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Interview with 420 Investor’s Alan Brochstein: Why Have Marijuana Stocks Gone Up in Smoke?

It wasn’t too long ago that all any investor could talk about was the red-hot marijuana industry and the skyrocketing stocks. At the time, the legalization of marijuana for recreational
Alan Brochstein launched 420 Investor in September 2013 with the goal of building an internet community focused on cannabis stocks. Alan began his career in fixed-income with Kidder, Peabody and First Boston and spent four years as a portfolio manager with Criterion Investments. He spent 7 years with Piedra Capital as a porfolio manager, analyst and principal before forming his own independent consulting company in 2007, AB Analytical Services, where he has shared his research with institutional clients. Alan is a highly regarded contributor to Seeking Alpha and also offers newsletters to help individual investors.
Alan Brochstein launched 420 Investor in September 2013 with the goal of building an internet community focused on cannabis stocks. Alan began his career in fixed-income with Kidder, Peabody and First Boston and spent four years as a portfolio manager with Criterion Investments. He spent 7 years with Piedra Capital as a porfolio manager, analyst and principal before forming his own independent consulting company in 2007, AB Analytical Services, where he has shared his research with institutional clients. Alan is a highly regarded contributor to Seeking Alpha and also offers newsletters to help individual investors.

It wasn’t too long ago that all any investor could talk about was the red-hot marijuana industry and the skyrocketing stocks. At the time, the legalization of marijuana for recreational purposes in two states fueled a frenzy of investors dreaming about the possibilities that the new market would create, and the allure of getting in the green in more ways than one were too tempting to ignore.

Fast forward several months later, and the euphoria is long gone. Most of the biggest names at the height of the boom are now trading at just a mere fraction of where they were at the start of the year. Yet, while the stocks have taken a beating, the economic and political momentum for marijuana legalization arguably has never been stronger. had the opportunity to catch up with Alan Brochstein, Founder of to find out more about the perplexing disconnect between marijuana stocks and the economy in which they operate, as well as whether the long-term outlook is still as bright as it was when the year started.

EQ: Marijuana stocks were one of the hottest areas in the market at the start of 2014, thanks in large part to the legalization for recreational purposes in two states. We’ve seen a major pullback in most of these stocks in the latter part of the year. What’s happened?

Brochstein: The beginning of the year was a frenzy that was set off by Colorado and Washington going legal. Really, it was Colorado, because Washington didn’t take place until July8th. The media frenzy pulled in a lot of new investors, which fed a rally and drew in the momentum crowd that ran the stocks up. We’ve seen this happen recently with Ebola stocks for instance.

The Benzinga 420 Marijuana Index started the year at 159. It peaked March 18th at 1010 and bottomed out at 178 in mid-October. That was an 82% decline.

EQ: As you said, Colorado and Washington were the two states to legalize marijuana for recreational use. How has that gone so far in each of those markets?

Brochstein: I would say it's really too early to tell on Washington. It’s been interesting because there have been some regulatory issues, which I think is very positive for the long run of the industry. The liquor control board there is definitely on top of things because if we're going to see more legalization, and we're going to see the experiment continue with the federal government taking a laissez-faire approach, we're going to need to make sure that there is regulatory compliance. 

Even the critics, for the most part, would assess the experiment in Colorado as being better than expected. There have been a few issues, and there’s one area that is pretty topical right now in terms of edibles being somewhat of a regulatory issue, mainly due to packaging and labelling. But I think this will resolve over time. It’s definitely something that the industry needs to do a better job with.

All in all, in terms of the broad theme, medical marijuana is proliferating, and there are also the legalization efforts that are proliferating as well.

EQ: To that point, Alaska, Washington DC, Oregon and Florida could each be the next on the list to follow in this area. Just the attitude, politically and everything, it's a lot more accepting now. Do you think this will reignite the excitement in the space to, if not to where it was earlier this year, then to a healthier level?

Brochstein: I think it's important to note a couple of things. First of all, the excitement was a little bit too frothy, quite frankly. It was a lot of momentum money just chasing OTC stocks and penny stocks. That's really not the future that I envisioned. I think the more important thing to focus on is whether or not this industry is moving forward. We have a big problem right now in that the access to capital is one of the major barriers that could really derail this sector.

It comes right after government. Obviously, the 2016 election and a change in administration for sure, as well as potential Congressional changes could really throw us a monkey wrench. But absent that, I do think that this is going to be a long, drawn-out process, so I’ve gone all in.

Actually, since we last spoke in March, I set aside all my business. I’m 100% focused on this sector, not because of the companies that are currently trading, but because I envision an environment in the years ahead where gradually we're going to see better companies available for public investors.

EQ: That’s something you said the last time we spoke. That the future of the market is bright but the companies that were currently in the headlines may not be the companies that will be the ones pushing it forward. We characterized the Green Rush as the Wild West of the stock market earlier this year. Is that still the case right now or do you think it's approached more reasonable areas?

Brochstein: As a matter of fact, I underestimated it, unfortunately. It has been just insane. One of the other topics we can touch upon is what's going on with the SEC, although that's kind of moved to the backburner. But since we last spoke, I’ve added probably another hundred names that purport to be in the sector – many of them pink sheets. Even the ones that are SEC filers, there's just a lot of fluff there. It really makes it hard for investors when they see the landscape littered with trash like this. It’s gotten worse, unfortunately.

EQ: You mentioned the SEC. They did a mini-crackdown of sorts to a number of companies that were kind of flying pretty high. What happened there?

Brochstein: I actually take exception to the word “mini.” It was pretty bad. They actually came out with a press release in which they talked about it. It was not a mini-crackdown. It was a major crackdown. To back up a little bit, in August of last year, FINRA, the SRO—which supposed to protect investors—came out right when the market was pretty much at its low and right before I started 420 Investor. They gave pretty much what I would call the standard warning: "Be careful. Penny stocks are dangerous. Marijuana stocks are penny stocks." Which was true, and I support what they do, but they just had poor timing. After the market took off earlier this year, they came out and repeated the warning, with the market obviously at a much higher level. So it was better timed. I actually was echoing their sentiment at that time.

In early March, the SEC came out with its first suspension. It was a trivial company that most people had never heard of, that had no market impact. Later in the same month, they came out with the first of what I would say were substantial SEC suspensions in which they suspended a company called Advanced Cannabis Solutions, Inc. (CANN) , which was basically set up to be a capital provider to the market. They had an arrangement with the publicly traded business development company called, Full Circle Capital Corp. (FULL) , out of New York. It was a business development company, and was really set to be a leader in the industry. It was something that I actually embraced, although I didn’t have a formal recommendation on the name at the time. That was a real wakeup call. The suspensions were set to last two weeks.

But the day they suspended Growlife, Inc. (PHOT) , which was, in no uncertain terms, the most popular stock at the time in the market—that was a game-changer. That was on April 10th. A lot of people owned that stock, and it had a huge run. That became an instant 180-degree turn for a lot of people's willingness to take risks. As I said, the market had peaked on March 18. The move to the downside accelerated after the Growlife halt.

EQ: What were the specific reasons for the suspensions?

Brochstein:The issues weren’t really clear. At CANN, the issue became clearer over time. There's a lawsuit that shows what happened. Basically, it was a reverse merger and the person who put the deal together was a bad apple for the company. He wasn’t part of the company, so I’m not sure that the company was culpable at all. I don’t think that they were, but it certainly reflected poorly upon them. Nevertheless, they're trading in the gray markets still, even though they've filed a Form 211 with FINRA to get re-listed; that hasn’t happened yet.

With Growlife, nobody seems to know what exactly the issues were. There are a lot of theories, but there’s been no charges filed. It’s really a tough situation because I liked where the company was going and obviously, this was not good for me that this happened, but I’d like to learn more about it. But so far there's really not an answer.

EQ: GW Pharmaceuticals plc (GWPH) , which is actually a NASDAQ company in the biotech space that really tried to do everything the right way to kind of be a trailblazer, if you will, for operating with best practices in this space. But they also got hammered in the latter half of this year. More recently, they announced some disappointing data. What’s the story there?

Brochstein: Let's frame it for people who may not be familiar with them. I agree with your assessment that they are a trailblazer. They've been at it since 1998, and have been public since 2001. Last May, they did a game-changer by creating an ADR for the NASDAQ, which has really become their primary equity vehicle. It was under $9 a share and their stock trades at about $73 to $74 right now. This one has been great. It got up to $111.46 on July 1, so it has pulled back pretty substantially.

I don’t know all the issues, but I’ve been warning my subscribers that one of the things that I think is a big risk is this company is the underdog in some ways. For them to get their lead-candidate drug Epidiolex approved, it’s going to take rescheduling. Epidiolex has orphan designation and is targeting treatment-resistant epilepsy for children and these kinds of rare diseases.

There’s another company out there called INSYS Therapeutics, Inc. (INSY) . I don’t really follow it, but they have a similar orphan designation, although they're behind GW Pharma. They haven’t even started clinical trials at all but they were just announced month. It coincided with the bottom of GWPH, so I’m thinking that might be part of the issue. They use synthetic Cannabidiol (CBD) and I know that the FDA and DEA would much prefer to see synthetics over natural cannabis, but there's a lot of anecdotal and actually real data that suggests that the medicine needs to have more than just the one molecule.

We’ll see how that plays out, but to answer your question, the company had their first Research and Development day recently. It was in New York City, and at the same time that they presented what I thought was good data for Epidiolex, they also had disappointing data on ulcerative colitis. This is a company that has a lot of shots on goal, so it wasn’t a deal killer.

The bottom-line appears to be that the THC created some adverse side effects and people quit taking the medicine. For those that continued to take it, it worked well. The company’s response from what I understand is to use a tapering and maybe change the dosage. We’ll see how that plays out, but there's a ton of evidence that cannabis helps people with irritable bowel syndrome and ulcerative colitis.

EQ: So it sounds like the issue is really just a matter of the application of the treatment.

Brochstein: Right

EQ: Medbox, Inc. (MDBX) was another company that was really all over the place as far as coverage during the height of the boom. They were on CNBC, Bloomberg, Fox Business, etc. What's happened with them?

Brochstein: Complete, unmitigated disaster. Everybody that was there before is gone. They brought in outsiders. I listened to the conference call; I guess that would have been in August. The new CEO is Guy Marsala, and he comes from outside of the industry. For those that took the time to listen, you'd realize that if it's even going to turnaround, it’s going to take a while. They’ve brought in a new CFO who is also from outside of the industry.

The founder: Gone. The CEO: Gone. They’ve brought in some additional talent but none from within the industry. The company has totally changed its mission. It used to be about consulting and placing these boxes. Now they're talking about real estate and vaporizers and all sorts of other things. At the end of the day, I wish them the best but there’s just no way to justify that market cap. There are approximately 45 million diluted shares, which works up to be almost a $500 million market cap. That’s with converting their convertible preferreds.

The real issue is going to be in the next few months. At the beginning of 2015, approximately 15 million shares will become unrestricted. There’s going to be a huge supply of stock, in my opinion. I’d stay away from that one. I generally don’t give advice in interviews but I feel kind of responsible to say that.

EQ: That’s certainly appreciated. So there’s been a lot of shakeup in this industry over the past six months or so. What is some advice that you can give to people looking at this space now? Should they just turn and run, or are there opportunities here to find some quality long-term plays?

Brochstein: I’ve committed myself to this space because I do think it's a nice, long-term opportunity. But with that said, it still remains the Wild West that we talked about. You can get killed, so you have to be careful. That’s my first advice.

Second, if you're an institutional investor, there's really not a lot of opportunity here. I think a lot of your readership might be institutional, high-net-worth investors, but here's what I would say to them: First of all, look into the private placement market. It’s very fragmented but there's a lot of opportunity there, in my opinion. I have a new project called 420 Funders that addresses this, but there are several other ways to get involved with the market in terms of finding companies that are looking for capital.

I’d also say absent GW Pharma, there aren’t really a lot of ways to invest in the United States right now in publicly traded companies for an institutional investor. However, I would argue that Canada, which has a federally legal medical marijuana program across the nation would be a place to look into.

This is a market that I think is going to attract institutional capital over time. Tweed Marijuana Inc. ($TWD:CA) was the first company to begin trading publicly in the space, but now five of the 13 licensed producers are trading publicly. I think this is a huge opportunity, and this would apply also to individual investors.

If you’re an individual investor, I would suggest that if you're going to participate in the market, what I tell my subscribers is to be careful how much you put into it and to diversify among the names. Also, remember that the stocks are very volatile. This creates a lot of trading opportunities. It’s more of a trading environment. For people that want to buy and hold, it can be gut wrenching. I think that's the advice that I would share.

EQ: You mentioned the need of access to capital in order for this industry to grow. A lot of institutions and investment banks are turned off by the fact that there is some regulatory baggage when you deal with marijuana companies. Do you think Washington has some responsibility to maybe change that sentiment?

Brochstein: Responsibility? Yes, I think they have the responsibility to legalize it, quite frankly, based on all the evidence that I’ve seen. That is a huge barrier that they could do something about. There has been some efforts on the financial front to provide clarity, but banks, in particular, are very risk-averse institutions. They don’t want gray. They want black and white. They want to know what the rules are.

These guidelines that have been given have not provided a safe harbor. It’s really a problem, so yes, I think there's a moral responsibility for our government to help this market move forward. Is that going to happen? That's a different question.

EQ: You started 420 Investor to cover the Green Rush. That market has changed a lot since you started it. How has 420 Investor adapted to those changes in terms of the service you provide your subscribers? You also mentioned 420 Fund, if you can tell us more about that as well.

Brochstein: I’ll start with 420 Funders, which is simply a collaborative due diligence platform. It’s just getting started. We have about 36 companies on it, and we charge subscribers. We have a very low fee that's being waived right now. It’s consistent with my model of not being paid by companies. We're not out pumping and dumping companies. We don’t have any skin in the game in terms of making sure that people fund these companies. We’re trying to give them the opportunities and provide them a platform. So that's 420 Funders.

EQ: And for 420 Investor?

Brochstein: The evolution of 420 Investor has been dramatic. We launched on Sept. 15, which is a little over a year ago. I didn’t have any model portfolios, and the service was really about being a leader in the sector and sharing my knowledge. A couple of evolutions have happened since. First of all, the service has become more of a platform where people can collaborate and we have new technology that allows peer-to-peer discussions or forum-type discussions. People can upload their own content. So it's really evolved in that aspect. We have a lot of really smart people. It’s a great community. People don’t have to care what I have to say, but they can still derive a lot of value out of the community.

Second, we have two model portfolios and that's been kind of tough. As I told you a moment ago, it's not a buy-and-hold sector. It’s a trading sector. The first model we had came at the insistence of my subscribers. They wanted actionable ideas and well-supported ideas that they could choose to act upon or not. The model portfolio, which we called Flying High, started at $10,000. We funded it, and it’s a paper portfolio. It’s worth $20,000 right now. It sounds great honestly, if I had to grade myself. We did very well in fourth quarter of 2013. Everything was going up in the first quarter. I don’t really want to take a lot of credit for that.

In the second quarter, I started a second portfolio. That was April 8. Unfortunately, on April 10, that’s when they halted Grow Life. But I launched the second portfolio because I felt like the market had evolved to where I had enough names that I could create a diversified portfolio. That one is called 420 Opportunity and the idea is that it’s fully invested. I’m not going to make a call about the overall market, but what I’m going to try to do is give people what I think are the best ideas. It’s not a buy-and-hold portfolio, but hopefully people can learn from it and you don’t even have to necessarily follow it, but just the ideas and the process can be helpful.

EQ: So how has that portfolio ended up doing?

Brochstein: That model portfolio started 50,000 and honestly, it's really scary how much it's down. It is worth about $24,000. It’s down a little over 50% right now, but the overall market is down 70%. So it has done what it was supposed to do. Does that mean this is a good time to buy these stocks? I’m not going to say that, but that's kind of what we've been doing. It has been an evolution. I think where we are today will look a lot different from where I hope to be in the future.

EQ: Alan, thanks so much for taking the time to catch up. We look forward to speaking again with you soon.

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