Last November, Edmonton, Alberta-based cannabis behemoth Aurora Cannabis (TSX: ACB) (OTCQB: ACBFF) secured the right to buy about 40% of Choom Holdings (CSE: CHOO; OTCQB: CHOOF), an emerging penny stock company—with no revenue—that is in the early stages of building a cannabis retail network in Canada.
To be clear, Aurora does not yet own 40% of Choom’s future network dream. For $20 million invested in November, they received certain convertible debentures and share warrants, including the ability to buy approximately 40% of Choom within 2 years.
Why did Aurora buy into this small company with big dreams but no revenue? How much will it cost Aurora in the future to get the 40%? Couldn’t they just build their own network?
Was this an astute business deal, or a “pipe” dream?
On the face of it, the Choom brand isn’t terribly original. It’s about carefree good times among young friends on a beach getting high. We love that image, but how many millions of dollars could it be worth?
But wait. Digging deeper—into the beach sand, so to speak—we discover the Choom name, and the story behind the name, are based on the story of…Barack Obama’s childhood in Hawaii.
What? Apparently, several years ago, Obama spoke to a biographer about his smoking pot with friends as a kid in Hawaii—and calling it Choom. It’s there in the biography. Brazenly cool of Mr. O, we think.
Let that sink in a minute, like a good toke. So, the name Choom is the thing? The connection to Obama is what turns a bunch of friends on a beach into a mega-million dollar brand idea?
And now it seems, some guys in Canada are running with this little clam shell of an idea, hoping they can use it to build a tsunami-sized cannabis brand they can surf to the bank.
You gotta love entrepreneurs. Especially those smokin’ ganja. They can really dream big.
Choom, the company, was originally going to be cannabis producer. But they ran into a problem. (We think it’s legal—that they can’t be a producer and a retailer in all provinces.) So, they had to make a choice—what is the better business—producing or retailing? They decided their brand idea (Obama’s “choom”) was their best asset, and the best way to extract value for this brand was in the retail experience. So last year, they sold off their production-based assets, and started going all in to become a dominant retail brand.
Hence the complete absence of revenue so far, as they turn the ship around, spend a few years pursuing licenses, retail sites, building permits, etc.
And talking up the Choom name.
Now, we never underestimate the power of a good brand idea. Brands rule. Look what Starbucks did to coffee shops. Could Choom become the Starbucks of cannabis?
Frankly, we deeply doubt Choom can use Obama’s name. No freakin’ way Obama sold that. We found his name used once on the website. Once. After that, they don’t mention his name again, just phrases like “based on real people in the 70’s, carefree friends in Hawaii, who loved to get high on the beach.” We wonder how they get away with using his name once.
We suspect everyone involved—Obama, Aurora, Choom, and a whole bunch of lawyers—have worked this out a long time ago. (Or will.) We seriously doubt Choom can profit off Obama’s name. But it is there, once. So the story is out. Will it help them? Is it essential to the brand? Is it worth anything? Can it spread by word of mouth? And, if most people never connect Choom to Obama, does the brand have any edge in becoming a successful cannabis business?
Mysterious things can happen. And maybe just a faint whiff of the Obama connection, a whispered story passed by word of mouth, will give the brand the cache that makes it cool.
Or not. It’s a dream that could only happen in the cannabis business.
Last November, Aurora’s management showed that it likes whatever Choom has in its pipe. Aurora bought CAD $20 million of debentures in Choom, convertible into common shares of Choom at a price of $1.25 per share, if done within four years.
In the deal, Choom also gave Aurora 95.7 million share warrants—what will be approximately 40% of Choom if exercised today—and the right to exercise them at $2.75 per common share within two years.
Was this a good investment for Aurora?
On the face of it, one might wonder. Choom has no stores operating yet, and no revenue. So, valuing the brand is impossible. It is in the early stages of getting permits and sites to build a large network of branded cannabis retail stores across Canada. They will sell a curated selection of products from various licensed producers with a focus on an “elevated” (they are getting high, of course) customer experience.
No telling how much more money they will need to complete the network buildout.
And what will it cost Aurora to convert 95 million shares? Converting 95 million shares $2.75 per share will cost about CAD$150 million.
Nothing like cash to snap our minds out of a dream.
In today’s reality, this might seem crazy. Choom has lost share value steadily over the last year, and is now worth just $0.40 per share. Aurora would be paying seven times current value to buy it at $2.75. With Choom having little to offer today, we seriously doubt Aurora will rush to do this!
But…Aurora has two years to see if Choom is successful in building this network—and some revenue. If they are, their share price will likely rise a good deal, but Aurora’s purchase price will stay fixed.
It goes without saying, Aurora’s management are not dummies. They are dealmakers non pareil. If in two years, Choom is building a strong business, Aurora can buy a big stake in a large retail network for $150 million.
Choom is aiming to build a network of 75-100 stores. Maybe more. If each store generates CAD $2 million per year, that is $150-200 million in revenue per year. This may justify a $150 million purchase, depending on what multiple of revenue Aurora decides is worthy.
The deal has many features. If Choom falters and Aurora decides to pass on converting its 95 million shares in 2 years, Aurora can still collect 6.5% interest on the $20 million. And, it still has two more years to convert its $20 million in debentures into shares at $1.25. If the shares are worth more than that, they can make an instant profit and be done. So, it could still become a good investment for Aurora, even if they don’t spend $150 million to convert the 95 million warrants.
But if Aurora does buy into this network by converting the 95 million warrants, it could then exercise its 40% shareholder leverage to claim the real prize: the ability to give its brands dominant shelf space in a large retail network and claim a high profit margin indefinitely. That sounds like long term profit.
Despite the fact that Choom stock is in the pits today at $0.40, we think Aurora has probably made a smart deal. There are enough nooks and crannies in this deal that can pay out for them.
And Choom looks smart too. They get $20 million today to keep building the dream, and possibly $150 million in 2 years, to finance the continued building of its network if Aurora converts its warrants then.
So, what about the Obama legend?
It’s a nice hook. Totally cool if you like Obama. It sure looks like a brand differentiator today. For all we know, it might have made Aurora’s management smile and wonder, giving Choom a little psychological help in selling its financing deal with Aurora.
But in the long run, we don’t think anyone is hanging their hat on this to drive consumer loyalty. We doubt it will ever be the essential ingredient of the brand’s success. Canada has laws restricting brand marketing that will likely not allow it anyway. Success for Choom will come from smart management making many smart decisions along the way.
Kind of like they did making this deal with Aurora.
Disclosure: the writer has not stock in either Choom or Aurora Cannabis at the time of writing.