The marijuana industry is growing like a weed, and investors have certainly taken note. Over the trailing year, a majority of pot stocks in excess of a $200 million market cap have doubled in value, or perhaps headed even higher.
Behind this rally, and beneath steady double-digit sales growth for legal weed, is a change in the way the American public views marijuana. What had once been an off-limits topic that was better left swept under the rug is now a substance that nearly 2 out of 3 Americans would prefer to see legalized across the country, according to the latest Gallup poll.
When it comes to medical cannabis, support is even stronger. The independent Quinnipiac University poll in April found 94% support for legalizing medical weed compared to just 5% opposed to the idea.
With the tide clearly shifting on cannabis, investors have willingly jumped into marijuana stocks.
Surprise! There could be a mammoth marijuana merger on the horizon
Last week, though, investors were dealt a true surprise, with Canadian-based medical pot producer Aurora Cannabis (NYSE:ACB) making an unsolicited bid to acquire rival CanniMed Therapeutics (NASDAQOTH:CMMDF) for a maximum of $18.75 a share ($24 in Canadian dollars). The deal values CanniMed at roughly $425 million, which, based on Aurora's closing value this past Friday, would put this deal value at just north of $2 billion. In other words, it'd be the largest marijuana merger in history if it came to fruition.
Here are the three most important things you need to know about this possible pot tie-up.
1. It's a good deal for CanniMed Therapeutics and its shareholders
The first thing to note is that CanniMed shareholders would be receiving a pretty fair shake if this deal were to go through. The all-share proposal on the date of the unsolicited bid represents a nearly 57% premium to the closing price of CanniMed's shares on Nov. 14.
While CanniMed has made strides to grow its business, it's a relatively small fish in a pond that's dominated by less than a half-dozen industry sharks in Canada.
On the bright side, CanniMed wound up surpassing 14,000 eligible medical cannabis patients as of its second-quarter report in June. Also, nearly half of its sales are derived from cannabis oil, which is a positive for margins. Cannabis oils have a higher price point than dried cannabis, and thus are better for weed companies' bottom lines.
Then again, the company reported $4 million in net losses through the first half of fiscal 2017, and was only marginally delivering positive earnings before interest, taxes, depreciation, and amortization (EBITDA). Presumably, as industry giants like Aurora Cannabis expand their growing capacities, CanniMed could get squeezed out of the picture, or find its market share reduced. A merger with Aurora Cannabis would allow two medical cannabis companies to join forces and potentially claim a larger share of the Canadian market.
2. Aurora Cannabis is chasing recreational legalization (and Canopy Growth Corp.)
That brings us to the second thing you'll want to know: though this merger is geared at increased medical cannabis exposure, it's all about recreational marijuana and keeping pace with industry behemoth Canopy Growth Corp. (NYSE:CGC).
For those unaware, Prime Minister Justin Trudeau introduced a bill in April designed to legalize recreational marijuana by July 1, 2018. Doing so is expected to generate billions in added revenue for the Canadian industry, as well as create a major uptick in consumer demand. The largest players have been positioning themselves to take advantage of this demand, with Canopy Growth Corp. currently developing 2.4 million square feet of growing capacity. Canopy Growth also has not been shy about making acquisitions, with its purchase of Mettrum Health earlier this year expanding its medical patient reach and growing capacity.
Aurora Cannabis is in the midst of constructing the Aurora Sky project, which will be the largest and most automated grow facility in the world once complete by mid-2018. Aurora Sky is capable of more than 100,000 kilograms of annual dried cannabis production across the 800,000-square-foot facility, and it's likely going to play a key role in pushing all-in grow costs down significantly in the years to come.
Combining forces with CanniMed would create a company capable of 130,000 kilograms of dried cannabis production each year, and give the duo a medical patient base of around 40,000.
3. Aurora Cannabis could continue its streak of diluting shareholders into oblivion
Finally, even taking into account the positives that could be associated with this deal -- more capacity, potentially lower costs, greater medical patient reach, and possible pricing power -- investors have to keep in mind how Aurora Cannabis is getting the funding to make deals like this happen: bought-deal financing.
In Canada, bought-deal financing is a common practice for money-losing companies looking to raise capital. It involves selling common stock to underwriters at a fixed price before the release of a prospectus. While it guarantees the sale of shares and the raising of capital, it also dilutes existing shareholders by increasing the amount of shares outstanding. Between mid-2014 and Aurora's most recent quarter, its share count has risen by more than 2,200%, to over 375 million.
Just a day after announcing its unsolicited bid for CanniMed, it priced 100,000 special warrants to raise $100 million. These warrants can be converted to common stock down the road. Then, a day after that, it converted the remaining balance of a $75 million debenture into more shares of stock.
Though the company has a strong cash position, it's been diluting its shareholders into oblivion. Investors who are considering a stake in Aurora and/or CanniMed need to keep that fact in mind.