It looks like the U.S. cannabis market could get its first nationally recognized brand. Massachusetts-based Curaleaf Holdings (CURLF 0.57%) is the largest integrated retailer of licensed cannabis products on the East Coast, and it's about to get a lot bigger. Curaleaf has agreed to acquire Cura Partners for $950 million.
Cura Partners is a privately held company in Oregon that sells high-end vaporizer cartridges. Unfortunately, Cura's also part-owned by a Curaleaf insider.
Will spending $950 million on Cura benefit Curaleaf shareholders as much as it benefits Curaleaf's chairman? Here's what you need to know.
Why Curaleaf sees no conflict
The chairman of Curaleaf's board of directors, Boris Jordan, also runs a venture fund in his spare time that owns 11.5% of Cura Partners. To Curaleaf's credit, the company was upfront about a potential conflict of interest and even formed a special committee of board members that didn't own a piece of Cura Partners to investigate.
The special committee hired Beacon Securities, an independent Canadian investment dealer, to scrutinize the transaction. According to Beacon, the price was right, and that was good enough for the special committee.
Why it makes sense
Cura's Select brand of oil cartridges are popular enough on the West Coast that reports of unlicensed stores selling cheap knockoffs aren't unusual. If Curaleaf can re-create the taste and quality that Select brand cartridges are known for, this $950 million acquisition has some chance of paying off for investors in the long run.
In heavily regulated states without a great deal of competition, retail prices of around $40 for a cartridge with half a gram of oil in them aren't uncommon. It takes roughly five grams of dry flower to create a gram of oil, which makes cartridges extremely profitable.
Few producers will admit it, but oil can be made from excess dry flower that wasn't pretty or powerful enough to sell in its natural state. Excess cannabis flower that you can't sell to customers is a problem for every producer, and Curaleaf would like to send its leftovers to Select for processing into high-priced oil. Of course, Curaleaf also intends to market the Select brand throughout its retail outlets.
Reasons to be suspicious
If Curaleaf really wanted the deal properly scrutinized, it should have hired an independent accounting firm, not a Canadian investment dealer that cheers in approval after every decision Curaleaf makes. In addition to adjudicating on cannabis deals, Beacon Securities also offers debt and equity underwriting services and would like to earn Curaleaf's business down the line.
In addition to giving the deal a green light, Beacon slapped a buy rating on the stock two days before the acquisition announcement. After doing Curaleaf a solid, don't be surprised if Beacon also gets to underwrite Curaleaf's next offering.
Moreover, Curaleaf will not receive rights to any of Cura's popular cannabidiol (CBD) products. CBD is the nonpsychoactive component of cannabis that's popular among people with chronic pain who have full-time jobs and salaries large enough to pay extra for Select brand medicine.
Let's try this again
One reason Curaleaf is buying the Select brand is that the company has already burned the reputation of its own brand by shipping out too many cartridges filled with weak oil that tasted awful. Select is prized for strength and quality, but there are some holes in Curaleaf's plan to market the more popular brand in its own retail outlets.
Select is essentially a wholesale distributor of products to hundreds of different retail outlets in California, Nevada, Oregon, and Arizona. Unfortunately, Select won't be able to send cartridges to most of Curaleaf's stores. Florida, New York, and 10 other states insist on full integration from seed to sale before they'll grant a business license to sell cannabis to anybody.
In most of the states where Curaleaf operates now, any Select brand cartridges will need to be cultivated and processed in the state where they're to be sold. Curaleaf will inherit many of Select's employees, including its current CEO, Cameron Forni. Hopefully, Forni won't forget to bring the recipe that made Select so popular on the West Coast.
What the numbers say
Select brand sales climbed to $117.2 million in 2018 from $36.9 million a year earlier. If there were any profits, though, Curaleaf probably would have mentioned them.
Last year Curaleaf spent $65.3 million on sales, general, and administrative expenses to generate just $77.1 million in total revenue. Operations lost $28.7 million, and the value of a convertible promissory note the company issued last April grew so much that the company reported a net loss of $56.5 million.
Since Curaleaf doesn't have positive cash flows to make acquisitions, the company will create 95.6 million new shares to acquire Cura. That's enough to boost Curaleaf's outstanding share count 22% higher than its level at the end of 2018, and anyone that bought the stock last year needs the company to earn that much more to realize the same return they were expecting when they pulled the trigger.
Even if Curaleaf was able to sell Select products produced out West in nearly all of its current retail outlets out East, $950 million would still be an enormous sum to spend on a wholesale distributor of processed cannabis with negative cash flows. As long as the states in which Curaleaf operates won't allow out-of-state products from its new subsidiary, there's little chance for the two businesses to share expenses and zero chance this deal will work out for shareholders.