Last year saw the legal marijuana industry take steps that had never been taken before. More specifically, our neighbor to the north, Canada, legalized recreational cannabis, becoming the first industrialized country and only the second country in the world other than Uruguay to have done so.
More so than just bringing in billions of dollars in added annual revenue in the years to come, the passage of the Cannabis Act in June and the official legalization date of adult-use pot on Oct. 17, 2018 made the weed industry a legitimate business model. In other words, cannabis is no longer considered taboo, and the red carpet has been rolled out for investors big and small.
Dealmaking was on the docket in 2018
With the pot industry gaining validity, another trend we witnessed in 2018 was dealmaking. Lots and lots of dealmaking.
One culprit, if you will, is Aurora Cannabis (NYSE:ACB). When 2018 began, Aurora's peak annual capacity looked to be a little over 100,000 kilograms. But by year's end, Aurora was on track for possibly 700,000 kilograms in annual output within the next few years. The company accomplished this surge in capacity with organic projects, partnerships, and a lot of acquisitions.
It began early in the year when Aurora agreed to buy Saskatchewan-based CanniMed Therapeutics. CanniMed added modest production capacity for Aurora but it was more important given its diversified, high-margin product line and softgel capsule products. In July, the company gobbled up MedReleaf for $2.5 billion, tacking on an additional 140,000 kilograms in peak annual yield, with the potential to construct another facility on 95 owned acres adjacent to MedReleaf's Exeter facility. More recently, Aurora Cannabis closed on its purchase of South America's ICC Labs for $221 million. ICC has a bounty of available acreage that could be used for capacity expansion.
There were also product deals aplenty. In early August, Molson Coors Brewing Co. (NYSE:TAP) announced a joint venture with HEXO (NYSEMKT:HEXO) to develop cannabis-infused beverages. The deal leverages HEXO's knowledge of the cannabis industry with Molson Coors' deep pockets and marketing prowess. Of course, Molson Coors and HEXO are at the mercy of the Canadian Parliament since cannabis-infused beverages aren't yet legal, although that's expected to change by this coming summer.
This under-the-radar merger is actually a big deal
But chances are that you overlooked a small cannabis acquisition announced a month ago that, when complete, could turn out to be a pretty big deal.
On Dec. 19, vertically integrated cannabis company Aleafia Health (NASDAQOTH:ALEAF) announced that it would be acquiring Emblem Corp. (NASDAQOTH:EMMBF) for 173 million Canadian dollars. The agreement allows each Emblem shareholder to receive 0.8377 shares of Aleafia common stock, which, when the deal was announced, represented a 27% premium to Emblem's share price.
Though the deal is small in nominal terms, it's unique in a variety of ways. For starters, it'll combine two companies that first sought to create medical clinics to draw in consumers rather than simply tackling loyalty from the growing side of the equation. Aleafia's Canabo Medical Clinic and Emblem's GrowWise Health will combine to serve nearly 60,000 patients with 40 national medical clinics. Even with recreational weed legal, these high-margin patients are loyal to these clinics -- and loyalty doesn't come cheaply in the cannabis space.
Building on this first point, medical pot patients also tend to purchase a lot of high-margin alternative products, such as softgel capsules, sublingual sprays, and cannabis oils. Combining Aleafia and Emblem further emphasizes this product diversity and creates a broader-based portfolio of alternative consumption options.
Emblem also brings to the table a number of supply agreements that Aleafia, which is the larger producer of the two, will find useful. This includes supply deals with Ontario, Saskatchewan, British Columbia, and Alberta, as well as a national distribution partnership with Shoppers Drug Mart. Since Aleafia arguably has more prominent recreational pot brands, it can utilize Emblems supply network to reach more consumers.
Lastly, but perhaps most surprisingly, Aleafia Health will combine its projected 98,000 kilograms in peak annual output with Emblem's 40,000 kilograms in estimated peak production. For you math-phobes, this is 138,000 kilograms in potential annual yield. Depending on just how much cannabis-equivalent production Cronos Group delivers, the Aleafia Health-Emblem combination could soon slot in as the sixth-largest producer in Canada by peak output.
If this combined company, which would likely have a market cap of around $310 million, is capable of 138,000 kilograms in peak annual yield, why aren't investors diving into these stocks hand over fist?
One reason could be the duo's combined cash resources, which would stand at 69.9 million Canadian dollars when the deal closes. That may sound like a lot, but it's really not, considering how much capital it takes to open medical clinics, construct greenhouses, market and brand pot products, research new products, and expand into new markets. There's a good chance that this combined company will need to raise capital at some point in the near future, and that means a dilutive bought-deal offering.
Another concern might be that Aleafia and Emblem aren't yet listed on a reputable U.S. exchange. Of the largest producers in Canada, including the Aleafia Health-Emblem combo, very few aren't listed on a major U.S. exchange. The Aleafia Health-Emblem combo would be one of those currently on the over-the-counter exchange.
The issue is that Aleafia just began generating revenue last quarter, and there are a multitude of revenue, market cap, and business-model-based metrics that are examined when a company applies to uplist to a major exchange. This duo may not pass those measures yet, despite the fact that Aleafia previously applied for listing on the Nasdaq.
There's also a very good chance that this combination is going to lose money in 2019, with Aleafia busy completing its capacity expansion.
In short, this merger is very much worth keeping a close eye on, if not for sheer production potential alone. But as I've suggested before, production isn't everything when investing in pot stocks. Caveat emptor, folks.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Hexo. and Nasdaq. The Motley Fool has a disclosure policy.