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Workers in a HEXO (formerly Hydropothecary) greenhouse.

Harrison Koyman

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Is there such a thing as an undervalued pot stock? A U.S. investor sees one in HEXO Corp., known until last week as Hydropothecary Corp., and is urging the company to sell itself or merge with another player if it can’t drive its share price higher.

Shares in HEXO finished trading on Thursday up more than 20 per cent after a small New York investment firm, Riposte Capital, published a letter sent to HEXO’s board expressing concern about the company’s “severely depressed valuation.”

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Riposte describes itself as HEXO’s “second largest shareholder.” It has about 5 million shares, or 2.6 per cent of HEXO, worth about $35 million at Thursday’s close.

Riposte says HEXO has the industry’s largest and longest government contract – more than $1-billion over five years from Quebec. It is also in a joint venture with Molson Coors Brewing Co., making it one of just two cannabis companies with a beverage deal. (Canopy Growth Corp., with spirits company Constellation Brands Inc. as a major investor, is the other.)

HEXO has one of the strongest balance sheets in the industry, Riposte says, with cash equal to more than 20 per cent of the company’s market capitalization. And its production costs are the lowest in the industry thanks to cheap Quebec energy and labour.

And yet, Riposte says, HEXO has been trading at about eight times its forecast 2020 EBITDA, or earnings before interest, taxes, depreciation and amortization, versus a multiple of 30 times EBITDA, which Riposte says is the average trading of the top 10 Canadian licensed producers by market capitalization.

Applying the 30 multiple to HEXO, Riposte says, yields a price of $18 a share, versus Wednesday’s close of $5.89. Riposte blames, in part, “poor research coverage and investor awareness, a late listing to the TSX, no U.S. listing, and an investor relations effort that needs significant improvement.”

Sébastien St-Louis, co-founder and chief executive of HEXO, said in a statement Thursday: “Our management team is continuously evaluating incoming offers and acquisition opportunities … We look forward to revealing our plans to move into the international market and to list on a major U.S. stock exchange in the near future.”

A depressed share price isn’t just a problem for Riposte’s returns; in a race for scale in the cannabis industry, an undervalued stock is an undervalued currency, limiting HEXO’s ability to do deals and increasing the company’s cost of capital.

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The answer to jack the stock price, Riposte says, is for HEXO to initiate a strategic review. That could include a sale; taking the company private (with Riposte maintaining its existing ownership); extracting a direct investment from Molson Coors; or a merger with a comparably sized licensed producer that “that can add further geographic diversification, scale, international opportunities, and medical expertise.”

Molson Coors spokesman Colin Wheeler declined to comment on Thursday.

Riposte is led by Khaled Beydoun, the former CEO of Credit Agricole’s U.S. equities business. He joined Libra Group, a private company controlled by the Logothetis family, in 2012. Libra and Mr. Beydoun formed Riposte Capital in 2013 and opened up the funds to outside investors in 2015. Riposte, which is now independent from Libra, has between US$100-million and US$200-million in assets under management.

HEXO changed its name from Hydropothecary in late August after a shareholder vote. “HEXO” is its new brand for the adult-use cannabis market, while the “Hydropothecary” brand remains for the medical cannabis market.

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