First Stage Investor: Issue No. 24

The Cannabis Revolution

By Adam Sharp, Co-Founder, First Stage Investor

Longtime readers know I’ve been bullish on medical marijuana for years.

But lately I’ve started to think that even I may have underestimated this market. The medical potential of cannabis is becoming apparent, and it is nothing short of revolutionary.

Marijuana has already shown it can be effective in treating…

• Chronic pain
• Epilepsy
• Side effects of chemotherapy
• Inflammatory conditions (like arthritis)
• Insomnia
• Depression (in some cases).

This list alone terrifies the pharmaceutical industry. Marijuana-based medicine isn’t as patentable as traditional drugs, so it threatens Big Pharma’s business model.

And we have only begun to explore the medical uses of cannabis. Research in this field has been banned or restricted for too long.

More than 113 cannabinoids (chemical compounds with possible therapeutic use) in marijuana have been identified so far. These cannabinoids can make us feel hungrier, reduce inflammation and act as “messengers” in our system in many different ways, with many different effects. THC and CBD show the most potential so far.

THC is the chemical in marijuana that produces a “high” feeling. It has strong pain-relieving characteristics and shows medical promise when used in combination with other cannabinoids.

THC works well combined with CBD (cannabidiol), which has anti-inflammatory properties and can treat epilepsy. In fact, the FDA just approved the first CBD-based prescription product, Epidiolex. It was approved to treat two rare forms of epilepsy. But it can also be prescribed for other conditions at the doctor’s discretion. This is a huge development (and a wake-up call for the pharmaceutical industry). Epidiolex is made by a company called GW Pharmaceuticals (Nasdaq: GWPH).

This is just the tip of the cannabis iceberg. Another GW study shows the combination of THC and CBD extends the average life span of terminal brain cancer patients by six months. That might not sound like much. But normally, 70% of patients die within two years. So it’s a start. And we’re just beginning to understand these remarkable compounds.

It’s as if cannabis was specifically designed to offer treatments for many different ailments.

We’re even starting to see evidence that marijuana may be an effective treatment for schizophrenia and autism.

A recent Newsweek article titled “Is Marijuana the World’s Most Effective Treatment for Autism?” highlights the growing evidence that marijuana may be a breakthrough treatment for autism spectrum disorders.

The article shares remarkable stories of recovery in severely autistic children treated with specifically grown cannabis that has the right levels of both THC and CBD.

The government can’t hold back this flood anymore. It can’t ignore epileptic children whose only other choice is taking powerful, addictive sedatives like Xanax.

According to MedicalMarijuana.ProCon.org, 29 U.S. states have legalized the medicinal use of cannabis so far. And many more have already given up the epilepsy fight, allowing parents to access CBD-based medicines for their children.

Canada has approved recreational marijuana use (legislation has been passed, and October is the target for implementation).

Full legalization is coming to the U.S., and it’s going to change the world quite a bit.

Investing in Cannabis

Most of the hot marijuana companies are private, but there are a few good marijuana investments that trade publicly.

They’re nearly all trading at very high valuations, though. And for the most part, they’re still losing money or only making a little. But they’re able to raise money easily and are acquiring valuable properties and budding businesses in the industry.

One that I’ve mentioned before is a Canadian stock: Canopy Growth Corp. (TSX: WEED). I first wrote about it when it traded for about $12. Today it trades at $41 and has been promoted to the NYSE.

Canopy holds vast swaths of land dedicated to growing marijuana. It’s just waiting for Canada to set up its recreational market. Then it’s off to the races.

Cannabis is going to be a very big business. I suspect it will eventually outgrow the alcohol market, which is around $211.6 billion a year in the U.S. alone, according to industry experts at Park Street. The medical applications alone are staggering.

And the recreational market is getting ready to take off as well. In Aspen, Colorado, marijuana sales are already outpacing alcohol sales. In 2017, licensed vendors generated $11.3 million in marijuana revenue and $10.5 million in alcohol revenue. (The first legal sales of marijuana in Colorado began in 2014.)

Stocks like Canopy are well-positioned for the boom. But there is a fair amount of valuation risk at $8.2 billion. Because recreational marijuana has been legalized in Canada, there will likely be more companies like Canopy trading on Canadian markets. Canopy only made it onto the NYSE because it’s a Canadian company. If you have a full-service broker like Charles Schwab or an online broker like Interactive Brokers, you should be able to invest in publicly traded marijuana stocks. There are also over-the counter equivalents of Canadian stocks you can invest in as well.

I think most of the good deals in the U.S. will be in the private markets, where it’s perfectly legal to invest in a cannabis startup. The public markets simply aren’t an option because we don’t know if and when the federal government will allow U.S. marijuana companies to go public (IPO).

If you’re planning to invest in this industry, you need to get to know it first. Try to find marijuana entrepreneur meetings in your area. Go to a conference or two. There are groups meeting about marijuana all over the place – you just have to find them.

If marijuana isn’t legal in your state or region yet, preparing for eventual legalization could be a good move. If you get involved before legalization happens, you’ll be ready to reap the benefits when it does.

Either way, get involved. You have to earn people’s trust in this industry to find good investments.

And if you can’t afford to invest in the cannabis industry, try to get a job in it. Make yourself indispensable to good businesses. If you’re valuable enough to the company, it will be in the owner’s best interest to give you a piece of the equity (or cash). Otherwise you could go work for a competitor.

The goal should be to earn or buy a piece of a very promising cannabis business. It’s one of those rare circumstances where we can clearly see how big this thing is going to be in five or 10 years. I’m fairly certain of it.

Now comes the hard part – finding suitable investments. We’re on the lookout for them in the United States and Canada. And we will let you know if and when we find them.

If you find any great marijuana investments, share them with us at mailbag@earlyinvesting.com.

BREWDOG’S POTENTIAL

BrewDog’s Second U.S. Raise Has Potential

By Andy Gordon, Co-Founder, First Stage Investor

I like beer. I get a big kick out of trying new beers.

But for every new beer I buy, it seems there are three more waiting for me to try.

I can’t keep up.

For a beer drinker, it’s nirvana.

But for a beer producer?

It’s a crowded space. You really have to work to stand out.

That is, unless you’re BrewDog. These guys can’t help but stand out, thanks to their brash personality.

More Than Just Publicity Hounds

We recommended BrewDog back in September 2016, when it was doing its first “Equity for Punks USA” crowdfunding raise.

(You see what I mean by “brash”?)

But don’t be fooled… This is one smart company. You don’t achieve the remarkable success that co-founders James Watt and Martin Dickie have without knowing what you’re doing.

Their business IQ ranks among the best I’ve seen. Their story speaks for itself.

Armed with a modest loan and grant from a local bank, they began experimenting with beer recipes in 2007.

Today, BrewDog is the U.K.’s biggest craft brewery.

In 2017, it produced nearly 38 million pints of beer… pulled in $94 million in revenue (from its British consumers alone)… and shipped beer to 50 foreign markets.

The Original Investment Thesis

When we recommended BrewDog, here’s what we were thinking…

Though differences exist between the British and American beer markets, James and Martin should be able to leverage their experience in Britain and Europe to reach similar heights in the U.S.

The competitive U.S. beer market (with 6,372 breweries) gave us pause. But we also believed that BrewDog USA’s access to its parent’s resources – money, marketing and low-cost sharing of key personnel (James and Martin get no compensation for their U.S. work) – would give it a key edge.

Well, were we right?

Operationally, it’s a lot further along. BrewDog built a $50 million, 100,000-square-foot brewery in Columbus, Ohio. It started production last summer and began shipping beer last August.

In the last five months of 2017, it sold about 4,000 barrels. It’s distributing beer to seven states, with five more on tap for 2018

The company also operates a tasting room at its production facility, as well as two brewpubs.

In terms of marketing and infrastructure, a solid foundation has been built.

BrewDog is now ready to focus more on conquering the U.S.

And here’s the thing: BrewDog knows the drill. It’s done it before… in its home market.

BrewDog has averaged 63% annual growth over the last six years. Its average annual operating profits have grown by 76%.

This hard-won experience is its secret weapon.

It’s why the company is expanding into China and Australia, in addition to the U.S.

Crowdfunding Key to Success

These guys wrote the book on how to grow a craft brewery business using a crowdfunding model that attracts hordes of investors who become consumers (and vice versa).

So far, BrewDog has raised more than $103 million from more than 80,000 investors worldwide.

BrewDog is on its fifth crowdfunding campaign in the U.K./Europe. It’s launching its second one here in the U.S. It’s contemplating its first in Australia.

In the U.S., BrewDog is getting ready to…

• Go from 4,000 barrels sold last year to 24,000 this year to close to 50,000 next year
• Add more brewpubs to increase brand recognition and consumption (these BrewDog pubs are a hit overseas)
• Build a dedicated events space on its Columbus campus, install an automated keg line and finalize a new sour beer.

But to get to the next level, it needs more money. So it’s launching a new U.S. campaign.

In 2016, it raised $7 million from 8,000 investors. This time around, it wants to raise between $10 million and $40 million.

At the time of its last crowdfunding campaign, BrewDog PLC was valued at about $2.4 billion. A few months prior, it received a $282 million investment from TSG Consumer Partners at a valuation of $1.3 billion.

Investors who bought shares in the company’s first Equity for Punks campaign are sitting on 2,765% profits.

Upside Is Big… but Big Enough?

If all of the shares being offered in its second U.S. crowdfund raise are sold, BrewDog USA will be worth $363 million. If BrewDog USA’s valuation reaches the current level of its parent company, investors in this round will earn a 560% profit (not including dilution effects).

When dilution is accounted for, your profit will be roughly 280%.

But the U.S. market is five times bigger than the British market. BrewDog USA could grow bigger than its parent… IF EVERYTHING GOES ITS WAY.

Think Boston Beer Company. It boasts a $3.4 billion cap. In addition to Sam Adams, the company owns smaller beer brands, including Coney Island, Concrete Beach, Angel City and Traveler.

But BrewDog is gearing up for its U.S. push at a less-than-ideal time. Growth has slowed from the double-digit pace seen earlier this decade.

Beer lovers are favoring local, small and independent community craft breweries.

Larger companies like Boston Beer have struggled recently. National brands are seen as less “authentic.”

Can BrewDog buck these trends?

I believe that James and Martin are better marketers than the Boston Beer folks. So, yes, they can.

But it won’t be easy. The market is not trending in their favor.

And, for this reason, I am refraining from giving BrewDog a full-blown recommendation. The riskreward calculus is not quite compelling enough.

Though I must repeat, we remain impressed with their progress.

So, I’ll leave the decision up to you. For those of you leaning toward an investment, BrewDog is offering an array of perks to make the decision easier for you.

Visit https://www.brewdog.com/usa/ equityforpunks for more details on its current Regulation A+ offer. I encourage anyone who wishes to invest to read its offering circular (https://www.brewdog.com/usa/ equityforpunks/downloads).

The price per share is $50, slightly more than the $47.50 price for the company’s first U.S. Equity for Punks campaign. Minimum investment is one share, or $50.

Note from BrewDog USA: You must use the same email address used in previous investment rounds to ensure any shares you’ve purchased will stack on your account.

LOOKING AT CRYPTO THE RIGHT WAY

Learning to Look at Crypto the Right Way

By Adam Sharp, Co-Founder, First Stage Investor

Cryptocurrency has come a long way in the last few years. At this point, most investors know what bitcoin is (basically). That’s a monumental change from just a year ago.

Still, it takes years for most people to get truly comfortable with this field. That’s because in a space as new as cryptocurrency, you don’t know what you don’t know. Every bit of information you get leads to more questions. Even those of us who have been around for years are constantly learning.

I want you to benefit from the lessons I’ve learned. So today I’m tackling some of the most common misconceptions about cryptocurrency… and providing a more constructive framework to view it with.

Misreading Bitcoin Charts

One of the first things any investment-minded person does when they discover crypto is look at a long-term bitcoin price chart. They want to see the price trends for the last few years. Smart thinking.

But let’s take a look at the chart (below) most people will see. It’s a simple linear chart of bitcoin’s price from around January 2013 to June 2018

This chart uses data from Bitstamp, one of the oldest crypto exchanges around. There are older data sets, but for now, this one will do.

The 2013 start date is easy to explain. When bitcoin launched in 2009, it didn’t start trading immediately. There were no real exchanges at the time. So at first, it was mostly “over the counter” (person to person) trading.

So far, so good. But there is a problem with this chart. It’s linear. Because the price of bitcoin has increased so much in recent years, the early days look tiny and insignificant by comparison.

For example, 2013-2014 was a hugely exciting and profitable time for bitcoin. But on this chart it looks like a small anthill. You can’t get a good feel for bitcoin’s price history looking at this linear chart. It makes the early days of bitcoin look calm, which they certainly weren’t.

To truly appreciate bitcoin’s price history, we need to look at it using a logarithmic (log) scale (below).

Log scale charts allow us to see percentage moves up and down. That’s far more useful for analyzing bitcoin’s long-term history. You can see the 2013-2014 move in all its glory – and still appreciate recent price action.

You can see that percentage-wise, bitcoin was far more volatile in previous cycles. Bitcoin is becoming more stable as the network grows. That’s not apparent when looking at a linear chart.

Look at Market Cap, Not Price

Another mistake many new folks make is focusing on a coin’s price instead of its market cap.

Price is meaningless unless you’re factoring in the total number of coins in existence. And when you multiply price by number of coins, you get market capitalization (cap). It’s a far more useful metric.

An example: There are 17.1 million bitcoins in existence today (there will be 21 million eventually). Multiply 17.1 million bitcoins by today’s price of $6,717 and you get the current market cap of $114 billion.

In fact, just looking at price can be downright dangerous. For example, I’ve had many people tell me they like ripple (XRP) because it’s so much “cheaper” than bitcoin (ripple is trading at around $0.53 as I write this).

But did you know there are currently 39 billion ripple coins already in existence? That gives ripple a hefty $20 billion market cap, despite the “cheaper” price per coin.

But ripple also shows the limitations of the market cap metric. Eventually, there will be 100 billion ripple coins. When you factor in these additional coins, ripple will be close to half the market cap of bitcoin (in the future). The new coins will dilute the value of existing coins.

That’s why you can’t rely exclusively on market cap. The total number of coins that will eventually be in circulation is important as well. There will only ever be 4 million more bitcoins, while there will be around 60 billion more ripple coins trading eventually.

Moral of the story: Having more coins at a lower price does not make a coin “cheap.” Market cap and total supply is what you should look at.

Crypto Is Programmable Money

Most people understand the value of crypto as “digital cash.” But it’s definitely not the whole story. Crypto is programmable digital cash.

An ICO uses “smart contracts” and blockchain technology to process money, handle escrow, distribute tokens/coins and perform other necessary functions. It’s incredibly efficient when done well.

This is just the first killer application of the programmable side of crypto. The potential applications for programmable money are similar in scope to the internet. Yes, that big. Maybe bigger.

Insurance, money transfer, escrow, banking, equity, bonds… all these things will eventually be done using crypto.

Using blockchain tech and smart contracts is vastly more efficient than existing financial service methods. In essence, it replaces banks and other middlemen with distributed networks and open source software.

So when you think about crypto, don’t think of just digital cash. Think of programmable money – a tool that has the power to change our financial landscape for the better. That’s a much better framework to think about this industry with.

MOST ABSURD THINGS

Andy Gordon Can’t Believe He Just Heard This…

The BIS waded into the shallow end of the crypto pool by wondering what would happen if a blockchain ledger captured the digital retail transactions currently handled by selected national retail payment systems.

The bank’s absurd working theory is that such a ledger would become impossibly long, eventually breaking the internet.

Fortunately, it’s not going to get to that point thanks to significant blockchain advances in off-chain transaction processing. The Lightning Network. Raiden (see Page 10 for how it’s now being used). Litecoin. They’re all incorporating, developing or deploying some form of off-chain technology that allows batch and simultaneous transaction processing.

It’s the future. And it’s coming our way.

Blockchain technology is not static, closed or private. It’s dynamic, open and public. Thousands of developers are working on this issue. How did the folks at the BIS miss this?

Well, they did get one thing right. If it’s not solved, most use cases won’t be able to scale.

Believe me, everybody in the blockchain community understands what’s at stake.

What the BIS views as a fatal and unavoidable flaw, developers see as another bump in the road.

Sure, it’s possible that thousands of the most brilliant coders in the world won’t come up with a solution.

But I’m not worried. To me, it’s more a matter of when coders find a solution – not if.

I’m a fan of the BIS. But in its zeal to discredit crypto, the BIS has badly overstated things. Frankly, I’m disappointed.

Yes, there’s a subset of people out there who wanted the SEC to come down HARD on ethereum and crypto. Mr. Byrne was one of them.

I don’t know much about him. I suspect he’s not a crypto hater. I think he’s a purist. He thinks ethereum is a security. He believes it’s an open-and-shut case.

Hence, the harsh “abdication of responsibility” remark. And you know what? He’s not exactly wrong – if we push all practical concerns to the side. Or we ignore the collateral damage to millions of ethereum owners.

The SEC could have designated ethereum a security. It could have – quite easily – put forward acceptable reasons why. Thank goodness it went down a more pragmatic path.

It chose not to punish ethereum buyers who – let’s face it – are NOT bad actors in any sense of the term as the SEC defines it. The SEC is looking at the big picture, as it should.

I can only hope that the federal courts will adopt the same pragmatic approach if given the chance.

Jim Chanos has had some nice moments. He predicted Enron’s 2001 collapse. He foresaw China’s 2009 real estate crash. But this statement isn’t one of his finer moments.

He dismisses blockchain technology and thinks crypto is dumb speculation. Chanos knows as much about crypto as Warren Buffett does… in other words, not much.

I’m going to fight fire with fire and cite a real crypto expert, Naval Ravikant. He’s the founder of AngelList and general partner of crypto asset hedge fund MetaStable Capital. Naval said this: “Bitcoin is a tool for freeing humanity from oligarchs and tyrants, dressed up as a get-richquick scheme.”

By the way, Naval’s quote came first.

This statement isn’t notable for what’s being said. What’s noteworthy is who is saying it – the head of Germany’s “SEC.” I’m pretty sure the U.S. government is watching Germany closely, rather than watching Chanos.

THIS MONTH IN FINTECH

We’re About to Find Out Just How Real the Blockchain Is

By Andy Gordon, Co-Founder, First Stage Investor

It’s crunch time.

So says a survey of 200 global financial institutions undertaken by Greenwich Associates. Over the next two years, more than 75% of fintech blockchain projects will go from proof of concept to live production.

The stakes are high. In 2017 alone, banks and financial organizations spent $1.7 billion on blockchain development. Early returns indicate it’s going to be a bumpy road.

More than 50% of executives surveyed said implementing blockchain technology “was harder than they expected.”

New game-changing technology often is. The shift from concept (theoretical use) to beta testing to widespread use exposes “real world” problems that need immediate attention.

According to the survey, 14% of respondents said they already deploy blockchain. And 10% say they’re spending at least $10 million on blockchain development.

A big budget doesn’t guarantee success. But it does suggest blockchain-based fintech won’t fail because of lack of funding.

That’s a big risk off the table. But, of course, that’s not the only risk…

Do these technologies actually work? Do they save financial institutions significant amounts of money (or make them loads more)? Can they scale quickly, securely and cost-effectively?

We’ll find out. But it’s never too early for a progress report…

Making an Impact in Developing Countries

South African company Wala is speeding up microtransactions (a dollar or less) for users across Uganda, Zimbabwe and South Africa.

Wala’s mobile app facilitates retail investment. But bank fees for transactions and other functions (like inquiries on fraudulent account activities) were too high. If Wala wanted to grow, it needed to find a fix.

So it turned to the ethereum blockchain and created its own coin. Wala now supports 100,000 merchants on its platform and charges them zero fees.

A pretty neat trick, yes? Wala does it using a blockchain system called Micro Raiden. It’s a slimmed-down version of Raiden.

How It Works

Raiden transacts sales and payments off-chain. Micro Raiden helps set up channels that only receive payments. So it does half the work for Raiden.

Wala currently absorbs the transaction fee from money it raised through its “dala” token sale and its $2.2 million venture capital raise.

The World Bank says Africa is the most expensive continent in the world to send money to. The dala, used across 10 African markets, addresses a critical need.

“Consumers can receive remittances and then go purchase products in the app or in person,” says Wala CEO Tricia Martinez. “So it’s a fully functioning financial product a consumer can use instead of cash.”

“We really believe cryptocurrency is what is going to drive a financial revolution in Africa,” Martinez says.

The U.S. in “Coulda, Woulda, Shoulda” Mode

What if? As in… what if the Federal Reserve Bank adopted a digital “Fedcoin”? Sheila Bair, former head of the Federal Deposit Insurance Corp., likes the idea. She says if this central bank digital currency (CBDC) was held by all consumers, then changes in interest rates (down to encourage spending and up to encourage saving) could be DIRECTLY felt by consumers.

How it’s done now is indirect. The government sponsors securities sales with banks, which increase or decrease the availability of money in the direction it wants interest rates to go.

Bair says centralized digital currencies would be “much more effective tools” for addressing economic cycles.

“If [the Fed] does not stay ahead of this technology, not only could banking be disrupted – but the Fed itself could also be at risk,” she warns.

For Others, It’s “Too Early”

B2B payments solutions provider FleetCor Technologies is exploring blockchain tech through its Cambridge Global Payments subsidiary.

Cambridge, which specializes in crossborder payments, recently partnered with ripple, the open payment network behind the cryptocurrency XRP.

“Delivering money globally is sort of a broken system,” says John Coughlin, FleetCor’s executive vice president for corporate development.

“In a world of electronic money transfers… why do I have to go through three banks to send money from the U.S. to Brazil?” he says. “It’s just crazy.”

Coughlin says ripple is a “logical partner” for Cambridge but that it’s “too early” to discuss the impact of its pilot program with ripple.

PORTFOLIO UPDATE