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2 Ways Aurora Cannabis Could Pay the Price for Its Aggressive Growth Strategy

By Prosper Junior Bakiny - Oct 8, 2019 at 6:00AM

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Here is what's holding Aurora Cannabis back in the competitive cannabis industry.

Aurora Cannabis (ACB 3.08%) is one of the most popular marijuana companies, particularly among millennials. The pot grower famously ranked as the top stock holding on Robinhood. Aurora isn't just popular among younger demographics, though, with several analysts giving the company a nod of approval in the form of a buy rating earlier this year.

How did Aurora manage to attain its current status in the industry? By implementing an aggressive growth strategy marked by acquisitions, international expansion, and strong efforts to ramp up its production capacity. However, this master plan wasn't without its downsides, and the cannabis company could feel the pressure from its after effects for many years to come. Here are two ways Aurora could pay the price for its growth strategy.

Too much goodwill

Aurora has been on an acquisition spree for the better part of three years. On the one hand, this strategy makes sense. Acquiring smaller marijuana companies presents several advantages. First, doing so eliminates at least some competition in the industry. Second, it is a relatively quick and easy way to have greater access to important assets that are critical to getting cannabis products to consumers. But in the midst of making acquisition after acquisition, Aurora seems to have paid a bit too much for many of these transactions, resulting in an astronomical amount of goodwill on its balance sheet.

Cannabis oils and grains.

IMAGE SOURCE: GETTY IMAGES.

Goodwill isn't necessarily bad in and of itself. In accounting terms, it represents the difference between the amount of money a company paid to acquire another entity and the fair value of said entity, whatever that is. However, too much of anything isn't good, and it is fair to say that Aurora has too much goodwill on its balance sheet. The company ended its fiscal year 2019 with more than $3 billion worth of goodwill -- which, by the way, represented an increase of more than 300% year over year.

How could this affect Aurora in the future? Writedowns of goodwill can significantly reduce a company's bottom line. That is bad news for any company, particularly one that isn't even profitable yet.

Dilution, dilution, dilution

Aurora's expansion efforts weren't free or even cheap. The company had to spend a lot of capital to grow its presence in North America and abroad. However, due to its status as a start-up -- not to mention other barriers caused by the nature of its business activities -- Aurora didn't always have the means to fund these efforts, and the company turned to dilutive forms of financing. To be fair, this strategy was a necessary evil. Other marijuana companies have also resorted to raising money by offering stock options, convertible debts, etc.

But once again, Aurora has been one of the unfortunate leaders of this unflattering category. Aurora has already issued about 1 billion shares in its race to the top of the marijuana industry. This much dilution is unhealthy, and it is likely already having a negative impact on the company. Further, many potential investors who would have otherwise seen Aurora as an attractive option might choose to keep their distance for fear of its share price being dragged down as a result of this issue. In other words, Aurora isn't done having to deal with its share dilution problems.

What's the appeal?

Aurora certainly has a lot of baggage, but many still see it as one of the better options in the marijuana industry. One reason is its market-leading presence in the Canadian marijuana market. Others would point to its international presence that compares favorably to that of almost any of its competitors. Whatever argument those in the pro-Aurora camp give, they will have to contend with the company's most important problems, which include the amount of goodwill on its balance sheet and the degree to which it continues to dilute existing shares.

Prosper Junior Bakiny owns shares of Aurora Cannabis. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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