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The Tilray Bubble Has Popped, And TLRY Stock Still Has Further to Fall

Since going public at $17 per share at the end of July, shares of Canadian cannabis producer Tilray (NASDAQ:TLRY) had gone so far, so fast that TLRY stock had bubble written all over it. That is why I, and many others, warned that as Tilray stock surpassed a $20 billion valuation (a 14-fold increase from its IPO valuation in just two months), the rally had become nonsensical. At those levels, it was simply a matter of when — not if — the bubble pops.

We all knew was going to happen. It was just a matter of when it was going to happen.

It appears the TLRY stock bubble has finally popped.

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On Wednesday, September 19, TLRY stock passed the $200 and $300 marks in the same day. On that same day, Tilray stock dropped to $150, then bounced back to close at $215. TLRY stock dropped to $175 on Thursday. And then, to end the week, Tilray stock dropped again — closing at $123. But not even the weekend slowed TLRY’s plummet. Trading opened Monday morning at $100 a share.

That is a 66% drop from its all-time highs in just three trading days. If that isn’t a bubble popping, I don’t know what is. And this selloff is far from over. At current levels, the company still has a market cap of $12 billion, which seems silly given peer valuations and fundamentals.

I think TLRY stock continues to drop, and won’t find a bottom until around $80, a price tag which makes sense given peer valuations and fundamentals.

Investment takeaway? Stay away from this falling knife. It’s bound to keep falling. But, if you are keen on buying the dip, wait for prices below $80.

Why The Tilray Stock Bubble Is Popping

Tilray stock went parabolic because of a big investment into the cannabis space from Constellation Brands (NYSE:STZ), a bunch of speculation about cannabis investments from Coca-Cola (NYSE:KO) and others, a ton of hype from pot stock enthusiasts, a few landmark deals regarding cannabis legalization and research, and mainstream publicity from financial media platforms. For the full recap, read here.

But, with Tilray being valued at over $20 billion with $40 million in sales projected this year, it was clear that the stock was being influenced by speculation, not fundamentals.

That speculation ended recently. You had an epic rally on Wednesday, September 19, when Tilray stock at one point was up nearly 100%. That huge rally was a wake-up call to speculators that maybe, just maybe, this rally had gotten out of hand. Huge sell orders flew in. And, as dynamics of speculation go:  whereas big buying breeds more buying, big selling breeds more selling. So, the selloff didn’t stop with the big sell orders at $300. The sell orders kept coming in, and as of this writing, they are still coming in at $135.

So why did the Tilray bubble pop? Because the stock got to levels that were too speculative for even the biggest speculators. All you needed was one big sell order to knock the whole house down. You got that big sell order at $300. Now, the whole house is coming down.

Where Fundamentals Say TLRY Stock Should Trade

Given the aforementioned speculation dynamics, it is fair to call Tilray stock a falling knife right now. Speculation drove the stock up quickly. Now, lack of speculation will drag it down just as quickly.

But, the cannabis space projects to be extremely valuable one day, and Tilray is a leading player with first-mover advantage in that space. Thus, not all is lost with this company, and Tilray stock’s valuation does become justified by long-term growth fundamentals at some point.

What point is that? I think around the $80 mark, which would put the market cap at $7-8 billion. That level feels right to me for two reasons. One, it makes sense relative to peer cannabis stock valuations. Two, it makes sense relative to long-term fundamentals.

On the first point, Tilray is a leading player in the cannabis market. But, it is far from the biggest player or surest bet in the market. That honor belongs to Canopy Growth (NYSE:CGC), the leading Canadian cannabis producer who has already scored a big investment from Constellation Brands. Instead, Tilray is more-in line with Aurora (OTCMKTS:ACBFF) and Cronos (NASDAQ:CRON).

Canopy Growth has a market cap of $10 billion. Aurora’s market cap is $8 billion. Cronos has a market cap of $2 billion. Thus, in that landscape, $7 to $8 billion seems to make sense for Tilray.

On the second point, the cannabis market projects to be huge one day. Most estimates put this market at $150 billion in 10-15 years. Right now, Tilray is highly speculative because it could leverage first mover advantage to grab a huge portion of that market, or competition could arise en masse, erode the company’s leadership position, and Tilray could be left with a tiny portion of that huge market.

From this perspective, I see two potential outcomes for Tilray in 15 years. In the first, Tilray grabs 15% market share, grows gross margins to 60%, uses big revenue growth to drive the opex rate down to 20%, has a net profit base of $7.2 billion, and is worth $144 billion (using a 20x P/E multiple). In the second, Tilray grabs 1% market share, has gross margins plateau at 50%, drives the opex rate somewhat lower to 30%, has a net profit base of $240 million, and is worth $4.8 billion. Discounting those two valuations back by 10% per year, you arrive a bull-case present value of ~$34 billion and a bear-case present value of ~$1 billion.

I put the bull-case scenario success probability at 20% and the bear-case scenario success probability at 80%, given the plethora of unknowns in this market. Applying those weight, I arrive at a present value of just below $8 billion for Tilray stock.

Bottom Line on TLRY Stock

The Tilray stock bubble is popping, and there’s more room to fall. But, eventually, fundamentals will provide a support for this drop because the cannabis market promises to be huge. I think that floor could come in around $80, but until then, it’s look out below for Tilray stock.

As of this writing, Luke Lango was long CGC, and may initiate a long position in TLRY within the next 72 hours. 

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