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Citron Case Study: CRON targeted by dubious short-attack

NASDAQ:CRON   CRONOS GROUP INC
I like the clean horizontal support/resistance and patterns on this CRON chart. I don't have much to say about the technicals as the news and hype (both positive and negative) are the main factors driving the price here. The technicals are helpful, however, in giving targets for buys and sells trading the news/hype.

CRON tanked on a hit piece by Citron Research/Andrew Left with a target of $3.50 alleging securities fraud.

Citron/Left apparently has a history of exposing real fraud and doing short reports on such companies, but is currently in a bit of credibility crisis after being fined by the Hong Kong Market Misconduct Tribunal and banned from trading Hong Kong securities for five years due to what they ruled was a sloppy short-attack report on Evergrande (a report that was quickly refuted by Deutsche Bank and other institutions) that improperly understood Hong Kong accounting rules. (His appeal of the fine/ban failed as well.)

The Tribunal wrote in their report that "no evidence was placed before the Tribunal to indicate that he chose to obtain expert advice on appropriate regulatory restrictions, especially applicable accountancy standards, to which Evergrande would have been subject. If what was sought was a carefully weighed, objective analysis, as opposed to one being employed essentially as a short selling weapon, the decision not to seek advice was, in the judgment of the Tribunal, a rash one." Sadly this seems to me to be a very good description of a subset of Citron's reports, less of what appears to the judgment of reasonable observers to be an honest, even-handed report and more of a "short selling weapon" meant to trade on Left's reputation to tank stocks in the short term for short term profits.

Citron's marketing of their Evergrande short-thesis report alleged, "This research and analysis, complied over several months, presents the conclusion that HK:3333 (Evergrande) is essentially an insolvent company that has consistently presented fraudulent information to the investing public. We prove this conclusion in the following presentation. Evergrande is not a story about the 'China real estate bubble'; rather it is a tale of a company who has abused the capital markets as well as the generous lending of the Chinese Government in order to enrich one man, aggrandize his personal ego and support his pet projects. Bribery, excessive spending, and off-balance sheet transactions are the foundation of Evergrande’s financials."

During the tribunal hearing, Left's lawyers declined to present any evidence substantiating those wild claims of bribery and other outrageous fraudulent behavior. Thus the tribunal focused mostly on the accounting allegations against the audited company financials. Doing so seemed rather generous as unsupported allegations of criminal bribery are very serious from a moral perspective, if not a legal one.

The second big hit to Citron's credibility came after Left called a short on SQ around the $45-47 range on 30-Apr-18 with a "short-term $30". The huge volume spike and price action surrounding the Twitter short-call at 17:53 UTC hints strongly at front-running short sales (or maybe he released in other venues before the surviving Tweet) that briefly dipped the price. However, the high volume of SQ means Citron could not move the share price like they have in other cases and the dip got quickly bought and that was the lowest SQ has been since. It closed at $88.64 last Friday, up 93% from the short call.

CNBC Fast Money did a pretty good job interviewing Left and factually taking apart his central headline allegation against Cronos of securities fraud (though I'm dubious of the consistent platform they give him). Watching their segment is what prompted my investigation. (I had previously uncritically RTed Citron's report, which I'm now ashamed of.) I especially appreciated CNBC highlighting that the voluntary recall of the cannabis in Germany was only 1 KG of product (a very small fraction of their output) because it failed its final microbe test. (It had passed earlier tests by independent labs. It only failed a later further precautionary test. Microbe tests test for the presence of E. coli, salmonella, and other yeasts, molds, and bacteria which can contaminate products in transit as well as during production. This is further supported by the fact that multiple tests are done along the supply chain.) Citron alleged that, "Without disclosing to investors or to the SEC, their product got recalled in Germany for Microbal contamination Cronos raised $100m just a few days later on Mar 21, 2018, In our opinion that is securities fraud".

In this allegation, they included a link to the source article. I copied and pasted the URL into my browser (because even though the URL was blue and underlined, it was not clickable). The URL led to a 404 error, so I could not initially view the source of the fact which Citron interpreted as securities fraud. I am an IT professional, so I spent about five minutes playing with Google trying to get a cached version of the article which I assumed had been removed. I finally discovered thanks to Google's help that the article was very much alive, it's just the URL Citron gave was incorrect. When I pasted the URLs (both the correct URL and the Citron version) into a text editor to view them side by side, they appeared identical. I was mystified why one worked and the other did not. So I did a character by character analysis of the URLs in Google Sheets and was shocked when I found what they had done. They had replaced the standard ASCII code 45 hyphen with the Unicode 8208 character. They are visually identical, but web servers view them as different characters thus different URLs, thus the 404 not found error. It is possible that this swap of characters was done inadverdently without human intervention, but I was unable to replicate the character-substitution when I pasted the URL into Microsoft Word and converted to PDF (as clues in their PDF suggest they did). (They also added an ASCII 10 Line feed character in the middle of the URL in a different place than the natural word wrap in the PDF , but Google Chrome automatically corrects that error upon pasting into the address bar.)

After my struggle, I was able to read the source article and immediately realized why it was very advantageous to Citron's short case to keep most of their report's readers from seeing the source article. The source article made it quite clear that the recall was only of a single KG of product and was totally immaterial to their financials and operation. Ironically if they had proactively revealed such a teensy operational blip, Cronos might have rightly fallen under suspicion for manipulation for trying to make something out of nothing.

I found the case study on Evergrande above very intriguing as Left followed the same playbook for both Evergrande and Cronos. In both, he made very dramatic allegations of hiding and obscuring material financial information in a fraudulent and criminal way. In the case of Evergrande, the Tribunal's discovery revealed how Left made his short trades. He accumulated a short position in the months leading up to his short-attack hit-piece report. He released his report in the Hong Kong morning and cratered the stock by 20% in intra-day trading. He covered his entire short position the day he released his report. In the CNBC interview about Cronos, the very sharp Melissa Lee's opening question was whether Left was still short or whether he had already covered. Left said he's still short, but not by how much. Lee then returned to the question at the end of the segment asking for specifics on whether he's covered most of his short or not. Left tried to evade and brush it off as irrelevant (which it clearly wasn't, money where mouth is and all) but when Lee followed up, he admitted he had partially covered, using subjective terms to describe the amount of his covering rather than objective percentages.

It is also interesting to me how Citron's short-attack on SQ failed so badly (classic bottom shorting) while their attack on Cronos was so successful to the tune of a ~30% cratering over two days. Part of the answer lies in the fact that SQ's average daily volume of ~$928m vs. Cronos's average daily volume of ~$88.5m because lower liquidity/volume issues are easier to manipulate. I would also guess that the percentage of easily manipulated and emotional retail investors is quite a bit higher in Cronos while the percent of institutional investors was higher in SQ--institutional investors who tend to trust their own research above that of someone like Left who is known to be a self-interested short-attack person who has been convicted by Hong Kong courts of issuing "rash" reports that were not backed by facts. Given Left's history, it is surprising to me how positively the financial press covers him. I suppose when you do a genuinely good job taking down several reviled, shady corporate villians, you accrue a lot of brownie points to spend on less factually sound, but potentially very profitable short-attacks.

It was also interesting to me how when pinned down on the headline-grabbing "securities fraud" allegation in the CNBC interview, Left kept quickly pivoting from an allegation of wrongdoing to simply opining the company is overvalued based on EPS and revenue and structural profitability issues. On this he may be correct and the case he makes there is far more compelling than allegations of securities fraud. Perhaps he judged his valuation case would not get a fair hearing without a dubious clickbait headline alleging securities fraud.

As I did a quick skim of Cronos's financials, here are a few things that stood out to me:
  • Their shareholder dilution is crazy. They keep raising money through selling shares. Current EPS will keep being diluted through convertible debt and whatever other instruments they're using.
  • Their current price to revenue is abysmal. Analyst estimates make clear that they see something in the company that will lead to $0.12 EPS next FY, up from $0.01 diluted EPS in 2017. Obviously Cronos is undergoing massive growth. Left makes the case that Cronos' cost structure cannot be profitable as margins are squeezed. I have not done the DD necessary to understand whose estimates are more likely accurate. I know current earnings must be sacrificed for growth and that establishing incumbent market share is highly prized by investors even at great cost, ala Uber. But I don't understand the market dynamics well enough to opine well on this topic.
  • While Citron's assertion that failing to report 1 KG of MJ being recalled equals securities fraud looks like dishonest bunk, the trajectory of quarterly revenues is concerning and looks like they packed some Q2 2018 revenue into Q1. Q3 revenue will help tell the story.
  • It's actually in Left's hit piece where I find the best financials-based support for Cronos's price. In his comparison with WEED, he gives Cronos an Enterprise Value to estimated 2019 revenue multiple of 19.6x vs 14.4x for WEED. That reveals the incredible boosted revenues that analysts are expecting for 2019 as massive amounts of capacity comes online, given current EV is $2.59b CAD compared to a measly $4.08m CAD in 2017 revenue. That implies a $132m CAD 2019 revenue, a huge jump from 2017 numbers.

This should not be treated as a comprehensive report on Cronos. It is not. I do not have the time or interest to do a proper deep dive. These are just a few things that jumped out at me as I spectated this little debacle. I have no long or short position in Cronos currently. I am considering setting some lower bids just above support for the Tuesday opening in case this was a dead-cat bounce, but I've not yet decided.

I would say that I don't like the R/R for either long or short where the stock is right now. It's already pumped a lot for a long at current prices and I certainly am not going to short it as we segue into fall MJ stock mania and Canadian legalization. The only way to safely short it in this environment is to have the PR muscle of a guy like Left/Citron to make an big PR attack (however temporary the effects).

Here are two excellent analyses of Citron's short-attack on Cronos, one of which agrees with the fundamental case against Cronos and one which disagrees. Both provide valuable research numbers in a far more balanced way than Citron:
We have both pretty much come to the same conclusion...depending on the market on Monday will decide if to buy or dump cron all together...I am in the process of finding another canopy stock...ACBFF seems to stick out, about to do some research!
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Dummy software thinks that any acronym you use is a stock symbol!
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If I had went long on every one of his shorts I'd be one rich dude. Left is a bumbling idiot with a vengeance.
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tl;dr
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