Eco Equity - Growing ambition
Eco Equity has established a unique position within the fast-growing market for legal cannabis. The company holds a licence for producing and processing cannabis in Zimbabwe and is in the process of developing a 30,000 square metre facility for the cultivation of cannabis and extraction and refining of cannabis oils.
We are expecting the first small scale crop harvest and first revenues in 2020, leading to a rapid transition to profitability and cash generation thereafter.
The market opportunity:
Eco Equity was conceived as a vehicle for producing cannabis and concentrates for the medical market. Medical cannabis is now legal in 26 countries worldwide, and represents a market of more than $US10bn and growing. Market growth is driven by new applications being identified, more accommodating regulation in existing medical cannabis markets, and new jurisdictions opening up to medical cannabis.
The same cannabis materials (flower and oil) that are used for medical applications can also be sold for the recreational market in jurisdictions that permit it, and this offers another route for revenue growth for Eco Equity.
Eco Equity has a strong focus on maintaining the necessary regulatory expertise to operate within the legal frameworks of each of its target end markets.
Growth market, attractive positioning
The Eco Equity Zimbabwe cultivation and processing venture offers a very attractive return on capital and a fast operational ramp-up trajectory. In broad terms, we believe that US$10-15mln of investment capital expenditure (Capex) can generate US$50-60mln of revenue (annual ongoing run rate) at a profit margin of more than 50% in terms of EBITDA (earnings before interest tax depreciation and amortisation). We believe that the company can hit its full production run-rate before the end of 2021e.
In this report, we examine what these financial dynamics mean in terms of returns to the shareholder and potential valuation of the enterprise. Using a discounted cash-flow methodology (detail p9) we argue that the business could be valued at $US158mln.
This report has been written based on industry sources for general information, and specific investor information materials from the company. These materials are available on request from jpdcapital.com/investors.
Financials and valuation
Year end Dec 31 · Current · 2021 · 2022 · 2023
Revenue (US$M) · 0.00 · 12.50 · 48.00 · 57.50
EBITDA (US$M) · (1.10) · 5.00 · 27.50 · 35.80
Net Cash · 14.1 · 17.4 · 30.9 · 65.3
Legal cannabis market - North America
Source: Proactive Research
Zimbabwean cultivation the lead opportunity
In addition to the US and Canada, there are significant legal market for medical cannabis in Europe, and emerging markets within Latin America, Africa and Asia-Pacific.
Eco Equity’s most advanced project is a production centre in Zimbabwe. The company has acquired a licence for cannabis cultivation and extraction and has a 30,000 square metres facility under development including facilities on-site for drying and processing.
We expect the first harvest to be delivered in 2021 with profitability from the outset. With a full year of growing in 2022 and with scope to expand growing and to initiate the extraction and processing capabilities, we expect continued growth in revenue and profit over the 2020-2023 period, with opportunities to continue expanding organically or through mergers & acquisitions (M&A) going forward.
The following chart shows our forecast for Eco Equity revenues and profit for the next three years.
Eco Equity Zimbabwe financial outlook
Source: Proactive Research
From an investor’s perspective, Eco Equity offers:
- Exposure to a fast-growing end market
- A rapid pathway to profitability
- A cost-effective and scalable business model
Cannabis now legal (either medical or recreational) in 26 countries and 33 US states
The legal cannabis market
The legal cannabis industry represents a rapidly growing market worldwide, with legal sales of cannabis products (either medical or recreational) in 26 countries and 33 US states.
The main market segments are:
- Pharmaceutical use of cannabis extracts
- Medicinal use of cannabis for conditions that are not responding to conventional medicine
- Recreational use of cannabis
Medical market
In the pharmaceutical space, a number of drugs based on cannabis have been approved in recent years, with further developmental drugs continuing to move forward. Drugs that have already come to market include Savitex — a drug to alleviate some symptoms associated with multiple sclerosis; Marinol — an appetite stimulant for patients with HIV and for some types of cancer; and Epidiolex — a treatment for certain types of epilepsy.
Growing applications as a medicinal alternative / supplement
Medicinal (non-pharmaceutical) cannabis has been an even bigger growth space in recent years. Applications include the management of pain, nausea, muscle spasms, Tourette’s syndrome, and other conditions. The medicinal cannabis market took a major step forward with the 1996 legalisation bill in California, allowing the use of medicinal cannabis for patients with a doctor’s recommendation, and with that stipulation later being relaxed. Other jurisdictions have followed California’s lead in subsequent years, including the UK finally legalising medicinal cannabis (with a doctor’s prescription) from November 2018.
The following map shows the legal status of medical cannabis around the world.
Medical cannabis now legal on six continents
Legality of medical cannabis by jurisdiction
Source: Proactive Research
We believe there is strong potential for further growth in the medical cannabis market, driven by increased understanding among physicians, additional applications being identified, and additional jurisdictions legalising medical cannabis.
Recreational market
Recreational cannabis has also been gaining increased legal acceptance in recent years. The following map illustrates the legal status of recreational cannabis worldwide.
Recreational market current primarily in North America. Other regions could follow.
Legality of recreational cannabis by jurisdiction
Source: Proactive Research
Legalisation is clearly more useful from a commercial perspective than decriminalisation. The first US states to legalise recreational cannabis were Colorado and Washington in 2012, followed by nine other states in the period 2012-2018. Canada legalised recreational cannabis nationwide from 2018, representing a significant step forward for the industry globally.
Even in jurisdictions where there has been the legalisation of cannabis, there can sometimes be difficult regulatory grey areas to navigate. For example, in US states where recreational cannabis has been legalised, federal law still does not fully recognise this status, leading to some difficulties in distribution. And in South Africa, although the constitutional court has ruled in favour of legal cannabis, the national parliament has still not passed all the necessary legislation as of June 2020.
Eco Equity has placed a strong emphasis on building a robust compliance framework, to ensure that the company will conduct itself within the regulatory requirements of each of the different jurisdictions where it will be selling products.
Cell company structure offers investors flexibility and diversification options
The company
Eco Equity is a venture within the portfolio of JPD Capital which is a Protected Cell Company (PCC) focussed on opportunities within the cannabis space. A PCC is a corporate structure in which a single legal entity acts as an umbrella for several underlying cells. This structure empowers investors to choose how much of their capital to invest in each cell, spreading the risk and achieving valuable diversification benefits.
Corporate structure
Source: Proactive Research
Jon-Paul Doran is founder and chief executive officer (CEO) of both JPD Capital and Eco Equity. He was born in Zimbabwe and has strong ties to the country. He chose Zimbabwe as the base for the first Eco Equity cultivation project based on its accommodating regulatory environment and ease of export into the EU.
We provide a brief overview of the other two cells, Eco Equity Antigua and Eco 710, on p10.
A licensed facility with capacity to grow 30,000 flowers at a time
Eco Equity Zimbabwe
The Eco Equity Zimbabwe project aims to become a world leader in the production of high-quality cannabis and extracts.
The company has acquired a licence for cannabis cultivation and extraction in Zimbabwe and will be conducting business just outside of Harare, and will have the ability to vegetate up to 30,000 plants and flowers concurrently.
Eco Equity is developing an initial cultivation footprint of 10,000 metres consisting of greenhouse and polytunnel systems, based within a 30,000 square metre operating facility including on-site extraction and refining facilities for cannabis oil.
The Eco Equity Zimbabwe project will produce two end products to sell into the market place. Dried Flower (the flower is the part of the plant that contains most of the active components) is used by consumers as a combustible or an edible, and can also be sold business-to-business (B2B) as source material for producing cannabis-based products. Refined oils can be sold B2B or business-to-consumer to be used either as a finished product or as a raw material.
Two forms of end product
Source: Proactive Research
There are two main active components in cannabis – tetrahydrocannabinol (THC) which has an intoxicating property, and cannabidiol (CBD) which is non-intoxicating and used in some consumer healthcare applications. These can occur in different levels in the flower or the extracted oil, depending on the cannabis strain and the process.
Key dates in the rollout of cultivation
The following key dates summarise our expectation for the growing programme:
- Small scale indoor growing to begin the fourth quarter of 2020. The indoor facility will later be repurposed purely as a research & development (R&D) facility and nursery.
- Growing to begin in a polytunnel environment in March 2021. This will produce material for the production of CBD oil.
- Full scale growing in the glass greenhouse environment to begin January 2022, producing THC-bearing flower.
Extraction and purification technologies
The processes for oil extraction and refining are an important value-added component of the production capability.
High yields, no toxic solvents, and no thermal degradation
Eco Equity Zimbabwe will employ a supercritical CO2 extraction system to derive high-quality oil from the biomass grown on-site. This system produces high yields of oil, with no thermal degradation (the system runs cold), and uses no toxic solvents. The system will also allow Eco Equity to target specific compounds — CBD, THC, terpenes — so that it is not just yielding the maximum amount of oil, but actually maximising the yield of active ingredients that Eco Equity’s customers are seeking.
The following diagram gives an overview of the CO2 extraction system.
Supercritical CO2 extraction
Source: Eden Labs
Following extraction, the oil will then be further processed using a system called Wiped Film Evaporation, which works by a process analogous to fractional distillation in oil refining. This process will allow Eco Equity to market oils with a precise concentration of CBD or THC depending on the customer’s requirement.
Financials
Based on the operational timeframe that we have described on p6, we expect first revenues in 2021, with strong growth going forwards into 2022 and 2023.
We assume that the revenue is composed of two separate streams — CBD oil, and dried flower (which contains THC and CBD). In practice, the company could potentially extract THC oil as well, but for simplicity, we consider CBD oil only. The following chart shows our revenue forecast through to 2023:
Two revenue streams - flower and oil
Revenue streams
Source: Proactive Research
During this period we believe that profitability will benefit from an increase in volumes, and also the shift towards higher-priced THC-bearing product. For these reasons, we expect increasing profitability even with a certain degree of deflation in wholesale prices.
The following chart shows our forecast for profitability for Eco Equity Zimbabwe.
EBITDA margin to expand rapidly
EBITDA margin
Source: Proactive Research
In terms of investments required to support this growth trajectory, we are forecasting two major investments — firstly the polytunnel system and indoor growing nursery and R&D centre, and secondly the greenhouse growing space to be constructed in 2022.
We assume that the initial capex requirement will be funded using a lease finance structure, which is treated as debt in our financial model (see p11). From 2021 onwards we believe that all capex will be covered by profits generated. The following chart shows our capex forecasts compared with EBITDA.
Investments covered by EBITDA
Investments versus EBITDA
Source: Proactive Research
We argue that these forecasts illustrate one of the key strengths of the Eco Equity business model – a light capital requirement relative to the profit opportunity.
Based on these financial forecasts we argue that Eco Equity offers a compelling valuation case vis-à-vis a prospective future flotation of the Zimbabwe business. We examine the valuation using a discounted cash flow (DCF) methodology.
DCF
The following table summarises our DCF valuation for Eco Equity Zimbabwe.
DCF valuation - all figures US$-mln
Source: Proactive Research
We have built in a degree of conservatism in our longer-term assumptions:
- A long term growth rate of 5% assumes a slowing of the industry growth rate
- A long-term EBITDA margin of 50% reflecting some decline in pricing compared with the 2020-2023 period
Nonetheless, we argue that this represents a strong value proposition for shareholders. This is underpinned by:
- Exposure to an attractive growth market
- Ability to produce flower or oils, for THC or CBD focussed applications
- A competitive cost base and modest capital investment need
The other businesses
The other two businesses in the JPD Capital portfolio do not directly contribute to Eco Equity Zimbabwe, and are not included in our valuation or our financial models (p11). However, we believe it is instructive for investors to consider Eco Equity Zimbabwe within the context of the whole PCC, so we provide a summary of the other two:
Dispensaries to serve the local and tourist markets
Eco Equity Antigua
Eco Equity has been awarded licences for cannabis dispensaries and lounges in the Caribbean nation of Antigua and Barbuda. Through these outlets, the company will service the local market for legalised medical and therapeutic cannabis, which is open to both residents and tourists under a permit system.
The venture is at an earlier stage of development than the Zimbabwe operation but could provide a template for Eco Equity to operate in the retail space.
Exposure to the fast growing market for CBD-based consumer health products
Eco 710
Eco 710 is a consumer-facing business, initially focussed on the UK market, providing CBD-based products for the consumer health market.
CBD is a non-intoxicating extract of cannabis that is legal and widely available in the UK, already representing a £300mln per year industry. It is also legal in almost all European countries.
Products containing CBD are used by consumers to address a number of different aspects of their personal health. The illustration highlights some of these applications.
CBD
Source: Proactive Research
Eco 710 will offer a broad range of CBD products, including tinctures, oils, moisturisers, capsules, gummies, isolates, pet products and other items. These will be sold online and via high street outlets. This venture will give Eco Equity direct exposure to the consumer healthcare market.
Financial models
The following tables summarise our financial forecasts for Eco Equity Zimbabwe.
Income statement
Source: Proactive Research
Balance Sheet
Source: Proactive Research
Cash Flow
Source: Proactive Research