Big things are afoot in the marijuana industry. Following the legalization of recreational pot in Canada this past October, the legal weed industry has been validated like never before. As a result, global sales projections for cannabis are going through the roof. Some investment banks on Wall Street predict that annual sales could hit as high as $75 billion by 2030.
But as with any new industry, there's a process involved in its maturation. First came the capacity expansion wave, which is what dominated the newswires for much of the first half of 2018. Now, with the industry legitimized and capital more freely available (at least to Canadian-based pot stocks), we're witnessing the push into the next stage of cannabis evolution: consolidation.
To be blunt (and to also keep the puns rolling), the industry has far too many companies competing in multiple facets of the supply chain in Canada and the United States. As a reminder, even though the U.S. federal government still holds cannabis as an illegal substance, 33 states have chosen to legalize and regulate the drug in some capacity. Consolidation among growers and retailers could work to reduce expenditures and quickly expand brand appeal and/or consumer reach.
Perhaps no one particular niche has demonstrated this more than the vertically integrated dispensary space in the United States, with the largest U.S. marijuana deal in history being announced earlier this week.
This will be the largest U.S. cannabis deal in history
Before the opening bell rang in New York on Monday, March 11, a relatively unknown name to most investors, Harvest Health & Recreation (OTC:HRVSF), a vertically integrated multistate dispensary operator, announced that it would be acquiring privately held Verano Holdings for $850 million in an all-stock deal.
Expected to be completed during the first half of this year, the combined company will have 30 operating dispensaries, eight cultivation facilities, and seven manufacturing facilities upon completion. However, by the end of 2019, the combined entity should have 70 open dispensaries, 13 grow farms, and 13 manufacturing facilities.
Looking even further down the road, Harvest Health & Recreation and Verano have close to 200 licenses between them, spanning 16 states. If no additional licenses were applied for, the combined operation would have the ability to open 123 retail dispensaries. No other publicly traded retail operator has this many licenses in its coffers right now. The deal also pockets Harvest Health additional cultivation capacity of roughly 900,000 square feet.
It's also worth noting that Harvest Health & Recreation is one of a select few dispensary operators to currently be profitable on an operating and EBITDA (earnings before interest, taxes, depreciation, and amortization) basis. The combination isn't expected to compromise the company's existing positive free cash flow, according to the press release announcing the deal.
Harvest Health aims to keep up, or perhaps one-up, its competition
If you're wondering why Harvest Health & Recreation decided to pony up $850 million for Verano, look no further than opportunity cost. It can take an exceptionally long time to get approval for cultivation and processing licenses, as well as retail sales permits. In some states, issuance of cultivation licenses and retail permits is capped or severely limited. Acquiring an established company with licenses in hand (or being reviewed) reduces the time and cost it'll take to build up Harvest Health's brand.
It also allows Harvest Health & Recreation to keep pace with other deals within the space. Upscale retailer MedMen Enterprises (OTCBB:MMNFF) is in the process of acquiring PharmaCann for $682 million in what was the largest pot deal in U.S. history until this past Monday. The MedMen-PharmaCann merger will feature a company with 77 retail licenses -- a figure that's bound to keep growing.
There's also the more than $600 million deal between iAnthus Capital Holdings (OTC:ITHUF) and MPX Bioceutical, which recently closed. Following closure, iAnthus Capital now has a presence in 11 U.S. states, with 19 open dispensaries. However, the combined retail dispensary license count is 63, meaning iAnthus has a path to significant storefront growth, and a planned tripling in its cultivation capacity, too.
Of course, unlike Harvest Health, MedMen and iAnthus are losing significant amounts of money on an operating basis as they expand into new and existing states.
Now for the inevitable question mark
Then again, the legal cannabis industry is still relatively nascent, and there aren't any guarantees (despite the double-digit rise in Harvest Health's stock following the announcement) that consolidation among retail dispensary operators in the U.S. will improve shareholder value.
Arguably the two biggest concerns with this deal are 1) the purchase value being paid for entirely in common stock, and 2) the possibility of grossly overpaying for Verano.
To the first point, access to capital hasn't always been easy for pot stocks. This has led many to use their common stock like Monopoly money to get what they want. Although issuing stock pretty much always seems to get the job done in this high-growth industry, the dilution caused by such an event can weigh on existing shareholders and make it that much harder for already profitable companies, like Harvest Health, to turn a meaningful per-share profit. I don't see how the company completes this transaction without its intermediate-term earnings per share being weighed down.
The other concern here would be goodwill. When one company purchases another, we expect some amount of premium to be factored in. But for a company like iAnthus, as an example, its goodwill accounts for about 55% of its total assets. That's a dangerously high amount that suggests it may have overpaid for its previous acquisitions (not including MPX Bioceutical), and it could leave iAnthus open to possible writedowns in the future. We'll have to wait to see what sort of goodwill is recognized on this deal by Harvest Health & Recreation, but I wouldn't rule out the possibility of it overpaying for Verano.
With consolidation expected to remain the name of the game for the cannabis industry, expect more notable deal announcements this year.