12/2/19 CWEB $11.83, CWBHF $8.89

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Summary

  • Charlotte’s Web shares sold off sharply over the past few days due to news of an equity issuance and a statement from the FDA.
  • We believe that management is taking the right steps to grow the company and protect its share of the CBD market.
  • Market fears are overblown and create another buying opportunity.

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Introduction

Charlotte’s Web (OTCQX:CWBHF) shares have sold off sharply over the past week after running up to ~$12 due to two events: a statement by the FDA warning the public of the dangers of CBD consumption and the announcement of a $49.9 million equity issuance by CWBHF.

(TIKR)

Although we certainly don’t view these events as good for the company, we believe that their long-term impact on the company’s operational performance will be minimal and are confident that management is taking the right steps to grow and position itself as the leading CBD company on the market.

We will explain why we are not overly concerned by these events and why we feel that this dip presents an opportunity for investors.

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FDA Statement on CBD

On November 25, the FDA issued a public warning to 15 companies that it accused of “illegally selling products containing cannabidiol (CBD) in ways that violate the Federal Food, Drug, and Cosmetic Act (FD&C Act)”. Charlotte’s Web was not one of the companies named, which is likely attributable to the company’s excellent management team and strict regulatory compliance.

The FDA also announced that “it cannot conclude that CBD is generally recognized as safe (GRAS) among qualified experts for its use in human or animal food” and that CBD does not fit the criteria for classification as a dietary supplement.

The FDA based this decision on the following potential health risks associated with CBD use, which include the following:

  • Liver toxicity – The FDA claims that CBD may be dangerous for one’s liver based on findings during its review of the marketing application for Epidiolex, a drug used to treat two rare forms of epilepsy. Although the FDA did not provide much information with regards to the likelihood or severity of liver damage, it did mention that this was discovered through blood tests.
  • Drug interactions – The agency also warned that “there is a risk of CBD impacting other medicines you take – or that other medicines you take could impact the dose of CBD that can safely be used”.
  • Male reproductive toxicity – According to laboratory tests run on animals, CBD can have an adverse effect on male fertility – “the changes seen include decrease in testicular size, inhibition of sperm growth and development, and decreased circulating testosterone, among others.” However, the FDA did note that these changes were seen in animals, and it is unclear whether CBD would have the same effects on humans.

To be clear, while we don’t doubt the validity of these claims, we believe that the FDA is taking an overly cautious approach to the sale of CBD and CBD-infused products. The aforementioned health risks are likely very minimal and unlikely, given that there has been virtually no public reports or news about individuals reacting poorly to CBD, despite the fact that CBD products have become very popular over the past couple of years.

In addition, we view the FDA’s strict stance on CBD as irrational when viewed in relation to the legal and widely available status of cigarettes and alcohol, which are clearly far more dangerous than CBD.

However, it is important to note that the FDA has not explicitly banned or issued injunctions on the sale of CBD – it has simply outlawed the marketing of CBD products as dietary supplements and made it illegal to sell CBD-infused food products. While this is certainly a blow for Charlotte’s Web and the CBD industry as a whole, all other CBD products appear fine under current guidelines (e.g. tinctures, capsules, topical products).

In addition, we don’t believe that the public will be deterred from using CBD products due to FDA warnings given robust demand for alcohol and nicotine products that have also been the subject of public health concerns.

Concrete regulatory guidelines have yet to be set by the FDA, which said at the end of the statement that “as the regulatory pathways are clarified we will take care to inform all stakeholders as quickly as possible.”

Equity Issuance

Charlotte’s Web also issued a press release the morning of November 25 announcing the placement of 5 million common units (each unit representing one common share and a one-half common share purchase warrant) for $9.97/unit.

Although we were not thrilled by the news, we believe that it may be beneficial to shareholders in the long-run for the following reasons:

  • Growth – Charlotte’s Web is one of the largest companies in a nascent industry that is growing at a red-hot pace. It needs capital in order to continue growing and maintain its share of the CBD industry, and management noted in the press release that this offering will “fund the Company’s business development and for general working capital purposes”.
  • Dilution – Per the company’s Q3 earnings report, CWBHF currently has 106.2 million shares outstanding (on a fully diluted basis). This equity issuance will dilute existing shareholders by at least 4.7% (5 million shares divided by 106.2 million). However, this isn’t an egregious amount of dilution by any means, and it is clear that management is trying to exercise prudence with regards to its capital structure.
  • M&A Potential – Of the publicly-traded CBD companies on the market today, we believe that Charlotte’s Web is the most likely to be taken over by a large CPG (consumer packaged goods) company or major cannabis company. This belief is based on Charlotte’s Web’s rapid growth, dominant position in the industry, and clean track record (unlike competitor CV Sciences). Charlotte’s Web needs to continue to execute in order for this possibility to remain on the table, and additional financing will clearly help the company with regards to this.

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