by MC

Intro

To some, the legalization of recreational consumption of cannabis in November’s elections may come as a bit of a shock given that a total of eight states have now legalized recreational cannabis consumption and over half our Union (29 states to be exact) has legalized marijuana for medicinal consumption (see map below from Governing.com).

10 years ago, there were only six states who legalized medical marijuana: California, Oregon, Maine, Nevada, Colorado and Montana. What a difference 10 years has made and what a shift in the mentality and acceptance of marijuana to mainstream society! Make no mistake, cannabis is still considered a Schedule I drug by Federal Law under the Controlled Substances Act, so businesses and individuals may still be subject to Federal prosecution should the Federal Government decide to go after you. Fortunately though, the Feds thus far have taken a hands-off approach to regulating marijuana and have mostly left regulation up to the states.

This shift in societal mentality has piqued my curiosity of public investment opportunities in the industry and this article will cover some of the research I’ve done on a particularly interesting company whose focus is extracting and refining cannabinoids (a class of cannabis-derived chemical compounds that acts on and affects our cannabinoid receptors, thereby altering our movement, pain and sensory perception, cognition, emotion and, surprise surprise, our appetite) for use in solving real world medical problems like epilepsy in children.

Wait a minute! Did you just say we have cannabinoids in our bodies? Yes, otherwise known as our endocannibinoid system! In fact, to date, there are two types of known cannabinoid receptors: CB1 and CB2. Each is distributed in different parts of our bodies and when “modulated” by cannabis or phytocannabinoids, produce varying effects as mentioned earlier. That’s all we’ll cover on the topic for now, but if you want more info, here is are some great resources to educate yourself:

• http://dev-gwpharma.pantheonsite.io/products-pipeline/research-trials/mechanism-action
• https://www.medicaljane.com/category/cannabis-classroom/cannabis-science/#cannabinoids-101

Cannabinoids 101

We can’t discuss benefits of marijuana without differentiating between two important compounds found in the plant: THC (or tetrahydrocannabinol – the stuff that gets you “stoned”) and CBD (cannabidiol – the more useful phytocannabinoid that is known to provide real medical benefits). There are actually over 100 various phytocannabinoids but THC and CBD are the two most widely-known and used substances at present. Today most recreational facilities cater to the Cheech and Chongs of the world and produce high-THC flower (upwards of 25% plus) and edibles, which, trust me, is much higher and more potent than the dirt weed you’re used to buying from your “friend’s dealer”. But this blog isn’t about getting high, it’s about real companies out there creating viable, alternative solutions for serious medical problems.

A Deeper Dive into CBD’s

Cannabidiols have long been known to play important roles in the medicinal world. Here are just some of the ways CBD’s have helped improve the lives for many ailing patients:

• Slowing the effect of Alzheimer’s Disease
• Relieving effects of PTSD symptoms in veterans
• Soothing tremors of people with Parkinson’s Disease
• Reducing the amount of convulsions that come with epilepsy
• Reducing inflammation that results from those with an Inflammatory Bowel Disease
• General reduction of various pains felt in patients
• Reduces nausea and vomiting, particularly in cancer patients treated with chemo
• Slowing or even eliminating spread of cancer cells

While the majority of these are not widely accepted treatments by the FDA (U.S. Food and Drug Administration) because of marijuana’s status as an illicit drug (and subsequent inability to legally procure marijuana plants for structured R&D which leads to clinical trials which are needed prior to applying for a New Drug Application to the FDA), there are still companies out there exploring possibilities of CBD’s and therapeutic effect they provide and even a great many of advocates of cannabis as alternative medicine. One such example comes from a letter from the Director of the National Institute on Drug Abuse to the U.S. Senate Caucus on International Narcotics Control. It is a fascinating letter filled with evidence of CBD’s medicinal benefits.

GW Pharmaceuticals

Given the potential for marijuana to assist in a wide variety of ailments and diseases, there must be some legitimate, publicly-traded company out there conducting R&D and production of such drugs. Sure enough there is – GW Pharmaceuticals (GWPH). Founded in 1998 and headquartered in the U.K., the company was the first to develop a cannabis-derived drug, Sativex, which treats spasticity resulting from Multiple Sclerosis and is approved for use in 29 countries, not including the U.S.  GWPH recently completed their Phase 2 study of Sativex for children with spasticity due to cerebral palsy and we’ll be looking forward to results in 1Q 2017. Sativex is their only commercially viable product at the moment.

However, GWPH does have additional products in the pipeline, namely Epidiolex which is a CBD-derived drug to treat symptoms of Dravet syndrome, Lennox-Gastaut syndrome (LGS), Tuberous Sclerosis Complex (TSC) and Infantile Spasms (IS), all of which currently have few or no options for treatment. During 2016, GWPH did announce favorable results of their studies and efficacy of Epidiolex (in March and September), which the market found favorable (see chart below).

Though the results of Epidiolex for Dravet and LGS may have looked good on paper, the company has yet to bring in a profit since 2012, capital expenditures have gone through the roof and they continue to dilute shareholder’s equity through stock issuance (see financial table below from Morningstar).

In addition, GWPH still faces significant hurdles from a regulatory point of view. Since they’ve only successfully commercialized one product, they still have to prove success of another one and that not only includes successful clinical trials, it also includes FDA approval, ability to develop cost-effective and proven manufacturing of the drug, successful marketing of the product,  securing a distribution chain, competition from Insys Therapeutics and Zogenix, and gaining support of physicians, health-care providers and the wider community to accept use of what’s essentially been a severely stigmatized substance for decades.

Though the road for GWPH is a long and uphill one, there are a few things I do like about the company. For one, its Founder, Dr. Geoffrey Guy is still around and acts as Chairman of the Board. It is critical for companies out to prove an otherwise unproven concept to have their founders around to provide guidance and continued confidence in the long-term vision for their employees. Companies like Amazon, Walmart, Air BnB and Southwest Airlines, just to name a few, were successful in large part due to their founders sticking around for the long-haul. Without this foundation, it is exceedingly difficult for companies in such a competitive environment to succeed.

Another reason I like GWPH is that they take a very calculated, stringent scientific approach to the use of marijuana to cure medical issues and are extremely careful to not mis-communicate that message. Many outsiders looking into the marijuana industry are quick to make assumptions that most companies in this industry are your fly-by-night jokers who are in it to make a quick buck while having the pleasure of getting stoned. GWPH has carefully crafted their image to ensure the public does not make this mistake and have been largely successful in this endeavor.

Lastly, no discussion of this would be complete without some comment on the U.S. political situation. With the Republicans in the driver’s seat, one might fret that marijuana’s legalization days are over, however, I don’t necessarily agree. Though Trump’s selection in Jeff Sessions as AG may be seen as a blow to marijuana legalization given his past opposition to the substance, I feel Trump, being the businessman he is, will see the opportunity in the incremental taxes and job creation marijuana brings to the nation. Though he’s not been extremely vocal on marijuana, he’s been quoted as saying he believes marijuana legalization should be an issue left to the states. One should also note that GWPH seems to believe in the viability of the U.S. as a target market given that the CEO Justin Gover has recently setup shop in Southern California. At the end of the day it really is anyone’s guess as to what will happen at the Federal level so any astute investor in this industry would be wise to be watch closely.

Conclusion

While cannabis has the potential to become a serious contender in treating a variety of illnesses, the industry still faces an uphill battle not only from regulatory perspective, but also from the negative reputation that has been attached to it over the past several decades. Any publicly-traded company dealing in this business must face these hurdles and GW Pharmaceuticals seems to have established a favorable position for themselves to fight those battles over the long-term.

Though I believe GWPH has long-term potential, it comes with a high degree of short-term risk and uncertainty, making this investment what I like to refer to as purely speculative and does not adhere to any of the criteria we laid out in a previous blog: Screening for Winners in the Equity Universe – Employing the “2-10-10” Methodology.

GWPH, however, does remain a potential interesting long-term buy – one which we will continue to monitor and circle back around to in a future blog.