Marijuana stocks have started out 2019 on a positive note, and investors who see the promise of the cannabis industry are looking for the best way to invest in the space. One key proposition for many cannabis investors is finding promising companies that are likely to get attention from bigger players in the field, whether it's through key partnerships with nonmarijuana companies or buyouts from established marijuana businesses looking to expand their scope. Smart deals can make a company more successful, but bad deals can prove costly in the current ultracompetitive environment.

One of key deals in 2018 involved the acquisition of MedReleaf by Aurora Cannabis (ACB -3.20%). The $2.5 billion deal became the largest buyout in industry history, marking the latest in a series of Aurora purchases designed to add to its growing capacity. Having been announced in May, Aurora completed the acquisition in July. Six months after the deal closed, now's a good time to reflect on the MedReleaf acquisition to see what difference it's made for Aurora -- and whether it represents a model for other cannabis companies to follow in their own expansion plans.

Rows of cannabis plants under dim lighting in a greenhouse.

Image source: Aurora Cannabis.

Why Aurora thought MedReleaf was a good buy

Under the terms of the deal, shareholders got 3.575 shares of Aurora Cannabis for every MedReleaf share that they owned. That represented a 34% premium above the average price of MedReleaf shares during the 20 trading days preceding the offer. Although that's a sizable markup, it was far less than Aurora had paid in some of its previous deals.

Still, even at the time, some had concerns about how much Aurora was paying for MedReleaf. With MedReleaf having annual production capacity of roughly 140,000 kilograms of cannabis at the time of the deal, the purchase price amounted to nearly $18,000 per kilogram of capacity.

Moreover, Aurora structured its purchase of MedReleaf as an all-stock deal. For investors who've gotten used to the big share-price increases that cannabis stocks saw in the second half of 2018, that might seem to have been a good capital allocation strategy. Yet at the time of the deal in May, Aurora Cannabis was going through a share-price slump that had lopped nearly half its value off the stock in just a few months. That didn't stop Aurora from issuing the huge number of new shares necessary to make the deal go through.

What MedReleaf has done for Aurora

So far, Aurora seems to be happy with how the acquisition went. In Aurora's most recent quarterly conference call, CEO Cam Battley pointed to several success stories related to MedReleaf:

  • MedReleaf's San Rafael brand had the most popular strain of cannabis in the Ontario recreational market, helping Aurora hit 30% market share in the province. MedReleaf's brands have shown similar success across the adult recreational marijuana market.
  • The addition of MedReleaf production facilities helped Aurora more than double its production levels in just three months' time.
  • Aurora has been able to use MedReleaf's operational methods and data-driven cultivation practices to boost production across its network.
  • MedReleaf's interest in a Colombian business has helped Aurora expand its scope in South America, which has a lot of potential to be a key market for the marijuana company.

Of course, not everything about the deal was immediately beneficial. Because of the way that MedReleaf priced its extract products, overall average sales prices fell for Aurora after the integration was complete. Yet MedReleaf got higher prices for its dried cannabis products on the medical side of the business, and that had positive effects for Aurora.

In the long run, Aurora has high hopes that the successful integration of MedReleaf will lead to innovative new products, advances in production capacity, and efficiency gains that will benefit shareholders. With its Markham facility contributing to Aurora's overall boom in total cannabis capacity, MedReleaf could well prove to have been a crucial buy for the budding marijuana giant.

Sales need to catch up to supply

Just about the only hesitation investors have coming into 2019 is whether the demand side of the cannabis business will keep up with Aurora's supply expansion. Last week, Aurora said that sales would come in between 50 million Canadian dollars and CA$55 million during the fiscal second quarter, and although that's a big rise from previous quarters, it's not quite as much as many had hoped to see for the first period during which recreational cannabis sales in Canada were taking place.

Looking forward, Aurora will need to see further legalization of marijuana in key markets, especially a greater number of U.S. states. When those markets open, though, Aurora aims to be ready to serve them -- and acquisitions like the MedReleaf purchase are essentially bets that cannabis markets will open fast enough to warrant Aurora's early sense of urgency.

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