioned to take on the rapid growth in the marijuana industry – through consolidation, and organic means as well. The potential reward may outweigh the risks at the moment.
