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Market leaders still heavily in demand from short sellers
Rally from low valuations in Q4 has not dented short
demand
At $484m, 2019 delivers record revenue for lending Cannabis
equities
The Cannabis sector has delivered uneven returns, with positive
developments in some areas being offset by challenges elsewhere. It
seems fair to say that to this point the sector has rewarded those
who invested early, however it has generally frustrated efforts by
investors to get involved more recently. With significant
volatility in share prices, there is more to the returns of the
sector for investors, namely the revenues from lending shares to
short sellers.
One of the best examples is Tilray, which has been one of the
highest revenue generating US equities since its IPO in July 2018.
Since going public, shares of TLRY have generated $148m in revenue,
contributing 2.9% of all North American equity lending revenue.
That's impressive considering that the returns were generated on
0.04% of NA equity loan balances. From the perspective of an
investor who purchased shares on the first day of public trading,
the share price as of January 27th reflects a decline of just over
$11. Making reasonable assumptions around fee split and
utilization, that investor could have earned $36 in lending
revenue. The price of the security, and its value to investors, is
therefore fundamentally altered by the consideration of lending
revenues. Similarly, while shorting TLRY from the peak valuation
has been a fruitful venture for short sellers, their profit has
been meaningfully impacted by the borrow cost paid. Tilray is an
extreme example, reflecting as much the dynamics of lending fees
for low-float IPOs as the Cannabis industry, but it is instructive
for thinking about the lending fee and borrow cost as critical
inputs to the investment process.
Canopy Growth, one of the market leaders in the sector, has seen
consistent demand from short sellers in the years since going
public. 2019 was exceptional, however, in the scale of borrow
balances and related revenues, totalling $153m in revenue, or just
over 4% of NA equity total. YTD revenues of just over $23m equate
to 8.7% of NA equity revenues, suggesting this year could deliver
an even higher total. While the fees are unlikely to ever reach the
eye-popping levels observed for TLRY shares in the period between
the IPO and lockup expiry in January 2019, an early investor in
Canopy Growth could have fully recouped their investment in the
firm via lending fees by this point.
UK based GW Pharmaceuticals, which trades via GWPH ADR in the US
on the NASDAQ, is certainly a firm apart from those whose business
is related to Cannabis, with its focus on cannabinoid related
medicines. It too has been a target for short sellers, however, and
short interest in the stock has reached a new all-time high in
terms of shares and market valuation in 2020. An abundance of GWPH
shares available for borrow has kept a lid on lending fees to this
point, though it's worth noting the utilization of the shares in
lending programs has increased from a low point of 25% in August
2019 to just over 40% at present. A further increase in borrow
demand could start to push up on fees going forward.
The combined market cap for Cannabis related equities peaked in
October of 2018 at nearly $70bn, however that's a bit misleading
given that it was only for one day and Tilray represented $15bn of
the total. Excluding Tilray, the combined market cap peaked just
below $61bn in April 2019, on the eve of Canadian legalization in
June. Loan balances for Cannabis related equities peaked in the
weeks after CA legalization at just over $5bn.
Taken together Cannabis related equities contributed 13.6% of
all North American equity lending revenue in 2019, totalling more
$484m; That's up from $355m in 2018, which was 12.3% of the total.
Through January 27th the revenue contribution is 15.3%, with
Cannabis related equities on pace to have the greatest influence on
record. The increase in market valuations for Cannabis related
equities, from the low point in Q4, may reflect a starting point
for a broader recovery or a lower risk entry point for short
positions, in either case, a consideration of lending fees and
borrow costs are critical for all investors.
Posted 04 February 2020 by Sam Pierson, Director of Securities Finance, S&P Global Market Intelligence
