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Aurora Cannabis Is Facing a Tricky Catch-22

By Sean Williams – Apr 10, 2019 at 6:36AM

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This could explain why finding a brand-name partner is so difficult.

The marijuana industry is budding into a big business model before our eyes. Gone is the notion that this is an industry that simply sells dried cannabis to casual users. Now, the legal weed industry consists of a number of cannabis alternatives, such as oils, vapes, concentrates, topicals, and even beverages, and it's targeted at everyone from medical marijuana patients to upscale recreational consumers. This broad reach and ongoing maturation is a big reason Cowen Group expects the global industry to hit $75 billion in annual sales by 2030.

But it's also a highly polarizing industry, with some companies arguably having an almost cult-like following. One such company that's the bee's knees of pot stock investors is Aurora Cannabis (ACB -6.20%).

A flowering cannabis plant in the sunlight.

Image source: Getty Images.

Wall Street rallies around Aurora

There are quite a few factors about Aurora that have convinced Wall Street that the company will succeed over the long run. First, there's Aurora's leading production. When the company is running on all cylinders, I believe it'll be capable of around 700,000 kilos in peak annual output. With the exception of Canopy Growth at approximately 525,000 kilos in peak yield (also a projection from yours truly), no other grower even comes close to holding a candle to this duo.

But it's more than just production that has investors gravitating to Aurora. This is a company that's pushed into 24 total countries, including its domestic Canadian market. These overseas sales channels should come in particularly handy by 2021 or 2022, which is when most of its peers will also be operating at full capacity. It's likely that, given what we've seen in various U.S.-based recreationally legal states, oversupply and commoditization will hit the dried cannabis market in Canada. Therefore, growers with ample overseas sales channels will be in great position to avoid a margin contraction in Canada.

We've also seen a willingness for Aurora to diversify its product line away from dried cannabis. By honing in on medical marijuana patients, Aurora has focused on a group of consumers that's far more willing to purchase high-margin cannabis alternatives.

Two businessmen in suits shaking hands, as if in agreement.

Image source: Getty Images.

Aurora's missing piece

However, there's one pretty big piece of the puzzle missing for Aurora that a few of its larger peers, Canopy Growth and Cronos Group, have locked up --namely, securing a brand-name partner.

In March, Aurora Cannabis announced the hiring of billionaire activist investor Nelson Peltz as a strategic advisor. Peltz, the founder of Trian Fund Management, has had success in unlocking shareholder value in the food and beverage industries. This happens to be the area of the market where Aurora would love to find a partner, especially considering management's desire to enter the nonalcoholic cannabis-infused beverage space. Most alternative pot products, including nonalcoholic cannabis-infused beverages, will be legal by this coming fall.

Also, a brand-name partner with deep pockets would bring marketing expertise to the table that Aurora would be able to use as it looks to expand its existing overseas operations and moves into new countries.

But herein lies a big problem for Aurora Cannabis, one that I'd go so far as to say is a Catch-22 for the company.

An accountant chewing on a pencil while he closely examines figures from his printing calculator.

Image source: Getty Images.

Aurora Cannabis' Catch-22

On one hand, Aurora Cannabis is seeking a partner that's willing to invest in the company, much the same way Constellation Brands invested $4 billion in Canopy Growth in November, and Altria invested $1.8 billion in Cronos Group, which closed recently. A cash infusion from a brand-name partner would allow Aurora to really ramp up its inorganic expansion, which has been a major component of its growth strategy since January 2018.

On the other hand, brand-name food, beverage, tobacco, and pharmaceutical companies may be less than enthused about the idea of investing into a company that's constantly financing acquisitions and organic expansion by issuing its common stock like it's Monopoly money. Over the past 18 quarters (4.5 years), Aurora's outstanding share count has risen by 1 billion shares, to approximately 1.02 billion. This means that if a brand-name investor were to take a position, and even if this investor were to receive warrants to buy additional shares in the company, they'd potentially see their equity stake reduced due to bought-deal offerings and share-financed acquisitions.

In other words, Aurora Cannabis needs capital to satisfy its vision of global expansion, and an equity investment from a brand-name partner would be an easy way to obtain this cash. But brand-name investors are unlikely to take a stake given Aurora's penchant for dilution. This was my take on why Coca-Cola walked away from the bargaining table in September after discussions with Aurora Cannabis.

It would be surprising if Aurora hasn't landed a major partner before the end of the year, especially with the addition of Nelson Peltz. But this certainly could explain why finding a partner is tougher than it looks for Canada's top marijuana producer.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.

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